Audit Test 1

IAASB (International Auditing and Assurance Standards Board)

• Applicable to entities outside the US

• International Standards on Auditing

Professional Skepticism

an attitude that includes a questioning mind and a critical assessment of audit evidence

Characteristics of Professional Skepticism

• A questioning mind

• A suspension of judgement

• a search for knowledge

• Interpersonal understanding

• Self-esteem

• Autonomy

AICPA Code of Professional Conduct Principles

Aspirational and broadly stated

• Responsibilities

• Public Interest

• Integrity

• Objectivity & Independence

• Due Care

AICPA Code of Professional Conduct Rules

Enforceable Standards

• Independence

  • Members in practice must be independent of client

• Integrity & Objectivity

  • no misrepresentation; subordination of judgement

• General Standards

  • Competence, Due Care, Planning & Supervision

AICPA Code of Professional Conduct Interpretations

Specific Guidance on Applying Rules

• Financial interest rules, employment relationships, non-audit services

Independence in Mind/Fact

• The auditor has an unbiased mental attitude

• No relationship that compromises objectivity - even if no one else knows

• This is the internal standard; it governs the auditor’s own judgement

Independence in Appearance (Perception)

• A reasonable, informed observer would not question the auditor’s objectivity

• The external standard; governed by the ‘Reasonable Investor’ Rule

• Even if no actual bias exists, the appearance of bias can violate independence

Reasonable Investor Rule

Independence is violated if in light of all relevant facts & circumstances, a reasonable investor would conclude that the auditor would not be capable of acting without bias

A questioning mind

Consistently questioning of information & evidence obtained

A suspension of judgement

Hold judgement until there is appropriated level of evidence

A search for Knowledge

General Curiosity

Interpersonal understanding

Understanding the motivation & integrity of the individuals who provide evidence

Self-esteem

enables auditor to resist persuasion attempts and challenge another assumption

Autonomy

Ability to objectively audit evidence to determine if the evidence is sufficient

Financial Interests - Direct

When the auditor owns equity or debt instruments of a client directly

• No threshold for covered persons & family, no exceptions

• All firm professionals are prohibited from having direct investment of >5% in equity of the client

Financial Interests - Indirect

Occurs when a person who owns shares of a client through another entity or has a mutual interest in the client

• Firm, covered persons, and immediate family: prohibited from MATERIAL indirect investment

• Materiality is assessed in terms of the individual’s personal wealth and income

• Generally, 5% rule applies

Mutual funds as Financial Interests

• Investment by covered persons and immediate family of <5% of a diversified investment company is NOT a violation

• Investments of >5% and investments in non-diversified mutual funds must be evaluated based on net worth

Attest Engagement Team under Independence

All partners, managers, staff, and other professionals participating in any real engagement for the client. Includes those who perform concurring reviews

Immediate Family under Independence

Spouse and dependents

Close Relative under Independence

Parent, Sibling, or non-dependent child

• less stringent rules apply - but still relevant if a key position or material interest exists

Covered Member

• Individual on the engagement team

• Individual in a position to influence the engagement team

• Partner or manager who provides >10 of non-attest services to the client

• Partner in the office of the lead engagement partner

• The firm itself, including the firm’s employee benefit plan

• An entity that can be controlled by any covered member or combination of covered members

Key Position

Individual who has primary responsibility for

• Significant accounting functions

• Preparation of financial statements

• Ability to exercise influence over the contents of financials statements

Former Auditor that Joins the Client under Independence

Impaired if a former engagement team member joins the client in a key position.

Must not have been on an engagement team during the one-year period before joining (cooling-off period)

Former Client Employee Joins the Audit Firm under Independence

Firm must assess whether prior knowledge impairs objectivity

Typically requires removal from engagement until concerns are resolved

Immediate Family Employment at Client

If a covered member’s spouse holds a key position at the client: independence is impaired

Non-Audit Services Prohibited on Audit Clients

Limitation for public clients

• Bookkeeping

• Financial information systems design & implementation

• Appraisal or valuation services; fairness opinions

• Actuarial services

• Internal Audit sourcing

• Management functions or HR

• Broker-dealer, investment advisor, or IB services

• Legal

• Expert services unrelated to the audit

Proxy Disclosure

• Disclose fees paid to the auditor for the audit, audit-related, tax, and all other services

• Disclose whether the audit committee has considered whether non-audit services are compatible with maintaining independence

Quality Control Safe Harbor

Provides limited exception when a covered person unintentionally lacks independence

Firm will not be considered non-independent if all 3 pass

1. The individual did not know about the circumstances

2. The violation is corrected as promptly as possible

3. The firm had an effective quality-control system

Business Failure

Occurs when a business can no longer sustain itself - unable to repay lenders, meet investors expectations, files for bankruptcy, has persistent negative cash flows

Audit Failure

Occurs when the auditor issues an incorrect audit opinion because it failed to comply with the requirements of auditing standards

Audit Risk

The possibility that the auditor issues an incorrected opinion after conducting an appropriate audit - ex: auditor concludes financial statements are fairly stated when, in fact, they are materially missed

The Expectations Gap

Difference in what the auditors are required to do and what the users believe that they do

• Goal is reasonable assurance, not absolute

• Do not guarantee financial viability

Assertion

A declaration stated positively without support of proof

Management Assertions

Expressed of implied representations by management regarding the recognition, measurement, presentation and disclosure of information in the financial statements (about classes of information & F/S)

Why do Assertions matter for the auditor

We must ensure they are

1) Identify Claims

2) Set Objectives

3) Test whether claims are true

Audit Objectives

Apply to Income Statement

• Occurrence

• Completeness

• Accuracy

• Cutoff

• Classification

• Posting & Summarization

Occurrence - Audit Objective

Recorded Transaction occurred

events actually occurred & pertain to entity

Completeness - Audit Objective

Everything that should have been recorded is recorded is included

Accuracy - Audit Objectives

Checking accounts and other data relating to recorded transaction and if they have been recorded appropriately and accurately

Cutoff - Audit Objectives

Transactions have been recorded in the correct accounting period

Classification - Audit Objectives

Transactions have been recorded in the proper

Posting & Summarization

Transactions are properly included in the subsidiary records & correctly summarized in the general ledger

Audit Objectives

Driven managements assertion

• Break assertions into manageable chunks to allow auditors to test

• We cannot identify one simple test that can assure

• If the auditor has sufficient evidence that the objective is complete, they can say that the audit is complete

Existence - Assertions

Recorded assets & liability exists at balance sheet date

Completeness - Assertion

Everything that should be recorded is recorded & all assets, liabilities & equity interests are recorded

Accuracy / Valuation / Allocation - Assertion

Amounts are recorded accurately at the appropriate amounts

Rights & Obligations - Assertion

Company owns or controls its assets and owes its liabilities

• Entity has legal right to asset and has obligation liabilities

Classification - Assertion

Properly classified in the financial statements

Detail Tie-in — Assertion

Details agree to subsidiary ledgers, customer files, and underlying

Cutoff - Assertion

recorded in the proper period

Realizable Value - Assertion

Assets are stated at net realizable value, valuation adjustments are recorded

Presentation & Disclosure - Assertion

Items are properly classified, described, and disclosed according to GAAP

Existence/ Occurrence vs. Completeness

• These two assertions are opposites of each other

• Existences test for overstatement (too much)

• Completeness tests for understatement (too little)

Order for determining audit objectives

1. Assess Existence and Completeness

2. If both are satisfied, move onto other assertions/objectives

Audit Assertions

Apply to Balance Sheet items

• Existence

• Completeness

• Accuracy/ Valuation / Allocation

• Classification

• Detail Tie- in

• Cutoff

• Realizable Value

• Presentation & Disclosure

There are no unrecorded fixed assets in use

Completeness

Expense Accounts do not contain amounts that should have been capitalized

Classification

Deprecation is determined in accordance with an acceptable method and is materially correct as compute

Accuracy and Realizable Value

Details of PPE agree with GL

Detail tie-in

The company has valid title to the assets owned

Rights

Objective of an Audit

Obtain reasonable assurance about whether the financial statements are free from material misstatements

Material misstatement

• Misstatement that would influence a user’s decision

• Must judge if it would be significant to the user

• Both quantitative & qualititive factors

Error vs. Fraud

Matter of intention

Managerial Responsibility

• Adopting sound accounting policies consistent with GAAP

• Establishing & maintaining effective internal controls

• Fair representation of the financial statements

Auditor Non-responsibility

• Immaterial misstatements or errors below materiality

• Fraud successfully concealed through sophisticated collusion

Auditor Responsibilities

• Planning and performing audit

• Detecting material misstatements

• Giving independent opinion of financial statements

Auditors are required to by AS2401

1. Consider the presence of fraud risk factors during all stages of the audit

2. Based on risk factors present, make assessment of risk of material misstatements due to fraud

3. Based on assessment, develop an appropriate response

   1. Look for Opportunities, incentives, and rationalization

Directly-effected Illegal Acts

• auditors consider laws that have direct effect of financial statements

• Directly effect specific account balances

Indirect-effect illegal acts

• Could result in a fine later on

• Only responsible when fine has been given

Audit Evidence

Any information used by the auditor to determine whether the financial statements are stated in accordance to GAAP

What counts? Everything

Sufficient Appropriate evidence

Obtained through inspection and observation

Persuasiveness of evidence

Sufficient appropriate evidence to support the opinion issued

Determined by

• Appropriateness

• Sufficiency

Evidence criteria

Sufficiency of Evidence

• Determined by the quantity

• measured primarily by the sample size the auditor selects

  • As sample increase, sufficiency increases

• Quality also impacts sufficiency

  • is the sample representative of the population

Appropriateness of Evidence

• Measure of the quality of evidence

• The degree to which evidence is considered believable or worthy of trust

• Deals only with the audit procedures selected

• Cannot by improved by selecting a larger sample

Characteristics of Appropriate

1. Relevance

   • Evidence must pertain to or be relevant to the audit objective that is being tested

2. Reliability

   • degree to which evidence is believable or trustworthy

Reliability

Degree to which the evidence is believable or trustworthy

1. Independence of the provider

2. Effectiveness of Client’s internal Controls

3. Auditor’s Direct Knowledge

4. Qualifications of Individuals Providing the Information

5. Degree of Objectivity

6. Timeliness

Types of Audit Evidence

1. Physical Examination

2. Observation

3. Confirmation

4. Inspection

5. Inquiries of the Client

6. Recalculation

7. Reperformance

8. Analytical Procedures

Physical Examination

The inspection or count of a tangible asset by the auditor - inventory, cash, securities, equipment

Observation

Use of the sensed to assess certain activities

• Watch a process or procedure as it is being performed (inventory count, check signing

Limitation: people behave differently when watched

Inspection of documents (Documentation)

The auditor’s examination of the client’s documents and records to substantiate that the information is or should be included on financial statements

• Tracing tests completeness

• Vouching test existence

Can be internal or external documents

Confirmation

The receipt of a written response from an independent third party verifying the accuracy of information that was requested by the auditor

Can be positive or negative

Inquiry

Obtaining written or oral information from the client in response to questions from the auditor

• cannot be regarded as conclusive because it is not from an independent source and may be bias

Recalculation

Auditor independently reperforms the client’s arithmetic

Strength: Tests accuracy assertion

Reperformance

Auditor independently re-executes a procedure or control the client performs

Analytical Procedures

Evaluate relationships between financial and nonfinancial data for plausibility

• Required in planning and final review phases; useful for identifying unusual fluctuations

Analytical Procedure Examples

• Compare client and industry data

• Compare client data with prior-period data

• Compare client data with client-determined expected results