accounting 630 exam 1

a systematic evaluation of the correspondence between information or a process and stated criteria

audit

why do we audit

stakeholders want to know if the information or process is reliable

3 keys to demand for audit

1. stakeholders care about the veracity of the information

2. there is some criteria to measure or evaluate the information

3. a process can be used to collect evidence to support or refute

stakeholders, criteria, and process for a financial statement audit

stakeholders: investors & creditors

criteria: GAAP

process: risk-based audit

who are the stakeholders of a financial statement audit

investors, creditors, suppliers, regulators, customers, the public

what is used as criteria for an audit

GAAP, international accounting standards, etc

who primarily benefits from an audit

the company itself and its owners and managers

intentional concealment or misrepresentation of material facts in order to deceive

fraud

fraudsters use their influence for personal gain (ex: bribery)

corruption

theft or misuse of an organization’s assets

asset misappropriation

manipulation, falsification or alteration of accounting records, misrepresentation of events/transactions

fraudulent financial reporting

what are the most common types of fraudulent financial reporting

overstate assets & understate liabilities

overstate revenues & understate expenses (most common)

stealing payments on A/R and then using future payments for other A/R accounts to cover up

lapping

promise big returns, use next groups’ contributions to pay big returns to first group

ponzi scheme

3 elements of the fraud triangle

motivation, opportunity, rationalization

which element of fraud triangle: an accountant has $100k in credit card debt

motivation

which element of fraud triangle: no segregation of duties for cash receipts

opportunity

which element of fraud triangle: justifying that all companies play around with their numbers

rationalization

what was the change in the reason for auditors

originally was about theft of assets, now more about reporting to large groups

what does the PCAOB require auditors to do

make specific assessment of fraud risk

why does materiality matter

cost to find small frauds may not be worth it

being objective rather than biased

auditor independence

what kind of information do we want as auditors

reliable & unbiased

does the auditor seem independent? no ownership, contingent fees, bonuses, family relationships

independence in appearance

is the auditor objective, challenging to address via standards, a state of mind for the auditor

independence in fact

threats to independence

self-review threat, familiarity threat, undue influence threat, self-interest threat

what does an audit produce

an opinion on the financial statements’ compliance with a comprehensive set of accounting standards

what are the five PCAOB assertions

existence, completeness, rights and obligations, valuation, presentation and disclosure

which assertion: all the individual balances are included in the total

completeness

which assertion: each receivable from a customer represents a sale to a customer

existence

which assertion: the receivable from the owner is described as a related party receivable

presentation and disclosure

which assertion: the receivable is collectible

valuation

assets, liabilities, and equity interests actually exist

existence

all transactions are recorded, and all disclosures have been included

completeness

the entity controls the rights to assets, and liabilities are truly the obligation of the entity

rights and obligations

all items have been properly valued and all costs are properly allocated between the balance sheet and income statement

valuation

the information is appropriately presented and understandable to users

presentation/disclosure

what is the audit timeline

planning, interim work, field work, wrap-up

which stage of the audit: acceptance, risk assessment, control understanding

planning

which stage of the audit: risk assessment, controls testing, some early substantive procedures

interim work (before year-end)

which stage of the audit: controls testing, substantive procedures

fieldwork (after year-end)

which stage of the audit: concluding the audit and issuing report

wrap-up

5 stages of the audit process

client acceptance & continuance, risk assessment, internal controls, substantive testing, completion activities

client acceptance or continuance questions

are we independent, is the client auditable, do we trust management

risks to assess when performing risk assessment

1. internal control risk - how well do the controls prevent misstatement

2. inherent risk - high level of transaction volume?

3. audit risk - specific risks to the auditor of getting the audit wrong

the level at which information/data would change the decision of a typical decision maker

materiality

obtaining evidence about internal controls

document and evaluate internal controls, test to see if they work

what is the difference between a financial statement audit and an integrated audit

a financial statement audit does not include audit reports on internal controls

substantive evidence about accounts

gather evidence about accounts/disclosures/reports, evaluate management assertions (after year-end)

what is the point of substantive analytical procedures

tells us if the account balance is materially misstated or not

types of audit opinions

1. adverse → we don’t agree with the financial statements

2. standard unqualified → clean report

3. qualified → fairly presented except for a specific issue

purpose of the PCAOB

oversee audits of public companies and SEC-registered broker dealers

they inspect auditors/audit firms, reports on audit quality, and set standards for public companies

data, information, or material that supports or refutes a hypothesis or assertion

evidence

why do we need evidence for auditing

to support our opinion/reach our opinion

to defend out opinion to outside parties if our opinion is called into question

what do we base our evidence gathering off of

the five assertions - must get evidence for each one on their own

what is sufficient evidence

the quantity of evidence (enough to form an objective opinion)

appropriateness of evidence

quality of the evidence, both relevance and reliability

what are the 2 determinants of persuasiveness of evidence

appropriateness and sufficiency

the procedure you are using provides evidence on the assertion you are testing, and the assertion is important to the account you are auditing

relevance

the level of trust and confidence you have in the evidence

reliability

financing statements/general ledger to source document (ex: shipping document)

vouching, tests existence

source documents to financial statements/general ledger

tracing, tests completeness

what are the factor’s affecting reliability

1. independence of auditor

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

independence of provider

internal vs external evidence

*external is more reliable because no motive to manipulate the financial statements

effectiveness of client’s internal controls

better controls make the data more reliable

auditor’s direct knowledge

observations/computations done by auditor are more reliable than assertions provided by the client

degree of objectivity

unbiased evidence + freely verifiable = reliable

timeliness

must be relevant to the time period being reviewed

documenting audit evidence

documenting risk assessment procedures, tests of controls and substantive procedures, as well as significant findings and their resolution

why is documentation important

basis for communicating among staff, support judgement, regulators can better understand decisions

what does the SEC do for auditing

oversees financial reporting, issues rules for public company disclosures, oversees the PCAOB, allows FASB to set accounting standards

reasonable expected relationships for cash accounts

no unusual large cash transactions, operating cash flow consistent with sales and net income, etc

relationships that might suggest a heightened risk of fraud related to cash

consistent profits over several years but cash flows are decliidng, unexpected declines in the petty cash account or accounts receivable collections

biggest fraud risks

1. easy to use once stolen (incentive)

2. actual currency is hard to trace (opportunity)

3. capture at point of receipt before it is in the company

4. high volume - rationalization

can obtain understanding of internal controls using:

• a walkthrough of the process

• inquiry (interviewing staff)

• observation

• review of the client’s documentation

typical controls over cash

segregation of duties, periodic internal audit, requiring 2 signatures on checks, authorization of transactions, independent bank recs

typical substantive tests for cash accounts

inspecting bank recs, obtaining bank confirms and bank cutoff statements, analyzing interbank transfer schedules

which assertion: sending bank confirms regarding the reported cash balances

existence

which assertion: examining bank cutoff statement to ensure that the 12/31 outstanding check list includes all checks

existence (and partially completeness)

which assertion: recalculating the balances of foreign bank accounts using independent foreign exchange data

valuation

moving money to another account but not removing it from the originating account

kiting

which assertions are used when evaluating if cash is committed or restricted in any manner

rights and obligations

presentation and disclosure

what does the IAASB do

sets high-quality international standards for auditing, quality control, other assurance, and related services