Audit Exam 1

Audit exam

Audit

the accumulation and evaluation of evidence about information to determine and report on the degree of correspondence between the information and the established criteria. must be performed by a competent and independent person

Components of the definition of an audit

o Evidence

o Information

Has to be verifiable. Two types of information: quantitative (How much?) and subjective (How effective?)

Report

▪ Communicates findings to the users

▪ “Financial statements are prepared fairly in all material respects in accordance with GAAP”

Criteria

GAAP to GAAS

Competent

Someone who understands the Criteria

Independent

▪ Cannot have any relation to the client

▪ Covered members: Spouses or family

Accounting

preparation of financial records

Assurance services

Services that assess the quality of the information that is provided by a firm. Does not need to be performed by CPA’s

Attestation services

Review services not specific to the financial statements. Requires a report and must be external.

Information risk

The risk that the information that is provided to the firm is not accurate

Business risk

The companies’ ability to survive larger economic conditions and events unrelated to the health of their financial statements

Risk-free interest rate

The rate that all loans and bonds are based off of.

What is the definition of an audit?

the accumulation and evaluation of evidence about information to determine and report on the degree of correspondence between the information and the established criteria. must be performed by a competent and independent person

Why is there a demand for auditing?

Users of the finical statements want to know that the information they are using to make investment decisions is accurate

Which risk can an audit impact? Why?

Information risk. It can give assurance to the financial statement user from a third party that the statements are reported correctly

Explain the difference between audits, attestation services, and assurance services.

o Audit: Is on the financial statements

o Attestation services: System checks not specifically related to financial statements, but that require a report

o Assurance: services that assess the quality of information

Explain the difference between accountants and auditors

Accountants are people trained the criteria of an audit (GAAP), but do not preform audit services.

American Institute of Certified Public Accountants (AICPA)

o Sets requirements for the CPA

o 4 Areas of it sets standards:

▪ Auditing standards (Created by the audit standards board)

▪ GAAS (for private companies)

o Other attestation standards o Code of professional conduct (Independence rules we must follow)

Generally Accepted Auditing Standards (GAAS)

In accounting and auditing, GAAS are the fundamental standards and guidelines auditors follow when conducting an audit of a company's financial statements. (Created by the AICPA)

Generally Accepted Accounting Principles (GAAP)

The rules that people who prepare the financial statements must follow.

Public Company Accounting Oversight Board (PCAOB)

o organization that oversees and regulates the auditing of public companies in the United States.

o Members are appointed by the SEC

Securities and Exchange Commission (SEC)

Government agency that oversees markets

Sarbanes-Oxley Act (SOX)

o After Enron

o Established new rules and regulations that are designed to prevent accountants form manipulating financial statements

What did SOX do to management and auditor’s responsibilities?

Increased responsibility for management and required them to implement and maintain their own internal controls

What are the responsibilities of the PCOAB?

o Sets auditing standards for public-company audits.

o Inspects registered accounting firms to make sure audits are performed properly.

o Investigates potential violations by auditors and accounting firms.

o Disciplines auditors who violate PCAOB rules or auditing standards.

o Helps protect investors by improving the quality and reliability of public-company audits.

Auditors who audit nonpublic and public clients follow

GAAS standards

Public companies follow

GAAP standards

Determine the responsibilities of management and auditors

o Management prepares the statements and implements/maintains internal controls

o Auditors independently examine financial statements and determine whether they are fairly presented according to the applicable accounting standards.

Audit Committee (5 things)

o Oversee the external auditors

o Help ensure the auditors remain independent

o Review the company’s financial statements

o Monitor internal controls and financial reporting

o Discuss significant accounting or auditing issues with management and auditors

Direct financial interest

Owning stock in a company or owning debt

Indirect financial interest

Only an issue if it’s a material investment

Independence of mind

Independence of mind means an auditor must be able to make objective, unbiased judgments without being influenced by management or other outside pressures.

Independence in appearance

Perceived independence. Result of other people’s interpretation of the audits independence

Independence in fact

Making sure the auditors follow the correct rules and regulations

AICPA Code of Professional Conduct Independence Rule

A member in public practice shall be independent in the performance of professional services as required by the standards promulgated by bodies designated by Council

Covered member

o Any person who is of influence in the engagement

o Imitate relative or family member of an auditor is a covered member

Why is auditing considered a public good?

It helps ensure that the Financial statement information used by investors is accurate

Why does auditing require a code of professional conduct?

Auditing requires a Code of Professional Conduct because auditors are trusted to provide objective and reliable information to investors, creditors, and other users of financial statements.

Who must abide by the AICPA Code of Professional Conduct?

All auditors who are members and covered members

What are the two components of the AICPA Code of Professional Conduct Independence Rule?

o Independent in fact

o Independence in appearance

What are the six (6) independence issues specifically prohibited in the AICPA Code of Professional Conduct?

o Financial interests — An auditor cannot have certain direct or material indirect financial interests in an audit client.

o Loans and guarantees — Certain loans or guarantees between the auditor and audit client are prohibited.

o Business relationships — Certain business relationships between the auditor and client can impair independence.

o Family relationships — Certain close family relationships with client personnel can impair independence.

o Employment relationships — Certain employment relationships between the auditor and client are prohibited or restricted.

o Nonattest services — Auditors cannot provide certain services to an audit client when doing so would cause them to take on management responsibilities or impair independence.

Who and what do the independence issues listed in the AICPA Code of Professional Conduct relate to?

Direct and Indirect interests

Who is considered a covered member?

Anyone who is in a position to influence the engagement

What rules for independence must be followed for auditors of public clients?

auditors must follow the Independence rule

What are the nine (9) prohibited non-audit services described by the PCAOB?

o Bookkeeping

o Actuarial services

o Broker/Dealer

o Financial systems implementation

o Internal audit consulting services

o Legal services

o Export services

o Management or HR functions

o Appraisal or valuation services

Adverse opinion

Financial statements are materially misstated (both public and private)

Disclaimer of opinion

Unable to make a audit judgment due to lack of information (Both public and private)

Qualified opinion

Financial statements are presented fairly in all material respects (Public)

Unmodified opinion

Financial statements are presented fairly in all material respects (Private)

Unqualified opinion

Financial statements are presented fairly in all material respects, except for something (both private and public)

Explanatory language

o Other matter: discusses something that is not presented or disclosed in the financial statements but is relevant to understanding the audit, the auditor's responsibilities, or the audit report.

o Emphasis-of-matter: already properly presented or disclosed in the financial statements but is so important that the auditor believes users should pay special attention to it.

Clean opinion

the auditor believes the financial statements are fairly presented in accordance with the applicable accounting standards.

Critical audit matters

CAMs are included in the auditor's report for public-company audits.

Material misstatement

A material misstatement is an error or omission in the financial statements that is important enough that it could influence the decisions of financial statement users.

Pervasive material misstatement

pervasive material misstatement is a material misstatement that is so significant or widespread that it affects two or more financial statements.

Material

Material means that an item is significant enough to potentially influence the decisions of someone using the financial statements.

Immaterial

Immaterial means an error or omission is not significant enough to influence the decisions of financial statement users.

What are the five (5) reasons to add explanatory language to an unmodified (unqualified) audit report?

o Reports include other auditors

o Lack of a consistent application of GAAP

o Auditor agrees with a departure from GAAP

o Substantial doubt of a going concern

o Emphasis of other matters

What are the components of a standard unmodified (unqualified) audit report?

o Opinion

o Basis for opinion

o Responsibilities of management for the financial statements

o Auditor’s responsibilities for the audit of the financial statements

What are the common and different aspects between a standard unmodified and a standard unqualified audit report?

An unqualified audit report must have CAMS

What are the levels of materiality?

o Immaterial

o Material

o Prevasively material (two or more statements)

How does the auditor use materiality in determining an audit opinion?

determine whether errors or misstatements in the financial statements are significant enough to affect the auditor’s opinion.

What are the quantitative and qualitative considerations for determining materiality? (Know only broadly)

o Quantitative: Does this number impact on the statement enough to be important to the user?

o Qualitative: Does this number influence a user’s choice?

Why does the auditor only provide reasonable assurance?

Audit samples do not include every transaction or piece of data that could be tested

What are the auditor’s responsibilities due to fraud or error?

Auditors are responsible for obtaining reasonable assurance that the financial statements are free from material misstatements, whether caused by fraud or error.

What is the auditor’s responsibility when they find illegal actions by the client?

They must include that in their report

What are the two primary components of professional skepticism?

questioning mindset and critical assessment of the evidence

Why do auditors use the cycle approach to the audit?

Auditors use the cycle approach to organize the audit by grouping related transactions and accounts into cycles.

How do auditors consider the cycle approach when considering sufficient appropriate audit evidence?

Auditors use the cycle approach to make sure they gather enough reliable evidence for each major area of the financial statements.

What are the five (5) management assertions by the PCAOB?

o Existence or occurrence

▪ Assets/liabilities exist at a given time

▪ Transactions occurred

o Completeness

▪ All transactions are recorded

▪ All accounts are included in the statements

o Valuation of allocation
▪ Accounts are at the correct amount

o Rights and obligations

▪ Company holds or controls its assets

o Presentation of assets
▪ Financials are properly classified