covered member immediate family impaired not a covered member close relative not impaired

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1 BUS 425 Auditing Tad Miller May 22, 2017 Audit Planning, Analytical Procedures, Materiality & Risk, Internal Control Evaluation and Audit Plan 1. INDEPENDENCE All independence problems refer to a client in the San Luis Obispo office. Tom is an audit manager in the San Luis Obispo office who is not assigned to engagement. Tom's wife, who is independently wealthy, owns a material amount of stock in the client in question. The stock amounts to 2% of the client's equity. Tom is a his wife is the firm's independence is covered member immediate family impaired not a covered member close relative not impaired 2. INDEPENDENCE Sue is an audit partner in the Tampa Bay office. Sue's dependent child owns a material amount of stock in a San Luis Obispo client. The stock amounts to 1% of the client's equity. Sue is a her daughter is the firm's independence is covered member immediate family impaired not a covered member close relative not impaired 3. INDEPENDENCE Joan is a tax partner in the Tampa Bay office. Joan and her husband own an immaterial amount of stock in a San Luis Obispo client. The stock amounts to 6% of the client's equity. Joan is a her husband is the firm's independence is covered member immediate family impaired not a covered member close relative not impaired 4. PROFESSIONAL SKEPTICISM Define or describe professional skepticism. An attitude that includes a questioning mind, being alert to conditions that may indicate possible misstatement due to fraud or error, and a critical assessment of audit evidence. Professional skepticism is an attitude that includes a questioning mind and critical assessment of audit evidence. Auditors should not assume that management is dishonest but the possibility of dishonesty must be considered. The auditor should not assume that management is unquestionably honest. OR auditor should not be satisfied with less than persuasive evidence 5. AUDIT OBJECTIVES List the financial statement assertions to which you would refer when creating audit objectives related to transactions. Occurrence Completeness Accuracy Classification Cutoff

2 6. COMMUNICATION WITH PREDECESSOR AUDITOR Name four issues auditing standards require successor auditors to discuss with the predecessor auditor? If the client lacks integrity Disputes with the client regarding accounting principles Disputes with the client regarding auditing procedures Disputes with the client regarding fees 7. Related Parties Describe related parties in terms related to the audit of a client s financial statements. Related parties are an affiliated company, a principal owner of the client company, or any other party with which the client deals, where one of the parties can influence the management or operating policies of the other. 8. ANALYTICAL PROCEDURES Briefly explain the primary reasons auditors perform analytical procedures during the planning stage of an audit. Auditors perform analytical procedures during the planning stage to better understand the client s business and industry; and to indicate possible misstatements (attention directing). Assess going concern Reduce detailed tests To assist in determining the nature, timing and extent of audit procedures 9. PERFORMANCE MATERIALITY Describe performance materiality (tolerable misstatement). We refer to performance materiality as the allocation of materiality to account balances, used in audit planning.

3 10. ESTIMATED TOTAL MISSTATEMENT Accounts receivable includes 250 customers and has a balance of $50,000. Performance materiality for the account is 10% of the account balance. You took a sample of 45 items. The 45 items in your sample had a book value of $9,000 and the audited values of the 45 items in your sample totaled $8,280. Would you conclude that accounts receivable is NOT MATERIALLY OVER MATERIALLY OVER NEED ADD'L EVIDENCE NOT MATERIALLY UNDER MATERIALLY UNDER Explain or demonstrate how you reached your conclusion. Known error ,280 Projected to the population 250/45 4, ,000 Performance Materiality 5,000 50,000 allowance for sampling error 1,000. 4, CONTROL RISK Write the definition of control risk. The risk that a material misstatement that could occur in an assertion about a class of transaction, account balance, or disclosure and that could be material, either individually or when aggregated with other misstatements, will not be prevented, or detected and corrected, on a timely basis by the entity s internal control. (A measure of) the auditor s assessment of the risk that a material misstatement could occur in an assertion and not be prevented or detected by the client s internal controls. 12. DETECTION RISK Write the definition of detection risk. The risk that the procedures performed by the auditor to reduce audit risk to an acceptably low level will not detect a misstatement that exists and that could be material, either individually or when aggregated with other misstatements. The risk that the auditor will not detect a material misstatement that exists in an assertion that could be material, either individually or when aggregated with other misstatements. 13. SARBANES OXLEY The PCAOB has established reporting requirements for management regarding the company's internal control structure. List the three statements management must include in the company's annual report pertaining to internal controls. A statement that management is responsible for establishing and maintaining adequate internal controls over financial reporting A statement providing management's assessment of the effectiveness of the entity s internal controls A statement identifying the framework management used to evaluate the effectiveness of the entity s internal controls

4 14. INTERNAL CONTROL How does COSO define internal control a process effected by those charged with governance, management and other personnel that is designed to provide reasonable assurance about the achievement of the entity s objectives with regard to the reliability of financial reporting effectiveness and efficiency of operations compliance with applicable rules and regulations 15. COMPONENTS OF INTERNAL CONTROL List the five components of internal control. Control environment Control Activities Monitoring Risk assessment Information and Communications 16. SEGREGATION OF DUTIES what functional responsibilities need to be separated to have adequate segregation of duties? Separation of the custody assets from accounting Separation of the authorization of transactions from the custody of related assets Separation of operational responsibility from record-keeping responsibility Separation of IT duties from user departments Custody of the asset involved in the transaction Authorization to execute transactions Recording transactions in the accounting records 17. MANAGEMENT ASSERTIONS During the audit, you find an entry in the sales journal for which there is no underlying shipping document or sales order. To which financial statement assertion does this condition relate? Occurrence. There is no evidence that this transaction occurred. 18. MANAGEMENT ASSERTIONS During the audit, you find invoices with prices that are higher than the official price list. To which financial statement assertion does this condition relate? Accuracy. Although the sale did occur it is not recorded at the proper value. 19. MANAGEMENT ASSERTIONS During the audit, you find a customer order and a shipping document indicating the goods were shipped to the customer but you are unable to find where the transaction was recorded in the sales journal. To which financial statement assertion does this condition relate? Completeness. The sales journal is not be complete.

5 20. MANAGEMENT ASSERTIONS During the audit of accounts receivable, you become concerned that the allowance for doubtful accounts is not sufficient. To which financial statement assertion does this condition relate? Valuation and allocation. 21. MANAGEMENT ASSERTIONS During the audit of sales, you notice that sales discounts and sales returns are being categorized as operating expenses on the income statement. To which financial statement assertion does this condition relate? Valuation and allocation. 22. AUDIT RISK MODEL PRIVATE CLIENT NOT SUBJECT TO SEC (SARBANES OXLEY) We have obtained a sufficient understanding of the client's internal controls and have evaluated the design of their controls. We do not believe the client's controls would be effective even if properly implemented. We have documented our understanding of the controls and our evaluation of the design of the controls. Indicate which audit approach you will take and the extent of tests. 23..AUDIT RISK MODEL PRIVATE CLIENT NOT SUBJECT TO SEC (SARBANES OXLEY) We have obtained a sufficient understanding of the client's internal controls and have evaluated the design of the controls. We believe the client's controls would be effective if properly implemented. We have documented our understanding of the controls and our evaluation of the design of the controls. Indicate which audit approach you will take and the extent of tests. 24. AUDIT RISK MODEL SEC CLIENT SUBJECT TO SARBANES OXLEY We have already obtained a sufficient understanding of the client's internal controls and have evaluated the design of the controls. We not believe the client's controls would be effective even if properly implemented. We have documented our understanding of the controls and our evaluation of the design of those controls. We believe substantive tests would be less costly than tests of controls. Indicate which audit approach you will take and the extent of tests. 25. AUDIT RISK MODEL SEC CLIENT SUBJECT TO SARBANES OXLEY We have already obtained a sufficient understanding of the client's internal controls and have evaluated the design of the controls. We believe the client's controls would be effective if properly implemented. We have documented our understanding of the controls and our evaluation of the design of those controls. We believe substantive tests would be less costly than tests of controls. Indicate which audit approach you will take and the extent of tests.

6 26. AUDIT RISK MODEL PRIVATE CLIENT NOT SUBJECT TO SARBANES OXLEY You took a reduced level of control risk approach and after completing tests of controls, you assessed control risk as low. During your substantive testing, you detect a material misstatement. What steps must you take? This question refers to the audit approach. It is not asking to whom you might report the misstatement or which audit report you might issue. 27. UNDERSTANDING THE CLIENT'S ACCOUNTING SYSTEM In order to document our understanding of the client's accounting system, we need to demonstrate that we understand the flow of transactions by documenting: the various classes of significant transactions -the types of material errors and fraud that could occur The methods by which each significant class of transactions is authorized and initiated documented and recorded processed in the accounting system 4. - placed in the financial statements and disclosures SIGNIFICANT DEFICIENCY / MATERIAL WEAKNESS Define a material weakness. A condition that could adversely affect an organization's ability to initiate, record, process and report financial data in the financial statements/ A deficiency or a combination of deficiencies, in internal control, such that there is a reasonable possibility that a material misstatement would not be prevented or detected and corrected, on a timely basis. 29. Audit Reports You are unable to perform all of the audit procedures you believe are necessary. Because of this you were unable to obtain sufficient evidence. When preparing the audit report, which audit reports would you select from? Qualified Opinion or Disclaimer of Opinion

7 30. Which audit report is illustrated below and what is the nature of the problem, if any? Report on the Consolidated Financial Statements1 We have audited the accompanying consolidated financial statements of ABC Company, which comprise the balance sheet as of December 31, 20X1, and the related statements of income, changes in stockholders' equity, and cash flows for the year then ended, and the related notes to the financial statements. Management s Responsibility for the Financial Statements Management is responsible for the preparation and fair presentation of these financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error. Auditor s Responsibility Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditor's judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity's preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity's internal control.2 Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our adverse audit opinion. Basis for Adverse Opinion As described in Note X, the Company has not consolidated the financial statements of subsidiary XYZ Company that it acquired during 20X1 because it h as not yet been able to ascertain the fair values of certain of the subsidiary's material assets and liabilities at the acquisition date. This investment is therefore accounted for on a cost basis by the Company. Under accounting principles generally accepted in the United States of America, the subsidiary should have been consolidated because it is controlled by the Company. Had XYZ Company been consolidated, many elements in the accompanying consolidated financial statements would have been materially affected. The effects on th e consolidated financial statements of the failure to consolidate have not been determined. XXXXXX In our opinion, because of the significance of the matter discussed in the above paragraph, the financial statements referred to above do not present fairly the financial position of ABC Company as of December 31, 20X1, or the results of their operations or their cash flows for the year then ended. Adverse Opinion An accounting problem material misstatement