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AUD CPA Notes

Copyright belongs to Maggie’s CPA Notes
Please do not distribute illegal copies.
2007 2008[THANK YOU FOR USING MAGGIE’S CPA NOTES]
‐

1
Chapter 21 Standards and Related Topics

Chapter 22 Planning

Chapter 23 Internal Control

Chapter 24 Evidence and Procedures

Chapter 25 Audit Programs

Chapter 26 Statistical Sampling

Chapter 27 Audit IT System

Chapter 28 Reports on Audited Financial Statements

Chapter 29 Other Auditing Standards

Chapter 30 Other Types of Reports

Chapter 31 Other Services

2007 2008[THANK YOU FOR USING MAGGIE’S CPA NOTES]
‐

2
Chapter 21 Standards and Related Topics
SUMMARY
***Memorize***
TIP
i. Independence – must put in writing to the audit committee
1) Audit: reasonable assurance, independence required
2) Review: limited assurance, independence required
3) Compilation: no assurance, do not require independence
ii. SOX1) Rotate lead audit partner on audit every 5 years
2) Prohibit auditing if the auditor in the previous year becomes CEO, controller…
3) Require audit committees to be directly responsible for 1) hiring the auditor 2) compensate
auditor 3) oversee auditors’ work. Audit firm can perform tax service as well with AC’s approval.
QUALITY CONTROL
 A
Acceptance and Continuance of Clients and Engagements
 I
Independence, Integrity, and Objectivity
 C
Continuous Monitoring
 P
Personnel management
 A
Assurance regarding Engagement Performance
 The nature and extent of a CPA firm’s quality control depend on 1) the firm’s size 2) the nature
of the
firm’s practice 3) cost-benefit
General Standards
Standards of Field Work
Standards of Reporting
Implicit
2007 2008[THANK YOU FOR USING MAGGIE’S CPA NOTES]
‐

3 ***Memorize***
 Before accepting a new client, need to communicate with Predecessor Auditors
1. The integrity of management
2.Disagreements between thepr edece ss or and management on accounting principles, auditing
procedures, or other significant matters
3. The predecessor’s understanding about why there was a change in auditors;
4.Predecessor communications to audit committees (or similar authorities) regarding internal control
related matters, illegal acts by clients, and fraud.
POINTS

 SEE - Evidence – sufficient appropriate evidence

 Quality control is not part of GAAS, GAAS is the measures of auditors’ performance

 A successor auditor usually need/can review virtually all the predecessor’s WP

2007 2008[THANK YOU FOR USING MAGGIE’S CPA NOTES]
‐

4
Chapter 22 Planning (25%)
SUMMARY
FRAUD
i. Fraud risk factors
1. High turnover
2. Rapidly changing technology
3.Chang = risk
4. Aggressive earnings projections
5. Considerable competition
6. Negative cash flows
7. Off-shore holding companies
ii. Procedures to detect fraud
1.Unpredictable audit tests
2. Consider possibility & design Procedures to test management override of controls
3. Examine managemente st imat e s, year-end entries,unu sua l entries
iii. Auditor’s responsibilities:
Document the auditor’s response to any fraud risk factors found and evaluation in w/p
iv. Procedures after detecting fraud – always significant, despite of materiality
1. Inform BOD or AC (those charged with governance)
2. Serious breakdown in controls
3. Consult legal counsel
v. Communication of fraud/illegal action
1. Legal/Regulation requirement
2. Successor auditor
3. In response to a subpoena
4. Funding agency
ILLEGAL ACTS
i. Auditor’s responsibilities:
Evaluate risk factors and give reasonable assurance that there are no illegal acts that have adirec t effect
on the f/s
ii. Procedures after detecting illegal acts
1.Inform AC (those charged with governance)
2.Consider impact on evaluation of management integrity
3. Consider impact on audit report
4. Considerw ithdraw a l from engagement
5.Con sult legal counsel
2007 2008[THANK YOU FOR USING MAGGIE’S CPA NOTES]
‐

5
UNDERSTANDING WITH CLIENTS – ENGAGEMENT LETTER
***Read***
i. Objective of the engagement
ii. Management’s responsibilities:
(1)f/s as well as the selection and application of accounting policies;
(2) Establishing and maintaining effective IC;
(3) Identification andcomplian ce with applicable laws and regulations;
(4) Making all financial records and related informationava i la ble to the auditor,
(5)Adjusting the financial statements tocor rec t material misstatements
(6) Provide the auditor with management rep letter
iii. Auditor’s responsibility
(1) Reasonable assurance
(2) Obtain understanding of IC
iv. Limitations of engagement
(1) Not designed to provide assurance on IC
(2) If fraud is discovered – report to AC
***Read***
INFORMATION COMMUNICATED WITH AC
1.Signif icant matters related to internal control.
2. Selection of orch anges in significant accountingpo lic ie s.
3. Management’s process in making accountingest imate s.
4.Adjustments arising from the audit that could have a significant impact on the financial statements.
5. Anyd is agr eement s, whether or not resolved, with management about matters that, individually or in
the aggregate, could have a significant impact on the f/s
6. Any seriousd if ficu lt ies encountered in dealing with management related to the performance of the
audit.
7. Responsibility for other information in documents containing f/s.
8. Any consultations management had with other accountants about accounting and auditing
matters.
9. Any major issues discussed regarding initial or recurring retention of the auditor.
10. Uncorrected misstatements
POINTS
 D u r i n g t h e
i n i t i a l p l a n n i n g
p h a s e , a u d i t o r s
w i l l d i s c u s s w i t h
m g t t h e N E T o f t h e
a u d i t w o r k
 I f s e cp i f i c
i n f o r m t ia o n c o m e s
t o t h e a u d i t o r ’ s
a t t e n t i o n t h a t
p r o v i d e s e v i d e n c e
c o n c e r n i n g t h e
e x i s t e n c e o f
possible illegal acts that could have a material indirect effect on the financial statements, the auditor
should apply audit procedures specifically directed to ascertaining whether an illegal act has occurred.
 D r a f t o f a u d i t
p r o g r a m a d d r e s s i n g
N E T i s r e q u i r e d
2007 2008[THANK YOU FOR USING MAGGIE’S CPA NOTES]
‐

6
Chapter 23 Internal Control (15%)
SUMMARY
i. Understanding Entity and its environment (SEE) affect the
 N a t u r e
if IC is weak, CR high, use↑ outside evidence
 E x t e n t
of audit procedures
if IC is weak, need to gather more evidence
 T i m i n g
if IC is weak, testing will have to be done at
YE instead of interim (substantive tests vs. TOC)
***Memorize***
ii. Internal control components (CRIME)
 C o n t r o l A c t i v i t i e s –
p o l i c i e s a n d
p r o c e d u r e s - P a i d T i p s
1.Pre-numbering documents
2.Authorization of transaction
3.Independent checks
4.Documentation
5.Timely and appropriate performance review – budget variance
6.Information processing controls -ITG C
7.Physical controls
8.Segregation of duties(ARC)

 A u t h o r i z a t i o n

 R e c o r d

 C u s t o d y
 R i s k A s s e s s m e n t –

r i s k f a c i n g t h e e n t i t y

i n s t e a d o f a u d i t o r C R

 I n f o r m a t i o n a n d
C o m m u n i c a t i o n s –

a c c o u n t i n g s y s t e m

 M o n i t o r i n g
 C o n t r o l E n v i r o n
m e n t – t o n e o f t h e

o r g , e . g . m a n a g e m e n t ’ s

a t t i t u d e
iii. SOD for IT
1.Control group
2.Operators
3.Programmer
4.Analyst
5.Librarian
iv. Documentation - required in WP to be retained for at least 7 years per SOX
1)Understanding ofCRIME of IC
2) Sources of information
3) Risk assessment procedures performed
2007 2008[THANK YOU FOR USING MAGGIE’S CPA NOTES]
‐

7
v. Changes of controls
 M u s t b e t e s t e d i n
c u r r e n t a u d i t
 I t n o c h a n g e , m u s t
b e t e s t e d a t l e a s t
e v e r y 3 y e a r s , m o r e
o f t e n i f s i g n i f i c a n t
***Memorize***
STEPS IN THE AUDIT – (MEMORIZE!!)
1) Establish understanding with client

 S e r v i c e s t o b e

p e r f o r m e d

 O b j e c t i v e o f t h e a u d i t
 L i m i t a t i o n s ( r e a s o n a b l e

a s s u r a n c e )

 S p a c e / S t a f f i n g

r e q u i r e m e n t

 F e e s

 A u d i t o r /

m a n a g e m e n t ’ s

r e s p o n s i b i l i t i e s
2) Obtain understanding of entity and its environment, including its IC
 N E T
 R i s k a s s e s s m e n t
p r o c e d u r e s
3) Assess risk of material misstatement in f/s assertions – IR, CR
4) Design and perform audit procedures to address the risk of material misstatement
 T e s t o f c o n t r o l s
 S u b s t a n t i v e t e s t s

5) Evaluate audit evidence

6) Form opinion and issue report – public company, w/p reviewed by a 2nd partner
7) Understand IC Control risk assessment Perform Toc Assess Results Substantive
testing
***Memorize***
IC QUESTIONNAIRE – see P9 week 3
1.Bonding – insurance policy
Lower risk if bonding b/c 1) will recover, 2) investigated by insurance co.
2.Approval
3.Numeric checks – pre-numbered
4.Cross-checks
5.Internal audit function
6.Separation of duties
7.Mechanical devises – physical access
8.Other
9.Personnel policies - Rotate, mandatory vacation
2007 2008[THANK YOU FOR USING MAGGIE’S CPA NOTES]
‐

8
SIGNIFICANT DEFICIENCIES AND MATERIAL WEAKNESS
 A u d i t o r s a r e n o t
r e q u i r e d t o s e a r c h
f o r s i g n i f i c a n t
d e f i c i e n c i e s /
m a t e r i a l w e a k n e s s ,
b u t m a y r e p o r t t o
management / governance if find any (implicitly)

 I f m e n t i o n e d i n

t h e r e p o r t , s h o u l d

s t a t e t h a t t h e

a u d i t o r i s n o t

e x p r e s s i n g a n

o p i n i o n o n I C .

 N e e d t o r e p o r t i n

e a c h a u d i t

r e g a r d l e s s o f

p r e v i o u s

c o m m u n i c a t i o n

 W r i t t e n

c o m m u n i c a t i o n

s h o u l d b e n o l a t e r

t h a n 6 0 d a y s

f o l l o w i n g r e p o r t

r e l e a s e d a t e
Control deficiency report: Significant deficiency  report: Material weakness (more and more serious)
TRANSACTION CYCLES
i. Purchase and AP
Factory User
Prenumbered Stores Requisition
Storeroom
Prenumbered Purchase Requisition (PR)
Purchasing Dept
Prenumbered PO
Vendor
Receiving Dept
Receiving Report (RR)
Prenumbered, 3-copy voucher package
AP Dept
 Record transaction in AP sub-ledger
 Approve Payments
General Accounting
Treasury Dept
Sign & Send
Check
 C a n c e l f i l e s v o u c h e r p a c k a g e
 V o u c h ( w o r k b a c k w a r d s )  E x i s t e n c e
 T r a c e ( w o r k f o r w a r d s )  C o m p l e t e n e s s
ii. Sales and AR
Department
Documents
Sales
 P r e n u m b e r S a l e s O r d e r
Credit (Authorization)
Credit Approval (Valuation)
Shipping (Custody)
Shipping Documents (BOL)
Billing (Record)
Prenumber Invoices
Accounting (Record)
Record transaction in Sales/AR sub-ledger
Blind
#s Received
Filled in
2007 2008[THANK YOU FOR USING MAGGIE’S CPA NOTES]
‐

9
2007 2008[THANK YOU FOR USING MAGGIE’S CPA NOTES]
‐

10
POINTS
 I m m e d i a t e l y u p o n
r e c e i v i n g c h e c k s
f r o m c u s t o m e r s b y
m a i l , a r e s p o n s i b l e
e m p l o y e e s h o u l d
p r e p a r e a
duplicate listing of checks received
 A u d i t e v i d e n c e
c o n c e r n i n g
s e g r e g a t i o n o f
d u t i e s o r d i n a r i l y
i s b e s t o b t a i n e d
b y o b s e r v i n g t h e
employees as they apply control procedures

 D e b i t M e m o – A P ;

C r e d i t m e m o – A R
 T h e p e r s o n w h o

l a s t s i g n s t h e

c h e c k s s h o u l d k e e p

c o n t r o l o f t h e m

u n t i l t h e y a r e

m a i l e d .

 A l l r e c e i p t s f o r

g o o d s , i n c l u d i n g

r e t u r n e d g o o d s o r

m a t e r i a l s , s h o u l d

b e h a n d l e d b y t h e

r e c e i v i n g c l e r k .

 A n a l y t i c a l

p r o c e d u r e s a n d

c o n f i r m a t i o n s a r e

u s u a l l y f o r

s u b s t a n t i v e t e s t s .

 A P d e p a r t m e n t d o

3 - w a y m a t c h
2007 2008[THANK YOU FOR USING MAGGIE’S CPA NOTES]
‐

11 Chapter 24 Evidence and Procedures (35%)

SUMMARY
***Memorize***
AUDIT PROCEDURES
i. Test of controls
1. Observation
2. Inquiry
3. Inspection
4. Re-perform procedures
ii. Substantive tests
1. Analytical procedures
2. Tests of details
3. Confirmation
EVIDENCE -(3rd Standard of field work SEE)
1. Sufficient
2. Appropriate
 R e l e v a n t
 R e l i a b l e
1. From outside
2. Client has a strong IC structure
3. Obtained directly by the auditor
4. Exists in documentary form
5. Original documents
Generated
Circulated
Example
Level 1
Externally
Externally
Bank confirmation
Auditor’s direct knowledge
Level 2
Externally
Internally
Bank statement
External evidence
Level 3
Internally
Externally
Cancelled checks
Internal evidence
Level 4
Internally
Internally
PO, receiving reports
Oval evidence
 A u d i t e v i d e n c e
o b t a i n e d d i r e c t l y
b y t h e a u d i t o r
( e . g . o b s e r v a t i o n ,
c o n f i r m a t i o n ,
c a l c u l a t i o n ) i s
m o r e
reliable than audit evidence obtained indirectly or by inference (outside)
INTERNAL AUDIT
 I n t e r n a l a u d i t o r s
c a n n o t b e u s e d t o
m a k e
j u d g e m e n t / a s s e s s m e
n t ( e . g . a s s e s s I R
a n d C R )
 I n p e r f o r m i n g a n
a u d i t , t h e a u d i t o r
m a y r e q u e s t d i e c r t
a s s i s t a n c e f r o t m h e
i n t e r n a l a u d i t r s o ,
i n o b t a i n i n g
an understanding of the internal control structure or in performing tests of controls or substantive
tests.
 C o m p e t e n c e –
e d u c a t i o n a l
b a c k g r o u n d
 O b j e c t i v i t y –
l e v e l t o r e p o r t ,
s c o p e
2007 2008[THANK YOU FOR USING MAGGIE’S CPA NOTES]
‐

12
***Memorize***
MANAGEMENT REPRESENTATIONS
1. FS fairly presented in conformity withG AAP
2.Availabil it y of financial records and minutes
3. NoNon complianc e or deficiencies in financial reporting practices
4. No materialmisst ateme nt
5. Nof ra ud
6. No plan/intention of affecting CV of asset/liability
7. No material misstatement of Related party, guarantee, uncertainties
8. MaterialViolation of laws,cont ingen cies
9. Title ofow ners hip of assets, anycollat eral
10. Compliance of contractual agreements
11. Management’s belief of no material misstatements, no unrecorded subsequent events
*dated the same date as the audit report
ANALYTICS
Analytics
Commonly used
Required by GAAS
Planning stage
X
X
Substantive test
X
‐
Review stage
X
X
Test of controls
‐
‐
 A n a l y t i c a l

p r o c e d u r e s a l o n e

m a y p r o v i d e t h e

a p p r o p r i a t e l e v e l

o f a s s u r a n c e f o r

s o m e a s s e r t i o n s .

 A n a l y t i c a l

p r o c e d u r e s u s e d i n

p l a n n i n g a n a u d i t

g e n e r a l l y u s e d a t a

a g g r e g a t e d a t a

h i g h l e v e l

 A n a l y t i c a l

p r o c e d u r e s u s e d i n

p l a n n i n g a n a u d i t

s h o u l d f o c u s o n

e n h a n c i n g t h e

a u d i t o r ' s

u n d e r s t a n d i n g o f
the client's business
POINTS
 C P A o w n s w / p ,
b u t n e e d s c l i e n t ’ s
p e r m i s s i o n t o s h o w
t o a t h i r d p a r t y
 U n
- r eo nc c i l e d
d i f f
e r e
c e n s
b e t w
e e nc o n t r o l
a n d s u
s b i d i a r y
a c c o u sn t c a u s e s a n
a u d i t o r
t o s u s p e c t
t h a t
material misstatements exist in a client's financial statements.
 S p e c i a l i s t w o r k :
T h e a u d i t o r s h o u l d
o b t a i n a n
u n d e r s t a n d i n g o f
t h e m e t h o d s o r
a s s u m p t i o n s u s e d
b y
the specialist and evaluate whether the specialists findings support the related assertions in the financial statements.
The work of a specialist who has a contractual relationship with the client may be acceptable under certain
circumstances
 N o r m a l l y , t h e
a u d i t o r s h o u l d n o t
r e f e r t o t h e w o r k
o r f i n d i n g s o f t h e
s p e c i a l i s t ,
s p e c i a l l y f o r
s t a n d a r d
qualified opinion.
1. Unqualified Opinion, Standard ReportNo reference to the specialist.
2. Unqualified Opinion, Explanatory Paragraph Added to ReportRefer to specialist in explanatory paragraph onlyif
doing so will help clarify the reason for the explanatory paragraph.
3. Qualified or Disclaimer of OpinionScope limitation, the auditor is unable to obtain sufficient, competent evidential
matter—No reference to the specialist.
4. Qualified or Adverse OpinionAuditor concludes there is a departure from GAAP—Refer to specialist in explanatory
paragraphonly if doing so will help clarify the reason for the qualification or adverse opinion.
2007 2008[THANK YOU FOR USING MAGGIE’S CPA NOTES]
‐

13 Chapter 25 Audit Programs

SUMMARY
SUBSEQUENT EVENTS
1. Type 1

 C o n d i t i o n s e x i s t e d a t

b a l a n c e s h e e t d a t e

 R e q u i r e a d j u s t m e n t t o

f / s

 D u a l d a t i n g ( i f
d i s c l o s e d ) i s r e q u i r e d

i n o r d e r t o e x t e n d

r e s p o n s i b i l i t y o n l y t o

t h e s u b s e q u e n t
event
 N o c h a n g e o f d a t i n g i s
r e q u i r e d i f j u s t a d j u s t
f / s n u m b e r s i n s t e a d o f
d i s c l o s e i n n o t e s
2. Type 2

 C o n d i t i o n s d i d n o t

e x i s t a t b / s d a t e

 M a y r e q u i r e

d i s c l o s u r e , n o

a d j u s t m e n t s

 D u a l d a t i n g i s

r e q u i r e d f o r
-
Casualty losses
-
Purchasing a business or selling off a component of business
-
Issuance of stock
-
Issuance of debt
***Memorize***
How to look for subsequent events -MIRA CL
1.Management representation letter (dated same date as auditor’s report)
2.Inquire – significant∆ in c/s, LTD, contingent liability
3.Read - minutes, interim f/s
4.Any changes to assets or liability valuations
5. ProperCut-offs
6. ObtainLegal letter
POINTS

 O b s e r v a t i o n o f

i n v e n t o r y c o u l d b e

p e r f o r m e d b e f o r e

b / s d a t e

 P o s i t i v e

c o n f i r m a t i o n i s t h e

b e s t e v i d e n c e f o r
A R

 L a p p i n g - t h e

t h e f t o f o n e

c u s t o m e r s p a y m e n t

a n d s u b s e q u e n t l y

c r e d i t i n g t h e

c u s t o m e r w i t h

p a y m e n t
made by another customer.SOD is the best way to deter it.
 T e s t o f c r e d i t
a p p r o v a l i s f o r t h e
a s s e r t i o n o f
V a l u a t i o n o r
a l l o c a t i o n ( A F D A )
 A u d i t o r s r e v i e w
t h e r e c o n c i l i a t i o n
o f p a y r o l l t a x f o r m
t o i d e n t i f y
p o t e n t i a l l i a b i l i t y
f o r u n p a i d p a y r o l l
t a x e s
2007 2008[THANK YOU FOR USING MAGGIE’S CPA NOTES]
‐

14
Chapter 26 Statistical Sampling
SUMMARY
TYPES OF SAMPLING
1) Attribute sampling
 T e s t o f c o n t r o l
 T e s t f o r c e r t a i n
a t t r i b u t e o r
c h a r a c t e r i s t i c
2) Variable sampling

 S u b s t a n t i v e t e s t s

 E s t i m a t e t h e d o l l a r

v a l u e , h o w m u c h v a r y

f r o m a s t a t e d a m o u n t

 V a r i a b i l i t y ↑

u n c e r t a i n t y , ↑ s a m p l e

s i z e s

 U s e S t a n d a r d

D e v i a t i o n a s a m e a s u r e
NORMAL DISTRIBUTION
 E v e r y i t e m h a s a n
e q u a l c h a n c e o f b e i n g
s e l e c t e d
SAMPLING METHOD
1) Mean-per-unit Estimation
Population Total = Audited Sample total value / sample size * population size
2) Ratio Estimation
 R a t i o = A u d i t e d
S a m p l e t o t a l
v a l u e / B o o k S a m p l e
v a l u e
 P o p u l a t i o n v a l u e =
R a t i o * B o o k
P o p u l a t i o n v a l u e
3) Difference Estimation
[Difference b/w audit value & BV] / Size (S) * Size (P) + Book Value (P)
4) Projection:
 6 8 % / 9 5 % o f p o p u l a t i o n
w i t h i n 1 / 1 . 9 6 s t a n d a r d
d e v i a t i o n o f m e a n
 S D = S E 2
Population Value = Estimated Population Value ± # of SD* Standard Error*Population Size
50%
50%
Mean
Point Estimate
2007 2008[THANK YOU FOR USING MAGGIE’S CPA NOTES]
‐

15
SAMPLING STEPS
1) Define the population
2) Choose method
3) Determine sample size
4) Determine acceptable risk level
 S e l e c t t h e

r a n d o m s a m p l e

 A u d i t t h e r a n d o m

s a m p l e

 E v a l u a t e t h e

r e s u l t s

 D o c u m e n t t h e

p r o c e d u r e s
RISK - AR = IR*CR*DR
 A R , D R , I R , C R + S a m p l i n g
R i s k
SAMPLING RISK
1) Alpha risk
 T e s t o f C o n t r o l : R i s k
o f u n d e r - r e l i a n c e – t o o
m u c h s u b s t a n t i v e
t e s t i n g
 S u b s t a n t i v e T e s t : R i s k
o f i n c o r r e c t r e j e c t i o n –
w a s c o r r e c t , g i v e
q u a l i f i e d o p i n i o n
2) Beta risk
 T e s t o f C o n t r o l : R i s k
o f o v e r - r e l i a n c e – t o o
l i t t l e s u b s t a n t i v e
t e s t i n g
 S u b s t a n t i v e T e s t : R i s k
o f i n c o r r e c t a c c e p t a n c e
– w a s i n c o r r e c t , g i v e
u n q u a l i f i e d o p i n i o n
Sample Size
Expected Deviation rate (Variability) /
Expected amount of misstatement
Direct (higher variability, larger size)
Tolerable deviation Rate / Tolerable
Misstatement Rate
Inverse (lower %, larger size)
Assess risk of assessing control risk too low / Assess misstatement risk (1 less assessed risk = confidence level)
Direct (higher assessed risk, larger size)
Allowable risk of assessing control
risk too low / Allowable misstatement
risk
Inverse (higher risk willing to assume,
smaller size)
Population size
Almost no effect if >5,000
Achieved upper precision limit = Observed sample rate+ Allowance for sampling risk
Increase planning CR if Achieved upper precision limit > Tolerable rate

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