Professional Documents
Culture Documents
The CPA Vision Project gives an overall view of where the profession stands and where it is
headed. An understanding of the overall profession is crucial to a good foundation of the role
auditors have in the accounting profession and in the business world.
The Sarbanes-Oxley Act (SOX) of 2002 has created jobs for everyone in the accounting
profession. The Securities and Exchange Commission (SEC), Public Company Accounting
Oversight Board (PCAOB), and the American Institute of Public Accountants (AICPA) are all
integrally influential over the activities of registered CPA firms and impact the global
community.
The objectives of the CPA Vision Project include leveraging CPA core competencies and values
in order to guide current and future initiatives to support the profession and the public interest.
The purpose of the CPA vision is to better define the CPA's role in an increasingly competitive
environment. This is being done by assembling a cross-functional team of experts composed of
internal and external experts and targeted focused groups of stakeholders. "Moving up the value
chain" refers to an incremental analysis (from the end customer to the CPA) of the services
provided and value generated by the profession.
Our first week's discussion together begins with your understanding of the CPA Vision Project
and the direction the accounting profession is headed to better serve the needs of the investing
public.
A significant aspect of any successful audit is the proper exercise of the auditor's professional
judgment. Following the standards is not enough without incorporating professional judgment.
An auditor's professional judgment is strongly influenced by many competing factors, including
the public's needs, client interests, and governmental regulation.
Security issuer clients are regulated closely by the SEC, a federal government agency. CPA firms
must register with the agency and are subject to particular rules and regulations beyond the rules
of the AICPA. The auditor is challenged to exercise professional judgment while complying with
the standards and reaching the appropriate conclusionary report on the fairness of the financial
statements presented as a whole. SOX established the PCAOB to oversee registered accounting
firms in the practice of servicing public entities issuing securities. This oversight board
establishes auditing and related professional standards to be used in the preparation and issuance
of audit reports for issuers.
Through the readings, your research, and the discussion we shall share in Week 1 of this course,
you will develop a better understanding of the external auditor's important role in the global
business community.
Audit Reports
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When we have finally completed the audit of our client, we will issue our findings in a report.
Investors and creditors place great reliance on our opinions regarding whether or not the
financial statements fairly present the financial position of the business.
Review Question
Please work Review Question 3-6 in the 14th edition; this is under the Review
Question section, not Problems.
Click here to review the solution after you have come up with an answer.
Review Question
Please work Review Question 3-14 in the 14th edition; this is under the Review
Question section, not Problems.
Click here to review the solution after you have come up with an answer.
Dear student,
In an effort to enhance your comprehension of this difficult subject and to introduce you to some
of the tools available from Becker Professional Education, you are being given access to a series
of links (see below) to Becker CPA Review materials on audit reports.
We hope you find this access to be an excellent complementary resource for you during Week 1
of this course. However, it must be emphasized that your eBook readings and other assigned
materials for this week will be covered in the graded assessments for this course, so you will
want to focus on those as you prepare for any exams, projects, quizzes, and so forth.
Week 2
Ethics and Legal Responsibility
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This week, we more closely examine the rules by which the profession requires CPA auditors to
live. The professional is challenged to comply with federal regulations, AICPA rules, statutory
laws, and the common law. A violation of any of these can place the CPA in professional
jeopardy.
Independence is very important to our roles as auditors because the users of financial statements
want to be sure that we take an unbiased viewpoint when we perform our audits. Because of its
importance, independence is the first rule of conduct.
So, to protect our independence, we must be both independent in fact and independent in
appearance. Independence in fact exists when the auditor is actually able to maintain an unbiased
attitude throughout the audit, whereas independence in appearance is dependent on others'
interpretation of this independence (hence their faith in the auditor).
Video
The CPA profession at its core is highly dependent upon independence in fact and
appearance. Please view the video below for a discussion on independence and its
role in the auditing profession.
For 56K users: You may want to download these video clips to your local drive and watch them from your computer. (To download
a video clip, right-click the video clip link and choose "Save Target As...")
The profession is a blend of disciplines from accounting to consulting to auditing and more. The
public depends on the professional judgment of the hard-working CPA auditor to give members
of the investing public a greater understanding of the companies they are evaluating. As such,
CPA auditors must have the knowledge and ability to understand and access the value of the
client's financial statements.
Who in the United States has not heard of the downfalls of Arthur Andersen, Enron, WorldCom,
Tyco, and Bernie Madoff, among countless others? As a result of their misadventures, new
legislation has greatly affected the way business is done. It has also opened up new opportunities
for those in the accounting profession. A pitfall for CPAs to navigate is keeping their
independence and integrity intact when the client is pushing for more control over what is
reported.
Review Question
36
Consider each of the preceding services separately. Evaluate whether the
performance of each service violates the AICPAs Code of Professional Conduct.
Click here to review the solution after you have come up with an
answer.
Professional Ethics
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The CPA external auditor owes a primary duty to the investing public. The AICPA recognizes
that the CPA must adhere to higher standards of behavior if the profession is to be respected and
trusted. As such, it has developed specific guidelines or rules of conduct for CPA members. A
detailed discussion of the code of professional conduct appears in Chapter 4 of your readings.
Your comprehension of this material is key to understanding the professional standards of the
CPA auditor.
Interpretations of rules are intended to clarify the rules of conduct. They are
not officially enforceable, but a practitioner must justify any departure.
Students will find that the rules are not as straightforward as they may seem. You must read the
interpretation of the rules in Chapter 4 of your text in order for you to fully grasp the significance
of the professional rules of conduct. Spend time understanding the differences between
circumstances that challenge the auditor's independence Rule 101 versus their integrity Rule 102.
A diligent attempt at working through the homework problems assigned will enhance your
ability to grasp the TCO to understand the ethical responsibilities of auditors under various
business situations, including fraud auditing. They are not one and the same. A fuller
understanding of these significant rules helps the successful auditor in maintaining his or her
reputation and license!
Legal Liability
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When performing services for their clients, auditors have a duty to provide a level of care that is
reasonable. Auditors who fail to exercise due care in the performance of services to their clients
may be liable for breach of contract. Further, auditors may also be held liable to third parties
under civil law, liable to shareholders under federal securities law, and even liable under criminal
law. We must act prudently when we undertake our audit engagements.
As auditors, we can take steps to protect ourselves from legal liability, such as
Each of the Big Four firms has experienced the pain of making mistakes of varying degrees and
paying the price of a lawsuit. The auditor's legal liability extends from mere negligence ("Oops, I
made a simple mistake") to committing fraud that results in loss of money and possibly freedom!
The SEC has regulations that begin with bringing a company public to its continued regulation.
Violations of those regulations result in penalties, extending from requiring more continuing
professional education to barring the firm or auditor from participating in public company
services to imprisonment.
A thorough review of Chapters 5 and 11 of the electronic readings will give you a comprehensive
understanding of the legal pitfalls the CPA professional must negotiate in the performance of an
audit.
Review Question
In the CPA Exam Question Section, please work CPA Exam Question 5-16.
The following questions concern CPA firms liability under common law. Choose
the best response.
3. Peters & Sons will recover both punitive damages and damages
for breach of contract.
4. Neither Sharp nor Peters & Sons will recover against the other.
c. The 1136 Tenants case was important chiefly because of its emphasis
on the legal liability of the CPA when associated with
1. An SEC engagement.
Click here to review the solution after you have come up with
an answer.
Review Question
Click here to review the solution after you have come up with
an answer.
Review Question
The CPA firm of Bigelow, Barton, and Brown was expanding rapidly.
Consequently, it hired several junior accountants, including a man named Small.
The partners of the firm eventually became dissatisfied with Smalls production
and warned him they would be forced to discharge him unless his output increased
significantly. At that time, Small was engaged in audits of several clients. He
decided that to avoid being fired, he would reduce or omit some of the standard
auditing procedures listed in audit programs prepared by the partners. One of the
CPA firms clients, Newell Corporation, was in serious financial difficulty and had
adjusted several of the accounts being audited by Small to appear financially
sound. Small prepared fictitious audit documentation in his home at night to
support purported completion of auditing procedures assigned to him, although he
in fact did not examine the adjusting entries. The CPA firm rendered an
unqualified opinion on Newells financial statements, which were grossly
misstated. Several creditors, relying on the audited financial statements,
subsequently extended large sums of money to Newell Corporation. Will the CPA
firm be liable to the creditors who extended the money because of their reliance
on the erroneous financial statements if Newell Corporation should fail to pay
them? Explain.
Click here to review the solution after you have come up with
an answer.
As auditors, we are certainly concerned with missing the signs of fraud when we undertake client
assignments. For our part, the fraud we may encounter concerns either fraudulent financial
reporting or the misappropriation of assets. These are the areas we should take into consideration
when we are doing a risk assessment of the business during our audit planning phases.
Auditors need to maintain their skepticism and a questioning mind throughout the audit so that
they can identify fraud risk and critically evaluate audit evidence.
Review Question
Click here to review the solution after you have come up with
an answer.
Week 3
Introduction
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The planning stage of the audit is a perfect opportunity for the CPAs to meet the client
management and its staff. Getting to know the client's business during a face-to-face meeting in
the field and planning how the audit will proceed is a significant event that lays the groundwork
for a successful audit.
The audit staff will interview key people in various departments to determine how the
departments operate and what internal controls are in place. Tests will later be performed on
those internal controls to determine the success or failure of the controls represented.
TCO G, regarding analytical procedures, is the next key area we will review. The audit will also
start the process of performing analytical procedures to determine the testing of various accounts
as TCO F directs. These procedures are necessary at various stages of the audit and serve the
purpose of giving the auditor a basis from which to proceed.
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The primary objective of an audit is to express an opinion on the financial statements. The
clients management asserts that the financial statements are complete, that all recorded assets
and liabilities are the rights and obligations of the business, that there has been proper valuation
or allocation of amounts, that during the accounting period all components of the statements
existed or occurred, and that they have been properly classified and disclosed.
Planning the audit will entail inquiries of any predecessor auditor. Matters to be discussed should
cover such things as reasons for the change in auditors, disagreements over accounting
principles, internal control issues, fraud, and illegal acts and whether they were communicated to
the audit committee.
Preliminary meetings with the client give the auditor and client an opportunity to have an
understanding of the objective of the audit, both parties responsibilities, any engagement
limitations, and any other matters that have significance to the engagement.
An overall audit strategy should include gaining an understanding of the clients business,
analytical procedures required, and having an understanding about materiality and audit risk.
The auditor should go through analytical procedures, such as identifying the relationship of data
to prior periods and current periods, making comparisons of budgets to actual figures, and
identifying any relationships of financial data with nonfinancial data.
When determining materiality, the auditor should determine whether the amount or omission
would affect the judgment of a reasonable person. The auditor will use materiality to help
determine the type and extent of testing necessary to arrive at an opinion of the fair
representation of the financial statements. Efficiency and effectiveness of the audit work are
concerns at this stage in the audit. Professional judgment is used to assess areas of high risk and
total likely misstatement.
A total likely misstatement is often thought of as audit risk. Audit risks include inherent risk,
control risk, and detection risk. These different forms of risk are sometimes within the control of
the auditor and sometimes not within the auditors control. Detection risk relates to the audit
procedures used, and it is within the auditors control to detect a material misstatement existing
in a statements assertion. The other forms of risk are not within the auditors control and exist
independently of the audit.
Review Question
Auditors provide reasonable assurance that the financial statements are fairly
stated, in all material respects. Questions are often raised as to the responsibility
of the auditor to detect material misstatements, including misappropriation of
assets and fraudulent financial reporting.
Click here to review the solution after you have come up with
an answer.
Week 3 Lecture
Review Question #1
a. Auditing standards indicate that reasonable assurance is a high
level of assurance. Accordingly, financial statement users should have
a high degree of confidence in the financial statements. However,
reasonable assurance is not an absolute level of assurance, and there is
at least some risk that the audited financial statements may include
material misstatements.
The auditor may also uncover circumstances during the audit that may cause
suspicions of fraudulent financial reporting. For example, the auditor may find
that management has lied about the age of certain inventory items. When such
circumstances are uncovered, the auditor must evaluate their implications and
consider the need to modify audit evidence.
Segregation of Duties
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video
Tim Gearty, CPA, JD, Becker Professional Review national instructor, explains in
a short but great example the significance of segregation of duties involving
computerized systems where there should be a control group, operators,
programmer, analyst, and librarian.
Gathering Evidence
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In order to perform our audit of the companys financial statements competently, we need to
gather evidence to support our conclusion. Generally, the types of evidence used by auditors
include
When gathering our audit evidence, we consider that the six factors determining the reliability of
evidence are as follows.
6. Timeliness
Review Question
The following are nine situations, each containing two means of accumulating
evidence:
Click here to review the solution after you have come up with
an answer.
Week 3 Lecture
Review Question #2
1. Independence of 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
b. and c.
We have three stages to our auditsplanning, testing, and completion. In all three stages, we use
analytical procedures.
When we plan our audits, we use analytical procedures to determine the nature, extent, and
timing of our audits. We also want to know where the audit risk lies and in what areas of
financial transactions we should concentrate our efforts. So, we perform a year-to-year
comparison of the financial accounts to see if there have been any material changes warranting
further investigation. We may also look to other companies in the same industry as our clients
and do a comparison of financial results. We want to have an understanding of our client so that
we can determine where material misstatements may possibly be occurring.
In the testing phase of our audits, we use analytical procedures to determine whether we have to
expand our audit testing in certain areas. These analytical procedures also give us an indication
that something is materially misstated.
When we are completing our audits, we again turn to analytical procedures to determine if there
are material misstatements and to assess ongoing concern.
Review Question
In the audit of the Worldwide Wholesale Company, you did extensive ratio and
trend analysis. No material exceptions were discovered except for the following:
Week 3 Lecture
Review Question #3
a.
b.
ITEM 1
ITEMS 2 AND 3
Select a sample of the larger inventory items (by dollar value) and
have the client schedule subsequent transactions affecting these
items. Note the ability of the company to sell the items and the
selling prices obtained by the client. For any items that the client is
selling below cost plus a reasonable markup to cover selling
expenses, or for items that the client has been unable to sell, propose
that the client mark down the inventory to market value.
ITEMS 4 AND 5
ITEM 6
Discuss the reason for the reduced depreciation expense with the
client personnel responsible for the fixed assets accounts. If they
indicate that the change resulted from a preponderance of fully
depreciated assets, test the detail records to determine that the
explanation is reasonable. If no satisfactory explanation is given,
expand the tests of depreciation until satisfied that the provision is
reasonable for the year.
Click here to review the solution after you have come up with
an answer.
Practice Exercise
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Match seven of the terms (ak) with the definitions provided below (17).
Definitions
View Answer
h. Fraud
2. A set of six audit objectives the auditor must meet, including timing, posting
and summarization, and accuracy
View Answer
View Answer
f. Management assertions
View Answer
5. A set of nine audit objectives the auditor must meet, including completeness,
detail tie-in, and rights and obligations
b. Tests of controls
d. Analytical procedures
Week 4
Print
Materiality, Risk, and Internal Control
Introduction
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The Sarbanes Oxley Act mandated many new changes to the field of auditing public companies.
The requirement for a specific form of audit committee was one new change. With that change
also came mandates for specific reporting by the auditors that affects how the auditor establishes
materiality and risk standards and assessment of the client's internal controls.
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We were first introduced to the concept of audit committees in Chapter 4 of our electronic
readings. The audit committee for a public company plays a significant role in the audit process.
As we learned from the prior weeks, auditors have special reporting concerns with the audit
committee.
Video
For a more expansive perspective of the audit committee, view the video clip
hosted by Alvin Arens.
Materiality
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When we are planning our audit, we must consider the materiality of the financial information.
Materiality means that if the accounting information is misstated or omitted, it would probably
change or influence the judgment of a reasonable person, which could possibly lead to financial
losses for the users of the financial statements.
Because there is little guidance provided to auditors in the area of materiality, we must use our
professional judgment in determining what financial areas are material and what financial areas
are not.
So when we plan our audit, we need to use our professional judgment about materiality, and we
need to consider
tolerable misstatement;
inherent risk;
risk of fraud;
The audit risk we consider in our audit planning lies in the possibility that the financial
statements prepared by management are materially misstated and that the auditor will not detect
such material misstatements.
We must also remember that when we are planning for a financial statement audit, we must
consider the risk of material misstatements in the financial statements resulting not only from
errors but also from fraud.
As auditors, we aim to reduce this audit risk to a low-enough level that, in our professional
judgment, is appropriate for expressing an opinion on the audit statements.
SAB No. 99: The SEC issued guidance on the need to consider quantitative as well as qualitative
factors in assessing materiality. Read the full text of SAB No.99 at the SEC's website.
Review Question
Please work Review Question 9-25 in the 14th edition..
You are evaluating audit results for current assets in the audit of Quicky Plumbing
Co. You set the preliminary judgment about materiality for current assets at $
15,000 for overstatements and at $ 22,500 for understatements. The preliminary
and actual estimates are shown next.
Accoun
ts
$10,000 $15,000 $9,000 $8,000
receivab
le
Inventor
$15,000 $22,000 $14,000 $5,000
y
Prepaid
$3,000 $5,000 $2,000 $1,000
expenses
Click here to review the solution after you have come up with
an answer.
Week 4 Lecture
Review Question #1
SUMMARY: This staff accounting bulletin expresses the views of the staff that
exclusive reliance on certain quantitative benchmarks to assess materiality in
preparing financial statements and performing audits of those financial
statements is inappropriate; misstatements are not immaterial simply because
they fall beneath a numerical threshold.
Jonathan G. Katz
Secretary
Part 211 - (AMEND) Accordingly, Part 211 of Title 17 of the Code of Federal
Regulations is amended by adding Staff Accounting Bulletin No. 99 to the
table found in Subpart B.
The staff hereby adds Section M to Topic 1 of the Staff Accounting Bulletin
Series. Section M, entitled "Materiality," provides guidance in applying
materiality thresholds to the preparation of financial statements filed with the
Commission and the performance of audits of those financial statements.
*****
M. Materiality
1. Assessing Materiality
Interpretive Response: No. The staff is aware that certain registrants, over
time, have developed quantitative thresholds as "rules of thumb" to assist in
the preparation of their financial statements, and that auditors also have used
these thresholds in their evaluation of whether items might be considered
material to users of a registrant's financial statements. One rule of thumb in
particular suggests that the misstatement or omission2 of an item that falls
under a 5% threshold is not material in the absence of particularly egregious
circumstances, such as self-dealing or misappropriation by senior
management. The staff reminds registrants and the auditors of their financial
statements that exclusive reliance on this or any percentage or numerical
threshold has no basis in the accounting literature or the law.
The FASB noted that, in certain limited circumstances, the Commission and
other authoritative bodies had issued quantitative materiality guidance, citing
as examples guidelines ranging from one to ten percent with respect to a
variety of disclosures.8 And it took account of contradictory studies, one
showing a lack of uniformity among auditors on materiality judgments, and
another suggesting widespread use of a "rule of thumb" of five to ten percent
of net income.9 The FASB also considered whether an evaluation of materiality
could be based solely on anticipating the market's reaction to accounting
information.10
[M]agnitude by itself, without regard to the nature of the item and the
circumstances in which the judgment has to be made, will not generally be a
sufficient basis for a materiality judgment.12
Evaluation of materiality requires a registrant and its auditor to consider allthe
relevant circumstances, and the staff believes that there are numerous
circumstances in which misstatements below 5% could well be material.
Qualitative factors may cause misstatements of quantitatively small amounts
to be material; as stated in the auditing literature:
Among the considerations that may well render material a quantitatively small
misstatement of a financial statement item are
This is not an exhaustive list of the circumstances that may affect the
materiality of a quantitatively small misstatement.15 Among other factors, the
demonstrated volatility of the price of a registrant's securities in response to
certain types of disclosures may provide guidance as to whether investors
regard quantitatively small misstatements as material. Consideration of
potential market reaction to disclosure of a misstatement is by itself "too blunt
an instrument to be depended on" in considering whether a fact is material. 16
When, however, management or the independent auditor expects (based, for
example, on a pattern of market performance) that a known misstatement
may result in a significant positive or negative market reaction, that expected
reaction should be taken into account when considering whether a
misstatement is material.17
For the reasons noted above, the staff believes that a registrant and the
auditors of its financial statements should not assume that even small
intentional misstatements in financial statements, for example those pursuant
to actions to "manage" earnings, are immaterial.18 While the intent of
management does not render a misstatement material, it may provide
significant evidence of materiality. The evidence may be particularly
compelling where management has intentionally misstated items in the
financial statements to "manage" reported earnings. In that instance, it
presumably has done so believing that the resulting amounts and trends
would be significant to users of the registrant's financial statements.19 The
staff believes that investors generally would regard as significant a
management practice to over- or under-state earnings up to an amount just
short of a percentage threshold in order to "manage" earnings. Investors
presumably also would regard as significant an accounting practice that, in
essence, rendered all earnings figures subject to a management-directed
margin of misstatement.
situations may arise in practice where the auditor will conclude that a matter
relating to segment information is qualitatively material even though, in his or
her judgment, it is quantitatively immaterial to the financial statements taken
as a whole.22
Registrants and auditors also should consider the effect of misstatements from
prior periods on the current financial statements. For example, the auditing
literature states,
Section 10A(b) of the Exchange Act requires auditors to take certain actions
upon discovery of an "illegal act."41 The statute specifies that these obligations
are triggered "whether or not [the illegal acts are] perceived to have a
material effect on the financial statements of the issuer . . . ." Among other
things, Section 10A(b)(1) requires the auditor to inform the appropriate level
of management of an illegal act (unless clearly inconsequential) and assure
that the registrant's audit committee is "adequately informed" with respect to
the illegal act.
The requirements of Section 10A echo the auditing literature. See, for
example, Statement on Auditing Standards No. ("SAS") 54, "Illegal Acts by
Clients," and SAS 82, "Consideration of Fraud in a Financial Statement Audit."
Pursuant to paragraph 38 of SAS 82, if the auditor determines there is
evidence that fraud may exist, the auditor must discuss the matter with the
appropriate level of management. The auditor must report directly to the audit
committee fraud involving senior management and fraud that causes a
material misstatement of the financial statements. Paragraph 4 of SAS 82
states that "misstatements arising from fraudulent financial reporting are
intentional misstatements or omissions of amounts or disclosures in financial
statements to deceive financial statement users."42 SAS 82 further states that
fraudulent financial reporting may involve falsification or alteration of
accounting records; misrepresenting or omitting events, transactions or other
information in the financial statements; and the intentional misapplication of
accounting principles relating to amounts, classifications, the manner of
presentation, or disclosures in the financial statements.43 The clear implication
of SAS 82 is that immaterial misstatements may be fraudulent financial
reporting. 44
Some have argued to the staff that registrants should be permitted to follow
an industry accounting practice even though that practice is inconsistent with
authoritative accounting literature. This situation might occur if a practice is
developed when there are few transactions and the accounting results are
clearly inconsequential, and that practice never changes despite a subsequent
growth in the number or materiality of such transactions. The staff disagrees
with this argument. Authoritative literature takes precedence over industry
practice that is contrary to GAAP.49
General Comments
This SAB is not intended to change current law or guidance in the accounting
or auditing literature.50 This SAB and the authoritative accounting literature
cannot specifically address all of the novel and complex business transactions
and events that may occur. Accordingly, registrants may account for, and
make disclosures about, these transactions and events based on analogies to
similar situations or other factors. The staff may not, however, always be
persuaded that a registrant's determination is the most appropriate under the
circumstances. When disagreements occur after a transaction or an event has
been reported, the consequences may be severe for registrants, auditors, and,
most importantly, the users of financial statements who have a right to expect
consistent accounting and reporting for, and disclosure of, similar transactions
and events. The staff, therefore, encourages registrants and auditors to
discuss on a timely basis with the staff proposed accounting treatments for, or
disclosures about, transactions or events that are not specifically covered by
the existing accounting literature.
Footnotes
1 American Institute of Certified Public Accountants ("AICPA"),
Codification of Statements on Auditing Standards ("AU") 312,
"Audit Risk and Materiality in Conducting an Audit," states that the
auditor should consider audit risk and materiality both in (a)
planning and setting the scope for the audit and (b) evaluating
whether the financial statements taken as a whole are fairly
presented in all material respects in conformity with generally
accepted accounting principles. The purpose of this Staff Accounting
Bulletin ("SAB") is to provide guidance to financial management and
independent auditors with respect to the evaluation of the
materiality of misstatements that are identified in the audit process
or preparation of the financial statements (i.e., (b) above). This SAB
is not intended to provide definitive guidance for assessing
"materiality" in other contexts, such as evaluations of auditor
independence, as other factors may apply. There may be other rules
that address financial presentation. See, e.g., Rule 2a-4, 17 CFR
270.2a-4, under the Investment Company Act of 1940.
4 TSC Industries v. Northway, Inc., 426 U.S. 438, 449 (1976). See also
Basic, Inc. v. Levinson, 485 U.S. 224 (1988). As the Supreme Court
has noted, determinations of materiality require "delicate
assessments of the inferences a 'reasonable shareholder' would
draw from a given set of facts and the significance of those
inferences to him . . . ." TSC Industries, 426 U.S. at 450.
1 The staff understands that the Big Five Audit Materiality Task Force
5 ("Task Force") was convened in March of 1998 and has made
recommendations to the Auditing Standards Board including
suggestions regarding communications with audit committees about
unadjusted misstatements. See generally Big Five Audit Materiality
Task Force, "Materiality in a Financial Statement Audit Considering
Qualitative Factors When Evaluating Audit Findings" (August 1998).
The Task Force memorandum is available at www.aicpa.org.
2 See, e.g., In the Matter of W.R. Grace & Co., AAER 1140 (June 30,
0 1999).
2 AUI 326.33.
1
2 Id.
2
2 AU 508.36.
5
2 AU 312.34
6
2 AU 380.09.
7
3 15 U.S.C. 78o(d).
1
3 So far as the staff is aware, there is only one judicial decision that
4 discusses Section 13(b)(2) of the Exchange Act in any detail, SEC v.
World-Wide Coin Investments, Ltd., 567 F. Supp. 724 (N.D. Ga.
1983), and the courts generally have found that no private right of
action exists under the accounting and books and records provisions
of the Exchange Act. See e.g., Lamb v. Phillip Morris Inc., 915 F.2d
1024 (6th Cir. 1990) and JS Service Center Corporation v. General
Electric Technical Services Company, 937 F. Supp. 216 (S.D.N.Y.
1996).
3 Id. at 46 FR 11546.
6
3 Id.
7
4 Id., at 11547.
0
Under SAS 82, assessing whether misstatements due to fraud are material to
the financial statements is a "cumulative process" that should occur both
during and at the completion of the audit. SAS 82 further states that this
accumulation is primarily a "qualitative matter" based on the auditor's
judgment. AU 316.33. The staff believes that in making these assessments,
management and auditors should refer to the discussion in Part 1 of this SAB.
The auditor should inform the audit committee about adjustments arising from
the audit that could, in his judgment, either individually or in the aggregate,
have a significant effect on the entity's financial reporting process. For
purposes of this section, an audit adjustment, whether or not recorded by the
entity, is a proposed correction of the financial statements....
4 See AU 411.05.
9
http://www.sec.gov/rules/acctrps/sab99.htm
Internal Control
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The internal control safeguards that a client institutes help to prevent, correct, and detect
material misstatements affecting the overall reliability and fairness of the financial
statements. As such, the auditor will seek to evaluate the internal controls to determine whether
they are adequate and whether they are being implemented as designed.
The strength of the control environment begins at the top of the organization. The management's
handling of issues affecting internal control set the tone of the control environment. The control
environment will influence the ethical behavior and integrity of the personnel who are
responsible for the financial representations on which the auditor bases his or her opinions. The
auditor will look for the client to clearly communicate and administer the controls with a
commitment to competency in the workplace. Management's operating style, human resource
policies and procedures, sense of accountability, and the organizational structure are evaluated
closely by the diligent auditor to assess the overall audit plan that should apply to that specific
client.
Ultimately, it is the auditors professional judgment of the internal control environment that
determines the extent of substantive procedures and timing of those procedures the auditor will
perform over the course of the audit. A weak environment will demand more substantive testing
at the balance sheet date, rather than on interim dates. If the environment has strong controls, the
auditor might decide that interim testing and less overall testing will be sufficient. More testing
leads to higher audit fees. This is the trade-off the client will want to be made aware of when
designing and implementing its entity's internal control policies and procedures.
Practice Exercise
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a. Business risk
b. Preliminary judgment about materiality
c. Inherent risk
d. Planned detection risk
e. Audit assurance
f. Acceptable audit risk
g. Tolerable misstatement
h. Control risk
i. Materiality
a. Business risk
h. Control risk
g. Tolerable misstatement
Match seven of the terms (ai) with the definitions provided below (17).
a. Control environment
b. Control activities
d. Internal control
e. Monitoring
f. Separation of duties
g. General authorization
h. Specific authorization
i. Risk assessment
e. Monitoring
g. General authorization
a. Control environment
4. Segregation of the following activities in
an organization: custody of assets,
accounting, authorization, and operational
responsibility
f. Separation of duties
i. Risk assessment
b. Control activities
d. Internal control
Week 5
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This week, we begin our journey into understanding the client's internal controls of the
information technology (IT) system.
Videos
These two very informative and entertaining clips will provide you with an
excellent oversight of internal control over the client's computer based technology.
Review these videos to gain an overall understanding of the IT internal control
concepts.
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The CPA exam tests the candidate's understanding of the significance of IT systems and how that
affects the auditor. This is done in both the audit exam and in the business environment concepts
exam.
Most businesses in the United States use some form of technical information systems to manage
their financial accounts. To imagine a Fortune 500 business not using a computerized system,
you would have to think back to pre-1980. However, once you move out of the range of mid- to
large-sized businesses, you would discover that use of sophisticated computerization in the small
business community is not as widespread. Those smaller businesses will still sometimes require
the services of the auditor. Even if you are fortunate enough to not have any smaller, computer-
less clients, an auditor must consider that the client's computerized system could be severely
corrupt and unreliable. Therefore, an astute auditor must understand how to audit around the
computerized accounting system.
As we learned last week, the auditor must have an understanding of the client's internal controls.
This includes the IT system. Under GAAS, the CPA auditor must document how he or she
evaluated the internal controls of the IT system and determined the degree of risk the IT system
presents. The risk includes reliance on inaccurate systems; unauthorized access to data leading to
inaccurate data; unauthorized changes to the data, system, or programs; and failure to make
relevant and required updates to the programs or systems.
A clients IT system is affected by the software, hardware, data, personnel, and network on which
the system is set up. A weakness in any of these areas is a weakness in the internal control of the
system. The system itself consists of accounting information, transaction processing, decision
support, management information, and executive information systems. Each of these systems
interacts with at least one other system in the series. The accounting information system creates
an excellent audit trail for accounting transactions. The auditor can determine whether the
accounting transactions are valid, properly classified, recorded at their proper values in the
proper accounting period, and fairly represented on the financial statements.
The readings and homework assignment this week will assist you greatly in understanding the
auditors internal control concerns involving the IT system and how the auditor works with those
systems.
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Businesses and auditors are certainly concerned with the governance of IT. The IT Governance
Institute (www.itgi.org) has developed a wide range of excellent resources for organizations and
auditors to use in looking at IT governance matters.
The use of technologies leads to different risks that the organization needs to manage to make
sure that IT supports the implementation of the organizations strategy and goals. IT governance
is an important part of the internal control environment. The board and senior management are
responsible for IT governance.
Auditors will likely consider the extent of the boards and senior managements involvement in
overseeing IT governance, which information would likely be used in the auditors evaluation of
the companys control environment, and the general controls over IT.
http://www.isaca.org/Knowledge-
Center/Research/Documents/An-Executive-View-of-
IT-Gov-Research.pdf
Week 6
Introduction
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Auditors are concerned with performing a sufficient audit in order to be able to have a reasonable
basis for rendering an opinion on the client's financial statements. Therefore, auditors employ
sampling techniques to help them determine where to most beneficially allocate their audit
resources for a proper result.
Sampling Risk
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Videos
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In nonstatistical sampling, the auditor's sample size is not determined mathematically. Instead,
the auditors will use their professional judgment to determine the sample size and analyze the
results of the sample taken.
Attribute sampling and variable and PPS sampling are other means of sampling that the auditor
relies upon during the audit. Attribute sampling is primarily used for testing internal controls,
whereas variable sampling and PPS sampling are typically used in substantive tests of account
balances, gathering evidential material, or verifying numbers.
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An auditor will perform tests of controls and substantive tests of transactions when testing how
effective the internal controls are and determining the rate of monetary misstatements.
On the other hand, the auditor will test the details of balances when there is a concern that the
monetary amount of the account balance is materially misstated.
Monetary unit sampling is used in audit sampling for tests of details of balances. Indeed, it is the
commonly used method of statistical sampling for tests of details of balances because
it is easy to use;
it can decrease audit cost because several sample items are tested at once;
and
it provides a statistical result in dollars, which can help the auditor make
more defensible conclusions.
Because there is a greater likelihood of higher cost items being selected for
the sample, there is a lesser likelihood that this account will be in the audit
sample if the auditor suspects an account balance may be understated.
http://www.nysscpa.org/cpajournal/2005/50
5/essentials/p36.htm
Revenue Recognition
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In their audits of the sales and collection cycle, the auditors use the sales cutoff test to see if the
sales were recorded in the proper period. There is always the potential for the client holding the
books open and recording January sales as December sales, therefore overstating sales, accounts
receivable, operating income, and total assets.
Typically, the auditor will perform the sales cutoff date as of the balance sheet date. The auditor
will select invoices from those recorded in the sales journal prior and subsequent to year-end,
typically for 5 to 10 days. The auditor will compare the terms on the invoices to the terms on the
shipping documents to make sure that the sales have been recorded in the correct year.
Due to the huge potential for fraud in the area of revenue recognition, which poses considerable
audit risks to the auditor, the auditor must take extreme care in this area in order to preserve the
integrity of the damaged financial reporting process. Such damage that has been imposed on this
process has resulted from recent financial frauds, of which the public is well aware.
IFRS UPDATE
More specific
differences occur
while assessing the
completion of the earning cycle,
particularly when evaluating the sale
of goods, rendering of services,
multiple elements, deferred receipt of
receivables, and construction
contracts. For more detailed analysis
of these differences, please refer to
SAB 104 and IAS 18.
http://www.sec.gov/interps/account/sab101.
htm
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Dear student,
In an effort to enhance your comprehension of this difficult subject and to introduce you to some
of the tools available from Becker Professional Education, you are being given access to a series
of links (see below) to Becker CPA Review materials on Sampling and Communications.
We hope you find this access to be an excellent complementary resource for you during Week 6
of this course. However, it must be emphasized that your eBook readings and other assigned
materials for this week will be covered in the graded assessments for this course, so you will
want to focus on those as you prepare for any exams, projects, quizzes, etc.
Week 7
Introduction | Check Fraud | The Accounts Payable Cycle | The Inventory Cycle |
Completing the Audit | Practice Exercise
Introduction
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We are entering our final week of lectures together and the end of the auditing cycle. We start
this lecture with a review of the concepts of check fraud. The accounts payable cycle is the
prelude to the client acquiring inventory. We also focus on the final work of the audit to arrive at
our audit report. The subsequent events and final analysis stage are where the auditor can
determine if the financials taken as a whole fairly represent the financial condition of the client's
business.
Check Fraud
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The tests of acquisition and cash disbursement transactions have two purposes.
employees causing their employers to pay for fictitious invoices for goods and
services;
Auditors need to be aware of such schemes to properly prepare their audits of the acquisition and
payment cycles.
Videos
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Accounts payable is an audit area that is concerned with the specific issues of unrecorded
liabilities and the proper recording of purchases.
In the search for unrecorded liabilities, the auditor reviews the supporting documentation for
significant cash disbursements after year-end to the last day of the auditor's fieldwork to
determine whether they are disbursements for transactions that occurred in the year of audit. If
they are, then the expenses should be accrued and added to accounts payable. Also, the auditor
should review all significant unpaid invoices to determine whether any should be accrued as of
the end of the year. If this is the case, the invoices should also be included in accounts payable.
Regarding the proper recording of purchases, for all significant purchases in the purchases
journal for a period prior to and subsequent to the year-end, the auditor should examine the
supporting documentation to determine whether the purchase was recorded for the proper period.
Further, on the last day of the year, the auditor should observe that the last receiving report is
issued, and the auditor should then review a sample of the supporting documents of prior and
subsequent reports to verify that each purchase was recorded in the proper period.
IFRS UPDATE
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there are several acceptable methods of valuing inventory, and some entities
use different methods for different types of inventory.
Further, inventory is a category that has been highly susceptible to fraudulent manipulation. In
the past 50 years, some of the companies that have been involved in inventory manipulations
include McKesson and Robbins, Equity Funding, ZZZZ Best, Phar-Mor, Rite Aid, and Crazy
Eddie's.
For example, Phar-Mor significantly overstated the value of its inventory and then moved
inventory back and forth between stores so that it could be counted multiple times. In the case of
Rite Aid, this corporation overstated net income by managing the value of its inventory. That is,
the senior management allegedly failed to record millions in shrinkage of its physical inventory
due to loss or theft. They also made journal entries that lowered the cost of goods sold.
When auditing inventory, therefore, auditors should consider using analytical analyses for
accounts where inventory-related financial statement fraud symptoms are generally present, such
as
inventory;
accounts payable;
cash; and
cost of goods sold.
Consequently, some of the analytical procedures the auditor might consider using might include
the following.
IFRS UPDATE
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When we are ready to wrap up the audit, we also have the responsibility to consider other audit
procedures in areas that could potentially have a material impact on disclosure and financial
statement presentation.
Contingent liabilities are future obligations to an outside party for an unknown amount resulting
from activities that have already taken place. Examples include
There are events that have a direct effect on the financial statements and
require adjustment, such as declaration of bankruptcy by a customer with an
outstanding accounts receivable balance due to deteriorating financial
conditions and settlement of litigation at an amount different from the
amount recorded on the books.
There are events that have no direct effect on the financial statements but for
which disclosure is advisable, such as
Practice Exercise
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e. No action is required.