AUD 3.04 - Specific Areas of Engagement Risk

  1. Define noncompliance (corruption)
    • An act of omission or comission by an entity, whether intentional or unintentional, which is contrary to prevailing laws and regulations.
    • It does not include personal misconduct unrelated to the entity.
    • But does include acts by personnal or governance on behalf of the entity.
  2. In what manner may noncompliance have an affect on the FS?
    Noncompliance can result in fine, litigation, suspension of ability to do business, or other consequences.
  3. Who is responsible for ensuring the entity conducts business in accordance with applicable laws and regulations?
  4. What is the auditor's responsibility with regarding to determining an entity's compliance?
    The auditor is responsible for obtaining reasonable assurance that the FS (not the entire company) are free of material misstatement due to noncompliance with laws and regulations.
  5. True / False: If a potential noncompliance issue is discovered, the auditor is responsible for the investigation of whether the act constitutes noncompliance.
    • False
    • The auditor has neither the authority to perform an investigation nor ability to make legal determination regarding compliance
  6. The auditor is responsible for obtaining sufficient evidence of compliance with laws and regulations that have a [2 words] on the FS.
    direct effect
  7. What activities should the auditor perform when the provisions of laws and regulations directly influence operations such that it could have a material effect on the FS (indirect effect)?
    • Inquire of mgmt and those charged with governance about whether the entity is in compliance
    • Get signed management rep. letter
    • Inspect correspondence with relevant licensing and regulatory authorities
  8. What is the auditor's responsibility if noncompliance is suspected?
    • Discuss with management at least one level above those suspected of noncompliance and, when appropriate, those charged with governance.
    • Consult with in-house counsel if the entity's response is not sufficient.
    • Certain instances must be reported outside the entity (separate flashcard)
    • Possibly withdraw from the engagement.
  9. When is the auditor required to disclose potential noncompliance outside the entity?
    • In response to inquiries from an auditor to a predecessor auditor
    • In response to a court order
    • In compliance with requirements for the audits of entities that receive federal financial assistance from a government agency.
  10. Does noncompliance change the auditor's report and, if so, how?
    • If the noncompliance has a material effect on the FS and has not been adequately reflected in the FS, issue a modified (qualified) or adverse opinion (GAAP issue).
    • If the auditor is unable to obtain sufficient appropriate evidence, issue a qualified (modified) or disclaimer of opinion (GAAS issue due to scope limitation).
    • If the client refuses to accept an opinion other than unmodified (unqualified) then withdraw.
  11. Define estimation uncertainty.
    The susceptibility of an accounting estimate to an inherent lack of precision in its measurement.
  12. Which accounts involve relatively low estimation uncertainty
    • When entities that are not complex
    • Estimates related to routine transactions that are frequently updated
    • Estimates derived from readily available data (interest-rates, exchange-traded securities)
    • Fair value estimates when easy to determine based on the reporting framework, or when the model used is well-known and inputs are easily observable in the marketplace
  13. Which accounts involve relatively high estimation uncertainty?
    • Due to litigation
    • For derivative financial instruments not publicly traded
    • Fair value estimates involving specialized, entity-developed models, or when inputs cannot be observed in the marketplace
  14. True / False: Certain accounting estimates require special audit consideration.
    • True
    • If the account is deemed a significant risk, then special audit activities are required.
  15. What are the indicators of possible management bias with respect to estimates?
    • Changes in accting estimate or method when mgmt has made a subjective assessment that there has been a change in circumstances
    • Use of in-house estimates despite available market estimates
    • Use of significant assumptions that yield a point estimate favorable for mgmt objectives
    • A consistent use of a point estimate that indicates a pattern of optimism or pessimism
  16. What are the possible sources of contingent liabilities?
    • Pending or threatened litigation
    • Actual or possible claims and assessments
    • Product warranties
    • Income tax disputes
  17. Under GAAP, when must contingent liabilities be estimated vs accrued vs disclosed?
    • Accrued & Disclosed: When the liability is probable and reasonably estimatable
    • Disclosed Only: If probable, but not estimatable.
  18. How does the auditor discover contingencies?
    • Inquire of management
    • Review minutes of the BoD, executive committees, stockholders
    • Review contracts, loan agreements, loan guarantees, leases, and correspondence from taxing authorities; discuss the status with the appropriate manager
    • Review bank confirmations for hidden bank loans, discounted drafts, guarantee of notes, etc
    • Discuss long-term purchase committments with the purchasing agent
    • Review the interim FS after year-end
    • Obtain a client representation letter
    • Send an inquiry letter to the client's attorneys
  19. For discovered contingencies, what 2 questions must be satisfied with audit evidence?
    • Documentation of the underlying cause for legal action
    • The degree of probability of an unfavorable outcome
    • The amount or range of potential loss
  20. True / False: A related-party transaction is assumed to be arms-length unless evidence indicates otherwise.
    • False
    • Because it's nearly impossible to determine if a related-party transaction would have been exactly the same if it were not a related party, it is assumed that the transaction is not arms-length.
  21. Who is included as a related party?
    • The entity's affiliates
    • principal owners
    • management
    • and members of their immediate families
  22. When related-party transactions are involved, the auditor should be concerned about which 2 assertions?
    • Accuracy
    • Completeness
    • Accurately captured and disclosed.
  23. What types of items would indicate a related-party transaction?
    • Compensating balance arrangements (which may be maintained by or for related parties)
    • Loan guarantees
    • Unusual, nonrecurring transactions near year-end
    • Transactions based on terms that differ significantly from market terms
    • Nonmonetary exchanges
  24. What audit procedures must be performed to identify related party (RP) transactions?
    • Discovery/Identification
    • Review material transactions including bank statements, minutes of meetings, prior years' audit documentation, SEC or regulatory filings
    • Inquire of the predecessor auditor
    • Inquire of mgmt and those charged with governance, including unauthorized or unapproved RP transactions & the reasons for these violations
    • Evaluate the entity's process, including controls, for identifying, authorizing, and approving.
    • Determine how the entity accounts for and discloses
    • Once RP transactions are discovered
    • Obtain a conflict of interest statement from the client
    • Obtain a list from mgmt that includes names, background info, nature of the relationship, and any changes to the transactions
  25. The auditor discovers a related-party transaction that does not appear to be consummated at arms-length, and management is unwilling to disclose this fact. Does this affect the auditor's report and, if so, how?
    The auditor should express a qualified (modified) or adverse opinion.
  26. Doug owns 60% of ABC Co. ABC Co purchased a building from Doug for $15M, although its fair market value is $40M. What should the auditor ensure has occurred with regard to this transaction?
    The auditor should verify that this related party transaction is recorded at $15M and disclosed in the FS notes.
Card Set
AUD 3.04 - Specific Areas of Engagement Risk
Becker Review 2017