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.
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.
Who is responsible for ensuring the entity conducts business in accordance with applicable laws and regulations?
Management
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.
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
The auditor is responsible for obtaining sufficient evidence of compliance with laws and regulations that have a [2 words] on the FS.
direct effect
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
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.
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.
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.
Define estimation uncertainty.
The susceptibility of an accounting estimate to an inherent lack of precision in its measurement.
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
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
True / False: Certain accounting estimates require special audit consideration.
True
If the account is deemed a significant risk, then special audit activities are required.
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
What are the possible sources of contingent liabilities?
Pending or threatened litigation
Actual or possible claims and assessments
Product warranties
Income tax disputes
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.
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
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
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.
Who is included as a related party?
The entity's affiliates
principal owners
management
and members of their immediate families
When related-party transactions are involved, the auditor should be concerned about which 2 assertions?
Accuracy
Completeness
Accurately captured and disclosed.
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
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
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.
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.
