Audit Exam 2

  1. What is the purpose of an engagement letter, who prepares it and when?
    • Purpose: To eliminate misunderstandings between the
    • CPA firm and the client.

    • Who Prepares it and when: The CPA firm prepares it. It is signed by the CPA firm and client and
    • is written prior to beginning the engagement.
  2. What is the auditor’s responsibility for detecting fraud? What are the conditions for
    fraud? Give examples of each.
    Conditions for fraud:

    • 1. Pressure or an incentive to commit fraud
    • a. Bonus,performance of company, stock price, keeping job

    • 2. A perceived opportunity to do so
    • a. Ability to override controls

    • 3. Attitude/rationalization- ability to justify fraud
    • a. Save the company, did it for the company
  3. What are the two types of misstatements arising from fraudulent activities and describe each?
    • Fraudulent financial reporting- intentional misstatements, omissions of amounts or
    • disclosures in the financial statements. Generally committed by management to
    • deceive financial statement users.

    • Misappropriation of assets - theft of an entity’s assets, also referred to as
    • defalcation. Committed usually by employees against the entity.
  4. In direction of testing, how do you verify existence? Completeness?
    • Verify Existence – ledger or recorded amounts -> source documents or assets
    • a. Ex. Go find the asset ( look at the building or land)

    • Verify Completeness- source documents or assets -> Ledger or recorded amounts
    • a. Pick a transaction and follow it through the accounting process.
  5. Regarding timing of field work, what activities are performed prior to the Balance Sheet Date,
    Year End, and After Year End?
    • Prior to the balance sheet date:
    • a. Testing internal controls
    • b. Audit of assets and prior accounts
    • c. Recorded liabilities

    • Year end:
    • a. Exam for proper cut-off of revenues and expenses
    • b. Complete testing of internal control and assets

    • After year end:
    • a. Search for unrecorded liabilities
    • b. Examine for subsequent events
    • c. Complete audit
    • d. Issue management letter
    • e. Issue audit report
  6. Describe the characteristics, advantages and disadvantages of the three approaches to
    documenting your study of internal control.
    Internal Control Questionnaire

    • Advantages
    • i. Easy to complete
    • ii. Comprehensive list of questions make it unlikely that important portions of internal control will be overlooked
    • iii. Weaknesses become obvious

    • Disadvantages
    • i. May be answered without adequate thought being given to the questions
    • ii. Questions may not fit client
  7. Describe the characteristics, advantages and disadvantages of the three approaches to
    documenting your study of internal control.
    Memorandum (written narrative)

    • Advantages
    • i. Tailor made for engagement
    • ii. Requires a detailed analysis and thus forces auditor to understand functioning of structure

    • Disadvantages
    • i. May become very long and time consuming
    • ii. Weaknesses in structure not always obvious
    • iii. Auditor may overlook important portions of the internal control structure
  8. Describe the characteristics, advantages and disadvantages of the three approaches to
    documenting your study of internal control.
    Flow chart

    • Advantages
    • i. Graphic representation of structure
    • ii. Usually makes it unlikely that important portions of internal control will be overlooked iii. Good for EDP system
    • iv. No long wording

    • Disadvantages
    • i. Preparation is time consuming
    • ii. Weakness in structure not always obvious.
  9. Discuss the characteristics of the two levels of assessing internal control, documentation
    requirements and how each relates to substantive testing.
    At the maximum level

    Greater probability that material misstatements could occur in financial statements and not be prevented or detected by internal control. Used when control procedures are absent or unlikely to be effective or evaluating effectiveness is not audit efficient. Auditor documents conclusion and goes to substantive testing. Does not perform test of controls.
  10. Discuss the characteristics of the two levels of assessing internal control, documentation
    requirements and how each relates to substantive testing.
    Below the maximum level

    Auditor determines that control procedures have been designed to detect or prevent material misstatements. Assessed level at which reliance may tentatively be placed on internal control. More evidence is needed to evaluate effectiveness of design and operation of internal controls. Auditor conducts tests of controls to evaluate effectiveness of controls. Auditor then reassesses control risk and documents conclusion and basis for conclusion. The auditor the develops substantive tests (minimum level).
  11. How does the external auditor evaluate internal auditor and how does reliance on internal
    auditor’s work impact the external audit?
    • The independent auditor should obtain and understand the work of the internal auditors to
    • determine its relevance to the audit

    Auditor must assess the internal audit staff in:

    • a. Competence
    • i. Education level,professional experience and professional certifications

    • b. Objectivity
    • i. Consider the organizational status of the director of internal audit, including whether the
    • director reports to and officer of sufficient status to ensure broad audit coverage, and has direct access to the audit committee of the board of directors
  12. What are the objectives of substantive tests and tests of controls?
    • Substantive tests
    • Are designed to detect material misstatements in the financial statements. Consists of analytical procedures and detail tests of transactions. Determines that account balances are accurate

    • Test of controls
    • Are used to determine the effectiveness of internal control procedures – are controls
    • actually working properly?
  13. Define Kiting
    Kiting - Improper cut-off of cash involving bank transfers around the Balance Sheet date resulting in a pad of cash position, concealment of cash shortage, or concealment of a bank overdraft
  14. Define Lapping
    Lapping - the concealment of a cash shortage by delaying the recording of cash receipts
  15. What is the best procedure to detect kiting?
    The best procedure to detect kiting is preparation and analysis of a bank transfer schedule.
  16. What is the best procedure to detect lapping?
    • 1. confirm A/R on a suprise basis using postive confirmation
    • 2. compare customer remittance advices to cash receipts journal, customer ledger accts, and deposit slips
    • 3. verify property of noncash credits to accts receivable
    • 4. Perform a surprise inspection of deposits and cash on hand
    • 5. foot cash receipts journal, cust. ledger acct and A/R control acct
    • 6. reconcile balance per customer accounts with control account
    • 7. compare monthly cust. statements with info. per cust. ledger accounts.
    • 8. Use analytical procedures to calculate the age of A/R and the turnover of A/R. Lapping increases the age and decreases turnover of A/R.
  17. Padding a cash postion
    Practice of recording transfer as a deposit in one accounting period and as a disbursement in subsequent accounting periods causing total cash to be inflated.
  18. Concealment of a cash shortage
    Conceals cahs shortage in bank. Transfer brings bank account into agreement with books.
  19. What is a cut off bank statement?
    A cut-off bank statement is a bank statement covering a specified number of busn. days after the clients balance sheet date.
  20. What is the purposes of obtaining a cut off bank statement?
    Auditors use this statement to dertermine that reconciling items are shown on the year end bank statement acre complete and have cleared the bank wiin a reasonable time Used to test teh accuracy of the year end reconcilation of the company's bank accounts. Allows the auditors to examine firsthand the checks listed as outstanding and the details of desposits in transit on the company's reconcilation.
  21. Is the confirmation of accounts receivable a generally accepted auditing procedure?
  22. What are the reasons for confirming accounts receivables?
    By confirming an account receivable, the auditors prove that the receivable and the customer exist.
  23. What type of confirmation should you use to confirm?
    • Two methods in which the client makes the
    • formal request:

    • Positive confirmations – request addressed to the debtor asking
    • for a reply
    • •Blank forms – leave amount blank

    • Negative confirmations – ask debtor to advise the auditors only
    • if the balance shown is incorrect
    • •Low level of assessed risk of
    • material misstatement
    • •Large number of small balances
  24. When during the audit should we confirm?
    • During the interim period:
    • -conditions: strong internal control is believed to exist
    • -purpose: test internal control effectiveness

    • At or near balance sheet date:
    • -conditions: where internal controls exist
    • -purpose: substantive test to determine if customer acct. balances are accurate
  25. What types of accounts should we confirm?
    accounts with relevant parties, accoutn with credit balance, account in dispute, account of customers having financial dificulties
  26. If we do not receive a response or can't confirm, what alternative procedures may we use?
    1. Examin the audit trail
Card Set
Audit Exam 2
Audit Exam 2 Major Questions