Audit Exam 2

• 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.

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

• 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.

• 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.

• 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

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

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

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.

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.

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).

• 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

• 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?

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

Lapping - the concealment of a cash shortage by delaying the recording of cash receipts

The best procedure to detect kiting is preparation and analysis of a bank transfer schedule.

• 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.

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.

Conceals cahs shortage in bank. Transfer brings bank account into agreement with books.

A cut-off bank statement is a bank statement covering a specified number of busn. days after the clients balance sheet date.

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.

yes

By confirming an account receivable, the auditors prove that the receivable and the customer exist.

• 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

• 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

accounts with relevant parties, accoutn with credit balance, account in dispute, account of customers having financial dificulties

1. Examin the audit trail