Audit Exam 3

Complexity in applying cost flow assumption (e.g. dollar value LIFO)

susceptibility to theft

lower-of-cost-or-market (LCM) valuation

effects on gross profits

bill of materials (prenumbered)

Job cost sheet (prenumbered)

labor cost distribution

materials requisition (pre numbered)

routing sheet

sales forcast

time cards/job tickets

stores control (raw materials)

production (WIP)

Warehouse (finished goods)

payroll accounting

inventory accounting (costing; overhead allocation)

• Production runs are authorized
• Raw materials are counted and inspected
• As production takes place, materials and labor quantities are summarized
• All inventory items are accounted for
• Use of transfer tickets
• Count/inspect the items and compare quantities
• Cost accounting dept. reviews

• Observe separation of duties
• Vouch costs to labor and materials reports
• -Time tickets
• -receiving reports
• -transfer tickets
• Check for proper authorizations
• Examine review of cost reports

• Physical observation of inventory count
• Tests of pricing and compilation (using client's cost flow assumption)
• Tests of compilation (extensions, footings, tracing)
• Analytical procedures
• ---excessive inventory
• ---slow moving inventory

....make, or observe, some physical counts of inventory and apply appropriate tests of intervening transactions"

• Verfity cutoffs for purchases and sales
• -examine receiving reports and vendor invoices occurring around year-end (purchases)
• -examine bills of lading and sales invoices copies (sales)
• -Consider terms of purchases and sales (FOB shipping point; FOB destination)
• -Agree to inclusion/exclusion from inventory at balance sheet date

• Watch for uncontrolled access to inventory
• Focus on high-dollar items that are easily marketed
• Be unpredictable when taking test counts
• Be skeptical of large differences between counts and inventory records
• Be alert for damaged inventory
• Follow up on unusual interplant transfers

• Lease Accounting
• Loan covenants
• Related party TRX
• Complex TRX
• Impairment of assets

• Carryforward schedules of account changes
• Analysis of current period activity
• Evaluation of Controls concurrent with application of substantive procedures
• Audit of related accounts simultaneously
• Evidence gathering for all trx above materiality threshold
• Confirmation with outside parties

• Transactions authorized by BOD
• Documentation
• -Investments in securities
• -PP&E
• -Bonds and notes payable
• -Stockholders Equity
• Cash Receipts/disbursements

• Physical controls:
• securites CUSIP numbers recorded
• securities recorded in client's name
• securities held by independent custodian
• access to safe deposit box requires more than one employee
• Physical items periodically compared to detail records

• Separation of duties:
• trx authorized by BOD
• external custodian has custody of stock and bond certificates

• Performance Reviews:
• compare current investing and cycle trx data against prior year and expected
• Compare revenue and expenses against org. stds. or expectations
• Compare trx on monthly stmt to cash receipts/disbursements

• Agree to beginning balance and confirm with holders or makers
• Loan/bond Proceeds
• -Vouch to cash receipts
• -recalculate discount/premiums
• -confirm liability amount, examine note

• Loan Payoff
• -recaluclate interest expense and accrual
• -recalculate premium or discount amortizations
• -recalculate gain/loss on early retirement
• -verify cash disbursements

• Interest Payments
• -recaculate interest expense

• Search for unrecorde liabilites
• -inquiry of mgmt
• -bank confirmations
• -unusual amounts of interest expense
• -large receipts of cash during the year

• Ensure Debt covenants are satisfied
• -inspect loan agreements
• -consider going concern
• -ensure proper presentation and disclosure

• Paid-in Capital
• Agree balances to prior year documentation
• Examine issuances an repurchases of Capital Stock

• Retained Earnings
• Agree beginning balances with prior year documentation
• Verify the appropriateness of prio-period adjustment treatment
• Trace net income/loss to income statement
• Ensure that dividends are properly authorized by BOD

• Agree beginning balances to prior year documentation
• Review Client's policies and procedures
• Purchases of Investments

updates records based on info from transfer agent

• similar to registrars and transfer agents
• can handle ownership of bonds

• an intermediary that handles company bonds and stocks
• tracks securities owners for payment of interest and dividends

• Vouch to broker's advice, cash receipts records and board minutes
• Recalculate gain or loss on sale
• Read minutes for sales of investments and trace to recording
• Trace cash Receipts to cahs receitps journal and bank stmt

• Valuation of Investments
• Propriety, effectiveness, and risk disclosure of derivative securites used as a hedge
• Determination of the FV of derivatives and securities
• Determination of significant influence relationship for equity method investments

• Review stocks held by client for dividend pmts (Moody's, Standard and Poor's)
• If securities held by broker review monthly statements for dividends
• Trace Dividend receibed to cash receipts records

• Mgmt's responsibility
• Market based values preferred
• If not available, use assumptions market would have used
• If not known, mgmt can use its own assumptions if no contrary data

• Examples: Interest, property taxes, wages, income taxes
• Not normally invoiced or evidenced by receipt of goods
• More difficult to detect unrecorded accruals

• Agree balances to prior year workpapers
• Verify payments
• Examine underlying agreements
• Recalculate
• Search for unrecorded accruals (cash disbursements at year end)
• Analytical procedures

• Agree balances to prior year documentation
• Purchases of PPE
• Expenditures subsequent to acquisition
• Disposals of PPE: recalculate G(L), trace to and from Board minutes
• Loopk for unrecorded disposals
• Depreciation Expense
• Leased Assets: verify proper treatement (capitalized fv. operating), ensure disclosure in footnotes is appropriate

• Genearl Cash account
• Restricted Cash Account
• Imprest Payroll account
• Branch cash account: transfer excess to general---leave @ particular balance
• Imprest petty cash fund
• Cash equivalents (3 months or less)

• Dual custody of cash at all times
• Lockbox arrangements
• Fidelity bonds for employees

• Information processing
• Voucher packet matched prior to cash disbursement authorization
• Deposits reconciled to amounts credited to AR subsidiary ledger
• Bank Reconciliation

• Physical controls
• Deposit cash and checks daily and intact
• lock box accounts
• EDI transactions
• Dual custody over cash
• Unused checks secured
• Check imprinting machine; authorized signature

• Segregation of Duties
• separate custody, authorization, recording, execution

Reconciliations

• Cash receipts journal
• Cash disbursements journal
• Bank reconciliations
• canceled checks
• Bank statements

• Cash on Hand
• count simultaneously with other liquid assets
• Count in presence of client employee
• Undeposited receipts
• ---trace to cash receipts journal
• ---vouch to subsequent deposit in bank statement

• Cash on Deposit
• audited mainly through the clients's bank reconciliation

In addition to corroborating cash and loan balances, a standard bank confirmation inquiry requests information about contingent liabilites and secured transactions

• Kiting is a fraud that occurs by reporting cash simultaneously in two different bank accounts
• Objective is to overstate cash
• A schedule of interbank transfers is useful in detecting kiting

• A proof of cash is used when controls over cash are weak or when fraud is suspected
• It essentially combines 2 bank reconciliations, reconciling all trx that occurred during the period to the client's cash receipts journal and cash disbursement journal

• count petty cash twice in one day
• examine endorsements on canceled checks
• audit genearl journal entries
• retrieve customer checks
• use marked coins and currency
• measure deposit lag time
• examine documents (bank stmts) for alteration
• covert surveillance

Assets & Revenues: risk of overstatement

Liabilites and Expense: risk of understatement

• Last invoice issued
• last bill of lading
• last receiving report
• last check issued
• last deposit ticket

• comparison of year-end balances & ratio analysis
• review of year-end activity

to protect the lender from the borrower substantially weakening the borrower's financial position.

• BS= Receivables
• TC= Revenue/collection

• Bs= Receivables, Investments
• TC= Financie/investment

• BS= PPE, Receivables, Investments
• TC= Acquisition/Expenditure
• Finance/ Investment

• BS= Inventories
• TC= Production

• BS= Liabilites
• TC= Acquisition/ Expenditure
• Finance/ Investment

Obtain mgmt description & evaluation of litigation, claims, and assessments (LCAs)

• Lawyer's refusal to respond is a scope limitation (assess severity)
• Lawyer's inability to evaluate potential outcome is an uncertainty
• Laywer's assessment that accounting is not in accordance with SFAS No. 5 is a GAAP departure

***Lawyer is required to indicate whether response is limited in any way.

• Inquiries of mgmt about possibility of unrecorded/undisclosed contingencies
• Review of current and previous RAR's and or regulatory reports
• Review of minutes of BOD and stockholder meetings
• Analysis of legal expenses, invoices & stmts
• Attorney's letters
• Examine letters of credit/credit lines

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Disclose if sure beyond reasonable doubt

• Evaluate reasonableness
• Consider subjective and objective factors

• Complexity and Subjectivity of estimation process
• Availability and reliability of relevant data
• Degree of uncertainty

Among other things, written represenations are intended to confirm in writing mgmt representations made to the auditor, either explicitly or implicitly, during the engagement; to indigate and document the continuing appropriateness of these representations; and to reduce the possibility of misunderstandings concerning the matters represented.

lack of due care

serious departure from standard on due care

failure to check up on something where you know fraud exist

• Auditor accepted duty of care
• Auditor breached that duty
• Plaintiff suffered loss or damages
• Casualty- plaintiff relied on report

ordinary negligence

ordinary negligence, gross negligence, or fraud

atleast gross negligence or fraud

Governs nonfinancial information (disclosures)

Governs Financial information

plaintiff

90 days of registrant's year-end

45 days of registrants quarter end

15 days of event

***Exception: change of composition of BOD or change of auditors must be filed within 5 days of event

permits defendent to be held liable only in proportion to their fault in creating the accident

include creditors, investors, or potential investors wose decisions normally rely on audited financial statements and opinions on those financial statements

auditors are liable is they are aware that their opinion and financial statements are to be used by some third party

third parties for whose primary benefit the audit or other accounting service is performed

2 or more people are liable with respect to the same liability

• Modified "joint & several" liability for peripheral defendents---established "proportianate"
• Created "safe harbor" for forward looking info
• Codified scienter pleading and proof requirements and strengthened rules of loss causation
• Eliminating bounty payments to plaintiffs, banning plaintiff referral fees, and limiting "professional plaintiffs" to 5 class actions every 3 years
• prohibited RICO from being used in civil cases involving securities fraud
• Auditors' responsibilities for detecting and reporting fraud mirro AICPA Stds

• Limited attorney's fees to a "reasonable" amount of the recovery
• Prohibited defendants for destroying documents & computer records once a complaint was filed

• Intended to curtail movement of organized crime into legitimate business
• Private parties, such as stockholders, can bring civil suits that include treble damages & attorney's fees

• Established PCAOB
• Prohibits auditors from offering 9 types of consulting services to audit clients
• Requires public accounting firms to rotate lead or reviewing partners from client assignments every 5 years

• Requires CEOs & CFOs to certify financial reports, forfeit profits & bonuses when earnings are restated due to securities fraud
• Prohibits executives from selling company stock during blackout periods; requires insiders to report all company stock trades within 2 days
• Prevents executives from receiving company loans unavailable to outsiders
• Requires companies to disclose immediately material changes in financial condition

Favorable: financial stmts taken as a whole present fairly the financial position, results of operations, and CFs in all material respects in conformity with GAAP

• 1. Lack of consistent application of GAAP
• 2. Departure from promulgated accounting procedures with which auditor agrees
• 3. reports involving other auditors
• 4. Emphasis on a matter, including uncertainties
• 5. Substantial doubt about going concern

Favorable, with Qualification: "Except for" the effects of particular matters

• 1. Scope limitation (moderate materiality)
• 2. GAAP departure (moderate materiality)

Unfavorable: financial stmts do not present fairly the financial position results

1. GAAP Departure (high materiality)

Neither favorable nor unfavorable: auditor does not express an opinion on the financial position

• 1. Scope limitation (high materiality)
• 2. lack of auditor independence

Shouldn't be dated early than the date on which the auditor has obtained sufficient appropriate audit evidence to support the opinion

Piecemeal opinions should not be issued, since the purpose of an audit is to render an opinion on the financial statements taken as a whole

• 1. after opinion paragraph
• 2. after opinion paragraph
• 3. after opinion paragraph
• 4. before opinion paragraph
• 5. no required placement (judgement)

• Auditor's report covers 2 or more periods
• Report on prior period may be "updated" (vs. "reissued")
• Report on each period should be considered separately
• New info in current year may necessitate a different opinion on prior year
• Format: change in explanatory paragraph ( date of previous report, type of opinion issued, event that caused opinion to differ, stmt that auditor's opinion is different from previously issued)

• To evaluate on every audit whether there is "substantial doubt" about going concern issue for a "reasonable" period of time (up to 1 year from most recent balance sheet date)
• To consider the adquacy of mgmt's financial stmt disclosure of the going concern issue
• To include an explanatory paragraph when auditor concludes there is "substantial doubt" (auditor's judgement)

• The principal conditions leading to substantial doubt
• The possible effects on the entity
• Management's evaluation of the situation and its plan to overcome
• Possible discontinuance of operations
• Management's plans
• Recoverability of assets & classification of accounts

• Plaintiff: materially false or misleading financial stmts
• damage or loss
• reliance on false or misleading financial stmts

• Defendant: same as 1933
• acted in good faith
• no knowledge of false stmts
• doesn't constitute scienter
• plaintiffs lack of reliance
• expiratiopn of statute of limitations

• Plaintiff: material false, misleading, or incomplete financial stmts
• Damage or loss

• Defendent: due diligence
• no errors (or atleast not material)
• Plaintiff purchased securites after issuance of earnings statement covering 12 months following effective date of registration stmt
• Statute of limitations has expired
• Plaintiff knew of false or misleading info

• Recorded PP&E exist
• All PPE are recorded (completeness)
• PPE are owned (rights)
• Repairs and maintenance expense does not include items that should have been capitalized (completeness)
• Freight-in is included as part of purchase and added to equipment costs (valuation
• Purchased Goodwill is properly valued (valuation)
• Goodwill is not impaired (valuation)
• Capitalized intangible costs relate to intangibles acquired in exchange transactions (existence)
• Amortization and depreciation expenses are properly allocated (valuation)