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Flashcards in AUD CH 4 - Audit Evidence Deck (329):

What is the nature, timing, and extent of the substantive tests based on?

Understanding of internal control


Sufficiency relates to _____ of ______ _________

Sufficiency relates to EXTENT of Substantive Testing

Sufficiency relates to QUANTITY of Audit Evidence (Conclusive Evidence < Persuasive Evidence)


Appropriateness relates to ____ of ______ ________

Appropriateness Relates to the NATURE of Substantive Testing

Appropriateness relates to the QUALITY of audit evidence


The extent of Substantive testing relates to

Sufficiency of audit evidence


the nature of substantive testing relates to

appropriateness of audit evidence


What is the Quality of audit evidence Based on?

1. Relevance: Relates to Management Assertions (U-PERCV)

2. Reliability/Faithful Representation – Source (Persuasiveness) and nature


Why is persuasive evidence More Important Than conclusive evidence?

- Due to the limitations of the Audit

- Cost/Benefit Trade off


What should be considered when assessing Risk and Designing audit procedures?

Sufficiency And Appropriateness Of audit Evidence


What is the source of evidence indicate?

Persuasiveness Of audit evidence (Persuasive > Conclusive)


List the Sources of Audit evidence

(Most to least persuasive)

1. Directly obtained by Auditor (Auditor developed > indirectly obtained)

2. Obtained from outsider (Outside)

3. Prepared by outsider but Obtained from client (Outside/Inside)

4. Prepared by client (Inside)

*Concerned with Accuracy & Completeness when using info provided by the client

*No audit can rely Entirely on Client prepared accounting Data


What is the relationship between Validity of evidence and Detection Risk?

- Inverse relationship

- The higher the level of Validity (Persuasiveness), the Lower is the achieved level of Detection Risk in the audit

- And audit with low acceptable level Of Detection Risk usually requires Highest level of Persuasiveness


What Document represents lowest level of persuasiveness?

Management representation letter

- Due to the absence of any effective internal control over Management


Corroborative evidence

“Other Information” Evidence used By the Auditor (except for the Client Accounting records)


With characteristics is Reliability of Audit evidence Directly related to?

1. Source in which it was obtained

2. Conditions Under which it is Developed and Acquired (original > photocopy)

3. its Form (written > orally)


Which levels should the Auditor respond to the assessed level of RMM to reduce Audit risk?

In 2 ways:

1. At the financial statement level

2. At the relevant assertion Level


At the financial statement, what will an Auditor consider to address RMM?

1. Users of the financial statements

2. Purposes for which F/S will be used

3. Economic and Industry Conditions

4. Management Compensation

5. Financing agreements

6. Changes in management

*to determine if there is any Incentive to Overstate/Understate Results


When is the Control environment weak?


*More sub. Testing (vs. interim period)


What does the nature of audit procedures include?

Purpose (Test of control vs. Sub Procedures)




What is the most important Consideration in responding to assessed risk?

The nature of Audit procedures


The HIGHER the auditor's risk Assessment (RMM).... the ….

1. The more relevant & reliable The audit evidence should be

2. The closer period end SUB procedures should be performed

3. The greater the extent of Audit procedures (more procedures or larger sample sizes)


What does Timing of audit tests refer to?

When Audit procedures performed


The period OR date Which the Audit evidence is Applicable

*tests performed at an Interim date or at period end)


What does the Extent of audit procedures refer to?

- The quantity of a Specific Audit procedure


What is the extent of audit procedures Based on?

The Auditor's Judgement which considers:

- Tolerable misstatement

- assessed RMM

- Degree of assurance they plan to obtain


At the relevant assertion level, what will an Auditor consider to address RMM?

The individual elements of Financial Reporting

- Operating items

- Account balances

*magnitude/materiality then procedures for SA evidence


Which assertion should an Auditor concentrate on if the asset is susceptible to theft?

Existence Assertion


Which assertion should an Auditor concentrate on if transactions include numerous shipping arrangements under various shipping terms?

Cutoff Assertion

- highly likely that the transaction (i.e. Sale) will be recognized on an inappropriate date



While assessing the level of RMM at the relevant assertion level, the auditor should identify....

1. Determine if E,A,T represents RMM

2. If RMM --- det. type of likely misstatement

3. Det. assertions most affected (U-PERCV)

*4. I/C reliance (if any – cost-benefit/don't exist) (combined approach)

*5. Test of Controls (if any) for S.A. Evidence (combined approach)

6. Sub. procedures (ICORRI-A) for S.A. Evidence

(required, at min. - Substantive Approach)


Which F/S elements is substantive procedures required for?

For Each Material:

- Transaction Class

- Account Balance

- Disclosure Item


When is Test of Controls required?

when Substantive testing alone cannot provide SUFFICIENT evidence to adequately reduce RMM

(i.e. not enough source documents to support Reasonable Assurance)


Define Management's Assertions

Implicit and explicit representations (11 assertions) made by management in the F/S being audited (AU-C 500)

- recognition, measurement, presentation, and disclosures (in F/S & related disclosures)

*U – PERCV* or *COCA-CURVE* (11 Assertions)


How many management assertions are there?



What are the categories of Management Assertions?

1. Classes of Transactions & events (CPA-CO)

2. Account Balances at Year-End (RACE)

3. Presentations & Disclosures (RACU)


What are the Management Assertions?


C – Completeness

O – Occurrence

C – Cutoff

A – Accuracy

C – Classification

U – Understandability

R – Rights & Obligations

V – Valuation & Allocation

E – Existence



11 Management Assertions

C – Completeness

O – Occurrence

C – Cutoff

A – Accuracy

C – Classification

U – Understandability

R – Rights & Obligations

V – Valuation & Allocation

E – Existence


Completeness Assertion

- All transactions/events have been recorded

- All A,L,&E interests have been recorded

- All disclosures have been included


Occurrence Assertion

Transactions/events/disclosures that been recorded have occurred & pertain to the entity


Cutoff Assertion

recorded in the correct accounting period


Accuracy Assertion

- amounts/related data recorded appropriately

- disclosed fairly and in appropriate amounts


Classification Assertion

- recorded in proper accounts

- fin. Info is appropriately presented and described


Understandability assertion

disclosures are expressed/described CLEARLY

*(auditor can use emphasis-of-matter paragraph)


Rights and Obligation assertion

- holds/controls rights to assets

- liabilities are obligations of the entity

- disclosures pertain to the entity


Valuation and Allocation assertion

A,L, & E interests

- appropriate amounts

- any resulting adjustments are appropriately recorded

- Disclosures: fair and in appropriate amounts


Existence assertion

A,L, & E interests exist


How should the auditor identify relevant assertions?

determine the SOURCE of likely potential misstatements in each:

- significant class of transactions

- account balance

- presentation & disclosure


How should the auditor determine if the assertion is relevant?

By Evaluating:

- Nature of the assertion

- Volume of transactions/data related to the assertion

- Nature and Complexity of the systems used to process



Classes of Transaction & Events (Mgmt Assertion Category)

C – Completeness

P – Period CUTOFF

A – Accuracy

C – Classification

O – Occurrence



Account Balances at Year-End (Mgmt Assertion Category)

R – Rights & Obligations

A – Allocation & Valuation

C – Completeness

E – Existence



Presentation & Disclosures (Mgmt Assertion Category)

R (O) – Rights & Obligations & Occurrence

A – Accuracy & Valuation

C – Completeness

U – Understandability & Classification


Understandability & Classification

Info: Presented & Described Clearly

T/E: Recorded in proper accounts


Presentation & Disclosure

All accounts in proper sections

All necessary disclosures have been made


Existence or Occurrence

- B/S A,L,& E exist

- disclosed T/E recorded have occurred & pertain to the entity


Rights & Obligations

- legal owner of all assets listed in the F/S

- Liabilities represent legal obligations of the entity

- all disclosed events pertain to the entity


Completeness & Cutoff

- ALL A,L,&E, trans/events have been recorded

- ALL disclosures have been included (that are required)

- T/E in correct account period (cutoff)


Valuation, Allocation, & Accuracy

- amounts are valued using a GAAP method

- revenues/expenses are allocated to proper periods

- trans/disclosures recorded appropriately


What is the purpose of specific audit objectives?

to substantiate (prove) assertions that are material to the F/S

*developed by the auditor


What are the categories of Substantive Procedures?

- Test of Details (ICORRI)

- Analytical Procedures (-A)


Tests of Details

designed to verify:

-the account balances, transactions, and disclosures that occurred DURING the year


- details were the source of the account balances


Analytical Procedures

examination of the relationship between *F/S numbers* and *clients expectations developed from non-financial/financial information* to identify unusual relationships

*may indicate misstatements


What should audit procedures be used for?

In Order:

1. Understanding of entity & environment, + I/C (Risk Assessment Procedures - AIIO)

2. Testing op. effectiveness of controls (Test of Controls – RIIO)

3. Detecting material misstatements (sub. Procedures ICORRII-A)


Which level(s) do risk assessment procedures assess RMM?

F/S Level & Relevant Assertion Level (both)

*do NOT provided sufficient basis for an opinion


Which level(s) do test of controls assess RMM?

Relevant assertion level ONLY

*necessary when rely on I/C (presuming effective) OR sub procedures do not provide S.A. Audit evidence


Which level(s) do substantive procedures assess RMM?

At ALL relevant assertion levels related to each material class of transactions, account balances, and disclosure

*used regardless of assessed level of RMM


When is Test of Controls necessary?

- when Auditor chooses to rely on I/C (presuming effective)


- sub procedures do not provide S.A. Audit evidence


Which type of audit procedures is required for all audits?

- Substantive Test of Details (ICORRII)



Substantive Procedures

Test of Details (ICORRII)

I – Inquiry

C – Confirmation

O – Observation

R – Recalculation

R – Re-performance

I – Inspection of tangible assets

I – Inspection (Examination) of records/ documents (Vouching/Tracing)

A – Analytical Procedures (expectation & anticipation)


What does the Auditor's decision of what Tests of Details to apply depend on?

- the level of detection risk that must be achieved


- the availability of appropriate evidence

*i.e can't test GW through observation (most effective but not available), therefore can accept evidence from other sources for sufficient/substantive info.


Incremental Audit Risk

Applying principal substantive tests to the details of an *asset or liability account* as of an INTERIM DATE (vs. B/S date) potentially increases the audit risk that misstatements that may exist at the balance-sheet date will not be detected by the auditor

*risk increases as go further away from B/S Date


Before performing substantive tests prior to the balance sheet date, what is the crucial assessment that the auditor must make?

The auditor must assess the difficulty in controlling the incremental audit risk.


What should the auditor address while assessing the difficulty of controlling incremental audit risk?

- Significant unusual transactions or entries

- Other causes of significant fluctuations, or expected fluctuations did not occur

- Changes in the composition of the account balances.


Under what conditions should an auditor accept incremental audit risk?

- Detection Risk is relatively HIGH (CR is LOW)


- the Year-End account balances are reasonably predictable


Test of Details (TIMING)


On B/S Date (or As close to the B/S date as possible)

*Marketable securities as well


Test of Details (TIMING)


- After B/S date (because must know what was recorded at fiscal yr-end)

i.e. searching for unrecorded liabilities or Mgmt Rep. Letter


When are “difficulty” or “expense” NOT valid reasons for choosing to omit necessary audit procedures?

when there is no alternative procedure for obtaining evidence


What is the basic premise underlying the use of analytical procedures?

that plausible relationships can EXPECTED TO EXIST among data

- payroll tax expense & payroll expense: indicates relevant tax rates

- actual costs & standard costs (mfg): indicates unusual deviations/fluctuations


Whats makes relationships (analytical procedures) more predictable?

relationships involving income statement accounts are more predictable

(than those involving ONLY B/S accounts)


What are the basic types of comparisons (relationships) that may be performed as analytical procedures?


C – Client vs. Industry averages (correlation)

R – Related Accounts (divide amounts

A – Actual vs. Budget (variances)

F – Financial vs. Non-Financial measures (stats multiplied/divided)

T – This Year vs Prior Year (I/S accounts, except in EXTERME co. changes)

*use of ratios for all


What must each analytical procedure include?

at least one amount from ACTUAL RESULTS OF THE PERIOD under audit


When can Analytical Procedures be performed? When is it required or optional?

1. Planning – REQUIRED as part of Risk Assessment procedures (AIIO)

2. Substantive Testing – optional as a Sub. Procedure to reduce Audit Risk

3. Overall Review (End) – REQUIRED in assessing Auditor conclusions. Performed by MANAGER/PARNTER with knowledge of biz/industry


Current Ratio of Less than 1 indicates....

Inability to to pay short-term debt

*May have substantial doubt of client being a going concern


Very low inventory turnover ratio

may ID slow-moving or obsolete inventory

*inventory may be valued inaccurately (LCM)


What does the quick (acid test) ratio measure?

Immediate liquidity, which is the short-term ability to pay debt


What does the current ratio measure?

Liquidity (short-term ability to pay debt)


Current Cash Debt Coverage Ratio


Net Cash Provided by Operating Activities / Average Current Liabilities


What does Current cash debt coverage ratio measure?

ability to pay off current liabilities in a given year from operations


What does receivables turnover measure?

liquidity of receivables


what does inventory turnover measure?

liquidity of inventory


Inventory Turnover Formula

COGS / Average Inventory


Asset Turnover Formula

Net Sales / Average Total Assets


What does Asset Turnover measure?

how efficiently assets are used to generate sales


Number of Days Supply in Average Inventory

1. 360 / Inventory TO


2. Average Ending Inventory / Average Daily COGS


What does number of days supply in average inventory measure?

number of days required to sell inventory


Number of Days sales in average receivables formula

360 / Receivables TO


What does number of days sales in average receivables measure?

number of days required to collect receivables


Profit Margin on Sales (Gross Margin) Formula

Net Income / Net Sales


What does Gross Margin (Profit Margin on Sales) measure?

net income generated by each dollar of sales


Rate of return on assets formula

Net Income / Average Total Assets


Rate of return on Common Stock Equity (Return on Equity) Formula

(Net Income – Preferred Dividends) / (Avg Common Stockholders Equity)


What does Rate of return on Common Stock Equity (Return on Equity) measure?

profitability of owners' investments


EPS formula

(Net Income – Preferred Dividends) / WTD Shares Outstanding


What does Earning Per Share measure?

Net income earned on each share of common stock


Price-Earnings Ratio Formula

Market Price of Stock / EPS


Payout Ratio formula

Cash Dividends / Net Income


What does the Payout Ratio measure?

the percentage of earnings distributed in the form of cash dividends


What does the Debt to Equity ratio indicate?

shows creditors the corporation's ability to sustain losses


What does the debt to total assets measure?

the percentage of total assets PROVIDED BY CREDITORS


Times Interest Earned formula

EBIT / Interest Expense


What does Times Interest Earned measure?

Ability to meet interest payments as they come due


Cash Debt Coverage Ratio formula

Net Cash Provided by Operating Activities / Average TOTAL Liabilities


What does the cash debt coverage ratio measure?

ability to repay TOTAL liabilities in a given year from operations


Book Value per Share formula

Common Stockholders Equity / Outstanding Shares


What does BV per Share measure?

amount each share would receive if the company were liquidated at the amounts reported on the B/S


What is ICORRII-A used for?

Substantive testing to the substantiate UPERCV in $$ dollar amounts (management's assertions)


What is RIIO used for?

Test of Controls for frequency & percentage


*O – Observation is most effective (auditor developed – most persuasive)


Which mnemonics are useful for the audit of individual accounts?



For audit of individual income statement accounts, which audit procedures should be performed?

Inspection (Examine) of documents

(& Vouch/Trace to related transactions)


What does tracing documents do?

in the normal order of processing*, tracing (from a shipping document) verifies COMPLETENESS

*Source to Book (follows normal trail into the book)


What does vouching documents do?

in the reverse order of processing*, vouching (from an invoice) determines EXISTENCE or OCCURRENCE

*Book to Source (backtracks to source)


What does comparing shipping documents to sales invoices verify?

Tracing a shipping document verifies

That all shipments have been billed (COMPLETENESS)


What does comparing sales invoices to shipping documents verify?

Vouching a sales invoice verifies that

All bills are goods for actually shipped (EXISTENCE or OCCURENCE)


What are the different Audit Approaches?

Test of Balances (auditing the end balances)


Test of Transactions (auditing the changes)


Test of Balances are common for

Audit Approach for MANY transactions, SMALL dollar amounts

- cash, AR, inventory, AP


Test of Transactions are common for

Audit Approach for FEW transactions, LARGE dollar amounts

- investments, PP&E, Bonds, N/P, Stockholders Equity


What should the Auditor do, if the Auditor is unable to obtain sufficient appropriate audit evidence regarding opening balances?

Issue a Modified Opinion or a Disclaimer of Opinion (as appropriate)

* not an Unmodified "except for" opinion or adverse opinion


When should be addressed when an auditor initially accepts an engagement or is engaged to re-audit F/S?

- if Opening Balances are fairly stated

- if Accounting Principles have been consistently applied in the current period in relation to the preceding period

*read most recent F/S & audit report (for opening balances, disclosures, & consistency)


Why would an Auditor want a bank confirmation if there isn't a deposit balance?

A loan payable with the bank may exist OR identify unreported balances

*bank confirmations provide balance & direct liabilities



attempt to overstate cash by showing deposit in current year and disbursement per books in subsequent year (overstates receiving account)


Which is important for auditing Cash & Cash Equivalents?

- RACE approach or PERCV approach

- Confirmations* (deposit balances & loans) (outside)

- Bank Reconciliation

- Bank Cutoff Statement* (outside)

- Observation on hand at B/S date (count)

- Interbank Transfer Schedule (kiting)

- Bank Statement (outside/inside)

- Statement of Cash Flows


Why is it important to prepare a bank transfer schedule?

Help identify Kiting (overstate) or Deposit-in-transit (understate)


Bank cutoff statement

bank statements sent directly by the bank to the auditor with a closing date a couple weeks AFTER year-end

(outside source)


Standard Bank Confirmation

Requested by the client, sent by the bank directly to the auditor (outside source*)


- Balances deposits as of B/S date

- Outstanding loan balances at that date

- Collateral agreements on loans (i.e. compensating balances)

*concern: incomplete information if Bank employee does not know about all relationships with the client


What is the Auditor responsible for when examining the statement of cash flows?

reconcile amount of Statement of CF's to the information on the B/S & I/S


What is the Bank to Book Reconciliation formula?

Balance per bank

+ Deposits in Transit

- Outstanding checks

= Book (Gen. Ledger)


Why is an interbank transfer schedule important? What does it include?

Auditor will examine each interco. bank transfer (around B/S date) to ID:

- Deposits in Transit at B/S Date

- Evidence of kiting of checks

Includes: all inter-company checks written around B/S date


When does a “deposit in transit” occur?

Disbursement PER BOOKS occurs BEFORE year-end


Receipt PER BANK occurred AFTER year-end

(Understates cash balance per book of the RECEIVING account)



When does “kiting” occur?

Disbursement PER BOOK occurred AFTER year-end


Receipt per bank/book occurred BEFORE year-end

(overstates cash balance per book of the receiving account)


Why is a “deposit in transit” important to an Auditor?

To verify the deposits in transit are listed on the bank reconciliation, which determines the correct cash balance of the receiving account (avoid understating account)


Important considerations when auditing Receivables

- RACE or PERCV approach

- AR confirmations

- Tracing AR to docs, collections (rights/valuation)

- Vouching documents

- NRV valuation

- A procedures for reasonableness of receivables

- Review estimating process of ALLOWANCE account

- if Factoring AR? (loan agreements, inquiry)

- Subsequent cash receipts

- Reconcile Sub ledger to GL

- Age AR (adequate allowance?)


What steps should the auditor complete when using analytical procedures in substantive testing?

1. Determine suitability of the procedure for given assertions

2. Evaluate the reliability of data (which develops Auditor's expectations)

3. Develop an expectation for a recorded amount/ratio

--- Evaluate if it is adequately precise to ID a misstatement

4. Determine the acceptable amount of discrepancy

(between expectation & recorded amount)


Who are external confirmations responses sent to?

Directly to the Auditor (Outside source only)


What are the types of confirmations?

- Negative Confirmation (implicit)

- Positive Confirmation (RSVP) (explicit)

- Blank Confirmation (special form of positive confirmation)

*confirmations are the strongest evidence of the EXISTENCE of receivables

*do not confirm payment


Define Negative Confirmation

Implicit Evidence; customer asked to respond ONLY IF AMOUNT IS INCORRECT

("no news is goods news")

- for low RMM

- auditor does NOT expect requests to be ignored

- low exception rate expected

- for small balances


Define Positive Confirmation

Explicit Evidence; customer asked to VERIFY CORRECTNESS of amount; RSVP

- Need a response

- for large balance

- active account


Define Blank Confirmation

Explicit Evidence; customer asked to PROVIDE AMOUNT w/o being told value on client records (special form of positive confirmation)


What are some factors suggesting the need for positive (or blank) confirmations?

- Large Balances

- Active Account

- Delinquency

- for HIGH RMM

- Expect that a negative confirmation will be ignored


How could an Auditor encourage higher response rate to confirmations?

- Clear wording

- Specific Individual addressed

- ID client being audited

- Hand-signed by client

- Deadline for response

- Send 2nd Request

- Call the individual (oral confirmation) & request written confirmation


What are some procedures when customer does NOT respond to positive or blank confirmations?

- Send 2nd request

- Ask client to contact customer & request response

- Review related transactions in subsequent period (AR cash receipts)

- Inspect supporting documents (shipping docs)

- Examine correspondence between client & customer

- Consider Audit adjustment (individual invoices may be an alternative method)


What is a suitable alternative when confirmation requests prove difficult?

Confirmation of single transactions (i.e. individual invoices)


What should the Auditor do if Management refuses to comply with external confirmation requests?

Seek evidence to determine if management's reasons are valid and reasonable


If managements reasons are valid & reasonable for not comply with external confirmations requests, what should the Auditor do?

1. Evaluate the effect on the RMM & apply alternative audit procedures

2. If no alternatives, communicate to Governance & evaluate implications on the Audit and auditor's repot


What should the Auditor do if management's reasons for complying with external confirmation requests are NOT reasonable & valid?

- Communicate to Governance


- Evaluate the implications on the Audit and Auditor's Report


Lapping of Account Receivable

attempt to cover theft of AR collection by receivables bookkeeper; posting subsequent collection from another customer to that subsidiary account

*break down of seg. Of duties (Recording & Custody) or Collusion


Subsequent Collection

the best evidence of the VALUATION of the receivable (net 30 even after B/S date; before Auditor report issuance)


What are some Valuation of receivables auditing procedures?

- Inspecting the aging of receivables

- examining credit ratings of customers

*Both to determine if allowance for collectibles is sufficient


Primary concern when Auditing receivables

Overstatement (i.e. kiting)


What is a limitation regarding confirmation?

they cannot be expected to provide significant information about UNDERSTATED receivables


What is best evidence of completeness regarding receivables?

To perform cutoff tests on shipments occurring immediately before and after the B/S date

*can also trace shipping docs (source) to sales invoices (books)


Why is a “number sequence” important in regards to documents?

Ensure that documents have not been lost (& recorded)


Which companies is it easier to cover lapping of AR?

In companies that frequently receive payments of the same amount from different customers (i.e. cable company)


What policies can mitigate lapping of AR?

- Strong Segregation of Duties

- Vacation policies

- Period rotation of employee responsibility


Which test will most likely detect lapping of AR?

Substantive test that involves comparison of dates on checks deposited to the bank with the posting dates of the receivables records (because “covering payments” are from a later collection)


What are some considerations when auditing investments in securities & derivates?

- Docs supporting acquisition (3rd party)

- Terms with counter-parties/holders

- Use as collateral

- Market Values (HFT & AFS)

- Amortization of discount/premium (HTM)

- F/S of major investees

- Interest & Dividends received

- Side Agreements

- Observation

- Pledging agreements

- Derivative economic substance

- Board minutes


While auditing investments, what are the two principal techniques that will be used for verifying the Rights and Obligations assertion?

Confirmation – If brokerage firms hold the securities, received directly from brokerage (not investee)

Observation – count of securities held by client (as close to B/S date as possible – examine bank access record)

*for client's ownership of the securities


How are the investments (other than those under equity method) valued?

1. Basis of the investee's financial results


2. Fair Value


What should the Auditor do if investments (except equity method) are valued on the basis of the investee's financial results?

1. Read investee F/S & audit report

(if not audited/acceptable, arrange for audit or apply audit procedures)

2. Obtain S.A. Audit evidence for factors NOT recognized in F/S or assets with FV's significantly different from CV

3. Eval. Effect of potential lack of comparability


What are derivatives valued at?

Fair Value


In regards to Hedging activities & substantive procedures, what should the Auditor gather evidence on?

To determine whether management:

- COMPLIED with GAAP hedge accounting requirements

- EXPECTED that the hedge would be "highly effective"

- PERIODICALLY ASSESSED the hedge's ongoing effectiveness


How should the Auditor verify Valuation when auditing equity method investments?

Investee F/S to verify amounts utilized

(equity method used when "significant influence" over investee)


Which investments should the auditor recompute amortization for?

Held to Maturity securities (investments)


Which investments should the auditor verify stock prices? Which date of stock prices should be verified?

Trading (HFT) & Available for Sale (AFS) Securities

- stock prices should be verified at the B/S date (via public source)


How are HFT securities reported on the Statement of Cash Flows?

Operating Activity


How are AFS securities reported on the Statement of Cash Flows?

Investing Activity


How are HTM securities reported on the Statement of Cash Flows?

Investing Activity


Which unrealized gains & losses from securities are reported in OCI?

Available for Sale (AFS) securities

*Accum. OCI in equity


Which type of security is only debt?

Held to Maturity (non-current on B/S)


Which type of security is reported only as current item on the B/S?

HFT (trading) securities


What is the “fair value” of an asset?

the amount at which an asset could be sold in a current transaction between wiling parties


What is the “fair value” of a liability?

the amount that would have to be paid to transfer a liability


What are the three approaches often used to audit fair values? (similar to estimates)

1. Review & test management's process


2. Independently develop an estimate


3. Review subsequent events


During risk assessment procedures (AIIO), what does an Auditor obtain an understanding of with consideration of estimates?

- Requirements of the AFRF about estimates

- How mgmt determines when estimates are NECESSARY for the recognition or disclosure of items in F/S

- How mgmt DEVELOPS accounting estimates & the data upon which they are based


What are the considerations when evaluating the RMM of estimates after obtaining an understanding?

(Taking into account the Nature of the estimate)

- events up to date of auditors report that provide evidence regarding the estimate

- Test the methods & assumptions used by mgmt & data used

- Test the operating effectiveness of controls (for estimate development)

- Develop an expectation (point or range) as a basis for evaluating the estimate


Regarding estimates, what does the Auditor do after obtained an understanding during risk assessment procedures?

Evaluate the risk of Material Misstatement & undertake one or more of the following (taking into account the NATURE of the estimate)

- events up to date of auditors report that provide evidence regarding the estimate

- Test the methods & assumptions used by mgmt & data used

- Test the operating effectiveness of controls (for estimate development)

- Develop an expectation (point or range) as a basis for evaluating the estimate


What will an Auditor do when estimates represent HIGH (significant) RMM?

Apply additional procedures

- Address effects of estimation uncertainty (alt. Assumptions / reasonableness of assumptions)

- Evaluate mgmt's decision to recognize/not recognize estimates & basis used for measurement

- Evaluate Reasonableness of the estimates

- Det. If disclosures comply with the AFRF

- Review decision/estimates to evaluate for potential mgmt bias


What will an Auditor document in regards estimates?

- Auditor's reasons why the estimates represent significant RMM


- indicators of possible management bias


Documents to consider while auditing Inventories

- Bank confirmations (pledged inventory?)

- Consignment agreements

- purchase documents/commitments

- Warehouse confirmations

- Cutoffs (sales. Sales returns, purchases, purchase returns)


What does AU-C 501 requires the auditor to perform in regards to inventory?

- Auditor required to attend the physical inventory count (observation / Existence assertion)

- determine if the accounting records accurately reflect the inventory count


While attending the physical inventory count, what should the auditor do?

- Evaluate instructions and procedures

- Observe performance of count procedures

- Inspect inventory

- Perform test counts


What should an auditor do if unable to attend the physical count?

- Apply alternate audit procedures (i.e. test counts)

- Apply audit procedures to transactions occurring between the count date & the F/S date


FOB Destination

title passes to the buyer WHEN THE BUYER RECEIVES the goods from carrier (receives from UPS)

- if in transit, in seller''s books at year-end (cutoff)


FOB Shipping Point

title passes to the buyer WHEN THE SELLER SHIPS the goods (gives to UPS)

- if in transit, in buyer's books at year-end (cutoff)


How are inventory purchases accounted for in a perpetual system?

Debited to inventory (therefore, QTY on hand can be determined at any point in time)



holding the inventory but NOT the owner of it



own the inventory, but NOT HOLDING it


How can the existence assertion be substantiated in a strong perpetual system (or low RMM) of inventory ?

Physical count of goods performed at various dates & different inventory can be counted at different times

* if this proves that physical inventory agrees with the records at those dates, it is S.A. Audit evidence that the B/S date will most likely be accurate

*also, vouch books to actual goods (supporting evidence)


How can the existence assertion be substantiated in a periodic system (or high RMM) of inventory ?

physical count of goods must be made at the B/S date (or as close as possible)

*also, vouch books to actual goods (supporting evidence)


How can an Auditor verify the rights and obligations assertion when auditing inventory?

- examine vendor invoices & other evidence of purchase of goods by the client

- inspect loan agreements (pledged/assigned as collateral?) (which also require disclosure)


Inventory is valued at

Replacement Cost (LCM)

Lower of Cost or Market


Documents to consider while auditing PP&E (Fixed Assets)

- Purchase Documents (trace additions)

- Bank confirmations (pledged/collateral)

- Loan Agreements (liens/restrictions)

- Board minutes (approval of additions)

- Reconcile Summary Schedules to GL

- Leases (Capital vs Operating)


What test approach is used when auditing fixed assets (PP&E)?

- Test of Transactions Approach – audit changes during the year (few transactions)


- A & S in the "BASE" formula

A – Additions

S – Sales (Disposals/Retirements)


With respect auditing fixed asset (PP&E) retirements/disposals, what assertion is the auditor primarily concerned with?

Completeness Assertion – to locate the actual assets to verify there are no unrecorded retirements of assets (still on the books but actually retired)

& examine J/E's for retirements to verify correct amounts/accounts (valuation)


When is a DEBIT to accumulated depreciation permitted?

- Removal of AD upon retirement/sale of an asset

- Correction of an excess depreciation expense entry made previously

- Costs incurred to extend the useful life of the asset


What is an Auditor's main concern for for fixed assets owned the entire year?


- need to review computations of depreciation (recalculation)

- consider useful life appropriateness

- methods to verify Allocation & Valuation (& associated proper posting)


How would an Auditor substantiate the rights and obligations assertion for intangible assets?

- inspection of records (purchased intangibles & expenditures to acquire/defend legal intangibles)


What does an Auditor need to consider in regards to the valuation of intangibles?

- Indication of impairment & if evaluated appropriately

- Amortization calculation (Math accuracy)

- Expenditures to defend/acquire legal intangibles.


In regards to Goodwill, which assertion(s) should an Auditor be concerned with?

1. Existence or Occurrence: GW is purchased as part of business combination

2. Allocation and Valuation: correction computation of original GW & amortization over an appropriate life


When auditing accounts payable, what is the most important management assertion? Why?

Completeness Assertion

Because the primary concern is understatement of liabilities (not overstatement)


What is the most effective procedure in regards to an understatement of liabilities?

examination of subsequent cash disbursements (“Search for Unrecorded Liabilities”)


How can an Auditor effectively substantiate the completeness assertion for accounts payable?

- Vouch subsequent payments to related P.O.'s and receiving reports (ID payables owed as the B/S date – net 30)

- trace receiving reports to postings of purchases (verify all received items have been recorded)


What would an Auditor use confirmations when auditing accounts payables?

Confirm with vendors showing a low or zero balance owed at the Balance Sheet (select from entire vendor Population that client did business during the year)


What is an Auditor often able to do when auditing payroll?

Rely on internal control structure of the Payroll cycle (Assess RMM LOW & Detection Risk HIGH & LESS Sub Procedures)


How should the Auditor verify the Completeness assertion when auditing payroll? Why?

Perform Analytical procedures (Actual Payroll vs. Budgeted/Standard Costs)

- payroll is generally more predictable than other costs


How should the Auditor support the Valuation assertion when auditing payroll? Why?

- Recalculate Payroll accruals

- Compare calculations with source info (time cards) to VERIFY hours worked

- Compare calculations with source info to personnel records to verify pay rates


How can an Auditor verify the Existence of Employees?

Observation of the distribution of paychecks


What is the recognition for a “Remote” Loss Contingency?

- No Recognition

- Don't Disclose / Don't Accrue


What is the recognition for a “Reasonably Possibly” Loss Contingency?

Full Disclosure / Don't Accrue (Fair Presentation)


What is the recognition for a “Probable” Loss Contingency?

Depends on if the loss contingency is ESTIMABLE

- if Estimable, Disclose & Accrue (both)

- If NOT estimable, Disclose / Don't Accrue (like reasonably possible)


What is the Journal Entry for a Probable & Estimable Loss Contingency?

Dr: Estimated Loss (I/S)

Cr: Estimated Liability (B/S)


What are the most common Objectives when auditing long-term debt?

- Verification of interest expense & accrued Interest payable (use of analytical procedures)


Important documents when auditing Long Term Debt

- Loan documentation

- Confirmations (sinking funds/unrecorded debt)

- Board Minutes


- Copies of notes/agreements


If a current note is renewed shorting AFTER year-end, how should it be classified?

as a LONG TERM Debt (not a current debt)

(Proper classification for the disclosure & presentation assertion)


When auditing capital stock and Other securities, what should an auditor verify? How?

That all issuances are APPROVED by the Board of Directors & CONSISTENT with Articles of Incorporation - (authorized properly)

- confirmation with a registrar (if none, stock certificate book)

- review of minutes of Board meetings

- inspection of corporate documents


What is a primary concern when auditing Retained Earnings?

Any actions on the use of Retained Earnings for the payment of dividends are DISCLOSED on the face of F/S or in F/S Notes


When do dividends become a liability?

on the Declaration Date (when the board commits to the dividends)


What are the important dates for dividends?

1. Declaration Date

2. Record Date

3. Payment Date (distribution)


Why is a registrar important when auditing Stockholder's Equity?

For confirmations (existence assertion) with the registrar

*registrar/transfer agent is responsible for issuing capital stock & other securities (if none, inspect stock certificate book)


If property is issued as a dividend, how should it be recognized?

at FMV on the date of DECLARTION

(Net Reduction on S/E is [RE-Gain] or [RE+Loss])

Dr: Retained Earnings

Dr: Loss (Plug)

Cr: Asset

Cr: Gain (Plug)


Which type of dividends do not reduce Stockholders Equity?

Stock Dividends and Stock Splits


What is the difference between a small & large stock dividend?

Small: @ FMV (Credit APIC) –

Large: @ Par Value (Dr: RE, CR: C/S – NO APIC) - >20-25%


What is the difference between a partial liquidating dividend & a (full) liquidating dividend?

Partial: Remove R/E first, then APIC

Full: Remove APIC


What is a scrip?

interest bearing note (give dividend but no money)

Dr: Retained Earnings

Cr: Note Payable


When are most revenue & expense (I/S) accounts verified?

- When test of controls are performed over the various functions (cash receipts/disbursements, purchases, sales)

- In conjunction with the audit of related asset or liability (B/S) accounts


Which I/S accounts do accounts receivable relate to?

Sales & Bad Debt Expense


Which I/S accounts do inventories & accounts payable relate to?

Purchases, COGS, & Mfg Payroll


Which I/S accounts do investments relate to?

Interest, Dividends, Gains & Losses on Sales


Which I/S accounts do PP&E relate to?

Rent, Gain & Losses on Sales, Depreciation, Repairs & maintenance expense


Which I/S accounts do Notes Receivable relate to?

Interest Expense


Which I/S accounts do Accrued Liabilities & Prepaid expenses relate to?

Warranty Expense, commissions, fees, insurance expense, & various expenses


Audit Program/Audit Plan

step by step list of audit procedures, which is required for every GAAS audit


What are the considerations when drafting an Audit Program/Audit Plan

To prepare a list a substantive tests to be performed:

1. Procedures – ID 1 procedure for each category in ICORRII-A (observation may not be possible if not tangible asset)

2. Assertions – At least 1 test for each assertion in U-PERCV

3. Related Accounts – at least 1 procedure fore each account related to one being addressed in the essay (i.e. if receivables, test bad debt accounts)

4. Certain Tests apply to almost every account


Which tests are applicable to almost every account?

- Read financial statements and notes

- Review minutes of the Board and shareholder meetings

- Representations From Management should be obtained

- Reconcile the trail balance to supporting records


What are the steps for drafting an Audit Program/Audit Plan

1. Obtain schedule from client

- Re-performance (foot, tie to PY & GL)



4. Revenues & Expenses / Gains & Losses / Contra Accounts

5. Generic tests (apply to most)

- Cut Off tests

- Board Minutes

- Perform subsequent events

- read F/S & footnotes



when analyzing working papers for weaknesses

C – Comment on Exceptions (resolve)

C – Conclusions (consistent with audit docs)

H – Heading (client name, title (i.e. acct name), & audit year)

I – Initials (from each person who prepares/reviews WP)

T – Tickmaks (symbols – all in legend)

FOOT – (schedule's math accuracy, re-foot)



Symbols next to amounts referencing information about how they were verified in a legend at the bottom of the paper

(each symbol needs to be defined in the legend)

- often inaccurate or missing


What is the process of source documents to the F/S's?

1. Source Documents (bank rec, confirmations, etc)

2. Schedule (i.e. "A-1")

3. Lead Schedule (i.e. Cash "Sched. A")

4. Working Trail Balance (I/S & B/S)

5. Financial Statements


Working Trial Balance

listing of ledger accounts with current year end balances & (PY end balance = CY Beg. Balance)

- columns: Schedule, Account, Beg Balance, "Reclass & Adjustments", End Balance

- usually both B/S & I/S included


Lead Schedules

schedules that summarize like accounts, the total of which is transferred to the working trial balance


Audit Documentation

working papers developed during the course of the audit (AU-C 230/PCAOB 3)

*principal support for the auditor's report

- sufficient for experienced auditor to understand (W/o knowledge of the audit)

- w/in 60 days of report release date (45 days if PCAOB)

- 5 Year retention period (7 if PCAOB)

- auditor's property but is still confidential


Under the AU-C & PCAOB guidelines, what is considered sufficient Audit Documentation?

Should enable an experienced auditor (with no connection to the audit) to understand

- nature, timing, & extent of the audit procedures to comply with GAAS and legal/reg requirements

- results of the Audit Procedures preformed & audit evidence obtained

- significant findings or issues arising during the audit, the conclusions reached thereon

- significant professional judgements made in reaching those conclusions


What are the six factors that must be considered in determining the nature & extent of documentation for particular audit area or procedure?

1. RMM associated with assertion

2. Extent of judgement the auditor exercises in performing the work

3. Nature of the auditing procedure

4. Significance of the evidence

5. Nature & Extent of exceptions the auditor identifies

6. Need to document a conclusion or basis for conclusion that is not evident from the other documentation


What are the specific types of audit documentation that must be included?

- abstracts/copies of significant contracts/agreements

- ID of items that were selected for inspection or confirmation (TOC & TOD)

- specific! (other engagement member can ID)

- i.e. list of invoice numbers selected in a sample


What is an Auditor responsible for regarding audit findings and issues?

REQUIRED to document significant audit findings and issues

- matters involving selections of acctg principles/related disclosures

- results of procedures that indicate the potential material misstatement/require modification to auditing procedures

- situations that cause the auditor significant difficulty in applying audit procedures

- other finds that could result in mod. Of auditor's report


What is relationship between IT and audit documentation?

Retention of records (audit documentation) after audit completion should be maintained in electronic form

*auditor must be able to access data throughout the retention period (may require file conversion/updated software)


What are some of the specific documentation requirements?

- Audit Risk and Materiality: nature & effect of agg. Misstatements & conclusion regarding F/S misstatement

- Analytical Procedures: factors for dev. Expectations, expected relationship, comparison results, & response to unexpected relationships

- Going concern doubts: conditions/events for led to doubt, work performed to eval. Mgmt's plans, conclusion on mgmt's plans (if doubt remains), effect of the conclusion on the F/S,disclosures,& audit report


At minimum, what should the audit documentation always include?

1. Reconciliation of accounting records with F/S

2. Audit Program

3. Auditor's understanding of I/C structure

4. Assessed level of CR

5. Proof of sufficient evidence obtained (to support opinion)

6. Management representation letter (obtained at end of fieldwork)


What affects the quantity, type, and content of the audit documentation?

- accounting records condition


- type of report being issued (qualified or adverse will require working paper discussion)

- Staff disagreements (team disagreements should be documented if impacts fieldwork or conclusions)


What is the relationships between the type of opinion being issued and audit documentation?

a qualified or adverse opinion require working paper discussion of the reasons

*audit documentation is the principal support for the auditor's report


What are the files that audit documentation may go into?

Current File (relates to this year only)


Permanent File (relates to more than one year)


What are examples of items included in the current file?

- Audit Program (unique every year)

- Working Trial Balance

- Lead Schedules

- Responses to information requests (confirmations, attorney's letter, mgmt rep letter)

- Reconciliations and Analyses by the auditor (directly obtained by the auditor to support CY F/S / notes)


What are examples of items included in the permanent file?

- Organization documents (articles of incorp. & bylaws)

- Minutes (often discuss LT significance)

- Flowcharts of the I/C structure (similar enough)

- Debt Agreements (LT liabilities) & Pension Agreement

- Analyses of equity accounts (rarely change)

- Depreciation Schedules


Audit documentation needs to be all written documents

True or False?


- computer printouts & itemized calculator tapes (when appropriate)


What does an audit manager do following completion of fieldwork?

Reviews the Audit Documentation

- Finalizes and organizes audit documentation

- Ensure audit documentation is consistent with audit report to be issued

- Ensure audit documentation is understandable and reference each other as appropriate


How many audit documentation reviews are there? By Whom?

Two Reviews

1. Audit Manager

2. Partner/Equivalent (Wrap-up Review)


What is a wrap-up review? What is it's purpose?

It is the second review of audit documentation

- performed by a partner or equivalent

Focuses on:

- the fair presentation of the F/S

- agreement of the working paper lead schedules to the statements & notes


What is inappropriate to discuss with the client in regards to audit documentation?

any disagreements between the members of the audit team regarding conduct of the audit or the conclusions


How are disagreements involving the audit team resolved?

the final decision is the responsibility of the Partner-In-Charge (or equivalent)



GAAS (audit standards) - non-public

*Equivalent to the PCAOB is "AS"


What is an engagement completion document?

Specifically REQUIRED to be prepared under PCAOB AS3 (public)

- Identifies all significant findings and issues

- must be sufficiently specific for a reviewer to understand

- cross-references to other available supporting documentation (as appropriate)


What are the specific requirements under PCAOB AS3 in regards to audit documentation (differences from GAAS AU-C)?

- engagement completion document

- demonstrates compliance with PCAOB standards

- completion period is 45 days after report release date (not 60 days)

- 7 year retention period (not 5 years) after report release date (OR the period required by law, if longer)


Which entities are required to have a engagement completion document?


(PCAOB AS3 – public)


Is a Management Representation letter required?

Yes (AU-C 580)


What happens if the management representation letter is not obtained?

It is considered a scope limitation imposed by the client ( most circumstances: Disclaimer of Opinion)

- precludes (prevents) an unqualified opinion on the F/S


Define Management Representation Letter/Client Rep Letter

required final evidence received by the auditor (mandatory audit procedure)

- signed by the client CEO & CFO

- dated NO EARLIER than the audit report day

- representations are not audited further

- obtained after the planning/performance of all other tests (no impact on gathering evidence)


Audit Report Date

usually the last day of field work

*not "report release date"


What type of opinion is precluded when an auditor fails to receive a management representation letter?

Unqualified opinion on the F/S


What is important about the management representation letter?

- Emphasizes management's responsibility for the F/S

- Provides the Auditor with some assurance that management is not intentionally concealing any information that may have affected the auditor's opinion


Why would an auditor place less reliance on a management representation letter?

the Auditor has some evidence of intentional misbehavior by management


What are the certain representation made in the management representation letter?

1. Mgmt's Responsibility (Prep/Fair Pres. of F/S, DIM of I/C)

2. Mgmt is UNAWARE (not "free") of any errors or fraud (material effect on F/S)

3. No acts of fraud or noncompliance (illegal acts) by mgmt or key I/C employees

4. Board Minutes are Complete & Available

5. All Financial Records (Available)

6. No Pending Legal Matters undisclosed (material)

7. All Estimates are reasonable

8. All Related Parties & Transactions are ID & properly accounted/disclosed

9. Subsequent events properly accounted/disclosed


What is management unable to represent in the rep. Letter?

There have been no errors or fraud committed by ANY employees

* only unaware & not committed by themselves


What is the primary source of information of evidence regarding ligation, claims, and assessments?

Management (client)


What does attorney-client privilege do?

Prevents the attorney from directly providing the auditor with information about legal matters (outside/inside)


What is the process regarding an attorney's letter (letter of audit inquiry)?

1. Auditor discusses with management how to ID legal issues with a material effect

2. Management meets with legal counsel

3. Management Representation Letter (assurance for disclosure of all material litigation, claim, & assessments)

4. Letter of Audit Inquiry (at client's permission - "mgmt's inquiry")

*physically mailed by the Auditor

5. Receive Attorney's Response (directly to Auditor)

*if not, scope of limitation


In regards to the Letter of Audit Inquiry (Attorney's Letter), Identify who performs the following:

1. Prepares the letter

2. Signs the letter

3. Requests the Inquiry

4. Mails the letter

5. Receives the response

1. Auditor prepares the letter

2. Management signs the letter

3. Management requests the inquiry

4. Auditor physically mails the letter

5. Auditor directly receives the response (outside)


What is the purpose of the letter of audit inquiry?

to obtain corroborating evidence


What does an letter of inquiry identify and request?

the material litigation, claims, & assessments the Auditor was informed by management (although need proof)


- likelihood of losses (remote, reasonably possible, probable)

- $$ estimates of losses (where appropriate)

- any significant disagreements


What does an auditor need to do if an attorney indicates a remote chance of loss (contingency)?

Nothing. No further information is needed


What does an auditor need to do if an attorney indicates a reasonably possible or probable chance of loss (contingency)?

May need clarification of the estimated loss

*to determine the appropriate disclosures and/or accruals

(probable & estimable/not estimable OR reasonably possible)


What is the effect of an attorney refusing to respond to a letter of inquiry (or if management refuses permission to communicate with the external legal counsel)?

Scope limitation on the audit

- may require a Qualified Opinion or Disclaimer of Opinion


What is the effect of an attorney being uncertain about the possible resolution of certain issues?

May result in an explanatory paragraph in the AUDITOR's Report

*WITHOUT requiring any modification of the opinion (only to report)


If the client's attorney resigns short after the Auditor receives the attorney's letter (response), what should an Auditor do?

If the letter indicated no significant disagreements, Auditor should inquire as to reason for the resignation

* may indicate a serious issue


What is the primary concern when auditing transactions with related parties?

Disclosure and Presentation assertion

- inform the users of the F/S


How does an Auditor ID related party transactions?

Inquiry of management (part of risk assessment procedures- AIIO)

- Identities

- Nature of relationships (board approval?)

- When entered into trans. & purpose for trans.

2 issues with Inquiry:

- management may try to conceal (collusion, manipulation)

- Management may not even be aware of certain related parties


Transactions that suggest involvement with related parties

- Loans at zero or unusually low interest rates

- Sales at prices far above or below FMV

- Large, non-recurring transactions occurring very close to the B/S date

- Loan guarantees


Arm's-length transaction

A transaction in which the buyers and sellers of a product act independently and have NO RELATIONSHIP to each other. (own self-interest, not under pressure/duress from the other party)


What is required when management claims transactions are at arm's length transaction (or would have taken place in the absence of the relationship)?

1. The auditor should obtain sufficient appropriate audit evidence about the claim

2. Verify if adequately disclosed

*no practical way to verify the transaction's relationship


An auditor is considered a specialist

True or False

False. An auditor is NOT considered to be a specialist


When using a specialist, what should the auditor keep in mind?

- The audit opinion is solely the Auditor's responsibility (no division with someone is not an auditor)

- The findings of the specialist constitute audit evidence to be evaluated by the auditor

- Auditor must understand the methods & assumptions underlying the specialist's work (documented)

- Objectivity & Competence of the specialist


What is required of the specialist?

Specialist must understand the manner in which the auditor will be utilizing the specialist's work to provide corroborative evidence to support the auditor's opinion (documented)


What traits should an auditor consider in regards to a specialist?

- Competence & Objectivity*

* if lacks objectivity, Auditor may still use the specialist (gauge level of persuasiveness of evidence received)


When must an auditor NOT refer to the specialist in the audit report?

If the audit report contains an UNMODIFIED opinion (clean opinion or “except for”)


When may an auditor make reference to the specialist in the audit report?

If the work of the specialist is relevant to the understanding of a MODIFIED opinion

** must indicate in the report that the reference DOES NOT REDUCE the auditor's responsibility for the opinion


Is a division of responsibility possible when referring to a specialist?

No, it is not appropriate to divide responsibility with someone who is not an auditor.

**However, a reference in the report is possible when a modified opinion is issued. There is still no division of responsibility (must be indicated in the report)


What is an external auditor's main concern when using internal auditors of the client? (AU-C 610)

Competence & Objectivity


How can an Auditor evaluate competence when outsourcing audit procedures?

education, experience, professional certifications, documentation, previous dealings


How does an Auditor consider when evaluating an internal auditor's objectivity?

- ability to act with integrity

- ability to provide info. That the client might not which the external auditor to know

-****the organizational level to which the internal auditor reports to (A.C. Is GOOD, HQ is a possibility)


When can you consider an internal auditor (of the client) to be independent?

Never. Regardless if the Internal Auditor achieves the highest level of competence & objectivity


How is division of responsibility treated when using a internal auditor (of the client) to assist in audit procedures?

- No Division of Responsibility (Not Independence)

- No reference to Internal Auditor in the auditor's report


When may an auditor make reference to the internal auditor (of the client) in the audit report?

Never. A Reference would imply division of responsibility and is PROHIBITED


What type(s) of procedures should an auditor reject (not allow) from an internal auditor (from the client)?

Judgmental Determinations by internal auditors


What can an internal auditor assist the outside auditor with?

1. Understanding I/C Structure – useful source of info

2. Testing controls – obtain evidence for review by the outside auditor

3. Substantive Testing – pull documents & locate assets (existence)

*no risk assessment procedures (judgmental)


What is the Auditor's main concern when auditing estimates? What should the auditor focus on to evaluate estimates?

- Auditor's main concern is to determine the REASONABLENESS of the estimates (made by management)

- To evaluate, concentrate on assumptions that are subjective (therefore, susceptible to bias)


What are the four approaches often used when auditing estimates?

1. Review & Test management's process (method/assumptions/data)


2. Independently develop an estimate


3. Review subsequent events (up to date of auditor's report)


4. Test effectiveness of I/C related to estimates (understand process, then ICORRII-A)


Which type(s) of estimate assumptions (made by management) should the Auditor be alerted by?

- Deviate from historical patterns (PY's vs. CY: % of sales, bad debts estimates)

- Are susceptible to bias

- Are extremely sensitive to variations


What is the Auditor's objective when auditing estimates?

to obtain S.A. Audit evidence to provide reasonable assurance that:

- All accounting estimates that could be material have been developed

- Reasonableness

- Accordance with AFRF (GAAP) & Properly disclosed


What are the GAAP approaches for estimating fair value?

- Market Approach (market data)

- Revenue or Cash Flow Approach (discounted CF methods)

- Cost Approach (replacement cost)


What should an Auditor gain an understanding of in regards to auditing fair value estimates?

- Measurements/disclosures development by management

- Conform with GAAP (AFRF)

- Potential RMM (based on the number, significance, & subjectivity of assumptions)


What are the impacts of subsequent events?

Type 1 – conditions existed @ B/S Date. require adjustment (recognized – affects the numbers)

Type 2 – conditions did NOT exist @ B/S, but are IMPORTANT so they should be DISCLOSED (non-recognized) to assist users (i.e. Warehouse FIRE on 01/04/X2) *** DOES NOT AFFECT THE NUMBERS


When are Issuer's(public) financial statements available to be issued?

The date the Auditor signs the audit report


subsequent events

Events occurring after the B/S date but before audit report is issued (different for issuers and non-issuers)


Subsequent events of non-issuers are evaluated until...

- The date of F/S issuance (date auditor signs report or later)


- The date that F/S are available to be issued (when auditor signs audit report)


Subsequent events of Issuers are evaluated until...

The date of F/S issuance (date auditor signs report or later)


Auditor responsibility for subsequent events

- that management has properly ID, Evaluated, Recognized, & Disclosed (as appropriate) UP THROUGH THE DATE OF THE AUDITOR'S REPORT


What audit procedures are likely to reveal subsequent events?

- Minutes of BoD

- Inquiry of client's legal counsel

- Interim Reports prepared by mgmt

- Inquiry of the client (+mgmt rep letter)

- Changes in LT Debt after yr-end (require classification adjustment, at least disclosure)


What does the search for subsequent events refer to?

Only audit procedures designed to ID events occurring AFTER the B/S Date

* AR confirmations (NOT part of the search)

* Write Offs (YES, b/c occurring after year-end)


Subsequent Event Period (& the auditor's responsibility)

Period between the B/S date and the date of the auditor's report (auditor is not responsible for EVENTS OCCURRING after audit report date)


What are the factors to consider when an Auditor discovers an event or transaction after the Audit report is issued?

Step 1. ONLY CONSIDER the occurrence if it represents information that should have been available at the report date (therefore could affect expressed opinion)

Step 2. Consider date of event/transaction:

- if occurred before B/S date, requires Adjustment

- if occurred before Audit Report Date, F/S disclosure

- if occurred after the Audit report date, no responsibility

Step 3. if within Auditor's responsibility, notify the parties relying on the audit report that they report cannot be relied on (if parties would find this information important)


Omitted Procedures

Auditor discovers after the Audit Report is issued they omitted procedures which were believed to be necessary at the time of the audit (“forgot to do something important”)


What should an Auditor first consider when discovering an omitted procedure? Why?

Assess the importance of the omitted procedure (needed to support the opinion? Other applied tests that can support?)

- if not important, no further action necessary

- if considered important, contact client & perform procedure

--- if supports, no further action (no notifying)

--- if does not support, notify parties not to rely (withdraw report)


When should an Auditor withdraw the auditor's report & notify parties not to rely on the report?

- When there is a subsequent discovery facts (important enough to the parties & affects opinion negatively)

- If management refuses to permit the auditor to perform the omitted procedure


In regards to omitted procedures, when would an Auditor not need to notify parties relying on the Audit report.

Auditor's omitted procedure is performed (permitted by mgmt) and still supports the Auditor's opinion.


If an omitted procedure is performed & does not support the auditor's issued opinion, what should an auditor do?

treat the situation like a subsequent discover of facts