Becker AUD 4.3 - Other Audit Procedures Flashcards Preview

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Flashcards in Becker AUD 4.3 - Other Audit Procedures Deck (18):

Per PCAOB standards:

(1) Auditor determines the accounting estimate included in F/S is UNREASONABLE or was NOT determined in CONFORMITY with the requirements of APPLICABLE FINANCIAL REPORTING FRAMEWORK, then the auditor should treat as a _________________________________.

(2) If auditor determines a range of reasonable estimates, then the auditor should treat as a misstatement the _________________________.

(3) The auditor also evaluate whether the difference between the reported estimate and the best estimate supported by the audit evidence indicate possible ______ ____.

1) misstatement the DIFFERENCE between the

Recorded estimate
and the
BEST Estimate supported by audit evidence.

2) The difference between:

Recorded estimate
and the
CLOSET reasonable estimate supported by the audit evidence.

3) Management bias


(1) Which group of people in the client company is the primary source of information regarding

Contingencies, including litigation, claims, and assessments?

(2) The letter sent to the client's lawyer is simply a means of corroborating information provided provided by _____.

(3) What is a related party transaction?

1) Management

2) Management

(3) A transaction that is not ARMS-LENGTH transaction.

Arms-length transaction = transaction between client company and its customers.
So: Related party transaction is between the client company and some party that is not a customer, but has a close relationship with the company.


(1) Is it the management or the auditor that is responsible for

identify and account for contingent liabilities, including litigation, claims, and assessment through the policies adopted by management for such purposes?

(2) What is the name of the letter issued by MGT that has disclosed to the independent auditor all relevant info on contingent liabilities?

(1) Management is responsible

2) Management representation letter


What are the 5 specific procedures used to DETERMINE the existence of related parties?

1) Evaluating the company's controls related to the authorization and approval of SIGNIFICANT related party transactions and the PROCEDURES identifying, accounting for, and disclose related party transactions.

2) Asking management for the names of all related parties.
This includes:
* Changes from prior parties on these related parties
* Nature of relationships between entity and related parties
* Whether entity has ENTERED into TRANSACTION with related parties
* Types and purposes of any related party transactions

3) Reviewing reporting entity's filings with the SEC and other regulator agencies concerning the
* NAMES of officers and directors who occupy management
* Or directorship positions in other businesses

4) Review MATERIAL TRANSACTIONS (esp. investment transactions) for RELATED PARTY evidence, including bank and legal confirmations, minutes, and other appropriate records and documents.

5) Review PRIOR YEARS' audit documentation or INQUIRING of the predecessor auditor.


(1) An understanding of related party transactions and relationships is relevant to the auditor's evaluation of __ __ because ___ is more easily committed through related parties.

(2) The Audit risk in related party transactions deals with what MGT financial assertion.



(2) Valuation, allocation, and accuracy.


(1) What is the primary emphasis on auditing related party transactions?

(2) What is the initial step (first step) only in auditing related party transactions?

(3) Emphasis on actual related party transactions that

Occurred or
the probability that related party transaction could recur in the future?

(4) Verification of amounts associated with related party transactions (verify the valuation) is the same as the empathizes on the adequate disclosure of related party transactions?

(1) Adequacy of the disclosure of related party transactions.

(2) Confirming the existence of related parties.

(3) Actually occurred. Not the probability that it will occur in the future.

(4) Not the same.

Disclosure of related party transactions means that such transactions is reported on the F/S.

Verify amounts (or verify valuation) just focused on if the numbers are presented properly.


Which statement for contingencies on lawsuits is

* Remote
* Reasonably probable
* Probable

a) "we believe that the company will be able to defend its action successfully"

b) "We believe that the plaintiffs case against the company's without merit."

c) "We believe that the possible liability to the company is nominal in amount."

d) "We believe that the action can be settled for less than the damages claimed."

e) "I believe that this action has only a remote chance in establishing any liability"

f) "I believe that the company will be able to defend this action successfully."

g) "I believe that the plaintiff's case against the company is without merit."

h) "I believe that the plaintiff will have problems establishing any liability."

(2) Based on question 1 (above) which of these needs clarification?

a) Probable - this is a probable gain that is going to be disclosed in the footnotes to the F/S. There will be no recorded amount on the face of F/S until the the win actually did happened in the later period.

b) Remote

c) Reasonable possible - footnote disclosure on this one.

d) Probable - this is a probable loss that is going to occur.

e) Remote

f) Probable gain: Disclose in current F/S, only report actual $$ amount when realized in a later period's F/S

g) Remote

h) Probable

(2) The (d) "We believe that the action can be settled for less than the damages claimed."

This because: First: it is probable that a loss is going to occur. 2nd: "settled for less" means there is going to be an estimate lawsuit loss amount or an actual known amount that needs to be clarified.

The (h) "I believe that the plaintiff will have problems establishing any liability."

This does not provide a evaluation of an likelihood of unfavorable outcome. Does "will have problems' mean a loss is probable, reasonably possible, or remote?

Auditor should request more information on this for clarity


In auditing contingencies:

To identify a contingency, the auditor asks whom about contingent liabilities including pending litigation or possible future litigation (lawsuit) and about controls adopted to identify, evaluate, and account for such items.

Asks management


Which of the following procedures that the auditor would use to inquire and identify the existence contingent liabilities(i.e. lawsuits, litigation (pending and future)):

a) Confirm details of outstanding purchase orders

b) Review the minute at board of directors meetings

c) Review correspondence and invoices from lawyers

d) Apply analytical procedures to accounts payable

e) Apply ratio analysis on sales volume in prior year to current year and liability accounts

f) Review contracts, loan agreements loan guarantees, leases, and correspondence from taxing authorities

g) Perform tests of controls on cash disbursements activities

h) Review bank confirmations for hidden bank loans, discounted drafts, guarantee of note, etc.

i) Discuss long-term purchase commitments with the purchasing agent

j) Verify the valuation of impairments on intangibles.

k) Conduct positive confirmations with customers in regards to A/R

l) Review the status of long-term leases

m) Discuss sales contract with sales manager

n) Review interim F/S after year-end

o) Obtain client rep. letter

p) Send inquiry letter to client's attorney.

q) Obtain a letter of representation from client's underwriter of securities

a) No

b) Yes - it's a procedure to inquire on contingent liabilities

c) Yes - it's a procedure to inquire on contingent liabilities

d) No

e) no

f) Yes - it's a procedure to inquire on contingent liabilities

g) No

h) Yes - it's a procedure to inquire on contingent liabilities

i) Yes - it's a procedure to inquire on contingent liabilities

j) No

k) No

l) Yes - it's a procedure to inquire on contingent liabilities

m) Yes - it's a procedure to inquire on contingent liabilities

n) Yes - it's a procedure to inquire on contingent liabilities

o) Yes - it's a procedure to inquire on contingent liabilities

p) Yes - it's a procedure to inquire on contingent liabilities

q) No


True or False:

(1) Sending to client company's attorney to get information about whether a loss contingencies is possible, probable, or remote is the primary to send such a request.

(2) The attorney does provide information, regarding the degree of probability of an unfavorable outcome along with description of litigation, claims, and assessments that have a reasonable possibility of unfavorable outcomes.

(3) The attorney is an expert in litigation, claims, and assessment and can provide information about the nature of the matter, progress of the case, degree of probability of an unfavorable outcome and estimate of potential loss.

(4) The attorney is also an expert in the accounting in terms of providing assurance regarding the probable of assertion that is accounted for.

(5) The primary reason to request information from attorney on litigation, claims and assessments is to verify and to corroborate the information furnished by the management on these matters.

(6) Obtaining a letter of audit inquiry from the client's lawyer may aid the auditor in evaluating loss contingencies.

(7) Executives are related parties no matter if stock options are granted to them or not.

(1) False.
It is not. The primary reason to request info from attorney is to verify / corroborate management information pertaining to litigation, claims, and assessments.

2) True.
The attorney does provide such information.

(3) True.
This is what an attorney does.

(4) False.
An attorney is not accountant. They are not experts in accounting. Therefore they cannot assurance on the probable of assertion that is accounted for.

5) True.
You need to receive direct, outside information from third parties in this case an attorney letter to verify and corroborate MGT's information.

6) True.
Attorney letter can help you evaluate loss contingencies.

FYI - the only procedures that does not help to evaluate loss contingencies is:
* Checking arithmetic accuracy of accounting records
* Reading F/S including footnotes
* Perform analytical procedures
* Confirm and verify certain accounts in terms of correct $$ amount and it actually exists.

(7) True


(1) In an audit inquiry with attorney to gain audit evidence on actual or pending litigation, claims, and assessments,

The auditor letter should including information to inquire on what 3 things?

(2) True or false: Audit Inquiry letters to attorney

a) Attorney response to auditor's letter of inquiry does include the attorney's evaluation of the company's ability to be going concern if verdict is unfavorable and maximum damage is awarded.

b) An audit letter should inquire regarding only one specific matters that may result in litigation for the attorney to respond to.

c) An audit inquiry letter does not have to inquire about the progress of the case to date and management's intended response for the attorney to write a letter back to auditor.

d) An audit inquiry letter to the attorney should inquire about the degree of probability of an unfavorable outcome and the amount or estimate of potential loss.

e) Auditor should send an inquiry letter to attorney on estimate loss of potential loss that may be incurred due to the litigation

f) Auditor should send an inquiry letter to attorney on the appropriateness of managements F/S disclosure

g) Auditor should send an inquiry letter to attorney on on likely it is that there will be unfavorable outcome to the litigation

h) Auditor should send an inquiry letter to attorney on MGT's intended response and the progress of the case to date.

3) True or False: on Audit Procedures to Litigation

a) Auditor is allowed to inspect the legal documents in the client's lawyers possession regarding pending litigation

b) Auditor is allowed to confirm with the clerk of the court directly that the client's litigation is properly disclosed

c) Auditor can confirm details of pending litigation with client's adversaries legal representations.

d) Auditor can discuss with the management on its policies and procedure to entity and valuate litigation.


a) Period in which underlying cause for legal action occurred (when the legal action happened)

b) Degree of probability of an unfavorable outcome;
(is the lawsuit loss really, really going to happened)

c) The amount or range of potential loss
(this can be an actual amount or a REASONABLE ESTIMATE)


a) False.
Attorney's job does not include evaluating the going concern of an entity. That's the auditor's responsibility

b) False.
Audit inquiry letter covers all signification matters that may result in a litigation

c) False.
Audit inquiry letter should inquire about the progress of the case to date and the management's response to such case.

d) True.
An audit inquiry letter to attorney should ask about Degree of probable unfavorable outcome and an actual loss amount or estimate loss amount.

e) True.
Attorney will response to auditor on estimate loss to be incur to date

f) False.
Attorney not responsible for this. Auditor is responsible for this.

g) True
Attorney will responsible on responding about unfavorable outcome coming out or not.

h) True
Attorney will responsible about MGT's attempt to response to this.


a) False.
The auditor is not allowed to go into the Lawyer's office or possessions to inspect legal documents. That's just wrong. The auditor is only allowed to just rely on the attorney's letter to evaluate the pending outcome of litigation against the client company.

b) False.
Court clerks do not have information regarding whether or not litigation is properly disclosed in the F/S.

c) false
It would be inappropriate for auditor to contact the legal reps. of the client's adversaries.

d) True.
The auditor should discuss with management the controls to identify, evaluate, and account for litigation.


Which of the following is an indication of:

* Related party transaction exists
* There is no related party transactions

a) Borrow funds at a interest rate significantly below the prevailing market rate

b) Maintain compensation balance arrangements for the benefit of principal stockholders

c) Purchasing an equipment at published price from a catalog of a seller that everyone goes to.

d) Writing off obsolete inventory to net realizable value just before year end

e) Making a loan with no scheduled date for funds to be prepaid differs from market terms.

f) Failure to correct internal control weaknesses on a timely basis.

g) High turnover of senior management and members of board of directors.

h) Selling real estate at a price significantly different fro appraised value.

a) Related party transaction exists

b) Related party transaction exists

c) There is no related party transactions

d) There is no related party transactions

e) Related party transaction exists

f) There is no related party transactions
Failure to correct internal control deficiencies is MGT responsibility

g) There is no related party transactions

h) Related party transaction exists


Which of the following is:

A procedure to evaluate reasonableness of estimate
Not a procedure to evaluate reasonableness of estimate

a) Develop an independent estimate and compare it to management estimate

b) confirm via MGT rep. letter that management has disclosed all significant estimates.

c) Determine how management developed their estimate and test procedures they used

d) Use subsequent events to determine whether the estimates was reasonable.

a) A procedure to evaluate reasonableness of estimate

b) Not a procedure
Using a rep letter to confirm estimate does not guarantee that the estimate is done properly. Therefore, auditor does more audit work.

c) A procedure to evaluate reasonableness of estimate

d) A procedure to evaluate reasonableness of estimate

To evaluate the reasonableness of an estimate, the auditor may perform 1 or a combination of the following:

* Review and testing MGT procures
* Develop an independent estimate for comparative purposes
* Review subsequent events and transactions (occurring prior to completion of fieldwork)


(1) Client company refuses the auditor to inquire outside legal counsel results in what 2 things?

(2) If the client's attorneys refuse to respond to the Auditor's inquiry, then what 2 things happen?


* Disclaimer of opinion on the auditor's report
* OR: Audit withdraws from the audit engagement.


* Qualified opinion on auditor's report
* Or: disclaimer of opinion on auditor's report.


(1) Does the external auditor or the client management can request inquiry of the client's lawyer/legal counsel/attorney?

(2) One of the auditor's main responsibilities is to inquire with client's lawyers in regards litigation, claims, and assessments. After getting such information, what does the auditor do with it in regards to MGT and the F/S?

(1) It's ALWAYS the client's management that CAN prepare to request inquiry with the attorneys.

Per Becker 2014 AUD 4.3, page A4-55:

"This letter [of inquiry to Client's attorneys] is prepared by management and be sent by the auditors to attorneys.

(2) After the auditor receives an Attorney letter on litigation, claims, and assessments, the auditor used such knowledge to see if the MGT made all disclosures in regards to unassertive claims that its lawyers has advised are probable of assertion.

In other words, use the attorney's letter to highlight any probable contingent event (litigation, claims, assessment) to be disclosed either on face of F/S or in the footnotes to the F/S.


(1) What is the auditor's responsibility with respect to Fair values?

(2) Does the auditor assess assess on the effect of fair values and disclosures subsequent to the audit?

(1) Obtain sufficient, appropriate audit evidence to provide reasonable assurance that fair value measurements and disclosures are in conformity with GAAP.

(2) No. The auditor does not do any work that happens after the auditor report date (the last day of any audit work on transactions in the company up to that date).


(1) How come attorney's letter is used to assess the materiality of all identified MGT's accounting evidence compared to let's say accounting estimates deviating from historical patterns?

(2) What is the first step in evaluating the management accounting estimates for reasonableness?

(3) After doing the first step to evaluate the management accounting estimates, what does the auditor do next?

(4) What are the key factor and assumptions the auditor normally concentrate on in regards to estimates?

(1) Attorney letters can reveal any omitted estimates of contingencies (i.e. lawsuits, ligitations claims) and / or see a comlete list of such matters to confirm that all accounting materila estimates are identified and disclosed in the F/S.

Also, accounting estimates deviating from historical patterns does help if the estimate already recorded is reasonable. But does not help in finding those that may have been omitted by error or intentionally.

(2) Obtain an understanding on how management developed its estimates.

(3) Auditor does one of the following or a combination of the following:
a) Review / test MGT's procedures to develop estimates
c) Review SUBSEQUENT EVENTS and TRANSACTIONS (before the last day of audit work i.e. auditor's report date) in order to CORROBORATE the value.

(4) Key factors / assumptions on evaluate ESTIMATES REASONABLENESS:

a) Significant assumptions to accounting estimates
b) Estimates sensitive to variations
c) Estimates that are deviating from historical patterns
d) SUBJECTIVE (not objective) and susceptible to misstatements and BIAS.


(1) What are the two steps for auditor to assess the related party transactions?

(2) In the first step, what documentation evidence is used in regards with related party-transactions?

(3) True or False:

(a) Related-party transactions are NOT done in an arms-length transaction

(b) Analytical procedures are not effective to identify related party transactions.

(c) Internal control tests such as tests of segregation of duties can help identify related part transactions.

(d) Related party transactions are related to transactions with affiliates, owners, or management.


First step: Identify and examine related party transactions (determine if they really exist).

Second Step: Inspect the underlying contracts or agreements, if any to EVALUATE WHETHER:

a) Business rationale of transactions were entered between Company and related party to ENGAGE IN FRAUD.

b) The terms of the transactions are CONSISTENT with MGT's explanations

c) Transactions have been APPROPRIATELY ACCOUNTED for and DISCLOSED.

Also: Obtain audit evidence that these related-party transactions were APPROPRIATELY authorized and approved.

(2) Here are the evidence to determine the existence of related-party transactions:

a) compensation balance arrangements (maintained by or for related parties)

b) Loan guarantees (done via review confirmations on loan receivable, loan payable indicating guarantees)

c) Unusual non-recurring transactions near year-end

d) Transactions based on terms that DIFFER SIGNIFICANTLY from market terms, appraised terms.
Example: sell real estate to a party less than appraised value

e) Non-monetary exchanges


a) True
Related party transactions are different from arms-length transactions. This because arms-length transactions is a ordinary transaction between a customer and the company.

b) True
Analytical procedures focuses on the actual $$ amounts in the F/S not actually analysis on specific documents that shows some unusual transaction between client company and the related party (i.e. a loan given to related party at a very low interest rate).

(c) False.
Internal controls testing cannot help to identify related party transactions. You have to look at specific documents to find the info that shows evidence of related parties

(d) True.
Related party transactions are between the related parties and affiliates, owners, or management of a client company.