Misstatements and internal control deficiencies Flashcards

(3 cards)

1
Q

An auditor determines that, due to accounting errors, a company’s expenses and revenues are materially understated, both by approximately the same amount. What is the auditor’s most likely course of action in response to these findings?

A. Determine whether accounting policy control weaknesses allowed the errors to occur.
B. No further action is needed because net income is materially correct.
C. Request that management make adjusting entries to correct both expenses and revenues.
D. Issue an adverse audit opinion because the errors were not detected by management.

A

C. Request that management make adjusting entries to correct both expenses and revenues.

A misstatement is a difference between the way an amount is presented on the F/S and how it should be presented. An auditor should accumulate misstatements that are more than trivial and determine their impact on the F/S. The auditor should communicate the accumulated misstatements (ie, understated revenues and expenses) to management and request correction.

In this scenario, even though net income is correct, the misstatements are material because they reflect revenues and expenses incorrectly and should therefore not be ignored (Choice B). Incorrect revenues and expenses can distort financial ratios or other comparisons upon which management, investors, and analysts base decisions. In addition, if material misstatements are ignored, the audit opinion cannot state that the F/S fairly reflect, in all material respects, the results of operations.

(Choice A) Material misstatements are detected during substantive testing, the nature and extent of which is based on results from the test of controls. The auditor would have already tested controls (ie, accounting procedures) and thus determined whether any weaknesses needed to be considered when planning for and performing substantive tests.

(Choice D) The presence of material misstatements does not always warrant an adverse opinion. If management agrees to correct the misstatements and the results of operations are fairly reflected, in all material respects, the auditor may be able to issue an unmodified (nonissuer) or unqualified (issuer) report on the F/S.

Things to remember:
An auditor should accumulate misstatements that are more than trivial, communicate the accumulated misstatements (ie, understated revenues and expenses) to management, and request correction.

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2
Q

When determining whether uncorrected misstatements are material, individually or in the aggregate, an auditor of a nonissuer would consider each of the following, except

A. The particular circumstances of each misstatement.
B. The cost of correcting the misstatements.
C. The effect of uncorrected misstatements related to prior periods.
D. The size and nature of the misstatements.

A

B. The cost of correcting the misstatements.

During an audit, the auditor should accumulate identified uncorrected misstatements that are more than trivial. The auditor must determine whether those uncorrected misstatements have a material effect on the financial statements.

The objective of a financial statement audit is to issue an unbiased opinion regarding the fairness of the statement presentations, indicating whether they are free from material misstatement. Therefore, the cost of correcting material misstatements would not factor into the auditor’s evaluation.

This evaluation should consider the:

Size and nature of the misstatements (Choice D).

Circumstances of each misstatement. For example, a misstatement that impacts regulatory compliance may result in circumstances that are considered material even if the amount does not have a material impact on the financial statements (Choice A).

Impact on prior periods since uncorrected prior period misstatements (eg, errors in depreciation) may also affect the current period (Choice C).

Things to remember:
The auditor must consider the size, nature, circumstances, and prior period impact of any uncorrected misstatements when determining materiality. The cost of correcting these misstatements would not be considered in the evaluation.

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3
Q

According to PCAOB standards, what should an auditor do to evaluate the potential effect of management bias due to management’s selective correction of misstatements?

A. Perform additional audit procedures to identify further uncorrected misstatements.
B. Reperform the substantive audit procedures that identified the uncorrected misstatements to evaluate their validity.
C. Consider whether other forms of management bias could offset the selective correction of misstatements.
D. Obtain an understanding of the reasons that management decided not to correct misstatements communicated by the auditor.

A

D. Obtain an understanding of the reasons that management decided not to correct misstatements communicated by the auditor.

A misstatement is a difference between the way an amount is presented on the F/S and how it should be presented. An auditor should accumulate misstatements that are more than trivial and determine their impact on the F/S. The auditor should communicate the accumulated misstatements (eg, understated revenues and expenses) to management and request corrections.

In this scenario, management has selectively corrected misstatements. The auditor should obtain an understanding of management’s reasons for not correcting some misstatements and take that into consideration when evaluating whether the F/S are materially misstated. This process should include evaluating the potential effects of management bias on the correction of only certain misstatements and the impact of their correction on the F/S, key ratios, and other significant performance measures.

(Choices A and B) Adding or reperforming audit procedures does not help the auditor evaluate the potential effect of management bias or management’s selective correction of misstatements.

(Choice C) Other forms of management bias should not be used to offset the selective correction of misstatements.

Things to remember:
If management has selectively corrected misstatements, the auditor should obtain an understanding of management’s reasons for not correcting some misstatements and take that into consideration when evaluating whether the F/S are materially misstated. This process should include evaluation of the potential effects of management bias on the decision to correct or not correct each misstatement.

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