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201

4FOCUS NOTES

CPAexcel®

EXAM REVIEW

Wiley

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201

4

AUDITING AND ATTESTATION

FOCUS NOTES

CPAexcel®

EXAM REVIEW

Wiley

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Cover Design by David RiedyCover image: © turtleteeth/iStockphoto

Copyright © 2014 by John Wiley & Sons, Inc. All rights reserved.Published by John Wiley & Sons, Inc., Hoboken, New Jersey

Published simultaneously in Canada.

No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, 978-750-8400, fax 978-750-4470, or on the Web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, 201-748-6011, fax 201-748-6008, or online at http://www.wiley.com/go/permission.

Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifi cally disclaim any implied warranties of merchantability or fi tness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profi t or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.

For general information on our other products and services, or technical support, please contact our Customer Care Department within the United States at 800-762-2974, outside the United States at 317-572-3993 or fax 317-573-4002.

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ISBN: 978-1-118-81683-7 (paperback); 978-1-118-85422-8 (ebk); 978-1-118-87198-0 (ebk)

Printed in the United States of America

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v

CONTENTS

Preface viiAbout the Author ixAbout the Contributor ix

Module 1: Professional Responsibilities 1Module 2: Engagement Planning, Obtaining an Understanding, and Assessing Risks 22Module 3: Understanding Internal Control and Assessing Control Risk 50Module 4: Responding to Risk Assessment: Evidence Accumulation and Evaluation 96Module 5: Reporting 160Module 6: Accounting and Review Services 223Module 7: Audit Sampling 239Module 8: Auditing with Technology 255

Index 263

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vii

PREFACE

This publication is a comprehensive, yet simplifi ed study program. It provides a review of all the basic skills and concepts tested on the CPA exam and teaches important strategies to take the exam faster and more accurately. This tool allows you to take control of the CPA exam.

This simplifi ed and focused approach to studying for the CPA exam can be used:

• As a handy and convenient reference manual

• To solve exam questions

• To reinforce material being studied

Included is all of the information necessary to obtain a passing score on the CPA exam in a concise and easy-to-use format. Due to the wide variety of information covered on the exam, a number of techniques are included:

• Acronyms and mnemonics to help candidates learn and remember a variety of rules and checklists

• Formulas and equations that simplify complex calculations required on the exam

• Simplifi ed outlines of key concepts without the details that encumber or distract from learning the essential elements

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Preface viii

• Techniques that can be applied to problem solving or essay writing, such as preparing a multiple-step income statement, determining who will prevail in a legal confl ict, or developing an audit program

• Pro forma statements, reports, and schedules that make it easy to prepare these items by simply fi lling in the blanks

• Proven techniques to help you become a smarter, sharper, and more accurate test taker

This publication may also be useful to university students enrolled in Intermediate, Advanced and Cost Accounting; Auditing, Business Law, and Federal Income Tax classes; or Economics and Finance Classes.

Good luck on the exam,

Ray Whittington, PhD, CPA

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ix

ABOUT THE AUTHOR

Ray Whittington, PhD, CPA, CMA, CIA, is the dean of the Driehaus College of Business at DePaul University. Prior to joining the faculty at DePaul, Professor Whittington was the Director of Accountancy at San Diego State University. From 1989 through 1991, he was the Director of Auditing Research for the American Institute of Certifi ed Public Ac countants (AICPA), and he previously was on the audit staff of KPMG. He previously served as a member of the Audit ing Standards Board of the AICPA and as a member of the Accounting and Review Services Committee and the Board of Re gents of the Institute of Internal Auditors. Professor Whittington has published numerous textbooks, articles, mono graphs, and continuing education courses.

ABOUT THE CONTRIBUTOR

Kurt Pany, PhD, CPA, is a Professor of Accounting at Arizona State University. His basic and advanced auditing courses provided the basis on which he received the Arizona Society of CPA’s Excellence in Teaching Award and an Arizona CPA Foundation Award for Innovation in the Classroom for the integration of computer and professional ethics applications. His professional experience includes serving for four years on the AICPA’s Auditing Standards Board, serving as an academic fellow in the Auditing Division of the AICPA, and prior to entering academe, working as a staff auditor for Deloitte and Touche.

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Professional Responsibilities—Module 1 1

CODE OF PROFESSIONAL RESPONSIBILITIES

AICPA

General Standards and Accounting Principles

• A CPA must perform with competence and must exercise due care• Competence implies combination of education and experience• Due care includes proper supervision and reviewing work of assistants• Examples of actions that would violate the standard of due care include

• Performing professional services without complying with the appropriate standards

• Expressing an unqualifi ed opinion on fi nancial statements known to be materially misstated

• Failing to report the discovery of fraud to the client’s audit committee

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Professional Responsibilities—Module 1 2

Independence

• A member in public practice should be independent in the performance of professional services as required by AICPA standards.

• The independence rule and its related interpretations are heavily examined; rulings are examined to a lesser extent.

• Interpretation 101-1 is extremely important; it has three major subsections.

A. Restricts activities and investments by those involved on the attest engagement—covered members.

B. Restricts investments in the client by all in CPA fi rm. C. Restricts positions held in the client by all in CPA fi rm.

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Professional Responsibilities—Module 1 3

Interpretation 101 A: Independence—Those Involved with the Audit

Covered members: The concept of covered members is important since certain independence requirements apply to them. Included as “covered members” are:

• A member of the attest engagement team.• A person who may infl uence the attest engagement (e.g., partner who supervises the

partner in charge of the attest engagement).• A partner in the office in which the lead attest partner practices.• Certain partners or managers who provide nonattest services to the client.• The fi rm, including its benefi t plans.

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Professional Responsibilities—Module 1 4

Interpretation 101 A: Independence—Those Involved with the Audit (continued)

A member in public practice shall be independent in the performance of professional responsi bilities

• Independence impaired if a covered member• Had committed to acquire any direct or material indirect fi nancial interest in the client.

• Was a trustee or executor for estate that had/committed to acquire any direct or mate-rial indirect fi nancial interest in the client in excess of 10% of assets.

• Had a material joint closely held investment.

• Had a loan to or from the client, officer, director of the client, or any individual own ing 10% or more of client’s capital (there are some exceptions to this).

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Professional Responsibilities—Module 1 5

Interpretation 101 B Investments that Impair Independence

• Partner or professional employee of the fi rm, his or her immediate family owned more than 5% of capital

• Was associated with the client as a(n) • Director, officer, or employee, or in any capacity equivalent to that of a member of

management • Promoter, underwriter, or voting trustee

Interpretation 101 C Activities that Impair Independence

• Independence impaired by• Supervising client’s personnel

• Signing client’s checks

• Acting as client’s stock transfer agent

• Entering into lease with client

• Accepting gifts from client

• Obtaining material loan from client, even if fully collateralized (except by cash balances)

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Professional Responsibilities—Module 1 6

Independence—Effect on Independence of Family Members, Relatives and Friends

Overall: These groups may impair a CPA’s independence.

General Rules:

Immediate family (spouse, spousal equivalent or dependent): Restrictions generally same as for accountant. Exceptions relate to those in other than a key position with a client and certain benefi t plans.

Close relatives (parent, sibling, or nondependent child): Independence not impaired unless close relative has a key position with client or a material fi nancial interest of which the accountant is aware.

Other relatives and friends: Independence not impaired unless a reasonable person aware of the facts would conclude there is an unacceptable risk.

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Professional Responsibilities—Module 1 7

Independence—Unpaid Fees

• Unpaid fees may impair independence.• May not extend beyond one year

• Audit may be performed, but report may not be issued until prior year fees paid

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Professional Responsibilities—Module 1 8

Independence—Auditor on Engagement Considers or Takes Employment with Audit Client

• Individual must inform the audit fi rm when seeking or discussing potential employment with client.

• Individual’s independence impaired (should be taken off job) until employment by client is no longer being considered by that individual.

• Once individual accepts employment with audit client, the audit fi rm should consider the need to mod ify the audit plan or change members of the audit.

• In any audit performed within a year of the professional joining the client, a member of the audit fi rm with no connection to the audit must review all work to ensure it takes into account independence issues.

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Professional Responsibilities—Module 1 9

Independence—Nonattest Services

• May provide advice, research materials, and recommendations• Client must accept responsibility for making all decisions• Specifi c client personnel must be designated to oversee services• Client must be responsible for establishing and maintaining all internal controls and may

not “outsource” such services to the auditor• An understanding of the objectives of the engagement and client responsibilities must be

documented prior to performing the nonattest services for an attest client

A member shall maintain objectivity and integrity, shall be free of confl icts of interest, and shall not knowingly misrepresent facts or subordinate his or her judgment to others.

• Misrepresentation of facts: Member is forbidden to knowingly (or let someone else)• Make materially false and misleading entries

• Fail to correct fi nancial statements or records that are materially false and misleading

• Sign a document containing materially false and misleading information

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Professional Responsibilities—Module 1 10

Independence—Nonattest Services (continued)

• A confl ict of interest may exist if member performing a service and the member/ member’s fi rm has a relationship that could in the member’s judgment be viewed as impairing the member’s objectivity. For example, • Suggest that the client invest in a business in which he or she has a fi nancial interest.

• Provide tax services for several members of a family who may have opposing interests.

• Have a signifi cant fi nancial interest or infl uence with a major competitor of a client.

• Obligations of a member to his or her employer’s external accountant• Must be candid and not knowingly misrepresent facts or knowingly fail to disclose

material facts

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Professional Responsibilities—Module 1 11

Responsibilities to Clients 

A member in public practice shall not

• Disclose any confi dential client information without the specifi c consent of the client• Accept a contingent fee for

• An audit or review of a fi nancial statement

• A compilation of a fi nancial statement

• An examination of prospective fi nancial information

• Prepare an original or amended tax return or claim for a tax refund for a contingent fee for any client

A CPA must maintain client information as confi dential. May disclose client information to

• Comply with a subpoena• Cooperate with a quality control review

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Professional Responsibilities—Module 1 12

Other Responsibilities and Practices

A CPA should not perform acts discreditable to the profession, such as

• Retaining client records• Understating anticipated fees for services• Accepting a commission in relation to an attest client• Practice under a misleading name

A CPA shall be competent.

• Agreeing to perform professional services implies that the member has the necessary competence to complete those professional services but is not infallible

• Involves both the technical qualifi cations of the member and staff and the ability to super-vise and evaluate the quality of the work performed

• If the member does not have the necessary competence, may perform additional research or consult with others

• But if cannot attain competence, should recommend client seek help from someone else

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Professional Responsibilities—Module 1 13

Tax Preparer

Actions by an accountant preparing a client’s tax return can result in penalties for

• Not providing client with copy of return• Failing to sign return as a preparer• Endorsing and cashing client’s refund check• Failing to fi le a timely return • Not advising client of tax elections• Neglecting evaluation of joint versus separate returns

A CPA performing tax services

• May not recommend a tax position that lacks merit• Must make a reasonable effort to answer applicable questions on the return• May rely on client information when preparing the return• Must make reasonable inquiries about questionable or incomplete information• May use estimates

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Professional Responsibilities—Module 1 14

Standards for Consulting Services

When performing consulting services, a CPA must adhere to certain general standards

• Professional competence• Due professional care• Planning and supervision• Obtaining sufficient relevant data

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Professional Responsibilities—Module 1 15

GAO Code of Ethics

Federal auditors, or CPA fi rms auditing federal dollars, should not perform management functions or make management decisions.

Federal auditors, or CPA fi rms auditing federal dollars, should not audit their own work.

Federal auditors, or CPA fi rms auditing federal dollars, should not provide nonaudit services that are material to the subject matter of an audit.

Emphasis:

• Accountability of government officials to the Congress • Accountability of the auditor to conduct work professionally• No requirement to evaluate management controls • Executive leadership of the audited agencies is not the primary customer • Management input not solicited as part of the audit process• Management input not solicited in development of solutions • Management is presented with “fi ndings” to which it must “respond”

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Professional Responsibilities—Module 1 16

Institute of Internal Auditors Code of Ethics

The IIA Standards focus on improvement of risk management, control and governance processes within an organization so that issues of concern can be identifi ed and corrected be fore they become persistent or pervasive problems.

• Mandate organizational independence of the audit department and mandate individual auditor objectivity.• Internal auditors (IA) must report to a level within the organization that permits the au dit

department to fulfi ll its responsibilities.

• IA must not perform management functions or make management decisions.

• IA must not audit their own work.

• IA must determine the nature and scope of their work.

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