Tom tat

Auditing Auditing

AttestationAttestation

Assurance Assurance

Fraud Fraud

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Truisms

■ ““In God We Trust, All Others We Audit”In God We Trust, All Others We Audit”■ ““Trust but verify”Trust but verify”■ ““Be not suspicious but be darn skeptical”Be not suspicious but be darn skeptical”■ ““When all else fails, use common sense”When all else fails, use common sense”■ ““Use common sense before you use Use common sense before you use

anything else”anything else”

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Introduction

■ What is an Assurance service?What is an Assurance service?

■ What is an Attestation service?What is an Attestation service?

■ What is Auditing?What is Auditing?

■ What is the difference between Accounting What is the difference between Accounting and auditing?and auditing?

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What do the following scenarios have in common?

■ Making a valuation statement about the accuracy Making a valuation statement about the accuracy and validity of someone’s decisions/assertionsand validity of someone’s decisions/assertions

■ An auto mechanic tells you that your alternator is An auto mechanic tells you that your alternator is defective?defective?

■ A stereo salesman suggests that a certain brand of A stereo salesman suggests that a certain brand of CD player is the best value for the money.CD player is the best value for the money.

■ A cellular phone company claims to have the best A cellular phone company claims to have the best rates in the area.rates in the area.

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What do the following scenarios have in common?■ A dentist urges you to put a crown on a tooth.A dentist urges you to put a crown on a tooth.

■ Your friends tell you to take Route 1 instead of Your friends tell you to take Route 1 instead of Route 95 to get to your destination.Route 95 to get to your destination.

■ A recruiter pushes his company’s employee A recruiter pushes his company’s employee benefits program during an interview.benefits program during an interview.

■ Management releases reports showing a 20 percent Management releases reports showing a 20 percent growth in revenue and profits.growth in revenue and profits.Aunt Edna tells you to put a cold compress on Aunt Edna tells you to put a cold compress on your tooth?your tooth?

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Common Themes

■ RelevanceRelevance■ ReliabilityReliability■ Users expectations of auditor’s behaviorUsers expectations of auditor’s behavior

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Methods to encourage appropriate behavior■ GAASGAAS■ SECSEC■ Legal LiabilityLegal Liability■ Code of ConductCode of Conduct■ Peer ReviewsPeer Reviews

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Is fraud present?

◆ Definition of fraudDefinition of fraud

◆ Management’s responsibilityManagement’s responsibility

◆ Auditor’s responsibilityAuditor’s responsibility

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Overview of Auditing

■ Why study auditing?Why study auditing?

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What is an Audit and what value does it have?

◆ Agent/Principal, Asymmetry of Information, and self-Agent/Principal, Asymmetry of Information, and self-protection.protection.

◆ Value Added--banks,creditors, governmentValue Added--banks,creditors, government◆ formal definition--systematic process of objectively formal definition--systematic process of objectively

obtaining and evaluating evidence regarding obtaining and evaluating evidence regarding assertions about economic transactions and events to assertions about economic transactions and events to ascertain the degree of correspondence between ascertain the degree of correspondence between assertions and established criteria and communicate assertions and established criteria and communicate the results to users of financial statements.the results to users of financial statements.

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Types of auditors?

■ The good, the bad, the ugly, and the untouchable.The good, the bad, the ugly, and the untouchable.■ formal definition--an independent party that formal definition--an independent party that

obtains and evaluates evidence to determine obtains and evaluates evidence to determine agreement between management’s assertions and agreement between management’s assertions and established criteria. Must plan and perform the established criteria. Must plan and perform the audit to obtain reasonable assurance that the f/s are audit to obtain reasonable assurance that the f/s are free from material misstatements.free from material misstatements.

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Auditor’s Responsibility

■ Financial statements (assertions) are the Financial statements (assertions) are the responsibility of management.responsibility of management.

■ Auditor’s responsibility is to opine that the Auditor’s responsibility is to opine that the f/s are, or are not, free of material f/s are, or are not, free of material misstatements (errors, irregularities, fraud) misstatements (errors, irregularities, fraud) based on evidence obtained (GAAS).based on evidence obtained (GAAS).

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Types of Audits

■ FinancialFinancial■ ComplianceCompliance■ OperationalOperational■ ForensicForensic

◆ F/S fraudF/S fraud◆ Insurance fraudInsurance fraud◆ EmbezzlementEmbezzlement◆ Money launderingMoney laundering◆ Matrimonial disputesMatrimonial disputes

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Types of fraud (against and on behalf of)■ Misappropriation of assets vs fraudulent Misappropriation of assets vs fraudulent

financial reportingfinancial reporting

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Why do frauds occur?

■ Perceived pressurePerceived pressure

■ Perceived opportunityPerceived opportunity

■ Ability to rationalizeAbility to rationalize

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Auditing vs attestation vs assurance■ Examinations-expresses written opinionExaminations-expresses written opinion

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Auditing vs attestation vs assurance ■ Attestations engagements--expresses Attestations engagements--expresses

written conclusion. .written conclusion. .

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Auditing vs attestation vs assurance■ Assurance services--improves the quality of Assurance services--improves the quality of

information. care services, TAMU vs UT, information. care services, TAMU vs UT,

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Generally Accepted Auditing Standards■ General Standards-TIP■ Field Work Standards - PIE■ Reporting Standards - DOGC / GCDO

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Professional Code of Conduct

■ General stds of ideal conduct with rules and examples of misconduct.

■ Four parts to the AICPA code of conduct.◆ PrinciplesPrinciples◆ Rules of ConductRules of Conduct◆ InterpretationsInterpretations◆ RulingsRulings

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Rules of Conduct

■ iindependencendependence, , intergrityintergrity and objectivity, and objectivity, general stds, compliance w/stds, acctg general stds, compliance w/stds, acctg principles, principles, confidential infoconfidential info, acts , acts discreditable, discreditable, advertising, commissionsadvertising, commissions, , and forms of practice.and forms of practice.

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Ethical behavior

■ Conduct that differs from what is Conduct that differs from what is considered appropriate under the considered appropriate under the circumstancescircumstances

■ Core values—Trustworthiness, respect….Core values—Trustworthiness, respect….

■ Ethical dilemmas Ethical dilemmas

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Independence

■ Independence in Fact and Independence in Independence in Fact and Independence in AppearanceAppearance

■ Advocate—to be or not to be.Advocate—to be or not to be.■ Unbiased in the performance of tests, Unbiased in the performance of tests,

evaluation of those tests, and in issuance of evaluation of those tests, and in issuance of the reportthe report

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Independence

■ Questions of “What if”Questions of “What if”

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Independence

■ Direct financial interestDirect financial interest◆ Covered members(ability to influence Covered members(ability to influence

engagement)engagement)✦ Members on ET and their spouses/immediate familyMembers on ET and their spouses/immediate family✦ Certain PartnersCertain Partners

◆ TimingTiming◆ MaterialityMateriality◆ ParticipateParticipate◆ Do not participateDo not participate

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Independence

■ Indirect financial interestIndirect financial interest◆ Mutual fundsMutual funds◆ Nondependent/close relativesNondependent/close relatives◆ TimingTiming◆ Covered members(ability to influence engagement)Covered members(ability to influence engagement)

✦ Members on ET and their spouses/immediate familyMembers on ET and their spouses/immediate family✦ Certain PartnersCertain Partners

◆ ParticipateParticipate✦ MaterialityMateriality✦ AwareAware

◆ Do not participateDo not participate✦ MaterialityMateriality✦ AwareAware

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Independence

■ Direct managerial interestDirect managerial interest■ Auditor and dependent/close relativesAuditor and dependent/close relatives■ TimingTiming■ PositionsPositions

◆ Audit sensitiveAudit sensitive◆ Significant influenceSignificant influence

■ ParticipateParticipate■ Do not participateDo not participate

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Independence

■ Indirect managerial interestIndirect managerial interest■ PositionsPositions

◆ Audit sensitiveAudit sensitive◆ Significant influenceSignificant influence

■ Nondependent/close relativesNondependent/close relatives◆ Covered members(ability to influence engagement)Covered members(ability to influence engagement)

✦ Members on ET and their spouses/immediate familyMembers on ET and their spouses/immediate family✦ Certain PartnersCertain Partners

■ TimingTiming■ ParticipateParticipate■ Do not participateDo not participate

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Auditor’s Reports

■ Attestation/GAASAttestation/GAAS■ Examinations, reviews, and agreed upon Examinations, reviews, and agreed upon

proceduresprocedures■ Reporting StdsReporting Stds■ Objective of reporting stdsObjective of reporting stds

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NO Qualifications

■ Unqualified reportUnqualified report◆ Std three par report pg 17-2Std three par report pg 17-2◆ f/s present fairlyf/s present fairly

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Modifications without qualifying

■ Uncertainties (litigation)Uncertainties (litigation)■ Going ConcernsGoing Concerns

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Modifications without qualifying

■ Departures from promulgated GAAPDepartures from promulgated GAAP■ reliance on other auditorsreliance on other auditors

◆ External (sharing;predecessor/successor)External (sharing;predecessor/successor)◆ InternalInternal

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Qualified for Scope limitations--pg 17-6■ Reasons to qualify (“except for”) for scope Reasons to qualify (“except for”) for scope

limitationslimitations

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Qualified for Disclosure problems--pg 17-14■ Reasons to qualify (“except for”) for Reasons to qualify (“except for”) for

disclosure problemsdisclosure problems

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Qualified (maybe) for Changes in GAAP or departures from GAAP■ Determining afffect on opinion depends on Determining afffect on opinion depends on

the answers to the following:the answers to the following:◆ Changing from GAAP to GAAP?Changing from GAAP to GAAP?◆ Is the method of change GAAP?Is the method of change GAAP?◆ Is there adequate justification?Is there adequate justification?◆ Yes Yes ◆ NoNo

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Adverse pg 17-13

■ F/S as a whole are/are not misleading.F/S as a whole are/are not misleading.■ Reasons for giving an adverse?Reasons for giving an adverse?

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Disclaimer pg 17-8

■ What happens to the scope paragraph?What happens to the scope paragraph?■ Reasons for giving a disclaimer?Reasons for giving a disclaimer?

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Other Reporting Issues

■ No piecemeal opinionsNo piecemeal opinions■ Use of a specialistUse of a specialist■ Updating the report (same) (17-21)Updating the report (same) (17-21)■ Updating the report (17-22)Updating the report (17-22)

◆ Changing prior opinionChanging prior opinion◆ Different (qualified vs unqualified)Different (qualified vs unqualified)

■ Dual datingDual dating

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Attestation stds vs GAAS

■ Similarites in TIP PIE GCDOSimilarites in TIP PIE GCDO■ Differences in TIP PIE GCDODifferences in TIP PIE GCDO

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Reporting on other information and special reports■ Other information (not required) presented Other information (not required) presented

with F/S with F/S ■ Other information (required)--segmentsOther information (required)--segments■ Other information(required)--supplementary Other information(required)--supplementary

informationinformation■ Other information(not required)--schedulesOther information(not required)--schedules

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Special reports

■ OCBOA pg18-8OCBOA pg18-8■ Specified elements pg18-10Specified elements pg18-10■ Agreed upon procedures pg18-11Agreed upon procedures pg18-11

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Special reports

■ Compliance with contractual agreements Compliance with contractual agreements (loan covenant reviews) pg18-13(loan covenant reviews) pg18-13

■ Special purpose financial statements pg Special purpose financial statements pg 18-1318-13

■ Prescribed forms pg18-14Prescribed forms pg18-14

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Deficient Report

■ Problem #16-41Problem #16-41

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Summary and Examples

■ Sharing responsibilitySharing responsibility■ Emphasis of a matterEmphasis of a matter■ Departure from GAAPDeparture from GAAP■ Inconsistency in GAAP (justified or not Inconsistency in GAAP (justified or not

justified)justified)■ UncertaintyUncertainty■ Going ConcernGoing Concern

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Summary and Examples

■ Billing rates-Proof PositiveBilling rates-Proof Positive■ QC#4QC#4■ Reporting on I/CReporting on I/C

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Overview of audit process

■ Obtain clientObtain client■ Understand clientUnderstand client

◆ StandardStandard◆ Strategic processesStrategic processes

■ Formulate audit planFormulate audit plan■ Determine level of risksDetermine level of risks■ Evaluate I/CEvaluate I/C■ Test I/C if warrantedTest I/C if warranted■ Perform substantive testsPerform substantive tests

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Audit Time Line

■ Strategy and budgets---April/MayStrategy and budgets---April/May■ Analytical Reviews and draft of program---Analytical Reviews and draft of program---

July/AugustJuly/August■ Obtain/document understanding of I/C;Obtain/document understanding of I/C;

Perform test;Evaulate results;Assess risks-----Perform test;Evaulate results;Assess risks-----Sept/OctSept/Oct

■ Substantive tests; Subsequent events; Rep Substantive tests; Subsequent events; Rep letter; Report---Dec/Febletter; Report---Dec/Feb

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Obtaining the client

■ CHANGING AUDITORSCHANGING AUDITORS■ WALK INSWALK INS■ REFERRALS (STAFF AND CLIENTS)REFERRALS (STAFF AND CLIENTS)■ BIDS (PROPOSAL LETTER)BIDS (PROPOSAL LETTER)■ ADVERTISINGADVERTISING

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Accepting Client

■ CREDIT CHECKSCREDIT CHECKS■ PRIOR F/SPRIOR F/S■ PRIOR AUDITORSPRIOR AUDITORS■ INQUIRE OF THIRD PARTIES (SMALL CLIENTS)--INQUIRE OF THIRD PARTIES (SMALL CLIENTS)--

MAGNUM PIMAGNUM PI■ DESIRED INFORMATIONDESIRED INFORMATION

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Engagement letters

■ Contractual relationshipContractual relationship■ Explains responsibilitiesExplains responsibilities■ New and continuing clientsNew and continuing clients■ 1136 Tenant’s Case1136 Tenant’s Case

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Understanding industry and economic conditions■ Organization structureOrganization structure■ Production linesProduction lines■ Capital structureCapital structure

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Understanding industry and economic conditions■ Operational structure, locations of subsOperational structure, locations of subs

◆ related parties SAS #57related parties SAS #57◆ how to identify?how to identify?

■ Distribution methodsDistribution methods■ Compensation policiesCompensation policies■ Control structureControl structure

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Understanding industry and economic conditions

◆ Control environmentControl environment◆ Risk assessmentRisk assessment◆ Control activitiesControl activities◆ Information and communicationInformation and communication◆ MonitoringMonitoring◆ acctg principlesacctg principles◆ risk areas risk areas

✦ risk factors of significancerisk factors of significance✦ red flags-danger signals to auditorsred flags-danger signals to auditors

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Sources of industry and economic information

◆ Touring facilitiesTouring facilities◆ Transaction reviewsTransaction reviews◆ Trade publications and business periodicalsTrade publications and business periodicals◆ SEC filingsSEC filings◆ prior year wpsprior year wps◆ Audit guidesAudit guides

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Formulate audit plan

■ Perform Analytical reviewsPerform Analytical reviews■ Determine audit strategyDetermine audit strategy

✦ materialitymateriality✦ Assess audit riskAssess audit risk

• AR=IR CR DRAR=IR CR DR✦ Assess risk of fraudAssess risk of fraud

• Types Types • ResponsibilityResponsibility• ReasonsReasons• Risk factorsRisk factors

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Formulate audit plan

■ audit program--road mapaudit program--road map■ EDPEDP■ StaffingStaffing■ SpecialistSpecialist■ Use of internal auditors Use of internal auditors

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Types of fraud

■ Financial reporting (mgmt)Financial reporting (mgmt)■ Misappropriation of assets Misappropriation of assets

(employees/customers)(employees/customers)

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Reasons frauds occur

■ PressurePressure■ OpportunityOpportunity■ Ability to rationalizeAbility to rationalize

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Responsibility for detection

■ ManagementManagement■ AuditorAuditor

◆ SAS no. 1: The auditor has a responsibility to SAS no. 1: The auditor has a responsibility to plan and perform the audit to obtain reasonable plan and perform the audit to obtain reasonable assurance about whether the financial assurance about whether the financial statements are free of material misstatement, statements are free of material misstatement, whether caused by error or fraud. whether caused by error or fraud.

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Risk Factors associated with

■ Fraudulent financial reportingFraudulent financial reporting■ Misappropriation of assetsMisappropriation of assets

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Common techniques used in fraudulent financial reporting■ Usually involves accounts receivables, Usually involves accounts receivables,

inventory, expenses, revenuesinventory, expenses, revenues

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Purpose of ICS

■ is to provide reasonable assurance that is to provide reasonable assurance that management’s objectives will be met. management’s objectives will be met. Safeguard assets, provide reliable data Safeguard assets, provide reliable data (safeg; author;segr;docu; indep rev), (safeg; author;segr;docu; indep rev), promote operating efficiency (indep promote operating efficiency (indep rev;monitoring;safeg;budget rev;), and rev;monitoring;safeg;budget rev;), and compliance with applicable laws.compliance with applicable laws.

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The Internal Control Structure

■ Why test I/C procedures?Why test I/C procedures?◆ Questions to ponderQuestions to ponder

✦ $45M in billings were placed in a drawer and $45M in billings were placed in a drawer and forgotten when the accountant was out sick.forgotten when the accountant was out sick.

✦ customer did not pay $15m for shipped merch. customer did not pay $15m for shipped merch. because their purchasing mgr was out of town.because their purchasing mgr was out of town.

✦ client has several cking accts;cks are not client has several cking accts;cks are not prenumbered;voids cks are discarded and the prenumbered;voids cks are discarded and the number reused; How would you determine that all number reused; How would you determine that all disbursements were recorded and were appropriate.disbursements were recorded and were appropriate.

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The Internal Control Structure

◆ Questions to ponderQuestions to ponder✦ client ordered chemicals for resale from different supplier client ordered chemicals for resale from different supplier

because of cheaper price. chemicals were unstable and because of cheaper price. chemicals were unstable and contaminated customer’s supply. client lost customer and is contaminated customer’s supply. client lost customer and is facing a lawsuit.facing a lawsuit.

✦ are 94 sales included with 95 sales; are 95 expenses included are 94 sales included with 95 sales; are 95 expenses included with 96 expenses; are all liabilities recordedwith 96 expenses; are all liabilities recorded

✦ how do you know that cash exist; complete; accurate;in the how do you know that cash exist; complete; accurate;in the proper period;properly valued;presented and disclosed proper period;properly valued;presented and disclosed properly;belongs to the company.properly;belongs to the company.

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Components of I/C S

■ control environmentcontrol environment■ risk assessmentrisk assessment■ control activitiescontrol activities■ information & communicationinformation & communication■ monitoringmonitoring

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Control environment

■ overall attitude--inherent risk factors (no overall attitude--inherent risk factors (no board of dir/audit committee; no I/A dept; board of dir/audit committee; no I/A dept; lacks integrity)--Tone at the toplacks integrity)--Tone at the top

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control environment

◆ embezzelment; computer down timeembezzelment; computer down time◆ aggressive in taking bus risksaggressive in taking bus risks◆ monitors operations--owner/mgr...monitors operations--owner/mgr...◆ pressures to achieve unrealistic goals--pressures to achieve unrealistic goals--

Management’s philosophyManagement’s philosophy◆ methods of assigning authoritymethods of assigning authority

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control environment

◆ use of budgets, forecastsuse of budgets, forecasts◆ hiring , training, promotions, compensationhiring , training, promotions, compensation◆ involvement of directors and audit committeeinvolvement of directors and audit committee◆ regulatory agenciesregulatory agencies

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Risk assessment

◆ What are the risks associated with achieving What are the risks associated with achieving control objectives?control objectives?

◆ What are the risks associated with providing What are the risks associated with providing reliable data?reliable data?

◆ What are the risks that data is incomplete, does What are the risks that data is incomplete, does not exist, not accuarate, not properly valued?not exist, not accuarate, not properly valued?

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Control activities

■ Performance reviewsPerformance reviews■ Information processingInformation processing■ Safeguarding assetsSafeguarding assets■ Segregation of dutiesSegregation of duties

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Information & Communication (Accounting system)

◆ documents, journals, ledgersdocuments, journals, ledgers◆ identify, classify, record, report all valid identify, classify, record, report all valid

transitions (consistent with magmata transitions (consistent with magmata objectives) on a timely basis, in the proper objectives) on a timely basis, in the proper period, and for the proper amount.period, and for the proper amount.

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Auditor must know (information and communication) ■ all classes of transactions, all classes of transactions, ■ how transactions originate;how a sale is how transactions originate;how a sale is

made; revenue recognition policies; how a made; revenue recognition policies; how a liability is incurredliability is incurred

■ all files and records, flow of the documentsall files and records, flow of the documents■ computer interface, normal and abnormal computer interface, normal and abnormal

transactionstransactions■ how accruals and estimates are madehow accruals and estimates are made

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Monitoring

■ Typical supervisory and/or managerial Typical supervisory and/or managerial functions to track the effectiveness of I/Cfunctions to track the effectiveness of I/C

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Different systems for different companies■ size, industry,regulatory size, industry,regulatory

requirements,complexityrequirements,complexity■ cost of implementing system (concept of cost of implementing system (concept of

reasonable assurance)reasonable assurance)■ computer Vs no computer, integrity of computer Vs no computer, integrity of

personnel, degree of seg. of dutiespersonnel, degree of seg. of duties■ internal auditors, easy access to assets.internal auditors, easy access to assets.

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Limitations

■ errorserrors■ collusioncollusion■ management overridemanagement override

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Auditor considers I/C S in determining the N,T,& E of Sub Test

■ Test of I/C procedures vs sub testTest of I/C procedures vs sub test◆ test of i/c: are employees performing their test of i/c: are employees performing their

duties. test that are directed toward the design duties. test that are directed toward the design or operation of an internal control structured or operation of an internal control structured procedure to assess its effectiveness in procedure to assess its effectiveness in preventing or detecting material misstatements preventing or detecting material misstatements in a f/s assertion.in a f/s assertion.

◆ standard audit procedures--I I O C Rstandard audit procedures--I I O C R

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Sub test

■ provides evidence of likely monetary errorprovides evidence of likely monetary error■ test of details and analytical procedures to test of details and analytical procedures to

detect material misstatements in the account detect material misstatements in the account balance, transaction or f/s assertion.balance, transaction or f/s assertion.

■ standard audit procedures--I I O C Rstandard audit procedures--I I O C R

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Assessment of I/C risk

■ Must decide the degree of risk that the Must decide the degree of risk that the control structure does or does not provide control structure does or does not provide some predetermined level of assurance that some predetermined level of assurance that management’s assertions are free of management’s assertions are free of material misstatements.material misstatements.

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Assessment of I/C risk

■ obtain and document understanding of how obtain and document understanding of how the systems should work.the systems should work.

✦ inquiry, inspection, observation, prior experienceinquiry, inspection, observation, prior experience✦ origination and disposition of transaction, origination and disposition of transaction,

documents used, depts and personneldocuments used, depts and personnel✦ more detailed if reliance approach used vs subst more detailed if reliance approach used vs subst

approachapproach

◆ auditable? identify I/R?auditable? identify I/R?

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Preliminary assess--

■ C/R at maximum if no reliance is planned C/R at maximum if no reliance is planned or it is not cost beneficial to perform I/C or it is not cost beneficial to perform I/C tests--small tests--small client;prepaids;accruals;intangibles--limited client;prepaids;accruals;intangibles--limited number of transactions--subst approachnumber of transactions--subst approach

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Preliminary assess ---

■ C/R at less than a maximum if reliance is C/R at less than a maximum if reliance is planned and auditor can identify controls planned and auditor can identify controls he/she wants to place on--reliance approachhe/she wants to place on--reliance approach

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Test controls and evaluate results

■ (increase/decrease preliminary assessment (increase/decrease preliminary assessment of C/R) to of C/R) to

■ determine the N,T,& E of sub tests (interim determine the N,T,& E of sub tests (interim tests)tests)

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Timing and situational risk factors--■ even if results appear positiveeven if results appear positive■ sampling risksampling risk■ observational riskobservational risk■ incompetenceincompetence

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The assessment of C/R

■ should be done for each acct and for each should be done for each acct and for each audit objective(assertion). audit objective(assertion).

■ Keep in mind the type of misstatements that Keep in mind the type of misstatements that would occur (over/under)would occur (over/under)

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Verify mgmt’s assertions

■ E C C A V PD ROE C C A V PD RO

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Existence

◆ from g/l to documentfrom g/l to document◆ tests for overstatementtests for overstatement◆ based on your direct knowledge or based on your direct knowledge or

interrelationshipsinterrelationships◆ sales represents goods shipped or services sales represents goods shipped or services

rendered. A/R are for amounts owned by non-rendered. A/R are for amounts owned by non-fictitious customers at the b/s date.fictitious customers at the b/s date.

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Completeness

◆ from document to g/lfrom document to g/l◆ tests for understatementtests for understatement◆ based on direct knowledge or interrelationshipsbased on direct knowledge or interrelationships◆ all credit and cash transactions were properly all credit and cash transactions were properly

recorded (inputted and processed)recorded (inputted and processed)

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Accuracy

◆ transactions, journals are accurate (reconciled, transactions, journals are accurate (reconciled, footed, extensions)--princes and footed, extensions)--princes and quantities;debits and creditsquantities;debits and credits

◆ based on review and resolution of errors based on review and resolution of errors identified in edit runs and exception reportsidentified in edit runs and exception reports

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Nature of evidence gathered to verify assertions■ Underlying accounting dataUnderlying accounting data■ Corroborating informationCorroborating information

◆ physical,external,internal,analytical,reperformaphysical,external,internal,analytical,reperformancence

✦ canceled cks,invoices, contracts, minutes, client rep canceled cks,invoices, contracts, minutes, client rep letter, atty letter, confirmationsletter, atty letter, confirmations

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Evidence must be evaluated for its competency and sufficiency■ competent--persuasive not convincing competent--persuasive not convincing

evidenceevidence◆ valid and relevant (reliable and useful)--valid and relevant (reliable and useful)--

persuasivepersuasive

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sufficiency

■ depends on audit risk and materialitydepends on audit risk and materiality■ Audit risk (AR=IRX CR X DR)Audit risk (AR=IRX CR X DR)

◆ present fairly in all material ....present fairly in all material ....◆ the risk that a material error /irreg. showing up the risk that a material error /irreg. showing up

in the f/sin the f/s◆ the risk that the wrong opinion was issuedthe risk that the wrong opinion was issued◆ level of audit risk should be lowlevel of audit risk should be low

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IR--

■ nature and characteristic of the account. nature and characteristic of the account. Depends on industry, regulation, economy, Depends on industry, regulation, economy, number of transactionsnumber of transactions

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CR--

■ based on assessment of internal control based on assessment of internal control proceduresprocedures

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DR--

■ level of sub test---quality controllevel of sub test---quality control

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Materiality

■ how much error can you live withhow much error can you live with■ defined during planning and revised during defined during planning and revised during

the auditthe audit■ allowance for undetected errorsallowance for undetected errors

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Materiality

■ b/s, i/sb/s, i/s■ score sheetscore sheet■ Number of items examined depends on Number of items examined depends on

sampling, judgment, costs of sampling, judgment, costs of reperformance,etc.reperformance,etc.

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Revenue/accounts receivable/cash receipts■ Control functionsControl functions

◆ sales order controlsales order control◆ execution of order controlexecution of order control◆ invoicing controlinvoicing control◆ recordingrecording◆ cash receiptscash receipts

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Management assertions and control activities

◆ Existence/completeness/accuracy?Existence/completeness/accuracy?✦ SafeguardSafeguard✦ Segregation of dutiesSegregation of duties✦ Independent reviewsIndependent reviews✦ Proper documentsProper documents✦ Proper authorizationProper authorization

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sales order control (phys, seg, indp, doc, auth)<==> (E,C,C,A,V,RO,PD)■ credit department receives and approves credit department receives and approves

customer order.customer order.■ prepares sales order for shipping, billing, prepares sales order for shipping, billing,

and customerand customer

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execution of order control (phys, seg, indp, doc, auth)<==> (E,C,C,A,V,RO,PD)■ shipping /stores prepares shipping shipping /stores prepares shipping

documents for billing and customer.documents for billing and customer.■ updates perpetual recordsupdates perpetual records

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invoicing control (billing) (phys, seg, indp, doc, auth)<==> (E,C,C,A,V,RO,PD)■ prepares invoice based on s/o and shp/d for prepares invoice based on s/o and shp/d for

customer and accts/reccustomer and accts/rec■ enters transaction in the sales registerenters transaction in the sales register

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recording control (accts rec) (phys, seg, indp, doc, auth)<==> (E,C,C,A,V,RO,PD)■ updates sub ledgerupdates sub ledger■ prepares COGS entryprepares COGS entry

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cash receipts (phys, seg, indp, doc, auth)<==> (E,C,C,A,V,RO,PD)■ lock boxlock box■ listing--names and amounts--> to accts rec listing--names and amounts--> to accts rec

for postingfor posting■ remittances endorsed immediately for remittances endorsed immediately for

deposit onlydeposit only

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cash receipts (phys, seg, indp, doc, auth)<==> (E,C,C,A,V,RO,PD)■ cashier deposits remittances daily-->deposit cashier deposits remittances daily-->deposit

slip sent to accts rec for postingslip sent to accts rec for posting■ total cash receipts (daily) posted to CR total cash receipts (daily) posted to CR

journal and reconciled with listing and journal and reconciled with listing and control accts.control accts.

■ establish control over post dated or establish control over post dated or incorrect cksincorrect cks

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Cash receipts (phys, seg, indp, doc, auth)<==> (E,C,C,A,V,RO,PD)■ returned cks (customer NSF ck)returned cks (customer NSF ck)■ should be controlled by employee not should be controlled by employee not

involved with making the deposits or involved with making the deposits or recording the entriesrecording the entries

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Testing control procedures---pgs 10-12 & 10-13■ AuthorizationAuthorization■ Proper docProper doc■ Safeguarding assets/accuracySafeguarding assets/accuracy■ Indp reviewsIndp reviews■ Seg. of dutiesSeg. of duties

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Expenses/accts pay/cash disb

◆ Control functionsControl functions◆ requisitionrequisition◆ purchasingpurchasing◆ receivingreceiving◆ recordingrecording◆ cash disbcash disb

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Requisition (phys, seg, indp, doc, auth)<==> (E,C,C,A,V,RO,PD)■ prepares purchase requisitionprepares purchase requisition■ examines merch for validityexamines merch for validity■ updates perpetualsupdates perpetuals

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Purchasing (phys, seg, indp, doc, auth)<==> (E,C,C,A,V,RO,PD)■ based on requisition approves purchase based on requisition approves purchase

(prepares PO) and selects vendor.(prepares PO) and selects vendor.

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Receiving (phys, seg, indp, doc, auth)<==> (E,C,C,A,V,RO,PD)■ receives merch and prepares receiving docreceives merch and prepares receiving doc■ distributes merchdistributes merch

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Recording (phys, seg, indp, doc, auth)<==> (E,C,C,A,V,RO,PD)■ based on RO,PO, RD,Inv, prepares voucherbased on RO,PO, RD,Inv, prepares voucher■ updates voucher register and a/p sub ledgerupdates voucher register and a/p sub ledger

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cash disb (phys, seg, indp, doc, auth)<==> (E,C,C,A,V,RO,PD)■ validity of supporting docvalidity of supporting doc■ signer of cks indep of CR and CD functionssigner of cks indep of CR and CD functions■ signer cancels docssigner cancels docs

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cash disb (phys, seg, indp, doc, auth)<==> (E,C,C,A,V,RO,PD)■ cks are pre-numberedcks are pre-numbered■ cks are mailed by signer and not the cks are mailed by signer and not the

preparerpreparer■ cks not made to cash or bearercks not made to cash or bearer

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cash disb (phys, seg, indp, doc, auth)<==> (E,C,C,A,V,RO,PD)■ cks not signed in advancecks not signed in advance■ unsigned cks and blank cks properly unsigned cks and blank cks properly

safeguardedsafeguarded■ petty cash used for small , miscellaneous petty cash used for small , miscellaneous

disbursementsdisbursements

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Testing control procedures--pgs 12-12 , 12-13

✦ AuthorizationAuthorization✦ Seg. of dutiesSeg. of duties✦ Proper docProper doc✦ Indp reviewsIndp reviews✦ Safeguarding assets Safeguarding assets

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Summary

■ Preliminary reviewPreliminary review◆ obtain and document understandingobtain and document understanding◆ Develop plan based on preliminary assessementDevelop plan based on preliminary assessement

■ Reliance plannedReliance planned■ Substantive testSubstantive test

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Review--test I/C for A/R & Rev

■ Which cycle? Which account? Which cycle? Which account? (Revenue;Payments Sales;A/R;Inventory; (Revenue;Payments Sales;A/R;Inventory; COGS)COGS)

■ Which assertion/objective? Which assertion/objective? (Accuracy;Completeness;Existence)(Accuracy;Completeness;Existence)

■ Which control procedure?---Testing Which control procedure?---Testing authorization....authorization....

■ Which control function? (Sales order; Which control function? (Sales order; Execution of order )Execution of order )

■ Which files? Which documents?Which files? Which documents?

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■ Which audit procedures?Which audit procedures?◆ inspect doc for signaturesinspect doc for signatures◆ inspect doc for proof of math accuracy inspect doc for proof of math accuracy

(recompute extensions--PxQ)(recompute extensions--PxQ)◆ inquire about credit granting policiesinquire about credit granting policies

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■ Which audit procedures?Which audit procedures?◆ inspect/observe posting and authorization for inspect/observe posting and authorization for

postings (any intentional under/over footingspostings (any intentional under/over footings◆ inspect/observe proof of authorizations for inspect/observe proof of authorizations for

correcting entries (from exception reports) and correcting entries (from exception reports) and client’s review of numerical controlclient’s review of numerical control

◆ inspect/observe proof of authorization for inspect/observe proof of authorization for shipping (all docs)shipping (all docs)

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Substantive tests--Accts Rec

■ Purpose of sub testsPurpose of sub tests■ Control functionsControl functions■ Control proceduresControl procedures■ Audit objectivesAudit objectives

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■ Completeness, Accuracy, and CutoffCompleteness, Accuracy, and Cutoff◆ test math accuracytest math accuracy◆ cutoff testscutoff tests◆ unmatched itemsunmatched items◆ test numerical sequence--if not prenumberedtest numerical sequence--if not prenumbered

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■ Existence; Rights and ObligationsExistence; Rights and Obligations◆ confirmationsconfirmations◆ confirmation proceduresconfirmation procedures

✦ populationpopulation✦ reconcile with subreconcile with sub✦ select sample (unusal balances)select sample (unusal balances)✦ positivepositive✦ negativenegative

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■ confirmation exceptionsconfirmation exceptions■ unable to locateunable to locate■ timing difftiming diff■ true exceptionstrue exceptions

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■ If you cannot send confirmationsIf you cannot send confirmations◆ sales orderssales orders◆ contractscontracts◆ shipping docshipping doc◆ cash receipts and remittance advicecash receipts and remittance advice◆ postingspostings

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■ LappingLapping◆ lockbox;segregation;vacation;monthly lockbox;segregation;vacation;monthly

statementsstatements

■ Tests for collectabilityTests for collectability◆ review and test aging schedulereview and test aging schedule◆ review problem acctsreview problem accts

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Other substantive tests

■ test math accuracy of ledgerstest math accuracy of ledgers■ examine credits and returns after year-endexamine credits and returns after year-end■ examine write-offs before and after year-examine write-offs before and after year-

endend■ examine contingent sales agreementsexamine contingent sales agreements■ examine related party salesexamine related party sales

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Substantive tests--Cash

■ TypesTypes◆ ConfirmationConfirmation◆ bank reconciliationbank reconciliation◆ transfer teststransfer tests◆ cash countscash counts◆ proof of cashproof of cash

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Confirmation

■ StandardStandard■ Normally done at year-end and interimNormally done at year-end and interim■ Also request a cutoff statementAlso request a cutoff statement■ confirm all accounts open during the yearconfirm all accounts open during the year■ other information--LTDother information--LTD

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Bank reconciliation

■ Standard --Standard --■ May review over a given period.May review over a given period.

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Bank transfer test--

■ provides reasonable assurance that kiting provides reasonable assurance that kiting has not occurredhas not occurred

■ compare dates that disb and receipts were compare dates that disb and receipts were recorded in g/l with date disb and receipts recorded in g/l with date disb and receipts recorded by the bankrecorded by the bank

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Proof of cash

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General

■ review cash transactions until field work review cash transactions until field work ends for unusual payments to officers, ends for unusual payments to officers, temporary reduction in N/P, or payments to temporary reduction in N/P, or payments to unrecognized vendors.unrecognized vendors.

■ any restrictions any restrictions

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Inventory--Substantive tests

■ Mckesson & RobbinsMckesson & Robbins■ Required by GAASRequired by GAAS

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Planning

■ Client has primary responsibilityClient has primary responsibility■ Review client’s instructionsReview client’s instructions

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Observation

■ s/b well informed regarding industry---may s/b well informed regarding industry---may need a specialistneed a specialist

■ inventory s/b well arranged to detect inventory s/b well arranged to detect consignments, age and neglect, movements, consignments, age and neglect, movements, shipments, receipts, awaiting repair or shipments, receipts, awaiting repair or delivery.delivery.

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Observation-test counts

■ confirm accuracyconfirm accuracy■ corroborate existencecorroborate existence■ records info from tag numbers for later records info from tag numbers for later

tracing to summerizationtracing to summerization■ how many depends on judgement, error how many depends on judgement, error

rate, type of inventory, client requestrate, type of inventory, client request

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Observation-tag/sheet control

■ Final summerizationFinal summerization

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Other tests

■ LCMLCM■ CutoffCutoff■

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Difficult inventories

■ logs in riverlogs in river■ piles of coal/scrap metalpiles of coal/scrap metal■ vats of chemicalsvats of chemicals■ cattle ranchcattle ranch

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If inventory not observed

■ alternative procedures on beginning or alternative procedures on beginning or ending inventoyending inventoy

■ over sleptover slept

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Variable sampling

■ Classicial Classicial ◆ MPUMPU◆ Difference estimationDifference estimation◆ Ratio estimationRatio estimation

■ PPSPPS◆ Use for testing overstatementsUse for testing overstatements

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Sampling risk

■ compliment of confidence levelcompliment of confidence level■ incorrect acceptance (overreliance)incorrect acceptance (overreliance)■ incorrect rejection (underreliance)incorrect rejection (underreliance)

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Precision~~materiality~~tolerable rate■ Precision interval=AV+PrecisionPrecision interval=AV+Precision■ Sample sizeSample size

◆ based on planned precision n=(#@~*/PP)based on planned precision n=(#@~*/PP)◆ planned precision is an adjusted TR determined planned precision is an adjusted TR determined

by IA, IR.by IA, IR.

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SS does not determine IA, IR, nor TR

◆ as PP increases===>SS decreasesas PP increases===>SS decreases◆ as CL decreases===>causes IA & IR to as CL decreases===>causes IA & IR to

increase (allowed to go up)===>increase in increase (allowed to go up)===>increase in PP===>SS decreasesPP===>SS decreases

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Common law

■ based on prior legal decisionsbased on prior legal decisions■ varies by statevaries by state■ burden of proof on plaintiffburden of proof on plaintiff

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Liabilitiy to client and subrogee under common law■ Can sue for ordinary negligence, gross Can sue for ordinary negligence, gross

negligence, fraudnegligence, fraud◆ Breach of contractBreach of contract◆ Lack of confidentiality (special breach)Lack of confidentiality (special breach)◆ Defalcation by employee not detected by CPA Defalcation by employee not detected by CPA

(because did not follow gaas)(because did not follow gaas)

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Plaintiffs must show

■ lossloss■ cpa had a duty to perform (privity)cpa had a duty to perform (privity)■ loss resulted from nonperformance of duty loss resulted from nonperformance of duty

(breach)(breach)

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CPA can show

■ not negligent not negligent ■ followed GAASfollowed GAAS■ causation defensecausation defense■ contributory negligencecontributory negligence

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Liability to third parties under common law■ Can only sue for gross negl and fraud unlessCan only sue for gross negl and fraud unless

◆ IdentifiedIdentified◆ Forseen third parties (ord., gross, and fraud)Forseen third parties (ord., gross, and fraud)◆ Forseeable third parites (ord., gross, and fraud)Forseeable third parites (ord., gross, and fraud)

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Liability under statutory law

■ 1933 act1933 act◆ burden of proof on CPAburden of proof on CPA◆ any buyer of shares can sue for ord. gross or any buyer of shares can sue for ord. gross or

fraudfraud◆ cpa must prove due diligencecpa must prove due diligence

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1934 act

◆ cpa liable for loss to buyer and seller for false cpa liable for loss to buyer and seller for false or misleading stmtor misleading stmt

◆ burden of proof on plaintiffburden of proof on plaintiff

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1934 act

■ cpa must proove due diligence (18a only) cpa must proove due diligence (18a only) and no knowledge of false or misleading and no knowledge of false or misleading stmt.stmt.◆ Rule 10b-5Rule 10b-5

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