2013 final review aud a

AUDITING 111 vnDIIIIIIC! J~

Opinions

Audit Opinions

Comparative Financial Statements

Other Items

2013 EdItIon-AudItIng FInal RevIew (A VersIon)

NOTES

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2013 Edition-Auditing Final Review (A Version)

SUMMARY NOTES

I. AUDIT OPINIONS A. Summary Chart

UNQUALIFIED OPINION

CLEAN MODIFIED REPORT REPORT

Standard Report 1. Another auditor 2. Necessary departure 3. Going concern 4. Emphasis of a matter 5. lack of consistency Oustified)

QUALIFIED OPINION

QUALIFIED QUALIFIED "EXCEPT FOR" "EXCEPT FOR"

GAAP GAAS 1. Non-GMP change 1. Uncertainty 2. Inadequate disclosure 2. Scope limitation 3. Departure from GMP 4. Unreasonable accounting estimate

ADVERSE DISCLAIMER

ADVERSE DISCLAIMER GAAP GAAS

1. Non-GMP change 1. Uncertainty 2. Inadequate disclosure 2. Scope limitation 3. Departure from GMP 3. lack of independence 4. Unreasonable accounting estimate 4. Unaudited FS

WITHDRAW False, Fraudulent, Deceptive, or Misleading

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B. Opinion Types

1. The fourth standard of reporting requires the expression of an opinion-The audit report must either express an opinion regarding the financial statements (FS) taken as a whole or state that an opinion cannot be expressed.

a. Unqua/ffled opinion-States that the FS present fai~y, in all material respects, the financial position, results of operations, and cash flows of the entity, in conformity with GAAP.

b. Modffled unqua/ffled opinion (explanatory language)-Unqualified report with additional language added under certain circumstances.

c. Qualffled ("except for")-States that "except for the effects of the matter to which the qualification relates, the FS present fai~y ... "-used for GAAS or GAAP issues.

d. Advers_States that the FS do not present fairly-GAAP issue. e. Disclaimer-States that auditor does not express an opinion on the FS-GAAS issue.

C. Standard Unqualified Opinion FS are presented fairly in all material respects. The following report is for a non issuer. (An example of an audit report for an issuer is found in the Audit Communications Appendix.)

INDEPENDENT AUDITOR'S REPORT

To the Board of Directors of ABC Company: We have audited the accompanying balance sheet of ABC Company as of December 31, 20X4, and the related statements of income, retained earnings, and cash flows for the year then ended. These flnancial statements are the responsibility of the Company's management. Our responsibility Is to express an opinion on these financial statements based on our audit.

We conducted our audit In accordance with auditing standards generally accepted In the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the flnancial statements are free of material misstatement. An audit includes cons/denrtJon of Internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's Internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test baSiS, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. in our opinion, the financial statements referred to above present fairly, in all materlai respects, the financial position of ABC Company as of (at) December 31, 20X4, and the results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.

Chanel Brown, CPA

March 23, 20XS

Note: The italicized language is not required, but may be added to emphasize that a GAAS audit does not require the testing/reporting on Internal control required for audits of issuers under sox.



D. Modified Unqualified Opinion 1. Types of Modified Unqualified Opinions

a. Audit opinion based upon report of another auditor (no explanatory paragraph. modify all three paragraphs).

b. Necessary and justified departure from GAAP (explanatory paragraph may be before or after the opinion paragraph).

c. Going concern issue (explanatory paragraph after the opinion paragraph). d. Emphasis of a matter (explanatory paragraph may be before or after the opinion

paragraph). e. Justified lack of consistency caused by a material change (explanatory paragraph after

the opinion paragraph). f. Required SEC quarterly data has been omitted or has not been reviewed (explanatory

paragraph after the opinion paragraph). g. Required supplementary information has been omitted. departs from GAAP. or there

are scope limitations (explanatory paragraph after the opinion paragraph). h. Other Information in a document containing audited FS is materially Inconsistent with

the FS (explanatory paragraph after the opinion paragraph). 2. Reliance on Work of Other Auditors

a. If another auditor conducts part of the audit (e.g . the audit of a subsidiary). the principal auditor must decide whether he/she can in fact act as principal auditor (has he/she audited enough?). This decision should be based on professional judgment, and on the materiality of portions examined by the other auditors in relation to the overall FS.

b. If the principal auditor is satisfied (must review the other audito~s documentation) and decides to assume responsibility for the work of another auditor, no reference will be made in the standard audit report. Under the ISA, no reference is made to the other auditor unless required by law or regulation.

c. If the principal auditor decides not to assume responsibility for the other auditor, the report will express a division of responsibility in all three paragraphs. The other audito~s name is not mentioned unless that auditor gives express permission and his/her report is presented. This division is quantified in terms of percentages of assets, total assets, total revenue, or other criteria. The Audit Communications Appendix contains an example of a report referring to another audito~s work. No division of responsibility is permitted under the ISA.

3. Justified and Necessary Departure from GAAP a. In the rare instance that the FS would be misleading If GAAP were followed, an

unqualified opinion with an explanatory paragraph is issued. (1) The explanatory paragraph, which may be before or after the opinion paragraph,

should describe the departure, its approximate effects (if possible), and the reasons why adherence to GAAP would make the FS misleading.

(2) The auditor must agree with the departure. If not, it is not justified, and an unqualified opinion would not be appropriate.

4. Going Concem-"ADMITS FINE" a. The auditor is responsible for evaluating audit evidence to determine whether there is

"substantial doubt" that the client will be able to continue as a going concern for a reasonable period (not to exceed one year from the date of the FS being audited). Note that under International Standards on Auditing, the going concern period can exceed one year.

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b. If substantial doubt exists, an explanatory paragraph stating the auditor's concerns should be added after the opinion paragraph. The words "substantial doubt" and "going concern" must be included. Note that Intemational Standards on Auditing use the term significant doubt.

c. The following audit procedures (ADMITS) may indicate that there is a problem with the entity's ability to continue as a going concem: (1) Analytical procedures. (2) Review of compliance with terms of debt/loan agreements. (3) Review of the minutes of stockholderlboard meetings. (4) Inquiry of client's legal counsel. (5) Confirmation of the details of financial support arrangements with third parties. (6) Review of subsequent events.

d. Conditions (FINE) that may indicate a problem: (1) Financial difficulties. (2) Internal matters (e.g., work stoppages, labor difficulties). (3) Negative financial trends. (4) Extemal matters (e.g., legal proceedings, new legislation).

e. The auditor should consider mitigating factors. Both intent and ability are required. f. If doubt is removed in a subsequent period, the going concern paragraph need not be

repeated. 5. Emphasis of a Matter

a. An explanatory paragraph (before or after the opinion paragraph) is not required, but may be included at the auditor's discretion. Under International Standards on Auditing, the emphasis paragraph should preferably be included after the opinion paragraph.

b. Examples include: (1) Related party transactions. (2) Significant subsequent events. (3) The entity is a component of a larger business enterprise. (4) Accounting matters that affect the comparability of the FS.

6. Lack of Conslstency--..Justlfled (auditor agrees) a. Consistency is implied in the standard report. If a material change in GAAP has

occurred between periods and such change is justified, the auditor should add an explanatory paragraph (after the opinion paragraph) describing the change and referring the reader to the note describing the change in detail.

b. Example of an explanatory paragraph following the opinion paragraph: "As discussed in note X to the financial statements, the Company changed its method of computing depreciation in 20X4."

E. Qualified Opinion 1. Due to GAAP

a. An explanatory paragraph, before the opinion paragraph, should describe the issue and its financial impact. The opinion paragraph should contain "except for" language.

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b. Four major categories: (1) Changes in accounting principle (auditor disagrees). (2) Inadequate disclosure. (3) Departure from GAAJ>. (4) Unreasonable accounting estimates.

c. If the auditor Is not satisfied, a qualified or adverse opinion should be Issued, depending on materiality.

2. Due to GAAS a. The scope paragraph uses "except"; the opinion paragraph uses "except for" language. b. Two major reasons:

(1) Uncertainty (insufficient evidence). (2) Scope limitation.

3. Note: The Audit Communications Appendix contains examples of qualified opinion reports (due to both GAAP and GAAS).

F. Adverse Opinion 1. An explanatory paragraph, before the opinion paragraph, should describe the issue and its

financial impact. The opinion paragraph should indicate that the FS taken as a whole do not presentfairly ... in conformity with GAAP.

2. Note: The Audit Communications Appendix contains an example of an adverse opinion. G. Disclaimer of Opinion

1. The auditor does not express an opinion on the FS, or is unable to form, or has not formed, an opinion as to the fairness of presentation of the FS in conformity with GAAP. A disclaimer is appropriate when the auditor has not performed an audit sufficient to form an opinion.

2. The auditor may elect to disclaim an opinion due to any of the following: a. Scope limitation. b. Lack of independence. c. Unaudited financial statements (FS). d. Uncertainty.

3. If an accountant is associated with the FS of a public entity without auditing or reviewing them, a disclaimer of opinion should be issued and the statements should be clearly marked Ilunaudlted,ll

a. Association-Either the accountant consents to the use of his/her name in connection with the FS, or he/she has prepared the FS, even if his/her name is not used.

4. Note: The Audit Communications Appendix contains an example of a disclaimer of opinion.

II. COMPARATIVE FINANCIAL STATEMENTS Multiple periods are presented in the financial statements. A. Change in Opinion-"DORCS"

1. A prior opinion may be changed. The auditor should update (i.e., either reaffirm or change) the opinion on any previously issued FS shown in comparative statements.

2. If the updated opinion differs from the previous opinion, the auditor should disclose the reason in an explanatory paragraph, including the:

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a. Date of the previous audito(s report. b. Opinion type previously issued. c. Reason for the prior opinion. d. Changes that have occurred. e. Statement that "opinion ... is different."

3. Note: The Audit Communications Appendix contains an example of a report on comparative FS with an opinion change.

B. Different Opinions 1. Some comparative reports will have different opinions for each year presented. Depending

upon the situation, the appropriate paragraphs will be modified. 2. Note: The Audit Communications Appendix contains an example of a report on comparative FS

with different opinions. C. Predecessor's Report Not Presented

The successor auditor should indicate in the introductory paragraph: 1. That other auditors examined the FS in prior periods (no name unless merged with successor

or acquired). 2. The date of the predecesso(s report. 3. The type of opinion expressed. 4. The substantive reasons if the opinion was other than unqualified.

D. Predecessor's Report Presented A predecessor auditor can reissue his/her report, but prior to reissuance, he/she should: 1. Read the statements for the current period; compare with prior statements. 2. Obtain a leiter of representation from the successor, to ascertain if anything material was found. 3. Obtain a leiter of representation from management regarding whether their prior leiter of

representation needs to be modified. 4. If the predecesso(s report is unrevised, use the previous report's original issuance date, or dual

date if the predecessor revises the report.

III. OTHER ITEMS A. Subsequent Events-"PRIME"

1. A subsequent event occurs between the balance sheet date and the date the FS are issued. Subsequent events may require either adjustment to the FS or additional disclosure. Subsequent events are divided into two categories. a. Type I (recognized) event-Condition existing on or before the balance sheet date;

usually requires adjustment to the FS. b. Type /I (nonrecognized) event-Condition existing after the balance sheet date; usually

requires disclosure, but no FS adjustment. 2. The auditor has an active responsibility to investigate subsequent events during the period from

the balance sheet date to the date of the audito(s report. Responsibilities include: a. Reviewing post balance sheet transactions. b. Obtaining a representation leiter from management.

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c. Inquiring. d. Reading the minutes of stockholder, director, and other committee meetings. e. Examining the latest available interim statements.

3. The auditor has no active responsibility after the date of the audito~s report, but cannot ignore information coming to hislher attention. If subsequent events result in adjustments or disclosures that are made after the original date of the audito~s report, the auditor may dual date the report to extend responsibility only for the particular subsequent event.

B. Subsequent Discovery of Facts Existing at the Date of the Audit Report 1. If the auditor becomes aware of material information after the report's issuance, and knows

persons are currently relying or likely to rely on the financial statements (FS), he/she should advise the client to immediately disclose the information and its impact on the FS.

2. If the financial impact cannot be timely ascertained, notification should be made that the FS cannot be relied upon.

3. The auditor must be satisfied with the client's action; if not, the auditor should notify the Board of Directors (BOD) and the client that the audit report cannot be associated with the FS. The auditor would also need to notify any regulatory agencies and any persons known to be relying on the statements and report.

C. Omitted Audit Procedures 1. The auditor should determine whether other audit procedures (already performed) might have

compensated for the missed procedures. a. If so, no action is required. b. If not, the auditor should attempt to apply the omitted (or alternative) procedures.

2. If the auditor determines a different opinion should have been issued, the auditor should advise the client to: a. Disclose the newly discovered facts; and b. Notify all parties likely to rely on the FS.

3. If the client refuses, the auditor should notify the BOD and disassociate himself/herself from the FS.



NOTES

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MULTIPLE-CHOICE QUESTIONS

QUESTION 1

An auditor who qualifies an opinion because of an insufficiency of audit evidence should describe the limitations in an explanatory paragraph. The auditor should also refer to the limitation in the:

Notes to the Scope Opinion Financial

ParagraQh ParagraQh Statements 1. Yes No Yes 2. No Yes No 3. Yes Yes No 4. Yes Yes Yes

QUESTION Z

The predecessor auditor, who is satisfied after properly communicating with the successor auditor, has reissued a report because the audit client desires comparative financial statements. The predecessor audito~s report should make:

1. Reference to the report of the successor auditor only in the scope paragraph. 2. Reference to the work of the successor auditor in the scope and opinion paragraphs. 3. Reference to both the work and the report of the successor auditor only in the opinion paragraph. 4. No reference to the report or the work of the successor auditor.

QUESTION 3

A client acquired 25% of its outstanding capital stock after year-end but prior to the date of the audito~s report. The auditor should:

1. Advise management to adjust the balance sheet to reflect the acquisition. 2. Issue pro forma financial statements giving effect to the acquisition as if it had occurred at year-end. 3. Advise management to disclose the acquisition in the notes to the financial statements. 4. Disclose the acquisition in the opinion paragraph of the audito~s report.

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NOTES



TASK-BASED SIMULATIONS

TASK-BASED SIMULATION 1: Audit Opinion

A manager is explaining to a staff auditor how various situations might affect the audit opinion. For each of the following scenarios, identify the appropriate reporting option by double-clicking on a shaded cell and selecting the appropriate option from the list provided. Assume that any financial statement effect is material and that U.S. auditing standards are followed.

1. The scope of the auditor's examination is affected by conditions that preclude the application of a necessary auditing procedure. 2. The auditor decides to make reference to the report of another auditor as a basis, in part, for expressing an opinion. 3. The financial statements are affected by an alternative accounting treatment that is a departure from GAAP. The use of GAAP would cause the statements to be misleading. 4. The company changed its method of accounting for long-term construction contracts, but management was justified in making the change. The new method is acceptable under GAAP, and the change was accounted for prospectively. 5. Doubt about the company's ability to continue as a going concern is fully disclosed in the notes to the financial statements. 6. The financial statements are subject to an uncertainty that will likely result in a material loss. Management has been unable to estimate the amount of potential loss, but has properly disclosed the details of the situation. 7. The company changed its method of valuing inventory, but management did not have appropriate justification for the change. The change is properly disclosed in the financial statements.

8. A predecessor auditor's unqualified opinion for a prior year's report on comparative financial statements is not presented. 9. Required supplementary information is omitted from the financial statements.

Unqualified opinion with explanatory language

Qualified opinion

Qualified opinion or adverse opinion

Qualified opinion or disclaimer of opinion

Adverse opinion

Disclaimer of opinion

Adverse opinion or disclaimer of opinion

OK Cancel I

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20U EdIIlDl'l-Audlllnl Final __ (A Vl!!l'IIonl

Solution ~LQ]~ 1, Qu.llftlld opinion or dIKl.I ....... of opinion

Wh.a h 'OD~ of h .ud)tor'lllXllmlnEion Is aIfectIId by condilions thm preo!lXl.th. application of a n_sary .uditing pr'CIC.:IUI1l, qualified opinion or dilcl.imar of opinion would b. ~propri .

2. Unqualllllld opinion with explanalory lang~ Whllflll.n lI.udltordecld_1o dMdal1!llpOfllllblllty, hi. or her report will be modlned to reIIect thll dM.lon.

J. Unqu_11ll1Id opinion with aplan_tory langUlglt Wh.alhllrlli. a n....ary and Jllltitled dapartu ... from GAAP, an unquallned opinion with nplanalDry IangU8ll' I. appropriata.

... Qu.llftlld opinion or advalM opinion Although mllflll!illllT1l_ julltified in making the change to an acceptable accounting principle, the method of eITecIIng the change was not ODrrect. The curoolllllve eIfect of a ch.nge In .ccounUng principle should be recognized _ .n edJustmanlln hratalned .amlngs ltaillmant:, noI.ccounllld for proaplldlvaly.

5. Unqualllllld opinion with expl.natory lang~ Doubt about lie company's II.bility to continua as II. going c:oncam "*Ills in an unqualified opinion with explanatory langu8lle, _long _ the situation Is fully disclosed In the noIM 10 the nnanclll.1 statements.

.. "nd.n:) unqu.llllad opinion Since Ih. poIanII.'1on ,. probebl. but not aeIImabl., Ih. prop.r Ir .. llII.nt II dl.cIosu ... only. M.n8ll1lTl.nI hal proparly dildoaed thislituation,.a a standard unqualifiad opinion i ppropriata.

7. Qu.llftlld opinion or advalM opinion Sinoe management lacked approprllllB Juatlllcalon for the ch.nge, GAAP h_ been violated despite the nnanclal staillmen! dIMllOMJ .... D.partu .... from GAAP 1UII111n. qu.,tned opinion or an adYIII"I8 opinion.

&. Unqualllllld opinion with expl.natory lang~ Wh.a _ pradacauor auditor's unqualified opi"lion for a prior yaar'l report on comparaliva financill.lllalam.nll is not presented, lie IUcceROr lI.uditor would need to include cerlllin informll.tion in the introduclDry parag ... ph of the current year's report.

t. Unqualllllld opinion with expl.natory lang~ Wh.a required luppl.rnantary information is omiltad from lie fin.nCi.1 ttatarn.nII,.n axpl.n.tory ~ragraph is ulll.d to diKIOlll lIis silulllion.

10. Unqu.lifilld opinion with apl.n.tory languaga The .udltor may emphll.&lze I matter while stili expreulng .n unqu.,tned opinion.


TASK-BASED SIMULATION Z: Review Notes

Review Notes I Authoritative Literature I Help I

Charles, CPA, audited the consolidated financial statements of Raleigh Industries and all but two of its subsidiaries for the years ended December 31, Year 1, and December 31, Year 2. Tyler is the staff accountant assigned to the Raleigh engagement.

Charles expressed a qualified opinion on the Year 1 financial statements because Raleigh capitalized certain research and development expenditures that should have been expensed, but Raleigh has corrected this error in Year 2. The Year 1 financial statements have been appropriately restated, and an unqualified opinion is currently being expressed on both sets of financial statements.

Karl & Karla, CPAs, audited the financial statements of Newton, Inc., and of Capricorn Consulting, both of which are consolidated subsidiaries of Raleigh. Charles has decided not to assume responsibility for the work of Karl & Karla with respect to the Newton engagement, but will assume responsibility for the work of Karl & Karla with respect to the Capricorn job. Raleigh is currently being investigated for possible securities law violations. This is adequately disclosed in the notes to the consolidated financial statements, but the ultimate outcome of these matters cannot presently be determined. Therefore, no provision for any liability that may result has been recorded.

Raleigh experienced a net loss in Year 2 and is currently in default under substantially all of its debt agreements. Management's plans in regard to these matters are adequately disclosed, although no financial statement adjustments have been made. These matters raise substantial doubt about Raleigh's ability to continue as a going concern.

Charles reviewed Tyler's draft of the auditor's report and indicated in his review notes that there were several deficiencies in the report. Based only on the review notes, select those items which Charles has correctly identified as deficiencies in the report by clicking the box beside the appropriate options. Select all that apply.

D 1. The reference to the subsidiary, Newton, and the magnitude of its financial statements should be in the scope paragraph rather than in the opening (introductory) paragraph.

D 2. The other independent auditors, Karl & Karla, should be named in the scope paragraph rather than in the opening (introductory) paragraph.

D 3. The reference in the scope paragraph to "the financial statements are free of material misstatement" should be followed by the phrase, "whether caused by error or fraud."

D 4. The required reference in the scope paragraph to assessing "significant estimates made by management" has been omitted.

D 5. The reference in the scope paragraph to "assessing fraud risk" is inappropriate and should be omitted from the report.

D 6. The required reference in the scope paragraph to "evaluating the overall financial statement presentation" has been omitted.

D 7. A separate explanatory paragraph describing the investigation into possible violations of securities laws is required to be placed between the scope and opinion paragraphs.

(continued)

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(continued)

D 8. The reference in the explanatory paragraph (between the scope and opinion paragraphs) to the qualified opinion on the Year 1 financial statements is not properly placed. The Year 1 opinion should be referenced in the opinion paragraph.

D 9. The reference in the explanatory paragraph does not express our belief that the disclosures are adequate. This belief should be specifically expressed in this paragraph.

D 10. The reference to the other auditors in the opinion paragraph is incomplete. It should specifically include the words "unqualified opinion" to describe the type of opinion expressed by Karl & Karla.

D 11. The opinion paragraph should extend the audito~s opinion beyond financial position to include the results of Raleigh's operations and its change in stockholders' equity.

D 12. The reference to the uncertainty in the opinion paragraph is incomplete. It should describe the nature of the uncertainty as pertaining to the investigation into possible violations of securities laws.

D 13. The explanatory paragraph following the opinion paragraph does not include the tenn "substantial doubt." This term is required to be used in this paragraph under these circumstances.

D 14. The explanatory paragraph following the opinion paragraph does not include the tenn "going concern." This term is required to be used in this paragraph under these circumstances.

D 15. The explanatory paragraph following the opinion paragraph includes an inappropriate statement that "the consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty." This statement is misleading and should be omitted.

D 16. The audito~s report is not correctly dated since it uses only one date. It should be dual dated because oftha notes referring to the investigation and the going concem uncertainty.


2013 Edlll ... -Aud~ FInal __ (A """ .. Ian)

Solution ~LQ]~ 1. Charla Is IncorlWCl:

~I 10 1111 IUblidiliry IIwI. WIll not audibld by 1111 princip!ll ludilor Ind IhIlTIIlgniludl of iIs fir'lllncial ..... 1MI1 .. iI im;:loo.d in 1'- o .. ning .. ~IlIPh.

2. Ch ..... II IrICOI'TKt The other .udltora CIIn only be named willi lI1.r 1IICPI'eII1*TTI1 .. lon and If their report II being p_ntecI iogeIher with 111111 01 Chari .. , CPA.

3. Ch ..... II IrICOI'TKt An ulllpllifiMl opinion mum ....... 1111. &.nciII1.tat.m.n15 1111 rr.. 01 mm.riId miubdem.nt. but don not ... "w .... eau.:l by.rrororhud,"

4. Charla II correc1 There lhould be a referenoe In Ihe soupe .. ....,.1lIPh to 'lIgnlllcllnt estIrnII1lIa made by management."

5. Charla Is correc1 ~Dlio 111. _n.nt of hud rilk is not p.rt of 1'- standerd r.port and Ihould be ralTlOVlld.

I. Ch ..... II carrect The audit raport lholJd Includ. a rnrarw;:e In the Ir::ope p.r:agraph 10 ___ Ultlng 1'- Oer.ll fln.ndal .... ment plMentlltlon. '

7. Charla Is IncorlWCl: Since Ralligh ... pl'D'lidlld lIdIIquete dilcloaura in 1111 naIM 10 iIs fir'lllncial staternen .. , 111 .. i. no ..-. for th. auditor to m.ke m.ntion ofth. uncertainly.

I. Ch ..... II IrICOI'TKt The IUbllanlvl reuonl for th. dllJerent opinion should be dllCtoMd In a IIPB/"IIte explanatory paragraph pnlOIdlng the opinion panlgraph. (Tl"I1 ... an exoepCIon 10 lI1e rule on the poIIDon of the explllnItory parafill1Iph.)

I. Ch ..... 1I11'ICOii'ect The .udilo .... belief that dilcloeu .... ralldequ .. il impliMl in th udit raport. .nd .-I nol be ~cally stat.d.

10. Ch ..... IIlrICOI'TKt The type of opinion IXPflIMMl by the oth ... auditor nlllld not be lpar::llk:ally Id~llIMl. Rdler, the prtncl .. laudltor plOYldes hll opinion on the col1lOlldated flllIrIcllil slldemen15111ken u whole, and limply menDonI tIIaI.. portion of thl work _ .. rronnMl by "0111 ... auditors."

11. Ch ..... IIlrICOI'TKt The opinion should Include the ... ub of operatio", .nd the l:8Ih 11_ for the .ppn:Jp .... ywra. Th. opinion .t1ould not Includ. changllin lIoekholdln' equity ~noorrectly luggIDd by Charlll).

12. Ch ..... IIlrICOI'TKt An uncerlaln1 that II Idlqulillily dilClOlld In 111. flnancillltlitllTilnts dolS not fflqulra 1'- ~lUonallXplan.1IonI .... 1I1I1IIId by Chi .....

13. Ch ..... II carrect The t.nn "lut.tantl.1 doubt' II fflquli"ld to be u.ed In .ello", wh,.,. IU"""aI doubt .....

14. Ch ..... II correc1 The IIInn "goIng concem" II NqIlINd to be ..ed In Illullllonl where lut.tantlal doubtllXl ....

15. Charla Isinooillect TyI"l raport oolTlClly uplainlth.t th ......,cillillalem ...... do not includ. any adjilllml ..... that might raull tom 1'-outcom. of the golnll eom;:.m uncertainly.

11. Ch ..... IIlrICOI'TKt Dual dating II not required bMed on going concem ..... or unoer1atnl .


TASK-BASED SIMULATION 3: Subsequent Events

i' Subsequent Events I Authoritative Literature I Help I '" On February 12, Year 3, an auditor issued an unqualified audit report on a client's comparative financial statements for the

years ended December 31, Year 1, and December 31, Year 2. The financial statements were issued on February 28. A number of independent situations related to the engagement are described below. For each situation listed, identify the auditor's responsibility in Column A and the proper effect on the auditor's report in Column B. Assume that the client declined to make any additional changes to the financial statements.

A B 1. On February 10, Year 3, the auditor discovered that a material receivable included in the December 31, Year 2 financial statements was worthless due to the deteriorating financial condition of one of the client's customers. The client did not adjust the financial statements for this occurrence, but fully disclosed the matter in the notes to the financial statements. 2. On February 23, Year 3, the auditor became aware of information leading him to believe that the client's investment in marketable securities was materially overstated in the December 31, Year 2 balance sheet. 3. On February 2, Year 3, the auditor finalized his divorce from the CFO of the client's company. The divorce was amicable and the auditor maintained an appropriate level of professionalism and independence throughout the audit. 4. On February 11, Year 3, the auditor discovered that, due to a computer failure, all records regarding the payment of invoices for the week of December 8 had been lost. Several material payments were made during this week. The auditor was unable to perform acceptable alternative procedures and was unsure whether the payments had been properly recorded. 5. On January 14, Year 3, the auditor discovered that for a number of securities held in the client's investment portfolio, the quoted market prices had materially changed since December 31, Year 2. The client had not adjusted the financial statements for this occurrence, nor had any disclosure of these changes been included in the notes to the financial statements. 6. On January 3, Year 3, the auditor discovered that the financial statements had been materially misstated due to a pervasive scheme involving fraud at the highest levels of management. 7. On February 20, Year 3, during an intemal quality control review, it was discovered that the auditor had not made any inquiries or performed any auditing procedures after February 12, Year 3.

(continued)

8J

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2015 Edltlon-Audltlrc Rnll ~_ (A ..... lIIonJ

(contlnuld)

8. On FlbrulllY 27, v.... 3, during In mrTIIIl quality control rwviIIw, it _ dlllca\/ered thll liMI I11III' MlCOUnillni on the Job never M:tl.illlly mailed lIIfly r.ce1vablM confhnlll.IIoM, but limply lIlRumed thai rw:.~ __ fUIy.a.ted. ~r, III outstanding rac.MIbl_ .t year .. nd __ paid withi"lSO~, and mallirilll cuh lWOlIipts ,ullsequ .. 1 to )'IIIII.r-end ~ audited and traced to thl .--1vIII.bI_

~_ .. ~rtofth,audllofCAh.

9. On February -4, Year 3, Ihe aucltor dllooverecllhat the ,*,nt wu It. defendant In I product liability IIIlwIuIt. 1111 cll .. ra manlgn"nt ...tad ill innoc.nc:., and ill atlom.y 8IIr..:l with lhil.....-n.,1. HoweYer, the llItomey 1liiio nDled thlill would be algnll'lcantly leu cody to HtIII oul of court IhIIln to pr"OCMd 10 trill, end thl cllda ITIIlJ8lllllIIIInt _ lit.1y to follow thl advic:. of CDul1ll,l. SaIII_nt oosts could not .,. rauor.bly MlimaIIKI .t thillima, but Ihlry_r. likaly to be mlller1l11. 111, client had not aocrued thl' 0081 or madl mantion ofthl, mattar In III "nanclal....",..,II, .. 1I did not wI,h to givl an ..,......,oa of guill in any-r. 10. On JanullllY 111, Year 3,the audllorbacallllllWV8thlll.llt. ell. __ racIIling onl of ill producla dua to a daaign daI'tIcI: th,1 ~ a potenlllillfety hlZll"d. The potenlllli cost of liMI recall program _ material end could be ellrnated with a _nebll degr. of pracilion. 1111 client had aa:rued thi' coal: in ill financial"tarn..Ia.

Select Item Select Item

n... .. dllDr_ ........... bll\ytol~. n... .. dllDr _ .... _ r.pIIMIbllly II>

'-

n... WlqYllilild opilian iliuM _.,rcpriaII n... WlqYIIIIItd opl1lon _M_ il"llflPl'llprillllo; ...... dilar ahauld '-illll*l qLIIIIIhd cr _ opinion

n... .. dllDr _ .... _ r.pIIMIbllly II> I~ bl.tahauld call1ldwwlwllir'' 1i'I1I"ICiII ... 1 , .. ,lIcrdilckaorHlhoLidbl

~-

n... WlqYllilild opilian illuM_ lrwppn>prI"; ...... dllDr ahauld '-1II1I*I , qLIIIIIhd crd.a.mer tltoplnlon n... Wlq..-llhd ophlon __ _

Il"IIfIPI'IIprI"; ...... dllDr ahauld '-1II1I*I dilcllimlr or opinion n... Wlq..-lllltd opl1lon __ _

Il"IIfIPI'IIprI"; ...... dllDr ahauld nat. '-.... n ____ ft'-II_I""

I Cn:" I

20U EdIIlDl'l-Audlllnl Final __ (A Vl!!l'IIon)

Solution ~LQ]~ ThIIaudllDr ha an KtiYII rnponllbllily 10 Invntlgnl OIIrt..ln subuqUIII'It IWI'Its bI~n trw da. of th. "ancllil ,tat.n1.m. and th. data ofth uditor'a r.port (12J31IY2through 2I121Y3, n'" CIIM). 111. audilorwoukl.r.o b. l'NPOIl"bIa for In-ugat;lnll til. atr.d;a af.ny omlltad audit pn;n::.dUIN dl~~ .1'Iar th ..... blnl.lon of tha .udlt ",port. The .udllDr hal no KtiYIIl'NPOIlllbllily 10 mllka Inqulrlaa or P8Iform .ny furthar auditing procadulM an. th. dlda of th. audlton report (2/121Y3), butlilould oonaldlll" the ImplicaDona of.ny Infor'TNIIon oomlnll to his or her atIIIntion. 1. 111. auditor hM ruponllblllt;J 10 IIIWItIgatI. ThII unqlllllfllcl opinion ....... _ Inapprap ...... ; 1M .udltor

.hould haval_d ... uallllad ar adnrwa opinion.

Sinea th .. dlst::ollary look pIaea prior 10 th. d of th. audllor'a ",port, th. auditor _ IMponalbl. to IlIYMIigaW. Addlaonally, alnea th .. oondltlon Ibly existed .tth. daN of th. finandallllllemerD, end linea th wu probabl. and Mlimablll, a finlneill .... msnt adjUllmant was raquirtKl. sno. no ad,jUllmant was mad., a qUlliliMl or ad_ opinion would h ..... baan appnIpri ....

2. 111. auditor h .. no _'" raapoMlbll1tJ to ~ ..... bul.hould I;Onlldlr whathlr th. flnandll .... mant. or dIIClMUr-.. should ba adJuRsd. The unqllllllled opinion !Ailed _ Inapprap ...... ; the .. dltor .hould haw _ulld qUII11l1ld or adYI .... opinion.

111. audilor had no I1IIpor1libility ID man inquiri .. or pClrfonn .ny further auditinll prooIIduru IIIIar F.bRlary 12, but oould not igno", infolTMliDn that cama 10 hill atIIIntion. Gi~ th. n_ infonnalion, qLllllifi.d or 8dI1M opinion would hawo t..n approprlata. (At th .. point. ,-, th. ellllnt would mOl1l lltaly be advised to AM_th. "anclal IlaiemerD, Iince th~ have not yet been !slued.)

s. 111. auditor haa no _'" I'IIpoMlbll1tJ 10 11IYMtI_. The unquallflad opinion I_d _ Ina""""",,; 1M MldllDr .hould h.".. _lied dllclalmar 01 opinion. 111 .. il no n.ad or raqui",mant for furth.r inv .. till.liDn of thill ~nahip. ,.. of Dacarrt. 31, y..,- 2, tha .udill:lr _ stl manlacl 10 th. CFO. Dlllpltlthl mclthl audllor mil)' have baan Indapandlll'lt In fact, th .. reIationahlp Impairs Independence becalllll he_ not hdependentln appearance. Lac* of Independence res .... In I disclaimer of opinion.

4. 1111 auditor haa rwaponllblilly to IrnrHI",ta. The unqlllllfllcl opinion !Ailed _ Inapprap ...... ; tha .udltor should havalllllld a dllClaimer of opinion. Since th .. dllcovary took place prior to th. daN of the audllor'a report, th. auditor _ responalble to 11IYMI1gate. Since tha audilor was unablillD pClrfonn IIOOIpillbIIln.rnaIiv1 proolldul'll Ind was un .... 111 wh.ther thl Pll)'ll'llnts hid blln properly rscord.d, qualifiacl or di.::lllimar of opinion would h.ve baan appropriata.

15. 111. auditor h .. no _'" I'llpoMlbl11tJ to IrNWtIgala. The unquallflad opinion I_d _ .pproprlata. 1111 audllor II only r.qul~ 10 Im.llllata eart.ln arbllqulll'lt _II ~n year-and and thl data of the .l.KIiIor'I report. Chanlllllin the msrket prices of IlCUrltllII _ not among U- l1li1111. Such chafllllllare to be expactIId and would not raquil1lIdjLlllrnllnt 10 or dilclOllll1l in .... financial ..... mants. The unqudl'illd opinion i.1.IId was th.l1Ifol1l _ ...

.. 1111 auditor h ... fllponllblilly to IrnrHI ...... The unqlllllflild opinion !Ailed _ Inapprap ....... blca.a thl .. ditor lhould not h.".. baIIn ..acIatad with thlll financial .... 1nIIItI. Since th .. dilooery took place prior to the dille of the audlton report, the audllor _ responalble to Investigate. Additiondy, lIinea "'illllitumion posad _au. OOIIOIm bouI boIh .... InmciIIIIIatam.ntsand m.n'lI.m.nt'1i Int.grlly, tha .udltor .houkl '- wI"'d~ from th nll'lIImant.nd lhould not have blln ~ wIIh th_ llnanelal llaIIm.m..

(continu.d)


(continued)

7. The auditor hae no active responsibility to Investigate. The unquallfted opinion Issued was appropriate. The auditor had no responsibility to make inquiries or perfonm any further auditing procedures after February 12. Since no problems had come to his attention, the unqualified opinion remained the appropriate option.

8. The auditor has a responsibility to investigate. The unqualified opinion issued was appropriate. The auditor is responsible for investigating the effects of any omitted audit procedures discovered after the submission of the audit report. In this case, it appears that other audit procedures tended to compensate for the omitted audit procedure, so the unqualified opinion remains the appropriate option.

9. The auditor has a responsibility to Investigate. The unqualified opinion Issued was Inappropriate; the auditor should have issued a qualified or adverse opinion. Since this discovery took place prior to the date of the audito~s report, the auditor was responsible to investigate. The incurrence of this cost was probable but not estimable, so GAAP requires footnote disclosure. Since the company neglected to disclose the situation, a qualified or adverse opinion should have been rendered.

10. The auditor has a responsibility to investigate. The unqualified opinion issued wae appropriate. Since this discovery took place prior to the date of the audito~s report, the auditor was responsible to investigate. The cost was both probable and estimable, so the company properly accrued this amount. Since GAAP was followed, an unqualified opinion remains the appropriate option.



TASK-BASED SIMULATION 4: Research

T Research I Authoritative LIterature I Help I An audit report includes certain basic elements. What guidance is provided by AICPA Professional Standards with respect b:J to the basic elements of the auditor's report?

I Choose a title from the list.

, Research Authoritative Literature I Help I 1 ~I I I ~B~ ~k==LI-=Ho=m=.~R~~~m~p~F~.~~~sh~s~========~~~~--._~~::~~ __ ~~_._--------------~III

IEnter Search Here -- se:;;dl 5eardl WAhft'l I Advanced Search rt"able of Contents I Prevlou,r~ptd! 11 r~extMat.ch

~AICPA Literature rt:J Professional Standards

AICPA Literature

Uniform CPA Examination Authoritative Literature To access Authoritative Literature:

Click on Table of Contents folders at left to locate and open appropriate documents

OR

Perform a search for a particular topic by entering text in the text box above. Use the buttons to the right and the links above the text box to perform more detailed or advance searches.

-------------------------------------------------------------------------------------------------------

~~~ ~~ Source of answer for this question:

AU 508.08 Keyword: Standard report

~ I

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AUDITING 2 Other Reports and Services

Special Reports

Statements on Standards for Accounting and Review Services

Review of Interim Financial Statements

Statements on Standards for Attestation Engagements


NOTES

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SUMMARY NOTES

I. SPECIAL REPORTS A. Types of Special Reports

1. Other comprehensive basis of accounting (OCBOA). 2. SpeCified elements, accounts, or items. 3. Compliance with contractual or regulatory requirements related to audited financial statements. 4. Financial presentations to comply with contractual/regulatory provisions. 5. Prescribed form presentation.

B. OCBOA 1. Other comprehensive bases:

a. Income tax basis. b. Basis required by regulatory agency. c. Cash receipts and disbursements basis.

2. Reporting on OCBOA financial statements (See the Audit Communications Appendix): a. Use non-GAAP titles for financial statements in the introductory and opinion paragraphs. b. Add an explanatory paragraph before the opinion paragraph, stale that the basis of

presentation is different than GAAP, and refer the reader to the relaled footnote. c. Render opinion paragraph appropriately. d. When reporting for a regulatory agency, include a paragraph limiting use to management

and other involved parties.

II. STATEMENTS ON STANDARDS FOR ACCOUNTING AND REVIEW SERVICES SSARS (Statements on Standards for Accounting and Review Services) are issued by the AICPA Accounting and Review Services Committee. SSARS provide guidance with respect to compilations and reviews of financial statements of non issuers. CPAs can perform either a compilation or a review. The Audit Communications Appendix contains both SSARS and SAS reports. A. Review Reports

1. Independence is required. 2. Each page of the financial statements should be marked, 'See accountant's review report . 3. Review procedures, consisting principally of inquiry and analytical procedures, should be

tailored to the specific engagement. 4. Required procedures-inquiries about:

a. Accounting principles and practices used. b. Procedures for recording, classifying, and summarizing transactions.

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c. How footnote information is accumulated.

d. Changes in business or accounting. e. Subsequent events. f. Actions authorized by stockholders or board of directors.

5. Inquiries should also be made regarding: a. Unusual or complex situations that may affect the financial statements. b. Significant transactions near the end of the period. c. The status of uncorrected misstatements from previous engagements. d. Material fraud or suspected fraud. e. Significant journal entries and adjustments. f. Communications from regulatory agencies.

6. Analytical procedures are also required. The auditor should compare current statements with prior statements, compare actual with budgets, and study specific predictable items. The auditor should also compare: a. Financial and relevant nonfinancial information.

b. Ratios and indicators with those of other entities in the industry. c. Relationships among elements in the financial statements within the period and with

corresponding prior period relationships. 7. The auditor should also:

a. Obtain an understanding of the client's business. b. Become familiar with the accounting principles used in the client's industry. c. Read the client's financial statements.

d. Obtain a representation letter. Management representations should include: (1) Acknowledgment of responsibility to prevent/detect fraud. (2) Knowledge of any material fraud or suspected fraud.

8. GAAP departures should be disclosed in a separate final paragraph of the review report, or the auditor may withdraw from the engagement.

9. The report provides limited assurance (less assurance than is provided by an audit) that no material modifications to the financial statements are required for conformity with GAAP (or other appropriate financial reporting framework). The Audit Communications Appendix contains an example of a review report.

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B. Compilation Reports 1. No independence is required. and no assurance is expressed. Lack of independence must be

disclosed in the compilation report. The accountant is permitted, but not required, to disclose the reason(s) for the lack of independence. The Audit Communications Appendix contains a compilation report.

2. The CPA presents in the form of financial statements, information that is managemenfs representation.

3. Requirements: a. Obtain knowledge of the client industry's accounting principles/practices. b. Obtain an understanding of the client's business. c. Read the financial statements to ensure they are free of obvious clerical errors and

obvious mistakes related to GAAP. d. Disclose lack of independence, if applicable.

4. GAAP departures should be disclosed in a separate paragraph of the report, or the auditor may withdraw from the engagement. If substantially all required disclosures (GAAP/OCBOA) are omitted, the auditor's report should clearly indicate this omission.

C. Change In Engagement If the client wishes to change an audit to a compilation or a review, the accountant should: 1. Inquire about the reasons for the change (e.g., a change in client requirements, a

misunderstanding as to the service to be rendered, a scope restriction). 2. Consider the estimated additional cost/effort required to complete the engagement.

If the accountant decides that the change in engagement is justified, he/she must comply with standards for a compilation or review and issue an appropriate report.

D. Comparative Reporting Different services may be provided in different years. 1. Increase in level of service-If a service upgrade (from compiled to reviewed) occurs:

a. The prior year report should be updated and issued as the last paragraph of the current period report.

2. Decrease in level of service-If a service downgrade (from reviewed to compiled) occurs, three options exist: a. Issue a compilation report and add a paragraph to the report describing the responsibility

for the prior period statements. Include the date of original report, and a statement that no review procedures were performed after that date.

b. Issue two separate reports. c. Issue a combined report presenting both full reports with an added statement to the

review report indicating that no review procedures have since been performed.



III. REVIEW OF INTERIM FINANCIAL STATEMENTS A. A review of interim financial statements provides a basis for reporting whether the accountant is

aware of any needed material modifications to interim financial information for GAAP conformity. Procedures include inquiries, analytical procedures, and other procedures.

B. For a public company, the required procedures are: U LIAR CPA

Understanding with the client must be established.

Learn and/or obtain sufficient knowledge of the entity's business and its internal control.

Inquiries should be addressed to appropriate individuals, including the predecessor auditor.

Analytical procedures should be performed.

Review-other procedures should be performed.

Client representation letter should be obtained from management.

Professional judgment should be used to evaluate results. Accountant (CPA) should communicate results.

C. In addition to the standard review analysis of aggregated amounts, analytical procedures should be applied to disaggregated revenue data (by month, by product line, etc.).

D. The accountant is required to obtain evidence that interim data reconciles to accounting records. E. In addition to the usual representations, the accountant should also obtain management's wrillen

representations related to internal controls and fraud.

F. Reporting 1. The accountant expresses limited assurance on interim financial information covering the

period from the last audit to the date of the interim statements. 2. GAAP departures must be disclosed. 3. A going concern paragraph is optional if there is adequate disclosure. 4. A lack of conSistency paragraph is optional if there is adequate disclosure. 5. The Audit Communications Appendix contains an example of a report on interim statements.

G. Letters for Underwriters 1. "Comfort lellers" are provided to an underwriter or other party (I.e., broker-{lealer) just before

the registration of the clienfs securities. a. The CPA is required to perform a review of interim financial information. b. The leller must include a restriction on its use (requesting party only).

2. Negative assurance is provided for most financial information. 3. Positive assurance is provided on CPA's independence and compliance of financial statements

with Securities Acts, assuming financial statements were audited; otherwise, negative assurance is provided.



IV. STATEMENTS ON STANDARDS FOR ATTESTATION ENGAGEMENTS A. Statements on Standards for Attestation Engagements (SSAE) apply to engagements in which a

practitioner is engaged to issue, or does issue, an examination, review, or agreed-upon procedures report on subject matter (or an assertion thereon) that is another party's responsibility. Independence is required.

B. There are three levels of reports: 1. Examination (highest assurance, with positive opinion). 2. Review (negative assurance). 3. Agreed-upon procedures (no assurance).

C. The report may be issued on the assertion itself or on the associated subject matter. D. Attestation standards:

1. SSAE are a natural extension of GAAS, but differ conceptually in three ways: a. No reference to financial statements. b. No reference to GAAP. c. Provide levels of assurance below that provided by a GAAS audit.

2. The eleven attestation standards are very similar to GAAS. There are five general standards: a. The first three are similar to GAAS (training, independence (required), and due

professional care). b. Two additional standards address knowledge of the subject matter, and the accountanrs

belief that the assertion is capable of evaluation and estimation against reasonable criteria.

3. There are two fieldwork standards (understanding the entity and its environment standard is omitted): a. Planning and supervision. b. Evidence.

4. There are four reporting standards (omit references to consistency and disclosures): a. Identify the assertion. b. Express conclusions based on the criteria. c. Include a statement of reservations.

d. Restrict the use of the report in certain circumstances.

2-7



E. "Agreed-Upon" Procedures Engagements: I AM SURE The practitioner is engaged to report findings using specific. agreed-upon procedures. Required conditions: 1. Independence of Practitioner. 2. Agreement of Parties-Practitioner and specified parties agree regarding procedures to be

performed. criteria to be used in determination of findings. and any materiality limits used for reporting.

3. Measurability and Consistency-Subject matter should be capable of reasonably consistent measurement. procedures should be expected to result in reasonably consistent findings. and evidential matter to support report should be expected to exist.

4. Sufficiency of Procedures-Specified parties take responsibility for sufficiency of procedures for their purposes.

5. Use of report is restricted to specified parties. 6. Responsibility for subject matter. Either:

a. Client is responsible for (or has a reasonable basis for providing an assertion about) subject matter, or

b. Client is able to provide evidence of a third party's responsibility for subject matter. 7. Engagements to Perform Agreed-upon Procedures on Prospective Financial Statements.

a. Prospective financial statements must include a summary of significant assumptions. F. Prospective Financial Statements (forecasts and projections)

1. Financial forecast: a. Based on expected conditions and expected courses of action. b. Available for general use or limited use.

2. Financial projection: a. Hypothetical assumptions ... "What if" b. Restricted use.

3. With respect to prospective financial statements, allowable engagements are: compilation, examination, or agreed-upon procedures (no review allowed). The Audit Communications Appendix contains reports on a compilation and on an examination of prospective financial statements.



G. Expressing an Opinion on Inlernal Control An accountant may be engaged to express an opinion on managemenfs written assertion about internal control. The Audit Communications Appendix contains an example of a report on internal control.

1. The examination of internal control should be integrated with an audit of the financial statements.

2. Generally, a written assertion from management is required. 3. The accountant may report either on the assertion or directly on internal control. 4. Management must accept responsibility (written) for the effectiveness of internal control. 5. Suitable criteria must be used in evaluating internal control, and sufficient evidence must be

available.

6. A review engagement is not allowed. 7. Significant deficiencies and material weaknesses in internal control must be communicated to

those charged with governance. 8. An inherent limitations paragraph should be included in the report. 9. Generally, use of the report is not restricted.

H. Other Attestation Services 1. Managemenfs discussion and analysis (examination or review). 2. Pro forma financial statements (examination or review). 3. Compliance (examination or agreed-upon procedures).

I. Assurance Services Assurance services are independent professional services to improve the quality of information, or its context, for decision makers. They are broader and more flexible in scope than attestation engagements. Trust services (including WebTrust and SysTrust) address the risks and opportunities of information technology. 1. WebTrust

a. Developed by the AICPA, Web Trust is the first assurance service and the only comprehensive e-commerce seal of assurance to employ independent verification to prevent online fraud and privacy infringements. CPAs conduct examinations every 90 days or less to ensure that the site continues to adhere to stated business practices and disclosures, provide safe, secure transactions, and protect private information.

b. Fundamental areas of electronic commerce, as appropriate, may be examined under a WebTrust engagement. Services may address security, privacy, availability, confidentiality, and processing integrity.

2. SysTrust SysTrust services address concerns relating to system reliability. The CPA performs procedures to examine and test infrastructure, software, people, procedures, and data. The CPA determines whether system controls exist, and performs tests to determine whether those controls operate effectively. System reliability is measured against four essential principles: security, availability, processing integrity, and confidentiality.

2-9



NOTES

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QUESTION 1

Which of the following is a prospective financial statement for general use upon which an accountant may appropriately report? 1. Financial projection. 2. Partial presentation. 3. Pro fonma financial statement. 4. Financial forecast.

QUESTION 2

An engagement in which a CPA considers availability, security, integrity, and confidentiality of a company's computer systems is most likely to be considered which of the following types of engagements? 1. An attestation engagement involving internal control over financial reporting. 2. A SysTrust service engagement. 3. An audit engagement during which internal control is evaluated. 4. A WebTrust engagement.

QUESTION 3

Financial statements of a non issuer that have been reviewed by an accountant should be accompanied by a report stating that a review: 1. Provides only limited assurance that the financial statements are fairly presented. 2. Includes examining, on a test basis, information that is the representation of management. 3. Includes primarily applying analytical procedures to management's financial data and making inquiries of

company management. 4. Does not contemplate obtaining conroborating audit evidence or applying certain other procedures ordinarily

perfonmed during an audit.

QUESTION 4

When an auditor reports on financial statements prepared on an entity's income tax basis, the audito~s report should:

1. Disclaim an opinion on whether the statements were examined in accordance with generally accepted auditing standards.

2. Not express an opinion on whether the statements are presented in confonmity with the comprehensive basis of accounting used.

3. Include an explanation of how the results of operations differ from the cash receipts and disbursements basis of accounting.

4. State that the basis of presentation is a comprehensive basis of accounting other than GAAP.

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QUESTION 5

During an engagement to review the financial statements of a nonissuer, an accountant becomes aware that several leases that should be capitalized are not capitalized. The accountant considers these leases to be material to the financial statements. The accountant decides to modify the standard review report because management will not capitalize the leases. Under these circumstances, the accountant should: 1. Issue an adverse opinion because of the departure from GAAP. 2. Express no assurance of any kind on the entity's financial statements. 3. Emphasize that the financial statements are for limited use only. 4. Disclose the departure from GAAP in a separate paragraph of the accountant's report.

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AUDITING 311 ~

Before the Fieldwork

Auditing-An Overview

Planning the Audit

Other Audit Items


NOTES

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SUMMARY NOTES

I. AUDITING-AN OVERVIEW A. Purpose ofthe Audit

The purpose of an audit is to express an opinion on the financial statements (FS). The audit process is an attest function performed according to generally accepted auditing standards (GAAS) that adds "credibility" to a company's financial statements.

B. The Audit Process 1. Engagement Acceptance

a. Consider firm's client acceptance and continuance policies. b. Determine whether the entity is auditable. c. Contact the predecessor auditor (with management's approval).

2. Establish an Understanding with the Client a. Obtain an engagement letter.

3. Plan the Audit a. Obtain knowledge of the client's business and industry. b. Develop the audit strategy, including a preliminary assessment of materiality and

tolerable misstatement. c. Develop the audit plan. d. Perform risk assessment procedures to obtain an understanding of the entity and its

environment, including its intemal control, sufficient to assess the risk of material misstatement and design further audit procedures.

4. Assess Risk a. Use the understanding of the entity, its environment, and its intemal control to assess the

risk of material misstatement. b. Document this understanding, the risk assessment, and the basis for the risk

assessment.

5. Respond to the Assessed Level of Risk a. Develop an overall response to address risk at the financial statement level. b. Design speCific audit procedures based on the assessed level of risk. c. Identify and test relevant intemal controls. d. Perform substantive tests.

B. Evaluate the Sufficiency and Appropriateness of Evidence Obtained a. Use auditor judgment to evaluate evidence. b. Document the results of audit procedures, as well as the linkage of those procedures with

the assessed level of risk. 7. Other Requirements

a. Audit work must include a subsequent events review. b. A management representation letter must be obtained.

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8. Prepare the Audit Report Introductory paragraph-Sets forth the entity, statements, and time period under audit and the responsibilities of management and the auditor. Scope paragraph-States that the audit was conducted in accordance with GAAS and specifies what GAAS requires, including reasonable assurance. Opinion paragraph----Contains the auditofs opinion that the FS are in confonnity with GAAP. Unless otherwise noted, there are no consistency or disclosure problems.

C. Management Assertions-COVERU Management makes assertions about transactions and events, account balances, and presentation and disclosure. 1. There are six main financial statement assertions (Note that under peAOB standards, the main

financial statement assertions are Completeness, Valuation or allocation, Existence and occurrence, Rights and obligations, and presentation and Disclosure): a. kompleteness

All account balances, transactions, and disclosures that should have been recorded have been recorded and included in the financial statements.

b. Cut-Qff Transactions have been recorded in the correct (proper) accounting period.

c. llaluation, Allocation, and Accuracy Account balances, transactions, and disclosures are recorded fairly and at appropriate amounts, and any resulting valuation or allocation adjustments are appropriately recorded.

d. Peistence and Occunrence Account balances exist and transactions that have been recorded and disclosed have occurred and pertain to the entity.

e. Rights and Obligations The entity holds or controls the rights to assets and liabilities are the obligations of the entity.

f. llnderstandability and Classlftcatlon Transactions have been recorded in the proper accounts. Financial infonnation is appropriately presented and described and disclosures are clearly expressed.

2. Relevant Assertions

Relevant assertions are assertions that have a meaningful bearing on whether an account, transaction, or disclosure is fairly stated. a. Transactions and Events

For transactions and events, relevant assertions include completeness, cutoff, accuracy, claSSification, and occurrence.

b. Account Balances For account balances, relevant assertions include completeness, allocation and valuation, rights and obligations, and existence.

c. Presentation and Disclosure For presentation and disclosure, relevant assertions include completeness, understandability and classification, rights and obligations, and valuation and accuracy.



D. Ten Generally Accepted Auditing Standards (GAAS) GAAS represent minimum audit performance quality requirements (not auditing procedures). 1. General Standards-TIP

a. Training-The auditor must have adequate technical training and proficiency to perform the audit.

b. Independence---The auditor must maintain independence in fact and in appearance in all matters related to the audit.

c. Performance-The auditor must exercise due professional care in performing the audit and preparing the report.

2. Standards of Fieldwork-PIE a. Planning & Supervision-The auditor must adequately plan the work and must properly

supervise any assistants. b. Internal Control-The auditor must obtain a sufficient understanding of the entity and its

environment. including its internal control. to assess the risk of material misstatement of the FS (whether due to error or fraud) and to design the nature. extent. and timing of further audit procedures.

c. Evidence-The auditor must obtain sufficient appropriate audit evidence to afford a reasonable basis for an opinion on the financial statements.

3. Standards of Reporting-ACDO a. Accounting-The auditor must state in the audito~s report whether the FS are presented

in accordance with GAAP. b. Consistency-The auditor must identify in the audito~s report those circumstances in

which GAAP has not been consistently observed from one period to the next (otherwise. consistency is implicit in the audito~s report).

c. Disclosure-The auditor must state in the audito~s report when informative disclosures required by GAAP are not reasonably adequate (otherwise. adequate disclosure is implicit in the audito~s report).

d. Express Opinion-The auditor must either express an opinion regarding the FS taken as a whole or state that an opinion cannot be expressed. The objective is to avoid any misinterpretations of the degree of responsibility the auditor assumes when his/her name is associated with the FS.

II. PLANNING THE AUDIT A. Engagement Acceptance

1. Consider the firm's client acceptance and continuance policies, including: a. The firm's ability to meet reporting deadlines b. The firm's ability to staff the engagement c. Independence d. Integrity of client management

2. Determine whether the entity is auditable by considering: a. The availability and adequacy of accounting records b. Management's attitude toward the internal control environment

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B. Predecessor Auditor 1. Contact with the predecessor auditor is mandatory (with client permission). 2. Inquiries should be made regarding:

a. Management integrity. b. Disagreements with the predecessor auditor (principles, procedures, etc). c. Reason for the change in auditors. d. Any fraud, illegal acts, or internal control matters and their communication to

management, the audit committee, and those charged with governance. e. Fee payment problems.

C. Establishing an Understanding with Client 1. Establishing an understanding with the client is required to reduce the risk of misinterpretation. 2. The understanding with the client should be documented through a written engagement letter. 3. The understanding should include:

a. The objective of the audit. b. Management's responsibilities. c. The audito~s responsibilities. d. Limitations of the engagement. e. Other matters.

4. If an understanding is not achieved, the auditor should withdraw. D. Planning the Audit

1. The auditor should obtain knowledge of the client's industry and business. 2. The auditor should establish an overall audit strategy, including a preliminary assessment of

materiality and tolerable misstatement. a. The audit strategy outlines the scope of the audit engagement, the reporting objectives,

timing of the audit, and required communications, and the factors that determine the focus of the audit.

b. Materiality is the amount of error or omission that would affect the judgment of a reasonable person. It can be measured in quantitative or qualitative terms.

c. Tolerable misstatement is the maximum error in a population that the auditor is willing to accept.

3. The auditor is required to develop a written audit plan that outlines the nature, timing, and extent of the procedures to be performed during the audit, including: a. Risk assessment procedures b. Further audit procedures (tests of controls and substantive procedures) c. Other audit procedures

4. The audit strategy and audit plan can be modified as the audit progresses in response to new information or to the results of other procedures.



E. Internal Auditor

1. Independent auditors cannot share responsibility for audit decisions. assessments. or for issuing the report with a client's internal auditor. However, the internal auditor may assist with routine tasks.

2. An auditor wishing to make use of an intemal auditor must consider critical factors regarding the intemal auditor, such as:

a. Competence and objectivity in performing procedures. (1) The organizational level to which the internal audit function reports affects

objectivity. F. Use of a Specialist

1. Actuaries, appraisers, attomeys, and engineers (specialists) may be used to assist the auditor in considering valuation or complex transactions.

2. The auditor must evaluate the specialist, his/her competency, and any relationship with the client (independence is not required) to determine the possibility of using the specialist's work.

3. If, as a result of the work performed by the specialist, the auditor decides to add explanatory language or depart from an unqualified opinion, the auditor may refer to the specialist in the report.

III. OTHER AUDIT ITEMS A. Supervision

1. GAAS requires supervision to ensure: a. Adequate performance. b. Accomplishment of objectives. c. ConSistency of work with audit report conclusions. d. Documentation of disagreements and their resolution.

B. Audit Documentation ("Working Papers") 1. Audit documentation is a written record of the work performed, evidence obtained, and

conclusions reached. Audit documentation:

a. Is divided into permanent and current files. b. Supports the audito~s reporUopinion. c. Aids in training and in the conduct/supervision of the audit. d. Provides a record of accumulated evidence.

e. Must indicate that the accounting records reconcile with the FS. f. Must be assembled within 45 days (public company audits) or 60 days (other audits)

following the report release date. g. Must be kept for seven years (public company audits) or five years (other audits). h. Must contain enough information to allow an experienced auditor with no previous

connection to the audit to understand the work that was performed.



2. Audit documentation is the independent auditor's property. It is confidential, but can be disclosed without client permission as part of: a. A quality review program. b. The subpoena process. c. An investigation conducted by the AICPA, state CPA society, or under state statute.

C. Related Party Transactions 1. Throughout the audit process, the auditor must be alert for the existence of transactions with

related parties, such as entity affiliates, principal owners, management, and members of their immediate families.

2. The auditor's primary concern with respect to related party transactions is their proper disclosure in accordance with GAAP.

3. Specific procedures regarding material transactions with related parties may include: a. Evaluation of the company's procedures to identify and account for related party

transactions.

b. Inquiry of management regarding the names of all related parties. c. Review of the reporting entity's filings with the SEC and other regulatory agencies

concerning the names of officers and directors who occupy management or directorship positions in other businesses.

d. Review of material transactions for related party evidence.

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QUESTION 1

The fourth standard of reporting requires the auditor to either express an opinion regarding the financial statements taken as a whole or state that an opinion cannot be expressed. The objective of the fourth standard is to prevent: 1. An auditor from expressing different opinions on each of the basic financial statements. 2. Restrictions on the scope of the audit, whether imposed by the client or by the inability to obtain evidence. 3. Misinterpretations regarding the degree of responsibility the auditor is assuming. 4. An auditor from reporting on one basic financial statement and not the others.

QUESTION Z

The third general standard states that the auditor must exercise due care in the perfonmance of an audit. This standard is ordinarily interpreted to require: 1. Thorough review of the existing safeguards over access to assets and records. 2. Limited review of the indications of employee fraud and illegal acts. 3. Objective review of the adequacy of the technical training and proficiency of firm personnel. 4. Critical review of the judgment exercised at every level of supervision.

QUESTION 3

Which financial statement assertion is violated when an expense occurring in one year is not recorded until the following year? 1. Accuracy. 2. Classification. 3. Completeness. 4. Occurrence.

QUESTION 4

Which of the following standards does not relate to planning? 1. Due professional care: The auditor should exercise due professional care in planning the audit. 2. Entity, environment, and intemal control: An understanding of the entity and its environment, including its

internal control, must be obtained to plan the audit. 3. Planning and supervision: The auditor must adequately plan the work and properly supervise assistants. 4. Consistency: The auditor must identify circumstances in which the planning of the audit has not been

perfonmed in a manner consistent with that of the prior year.



QUESTION 5

In assessing the competence and objectivity of an entity's internal auditor, an independent auditor would least likely consider information obtained from:

1. Discussions with management personnel. 2. External quality reviews of the internal audito~s work. 3. Previous experience with the internal auditor. 4. The results of analytical procedures.

QUESTION &

Analytical procedures used in planning an audit should focus on: 1. Reducing the scope of tests of controls and substantive tests. 2. Providing assurance that potential material misstatements will be identified. 3. Enhancing the audito~s understanding of the client's business. 4. Assessing the adequacy of the available audit evidence.


AUDITING 38 ~

Planning

Planning for Risk

Internal Control

Auditor's Risk Assessment

Responding to Assessed Risk


NOTES

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SUMMARY NOTES

I. PLANNING FOR RISK A. Audit Risk (AR)

AR is the risk Ihallhe auditor may unknowingly fail to modify appropriately the opinion on materially misstated FS. The auditor should plan the audit so that overall audit risk is limited to a low level. AR includes:

1. Risk of Material Misstatement (RMM) The risk that the financial statements are materially misstated. It can be subdivided into: a. Inherent Risk (IR)

Susceptibility of an assertion to a material misstatement assuming that there are no related controls. IR exists independently of the audit. The auditor cannot change this risk.

b. Control Risk (CR) The risk that a material misstatement could occur in an assertion and not be prevented or detected on a timely basis by an entitys internal control. CR exists independently of the audit. The auditor cannot change this risk. but can change his/her assessment of the risk based on evidence gathered during the audit. (1) The stronger the system of controls, the greater the reliance that may be placed on

it, and the fewer the substantive tests (or the lower the quality) required. 2. Detection Risk (DR)

The risk that the auditor will not detect a material misstatement that exists in an assertion. DR relates to the audito~s procedures. The auditor can change this risk by varying the nature, extent, or timing of audit procedures. a. As the acceptable level of DR decreases, the assurance provided from substantive tests

should increase.

B. The Audit Risk Model

THE AUDIT RISK MODEL

Risk of Material = Misstatement (RMM) x

(assessed by auditor)

Risk of Mlterf.1 Acceptable Level of Misstatement DetectIon Risk

High 0 (Bad) Lower 0 Low 0 (Good) Higher 0

38-3

Detection Risk (DR) (controlled by auditor)

Determine "NET' of Substantive Tests

High 0 Low 0



C. Fraud Risk 1. The auditor must obtain reasonable assurance about whether the financial statements are free

of material misstatements, whether caused by error or fraud. a. Error is an unintentional misstatement or omission.

b. Fraud is an intentional misstatement or omission in the financial statements. Fraud often involves management because management is in a position to manipulate, directly or indirectly, accounting records. Management also can override established controls.

2. Fraud is divided into two categories: a. Fraudulent Financial Reporting

Intentional misstatements or omissions of amounts/disclosures in the financial statements; committed by management with the intent to deceive.

b. Misappropriation of Assets (defalcetionj Theft of an entity's assets; committed by management, employees, or third parties.

3. There is a presumption in every audit that the following two risks exist: a. Improper revenue recognition. b. Management override of controls.

4. Fraud Risk Factors Three conditions generally are present when fraud occurs: a. Incentives / Prassure&-A reason to commit fraud. b. Opportunity-Ineffective controls or override of controls. c. Rationalization / Attitude-Justification of fraudulent behavior.

5. Audit Procedures to Address Fraud Risk The auditor must exercise professional skepticism throughout the audit process. a. Discuss fraud risk with engagement personnel. b. Obtain information to identify specific fraud risks. c. Assess fraud risk and develop an appropriate response. d. Evaluate audit evidence regarding fraud. e. Make appropriate communications about fraud. f. Document the audito~s consideration of fraud.

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6. Communication of Fraud a. Fraud that causes a material financial statement misstatement should always be reported

directly to management and those charged with governance. (t) Obtain sufficient evidence of fraud and its effects on the financial statements. (2) Discuss with an appropriate level of management at least one level higher than

where fraud occurred.

(3) Suggest that client consult with legal counsel. b. Ordinarily. the auditor does not disclose fraud to third parties. However, in certain

circumstances a duty to disclose to outsiders may exist:

(t) To the SEC in order to comply with certain legal and regulatory requirements, such as on Form 8-K and other required reports.

(2) To a successor auditor when they make inquiries. (3) In a response to subpoena. (4) To a funding agency that receives governmental financial assistance.

D. Illegal Acts 1. Illegal acts are violations of laws or governmental regulations committed by the entity or by

company personnel acting on behalf of the entity. a. The auditor is responsible for detecting illegal acts that have a direct and material effect

on the financial statements. (This is the same as the responsibility for detecting errors and fraud.)

b. The auditor has no responsibility to detect indirect effect illegal acts. 2. In response to discovered illegal acts, the auditor should:

a. Gain an understanding of the illegal acts.

b. Inquire of management at a level above those involved. c. Consult with legal counsel. d. Consider the effect on the financial statements. e. Communicate the illegal acts to the audit committee (or to those charged with

governance).



II. INTERNAL CONTROL A. Overview of Internal Control

1. The second standard of fieldwork states: liThe auditor must obtain a sufficient understanding of the entity and its environmentl including its internal controll to assess the risk of material misstatement of the financial statements, whether due ta error ar fraud, and ta design the nature, extent, and timing af further audit pracedures."

2. Internal control is a process set up by those charged with governance and management designed to provide assurance that an entity's objectives will be achieved. Objectives include: a. Reliability of financial reporting. b. Effectiveness and effiCiency of operations. c. Compliance with applicable laws and regulations.

3. Inherent Limitations of Internal Control a. Human error. b. Collusion, deliberate circumvention, fraud. c. Management override. d. Segregation of duties may be difficult in small companies.

B. Five Components of Internal Control

Mnemonic = CRI M E

1. Qontrol Environment Sets the tone of an organization and its policies and procedures. Key points include: a. Integrity. b. Competence. c. Participation of those charged with governance. d. Management philosophy. e. Organizational structure. f. Role assignment. g. Promotion and training.

2. Blsk Assessment

Management identifies, analyzes, and manages risks that affect the entity's ability to accomplish its major objectives. Once risks are identified, management considers their significance, likelihood of occurrence, and how they should be managed. Key points include: a. New products. b. Rapid growth. c. Other changes.

2013 final review aud a

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