Topic 6

  • Understand the responsibilities of management – Pg. 143
    • Maintaining adequate internal controls
    • Making fair representations in the financial statements
    • Integrity and fairness of the representations (assertions) in F/S
    • Sign statements to certify quarterly and annual financial statements submitted to SEC  fully comply with requirements
    • Responsibility for adopting sound accounting practices
    • CEOs and CFOs must certify the quarterly and annual financial statements submitted to the SEC
      • required by SOX 302 for public companies
    • how are those responsibilities expressed through certifications (for public companies) and audit reports
      • annual reports include a statement about managements responsibilities and relationship with CPA firm
  •  Understand the responsibilities of auditor – Pg. 144
    • Knowledge is limited to matters of internal controls acquired during the audit
    • Obtain reasonable assurance about whether financial statements as a whole are free from material misstatement, whether due to fraud or error
      • Thereby enabling the auditor to express an opinion on whether the financial statements are presented fairly, in all material respects, in accordance with an applicable financial reporting framework and…
    • Report on financial statements, and communicate as required by auditing standards, accordance with auditors findings
    • Identifying material weakness
    • Plan and perform the audit to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to error or fraud,
      in accordance with GAAP
    • Express an opinion about the fair presentation of the company’s financial statements
    • Express an opinion about whether the company maintained effective internal controls
      over financial reporting (required by SOX 404 for public companies)
    • How are those responsibilities expressed through certifications (for public companies) and audit reports
  • Define Reasonable Assurance
    • High but no absolute, level of assurance that the financial statements are free of material misstatements
    • Reasonable – but not absolute – indicates that auditor is not an insurer or guarantor of correctness
      • May fail to detect material misstatements
    • MATERIAL MISSTATEMENTS – when the combined uncorrected misstatements would have likely
      changed or influenced the decisions of a reasonable person using the
      financial statements
    • Including specific reasons why the auditor provides reasonable assurance
      • Audit evidence results from testing a sample population – Accounts receivable or inventory
      • Sampling inevitably includes some risk of not uncovering a material misstatement – evaluation of test results require significant auditor judgment
      • Even with good faith and integrity auditors can make mistakes and errors
      • Accounting contains complex estimates – uncertainty and can be affected by future events. Auditor must rely on evidence that is persuasive but not convincing.
      • Fraudulent F/S are extremely difficult for auditors to detect – especially when is collusion among management.
  • Define Absolute Assurance –


  • Assertions for transactions (description, examples of each)
  1. OCCURRENCE – transactions and events that have been recorded
    1. have occurred and pertain to the entity
    2. concerned with inclusion of transactions that should have been recorded
    3. violations relate to OVERSTATEMENT
    4. COMPLETENESS– all transactions and events should have been recorded
      1. have been recorded and included
      3. Concerned with possibility of omitting transactions that should have been recorded
      4. violations relate to UNDERSTATEMENT
      5. ACCURACY – amounts and other data relating to recorded transactions and events have been recorded appropriately – CORRECT AMOUNTS
      6. CLASSIFICATION – transactions and events have been recorded in the proper accounts
      7. CUTTOFF – transactions and events have been recorded in the correct accounting period
  • Assertions for account balances (description, examples of each)
  1. EXISTENCE – assets, liabilities and equity interest included on the balance sheet – ACTUALLY EXIST on the balance sheet data – INCLUSION of accounts that don’t exist
    1. Violations relate to overstatements
    2. COMPLETENESS – all assets, liabilities and equity interest that should have been recorded have been recorded – concerned with OMITTING
      1. Completeness is opposite of existence
      2. Violations relate to understatements
      3. VALUATION AND ALLOCATION – assets, liabilities and equity interest are included in the financial statement at appropriate amounts and any resulting valuations adjustments are appropriately recorded
        1. Account receivable included in the balance sheet are stated at NET REALIZABLE VALUE
        2. RIGHTS AND OBLIGATIONS – the entity holds or controls the rights to assets, and liabilities are the obligation of the entity
  • Assertions for presentation and disclosures (description, examples of each)
  1. OCCURANCE AND RIGHTS AND OBLIGATIONS – disclosure events and transactions have occurred and pertain to the entity
  2. COMPLETENESS – all disclosures that should have been included in the financial statements have been included
  3. ACCURACY AND VALUATION – financial and other information are disclosed appropriately and at appropriate amounts
  4. CLASSIFICATION AND UNDERSTANDABILITY – financial and other information is appropriately presented and described and disclosures are clearly expressed
    1. Amounts are appropriate classified in F/S and footnotes and whether balance descriptions and related disclosures are understandable


  • Chapter 6 Other smaller topics:
  • Describe why the auditor generally divides the audit into financial statement cycles/segments
    • Division makes audit more manageable and aids assignment of tasks to different members of the audit team
    • Ex: auditors treat fixed assets and notes payable as different segments
    • Common way of dividing is by closely related types – CYCLE APPROACH
    • Auditors consider relationships between accounts when dividing the audit into segments and assigning each portion to various members of the audit team
    • Think in debits and credits – what is the other side of the journal entry for typical transactions recorded during the course of the client’s business?
  • Distinguish between errors and fraud and the auditor’s responsibility for each
    • ERRORS – UNINTENTIONAL MISSTATEMENT – on financial statements
      • Ex: mistake in extending price times quantity on a sales invoice

1)       Misappropriation of assets – defalcation or employee fraud – GAAP

  • Clerk taking cash at the time a sale is made and not entering

1)       Fraudulent financial reporting – management fraud

  • Intentional overstatement of sales near the balance sheet date to increase reported earnings
  • At a high level, what are the phases of financial statement audit?
    • PHASE I – plan and design an audit approach based on risk assessment procedures
      • Cost minimization is necessary to be competitive and profitable
      • Effective – focus on risk
      • Efficient – focus on effort and cost
        • Thorough understanding of client’s business and related environment
        • Knowledge of strategies and processes
        • Study business model
        • Risk of misstatement is reduced if client has effective controls over computer operations and transaction processing
        • If internal controls are affective – planned assesses risk can be reduced and amount of audit evidence to be accumulated can be reduced
        • Assessment will impact audit plan and nature, timing and extent of audit procedures
    • PHASE II – perform tests of controls and substantive tests of transactions
      • SUBSTANTIVE TESTS OF TRANSACTIONS – evaluates client’s recording of transactions by verifying the monetary amounts of transactions
      • Completed before auditors can justify reducing planned assessed control risk when internal controls are believe to be effective
    • PHASE III – perform analytical procedures and tests of details of balances
    • quality of evidence
      • Relevance: Measure of the quality of evidence in terms of the audit objective
        • Ex: If we want to emphasize existence of accounts receivable, it would be an inappropriate procedure to negative confirmations.
      • Reliability: Believability of the evidence
        • Ex: Confirmations from external parties, auditor’s direct observation
      • Appropriateness
        • Sufficiency: Measure of the quantity of evidence
        • Most important factors include risk of misstatement and effectiveness of
          client’s internal controls for that account/cycle
      • 2 general categories

1)       ANALYTICAL PROCEDURES – evaluation of financial information through analysis of plausible relationships among financial and nonfinancial data

–          Ex: accuracy objective for both sales transactions (transaction related audit objective) and accounts receivable (balance related audit objective) – auditor would examine sales transactions in sales journal for unusually large amounts and compare total monthly sales from prior years – find SIGNIFICANT DIFFERENCES

2)       TEST OF DETAILS OF BALANCES – specific procedures intended to test for monetary misstatements in the balances in financial statements

–          Direct written communication with clients customers to identify incorrect amounts – tests of details of ending balances are essential to conduct audit because much of the evidence obtained from third party sources is considered HIGH QUALITY

  • PHASE IV – complete the audit ad issue and audit report
    • Combine the information obtained to reach an overall conclusion as to whether the financial statements are fairly presented


Topic 7

  • Define professional judgment – overall determination of whether or not, in the auditor’s view, goodwill has been impaired is a matter of professional judgment
    • Process of reaching a decision or drawing a conclusion where there are a number of possible alternative solutions.
    • Three broad areas in which professional judgment is often exercised:
      • Evaluation of evidence
      • Estimating probabilities
      • Deciding between options
  • Describe and be able to identify the judgment tendencies that we illustrated in class
      • Availability –Tendency to consider information that is easily retrievable as more important for a judgment
      • example of each judgment tendency in an auditing context
        • making opposing case, consult with others
      • Anchoring – Tendency to insufficiently adjust away from an initial anchor
      • example of each judgment tendency in an auditing context
        • make independent judgment or estimate void of anchor
        • consider anchor alternatives
        • solicit input from others
      • Overconfidence – Tendency for decision makers to overstate their own abilities to perform tasks, make diagnoses, or make other judgments
      • example of each judgment tendency in an auditing context
        • challenge expert or advisors estimates
        • ask about potential causes of unexpected outcomes
      • Confirmation – Tendency to seek or interpret evidence in ways that are partial to existing beliefs or expectations
      • example of each judgment tendency in an auditing context
        • confirm alternative explanations provided by others
        • consider disconfirming or conflicting information
      • Rush to judgment – Tendency to resort to mental shortcuts in decision making, especially under time constraints
      • example of each judgment tendency in an auditing context
        • take time to work through the decision using a framework or other tool
        • YouTube video – example –  he scraps the ice and snow off the wrong car
  • Define professional skepticism – auditor applies skepticism in evaluating management projections to be used in a goodwill impairment analysis.
    • Professional skepticism is an objective attitude that includes a questioning mind and a critical assessment of audit evidence that is an important part of the professional judgment process.

1)       Questioning mind = “trust but verify” mental outlook

2)       Critical assessment of the audit evidence = asking probing questions and attention to inconsistencies

3)       Suspension of judgment – withholding judgment until appropriate evidence obtained

4)       Search for knowledge – desire to investigate beyond the obvious (and corroborate)

5)       Interpersonal understanding – recognition that people’s motivations and perceptions can lead them to provide biased or misleading information

6)       Autonomy – self-direction, moral independence, and conviction to decide for oneself, rather than accepting claims of others

7)       Self-esteem – the self-confidence to resist persuasion and to challenge assumptions or conclusions

  • Other smaller topics:
  • Think through some ways in which judgment tendencies can be mitigated (e.g., Simon’s recommendations)
    • Judgment can only be as good as the best alternative considered
    •  Common pitfalls:
      • Consider only typical alternatives
      • Consider only the first alternative that comes to mind
      • Do the same thing as the prior year
    • Sufficient appropriate evidence
      • Sufficiency measures the quantity of audit evidence
      • Appropriateness measures the quality of audit evidence
      • Both concepts are considered when assessing risks and designing audit procedures



Topic 8- chapter 26 – pg. 807 – 813

  • Describe the GAO and its purpose
    • GAO – Government Accountability Office
    • Nonpartisan agency in the legislative branch of the federal government
    • Headed by comptroller general , GAO reports to and is solely responsible for Congress
    • Performs audit function for congress but has same responsibilities as CPA firm
    • Primary source for government audits – government auditing standards – “yellow book”
      • F/S for governmental units
      • Government contracts and grants
      • Internal controls
      • Fraud
      • Other noncompliance with laws and regulations
      • Other smaller topics:
      • Know the difference between the Yellow Book and Green Book
        • Internal control standards issued by GAO
        • Federal Managers’ Financial Integrity Act (FMFIA) requires that federal agency executives periodically review and annually report on the agency’s internal control systems.
        • In what ways does the Yellow Book differ from auditing standards for private commercial entities?
          • Includes guidance for performance audits as well as financial statement audits
          • Audits of governmental entities must follow SAS standards (issued by AICPA) as well as the Yellow Book standards. The following items reflect common differences:
          • Materiality and significance
            • In government audits the thresholds of acceptable audit risk and materiality are often lower – public accountability and sensitivity of government projects
            • Quality control
              • Auditors of governmental entities must have an appropriate system of internal quality control and participate in external quality control review program
              • Required to complete CPE hours – 80 total in each 2 year period with at least 24 hrs. of those to be in subjects related to government environment and auditing
              • Compliance auditing
                • Design audit to provide reasonable assurance of detecting misstatements resulting from noncompliance with provisions of contracts or grant agreements that have material and direct effect on the financial statements
                • Reporting
                  • The audit report must say report was in accordance with GAGAS
                  • Must describe the scope of the auditors’ tests of compliance with laws and regulations and internal controls





Topic 9 – chapter 8

  • Understand the factors affecting the auditor’s decision to accept a new client or continue with an existing client
    • INTIAL AUDIT PLANNING – 4 things done early in audit
  1. 1.       Decide whether to accept a new client or continue serving an existing one.
  • Auditor is unlikely to accept a new client or continue serving an existing client if the risk associated with the client is greater than the risk the firm is willing to accept. Decision should be made early before incurring significant costs that cannot be recovered.
  1. 2.       Auditors identifies why the client wants or needs an audit. Information is likely to affect the remain parts of the planning process
  2. 3.       Avoid misunderstanding, auditor obtain an understanding with the client about the terms of the engagement
  3. 4.       Auditor develops an overall strategy for the audit including engagement staffing and any required audit specialists
  • Describe how the auditor obtains an understanding of the client’s business and industry and then assesses client business risk

Three primary reasons for obtaining a good understand of environment

  1. Risk associated with specific industries may affect assessment
    1. May influence auditors accepting engagements in risker industries
    2. Inherent risks common to all clients in certain industries – familiarity of those risks aids auditor in assessing relevance to client
    3. Unique accounting requirements that auditors must understand to evaluate whether the client’s financial statements are in accordance with industry.

Understand factors such as major sources of revenue, key customers and suppliers, sources of financing and information about related parties that may indicate area of increased client business risk

–          Tour client facilities and operations

–          Identify related parties

RELATED PARTY: affiliated company, a principal owner of the clients company, or any other party with which the client deals, where one of the parties can influence the management or operating policies


Auditor should assess management’s philosophy and operating style and its ability to identify, respond to risk

–          code of ethics – communicate entity’s values and ethical standards through policy statements and codes of conduct

–          minutes of meetings


–          Understand client objectives related to

  1. 1.       Reliability of financial reporting
  2. 2.       Effectiveness and efficiency of operations
  3. 3.       Compliance with laws and regulations

Key performance indicators that management uses to measure progress towards its objectives, far beyond financial figures – such as sales and net income – include measures of client and its objectives

  • Other smaller topics:
  • Describe the communications between the successor and predecessor auditors
  • Know the purpose of an engagement letter
  • ENGAGEMENT LETTER – Auditors must document understanding with the client
    • Describes objectives, management and auditor responsibilities, identification of reporting framework, deadlines, proposed fees
  • What are analytical procedures and how are they used in audit planning?
  • ANALYTICAL PROCEDURES Evaluations of financial information through analysis of plausible relationships among financial and nonfinancial data.
    • assess whether account balances or other data appear reasonable relative to auditor’s expectations
    • Usefulness depends significantly on auditor’s ability to develop an  expectation of what the account balance or ratio should be
    • Auditors develop expectations from: 1) industry data, 2) similar prior-period data, 3) client-determined expected results, 4) auditor-determined expected results, and 5) expected results using nonfinancial data
    • Understand the concept of materiality
      • MATERIALITY – Standards require auditors to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.
      • Magnitude of an omission or misstatement of accounting information that, in the light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement.
      • factors used by the auditor to determine materiality for an audit client

Topic 10

  1. 1.       Relative to the size of the client
  2. 2.       Benchmarks are useful
  3. 3.       Qualitative factors also affect materiality
  4. 4.       Auditors must document all relevant decisions and judgment
  • Describe the audit risk model, its components (AAR, IR, CR, DR), examples of each component, and how the components are interrelated
      • AAR = IR * CR * DR – AAR should be set at low.
      • AAR = RMM * DR
      • DR = AAR/ (IR * CR)
      • ACCEPTABLE AUDIT RISK (AAR) – Measure of how willing the auditor is to accept that the financial statements may be materially misstated after the audit is completed and an unqualified opinion has been issued.
      • INHERENT RISK – auditor’s assessment of the risk of material misstatement (RMM) in an account/segment before considering the effectiveness of internal controls.
      • CONTROL RISK – auditor’s assessment of the risk that misstatements exceeding the tolerable amount for an account/segment will not be prevented or detected on a timely basis by the client’s internal controls.
        • IR and CR are a function of the client and its operating environment (“assessed by auditors”).
        • DETECTION RISK – Risk that audit evidence for an account/segment will fail to detect misstatements exceeding the tolerable amount. – amount of risk willing to expect – less risk = less work
          •  Dependent on the other 3 factors in the audit risk model
          • The amount of evidence that the auditor plans to accumulate is inversely related to plan detection risk.  – DR is a function of the effectiveness of the audit procedures performed (“restricted by auditors”).
          • EXAMPLES – inversely proportional
  • Know how the auditor uses the audit risk model to plan that audit
    • AUDIT RISK – The risk that the auditors will issue an unqualified opinion on financial statements that contain a material misstatement.
    • Auditors must assess the risk of material misstatement at:
      • The overall financial statement level
      • The relevant assertion level for each class of transactions, account balances, and disclosures
      • Other smaller topics:
      • Distinguish between preliminary judgment about materiality vs. performance materiality
      • Preliminary judgment about materiality
        • Combined amount of misstatements in the F/S that the auditor would consider material early in the audit as the auditor develops the overall strategy for the audit – Usually based on interim F/S
        • Revised judgment about materiality
        • Revisions to materiality resulting from changes in one of the factors used to determine the preliminary judgment
          • Amount(s) set by the auditor at less than materiality for the F/S as a whole to reduce to an appropriately low level the probability that the aggregated uncorrected and undetected misstatements exceed materiality of the F/S as a whole
            •  Auditors gather evidence by segment/account and then accumulate errors for the F/S as a whole
            •  PCAOB standards refer to this concept as tolerable misstatement
This entry was posted in Uncategorized. Bookmark the permalink.

Leave a Reply

Your email address will not be published. Required fields are marked *