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AUDITING & ATTESTATION – 4

TIP PIE ACDO = Evidence

Review:
Strong Internal Control
P – Pre-numbered Documents
A – Authorization of Transactions
I – Independent Checks
D – Documentation
T – Timely and Appropriate Performance Reviews
I – Information Processing Controls
P – Physical Controls
S – Segregation of Duties

Management Assertions:
C – Completeness
P – Proper period cut-off
A – Accuracy
C – Classification
O – Occurrence
C – Completeness
A – Allocation and Valuation
R – Rights and Obligations
E – Existence
About
C – Completeness
U – Understandability and Classification
R – Rights, Obligations, and Occurrence
V – Valuation and accuracy
ed assertions

Substantive Testing:
N – Nature
E – Extent
T – Timing

Transaction Cycles:

Cycle: Description
1. Revenue: includes sales revenues, receivables, and cash receipts
2. Expenditure: Includes purchases, payables, and cash disbursements
3. Payroll and Personnel: Includes payroll (salaried and hourly) and personnel functions
4. Inventory and Production: Includes perpetual inventory, physical counts, and manufacturing costs
5. Property, Plant, and Equipment: includes acquisitions and disposals and related depreciation expense
6. Investments: includes investments, related interest and dividend payments, proceeds from issuance and from payments of principal,
and payments for treasury stock
7. Other Liabilities: includes accrued liabilities, warranty costs, deferred income taxes, and lease obligations

Revenue Cycle: includes sales revenues, receivables, and cash receipts


Vouch down Biggest concern is overstatement of revenue.

Sales
 Preparation of the Sales Order: Paid Tips (Pre-numbered)
1) Receipt of a customer purchase order by the sales department
2) A serially numbered sales order is prepared and sent to the credit department for approval
 Credit Approval: Valuation assertion and Authority
1) Decides if the customer may receive goods on open account = Authority
2) If approved, copy of approved sales order is sent to shipping department, billing department, and the accounting department
 Shipment: Custody

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1) Serially numbered bill of lading is prepared and copy is sent to customer
2) Goods are shipped and receivable arises
 Billing: Recordkeeping
1) Prepares serially numbered sales invoice
2) Shipping documents, sales orders, and invoices are compared to assure that all shipments were based on valid customer
orders and properly billed
3) Prices and discounts are applied to the invoice, and extensions and footings are computed
4) Invoice is sent to customer and accounts receivable department
 Accounting: Recordkeeping
1) Sale is entered into sales journal, and receivable is recorded

Accounts Receivable
 Sales
1) Receivable is recorded in the A/R control account in the general ledger and in A/R subsidiary ledger
2) Periodically, an independent person should reconcile these two records
 Collection of Cash Receipts
1) When payment is received from customer, receivable is eliminated
 Uncollectible Receivables
1) Aging schedule is prepared and sent to credit department for use in carrying out its collection program
2) At some point, uncollectible receivables should be written off
3) Controls for writing off include proper authorization by treasurer and recordkeeping
4) The auditor observes the preparation of the aging schedule as part of the study of internal control
 Sales Returns
1) Returned goods examined to ensure they correspond with the reason for return before credit is given
2) Serially numbered receiving report may be used as a sales return slip
3) Once return is approved, the related receivable is eliminated
 Sales discounts
1) Discount procedures and records should be reviewed to ensure that discounts are properly given and recorded

Cash Receipts
1. Collection of Cash Receipts
1) Incoming mail must be opened by a person who does not have access to the accounts receivable ledger
2) The receipts should be listed in detail with one copy and the actual receipts sent to cashier for bank deposit
3) Another copy sent to accounts receivable department for entry in the accounts receivable subsidiary records
4) Third copy sent to accounting department for entry in general ledger accounts receivable control account
5) Accounts receivable department should match bank deposit ticket with remittance advices
6) Cash registers or lock boxes should be used as safeguards

***Treasury makes deposit if no cashier!

Order &Credit Department  Authority


Warehouse & Shipping Department  Custody
Billing/Accounts Receivable Department  Record Keeping
Accounting Department  Record Keeping
Mailroom Department Custody
Cashier / Treasurer Department  Custody
Accounts Receivable Department  Record Keeping
Accounting Department  Record Keeping

Must review pages A4-7 to A4-9

Audit Procedures Related to the Revenue Cycle


Sales:
1. Verify that recorded sales are based on approved sales orders and shipping documents
2. Determine that sales are recorded at appropriate amount and in proper period
3. Books and Records 

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 match sales invoices with supporting shipping documents
 compare sales journal with subsidiary ledgers
 test mathematical accuracy of trial balance
 compare the total in subsidiary ledgers with general ledger
4. Cut-off 
 Examine sales invoice before and after year-end
 Analyze sales returns after year-end

Accounts Receivable:
o Review accounts receivable schedule for accuracy and collectability
o Confirmation 
 Follow up on error reports (Rights and Obligations)
 Confirm receivables
o Adequacy of Uncollectible Accounts 
 Subjective judgment = “Risk”
 Calculate the adequacy of allowance for uncollectible accounts
 Aging schedule of accounts receivable should be constructed
 Tests of adequacy of allowance relate to the FS assertion of Valuation and Allocation
 Test credit approval

Audit Procedures regarding Cash Receipts: see below

Expenditure: Includes purchases, payables, and cash disbursements


Trace up Biggest concern is understatement of expenses and liabilities

Purchases:
 Purchase Requisition
1) Starting of purchasing cycle
2) Department in need of asset or services sends a properly approved, serially numbered requisition to purchasing dept
 Purchase Orders
1) Consider the relevance of the time and quantity of the request
2) Obtain competitive bids from various suppliers to make sure that the best price is obtained
3) Issue order after proper approval
4) It is best if the purchase orders are pre-numbered
5) Multiple copies sent to the requisitioning dept, the vendor, the receiving department, and accounting department
6) If order is cancelled, all copies should be recalled and filed
 Receipt of Goods or Services
1) They received their copy from the purchasing department, preferably it should be a blind copy
2) If blind copy, then receiving dept is forced to count the goods upon arrival
3) A receiving report is prepared and forwarded to the accounting department
4) Goods are forwarded to the requisitioning department

Accounts Payable:
 Has three functions: record the payable, approve the invoice for payment, and record the payment after it is paid by treasurer
 Recording the payable
o A/P = approval of bill
o They received their copy from the purchasing department
o Receiving report is compared with the purchase order and vendor`s invoice as to quantity
o Comparison is made to prevent payment of charges for goods in excess of those ordered/received
o Records the goods received in inventory and records a payable
 Approving Invoice for Payment and Recording Payment
o Indicate the debit and credit
o Accounting department approves invoice by matching the invoice, purchase order, receiving report, and requisition
o Confirm invoice amount is correct and reflects any purchase discounts before approving it for payment

Cash Disbursements:
 Best if invoices paid by check
 The functions of approving the payment and signing the checks should be segregated
 Approved voucher (invoice, purchase order, receiving report, and requisition) prepared by A/P are received by treasurer

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 Treasurer prepares, signs, and mails the checks and cancels all supporting documents after payment
 Paid vouchers are returned to accounting dept for posting of payment and filing of documents

Must review pages A4-13 to A4-14

Audit Procedures Related to the Expenditure Cycle:


 Confirmations 
o Not required of payables but may be used
o Confirm especially those showing small or zero balances
 Search for Unrecorded Liabilities
o Select cash disbursements made subsequent to year-end and examine the supporting documentation
o Look for items that should have been recorded at the balance sheet date, but were not
o Review bills in January, and see if they incurred in November or December

Audit Procedures regarding Cash Payments: see below

Cash: Audit procedures related to cash


- Look at all bank reconciliations and confirmations
- Obtain bank cut-off statements
- Internal control:
o Used for testing of lapping and kiting
o Segregation of duties relating to cash demands that close consideration be given to check-writing authority
o Good control would include: use of voucher system for cash disbursements
- Cut-off:
o Obtain cut-off bank statements ten to fifteen days after year-end
o Verify cut-off of cash receipts and cash disbursements
o Examine all wire and inter-account cash transfers close to year-end
- Books and Records:
o Foot and crossfoot all books and records
o Mathematically test calculations in the cash journals, vouch postings to ledger accounts, reconcile bank statements, and verify
cash transactions
o Compare cash receipts journal with deposit slips
o Evidence: Internal and External
 Examine all internal evidence, include counting the cash on hand and reconciling it with the journals
 Obtain external evidence would include confirming amounts on deposit with banks, confirming all securities on
deposit, and obtain bank cut-off statements
o Related accounts:
 Almost all asset, liability, and expense accounts are related to the cash disbursement function
 Specific attention given to petty cash, payroll, purchases, and miscellaneous expense
 Accounts be reconciled to appropriate journals
o Identification and prevention of fraudulent schemes with respect to cash
 Lapping: the theft of cash is often concealed by failing to account for cash receipts
◊ “Today’s cash receipts cover yesterday’s theft”
◊ Inspect when checks are deposited/cash and compare to when A/R was booked with “credit”
◊ Best ways to guard against lapping is use of “lock box” system
◊ Detect lapping by: comparing the dollar amounts and dates on bank deposit slips with customer remittance
credits recorded in the A/R ledger
 Kiting: when a check drawn on one bank is deposited in another bank and no record is made of the disbursement in
the balance of the first bank
◊ Used to cover cash shortage or to pad a company’s cash position
◊ Cash is in bank #2, cash “still in” bank #1 (lying)
◊ Audit procedure: bank cut-off statement
◊ Bank transfer schedule compares the dates checks are drawn (on the disbursing bank account) to the dates
checks are deposited (in the receiving bank)
◊ Indication: date stamped by the receiving bank on the rear of returned (paid) check precedes the date on
which the disbursement was recorded
o Transfer schedules, bank confirmations, and bank statements
 Main emphasis: verification of ending balances (existence) and detection of theft or kiting

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 Standard bank confirmation should be sent to all banks with whom the client has done business during the year,
regardless of whether there is a year-end balance to confirm  detect kiting!
 Purposes of bank confirmation: verify year-end balances, info on actual loans and contingent liabilities, discounted
notes, pledged collateral, and guarantee or security agreements

Risks to Consider
1. Incentives/Pressures:
a. Pressure to overstate revenues to achieve EPS targets
b. Pressure to overstate sales and/or receivables tin order to improve the balance sheet and liquidity ratios
c. Pressure to understate liabilities in order to improve balance sheet and liquidity ratios
2. Potential Misstatements:
a. Recording fictitious sales (existence assertion)
b. Holding open the sales journal to include next year`s sales (improper cut-off)
c. Shipping goods that were not ordered at or near year-end (goods are generally returned in the following period)
d. Failure to record payments
3. Other Potential Problems:
a. Errors – increased due to high volume of transactions
b. Theft of cash collections – sales adjustments may be used to conceal thefts of cash collections
c. Omission – existing sales and purchases may not be recorded (completeness assertion)

Audit Documentation  Supports auditor’s opinion


-known as “working papers”
-principal record of audit procedures performed, evidence obtained, and conclusions reached
-belong to the CPA

Purpose:
- Support for the auditor’s report, including evidence that the audit was conducted in accordance with GAAS
- Assistance in planning, conducting, and supervising the audit
- Accountability, emphasizing that the audit team is responsible for its work
- Information that may be useful for future audits, quality control reviews, or peer reviews

Requirements:
- Audit documentation should indicate that accounting records are in compliance with the FS
- Record of evidence and results of audit tests and procedures
- Details of audit procedures performed, the evidence obtained, the conclusions reached, and how the accounting records reconcile with
FS
- Demonstrate compliance with the standards of fieldwork by showing that work performed was adequately planned and supervised,
sufficient understanding of the entity and its environment was obtained, and sufficient appropriate audit evidence was obtained

Retention:
- Audit Documentation: the property of independent auditor (may be useful to client, but it is auditor’s property)
- Report Release Date: the date on which the auditor grants client permission to use the report. Usually is the date on which the report is
delivered to the client
o Private companies: retain documents for five years
o Public companies: retain documents for seven years per PCAOB
- Documentation Completion Date: the time following the report release date in which to assemble final audit documentation file
o Private companies: audit documentation must be filed within 60 days following the report release date
o Public companies: audit documentation must be filed within 45 days following the report release date per PCAOB
 Requires preparation of “engagement completion document”
- Safekeeping of Audit Documentation: establish appropriate controls for audit documentation to protect its integrity, prevent
unauthorized changes, etc

Nature and Extent of Audit Documentation:


- may be in paper form, electronic form, or other media
- oral evidence alone is not sufficient, but may be used for clarification of information
- specific quantity, type, and content of audit documentation are based on the auditor’s judgment, and should consider:
o risk of material misstatement  Objective of detailed substantive testing is to detect material misstatement
o extent to which judgment was required in performance and evaluation
o nature of specific auditing procedure

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o significance of evidence obtained
o nature and extent of any problems identified
o need to document conclusions that may not be obvious

Specific Contents:
- Permanent (continuous) File:
o Include continuing interest from year to year (such as contracts, pension plans, leases, stock options, bylaws, articles of
incorporation, minutes of meetings, bond indentures, and internal information
- Current File: documentation applicable to the year under audit
o Audit plan (audit program)
o FS and auditor’s report
o Working trial balance, adjusting journal entries, and reclassification entries
o Letters of confirmation and representation (attorneys, management representation letter, confirmation responses)
o Analyses, worksheets, schedules or commentaries.
o Abstracts or copies of entity documents, such as contracts or agreements
o Summaries of significant audit findings, actions taken, conclusions reached
o Records of tests of controls and substantive tests

Significant Audit Findings:


- Selection and application of accounting principles (consistency, complexity, unusual transactions, estimates, uncertainties)
- Possible material misstatements in FS
- Suggest a need to revise the auditor’s previous risk assessment
- Cause significant difficulty in applying necessary audit procedures or significant revision of planned audit procedures
- May result in modification to the auditor’s standard report

Tickmarks:
- Use tickmarks, or symbols indicating the work that has been performed

Confidentiality:
- Must obtain permission to disclose audit documentation. EXCEPT the following without client’s permission:
o If documentation used as part of voluntary quality review program under the auspices of AICPA or state society of CPAs
o If documentation is subpoenaed by a court
o If documentation is part of an official investigation being conducted by the AICPA, state CPA society, or under state statutes
o Your defence team: Lawyers/Court, Insurance Company, Expert Witness

Audit Evidence:

All the information auditor uses to arrive at the conclusions of the audit opinion (written, electronic, observable assets or activities).
It must be obtained to support auditor conclusions with respect to risk assessment, test of controls, and substantive testing.

Auditor should have access to all pertinent accounting data and corroborating evidential matter, otherwise it is a scope limit.

Underlying accounting records  consists of records of initial entries and any supporting records. Example: checks, records of EFT, invoices,
contracts, ledgers, journal entries, and worksheets. The auditor tests the accounting records through analytical procedures and substantive
tests, such as retracing procedural steps, recalculation, and reconciliation. Auditor tests the accounting records through analytical
procedures and substantive tests, such as retracing procedural steps, recalculation, and reconciliation.

Corroborating Evidence  includes meeting minutes, confirmations, industry analysts’ reports, data about competitors, and information
obtained through observation, inquiry, and inspection. Provides additional support and gives validity to the recorded accounting data.

Evidence in Electronic Form  auditor should consider the time during which info exists or is available in determining the NET of audit
procedures.

Third Standard of Fieldwork: “the auditor must obtain sufficient appropriate audit evidence by performing audit procedures to afford a
reasonable basis for an opinion regarding the financial statements under audit”

Objective is to detect material misstatement in financial statements

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Audit evidence must persuade the auditor that the ending balances in the FS are fairly presented. Audit provides reasonable assurance
regarding the fairness of the FS. Auditor is not a guarantor, and must rely on evidence that is persuasive, rather than conclusive.

Cost benefit may be a valid reason for performing only certain procedures, cost alone or difficulty in obtaining evidence is not a valid basis
for omitting a procedure for which there is no appropriate alternative.

Sufficiency of audit evidence: Must be Valid and Relevant


Amount of evidence gathered directly affects the level of detection risk (risk that auditor’s evidence gathering procedures will not be
sufficient to support the FS assertions.

Auditor’s decision regarding the sufficiency of evidence is influenced by: (Evaluate Management assertions)
1. Risk of material misstatement: greater risk implies more evidence will be required
2. Quality of audit evidence: less audit evidence may be required when that evidence is of higher quality

Evidence Hierarchy:
A – Auditor observation and knowledge
E – External Evidence
I – Internal Evidence
O – Oral Evidence

Evidence must relate to the FS assertion under consideration.


Evaluation of audit evidence must take into consideration and achievement of audit objectives.

Substantive procedures consist of:


- Test of details (as applied to transactions, balances, and disclosures)
- Substantive analytical procedures
These tests are designed to substantiate the validity of management assertions regarding the FS.

Tests of details:
- Procedures used to gather evidence to support the account balances
- Tests of details are performed on ending balances, the details of transactions, or a combination of the two
- Example: account has high turnover rate with many transactions, auditor will concentrate more on the ending balance total.
o Auditor must be satisfied that internal control is strong!
- Alternative approach: test the details of transactions. This approach is used when the account being substantiated has relatively few
transactions occurring during the year.
- Combination of both: when auditing sales revenue account, auditor might use procedures to substantiate the ending balance while also
performing extensive procedures on samples of transactions and related accounts
- Example 2: test the details supporting FS amounts and disclosures through inspection, observation, inquiry, confirmation, recalculation,
reperformance, etc.

Analytical Procedures:
- Evaluations of financial information made by a study of financial and nonfinancial data
- Comparisons (Ratios, percentages, actual to budget) of recorded amounts to independent expectations developed by auditor.
- Must use analytical procedures in planning and overall review, and may use analytical procedures as substantive tests

Analytical procedure in planning: Required. Purpose: to assist the auditor in planning the NET of auditing procedures. Used for risk
measurement to alert the auditor to problem areas requiring attention. Vital planning function.

Analytical procedure in final review: Required. Purpose: to assist the auditor in final review of overall reasonableness of account balances.

Substantive procedures: Not Required. Purpose: as substantive test to obtain audit evidence about specific management assertions related
to account balances or transactions. The evidence is circumstantial and generally, additional corroborating evidence (such as
documentation) must be obtained.

Analytical procedures generally include a review of the current and prior year’s FS and current year’s budget.

Auditor develops independent expectations for comparison to recorded amounts. Example:


a) Financial information for comparable prior periods
b) Anticipated results from budgets and forecasts

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c) Relationships among data within the current period
d) Industry norms
e) Relationships of financial data with nonfinancial data

• Income statement has more predictable relationships than the balance sheet
• Accounts with management discretion are less predictable

Analytical procedures used as substantive tests = NOT required:


The efficiency and effectiveness of analytical procedures detecting potential misstatements depends on:
1. Nature of assertion being tested: analytical procedures are most effective and efficient for assertions in which potential
misstatements are not apparent from an examination of the detailed evidence or when such detail is unavailable
2. Plausibility and predictability of the data relationship: must have clear understanding of data and analytical procedures should
be based on predictable relationships.
3. Availability and reliability of data used to develop the expectation: for reliability, see evidence hierarchy (AEIO)
4. Precision of expectation: more precise expectations = more effective in detecting misstatements
Documentation requirements when analytical procedures are uses as substantive test:
1. Auditor’s expectation
2. Factors considered in development of expectation
3. Results of the comparison of expectation to recorded amounts
4. Additional audit procedures performed in response to significant unexplained differences
5. Results of such additional procedures
Investigation of significant differences: may indicate possible material misstatement. Auditor should:
- investigate significant differences or unusual items
- reconsider the manner in which the expectation was developed
- make inquiries of management
- may expand audit procedures
- if no explanations obtained, auditor should obtain sufficient appropriate evidence about the related assertion by performing
alternative substantive procedures

Analytical procedures in overall review  required. Evaluate the overall FS presentation and to assess the conclusions reached. May
discover additional unusual or unexpected balances, and should consider whether additional audit procedures are needed.

Differences do not necessarily indicate errors or fraud, but simply indicate the need for further investigation.

Test of Details:
Directional testing – testing either forward or backward. Trace up/forward for completeness and coverage, where the risk is
understatement of expenses and liabilities. Vouch down/backward for existence and occurrence, where risk is overstatement of revenues
and assets.

Standard Auditing Procedures: FIVE CARROTS used in audit as risk assessment procedures, tests of controls, or substantive tests:

 F – Footing, Crossfooting, and Recalculation: verify the mathematical accuracy


 I – Inquiry: requesting information from knowledgeable parties both internally (managers) and externally (attorneys)
 V – Vouching: directional testing starting at accounting records and moving down. Existence and occurrence assertions.
 E – Examination/Inspection: evidence about existence assertion, rather than about ownership, rights, obligations, valuation.
 C – Confirmation: specific type of inquiry that involves obtaining representations from independent third parties
 A – Analytical Procedures: evaluations of financial information made by studying relationships among data (ex. Scanning)
 R – Reperformance: auditor performs procedures/controls that are performed as part of an entity’s internal control
 R – Reconciliation: substantiates the existence and valuation of accounts
 O – Observation: auditor looks at a process or procedure performed by others. Provides the auditor with direct personal
knowledge, but the evidence provided applies to only to the point in time during which observation occurred
 T – Tracing: directional testing starts from source documents and moving up. Coverage and completeness assertion.
 S – Subsequent Events Review: perform certain procedures between the balance sheet date and date of auditor’s report.

Other procedures include:


 Performing a cut-off review of year-end transactions
 Auditing related accounts simultaneously
 Requesting a comprehensive management representation letter

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 Reading pertinent information, such as the minutes of board of directors’ meetings, shareholder meetings, and management
committee meetings

• F – Footing, Crossfooting, and Recalculation


• I – Inquiry
• V – Vouching
• E – Examination/Inspection
• C – Confirmation
• A – Analytical Procedures
• R – Reperformance
• R – Reconciliation
• O – Observation
• T – Tracing
• S – Subsequent Events Review

Assertion Procedure
C Completeness Tracing
Analytical Review
Observation
P Proper Period Cut-off Cut-off Procedures
A Accuracy Inspection
Footing
C Classification Inspection
O Occurrence Vouching
CA Allocation and Valuation Independent recalculation
Reconciliation
R Rights and Obligations Inspection
E Existence Confirmation
Observation, inspection, and examination
CU Understandability and Review
R Classification Inquiry of management
V

Inventory and Production: Includes perpetual inventory, physical counts, and manufacturing costs
Inventory – Internal Control – Segregate the following duties:
1. Purchasing
2. Receiving
3. Storage (custody)
4. Shipping

Observation of beginning and ending physical inventory counts is required by GAAP. When physical inventory count is impossible, must use
alternative procedures.

If internal control is strong and inventories are well-kept perpetual inventories, then physical counts may be performed before, during, or
after the end of the audit period. If control risk is high, then observation should be performed at year-end.
= This is timing of the Nature, Extent, and Timing
*Should observe all inventory held in public warehouses if inventory is significant. Otherwise, confirmation of such is sufficient.

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Client Physical
Inventory Report List
Existence Existence

Completeness Completeness

CPA Test Counts Company Pre-Numbered


Accuracy Inventory Tags

Auditor should confirm that consigned inventory on hand is excluded from physical inventory count
Related accounts: inventories, purchases, sales, sales returns and allowances, COGS
Examine purchase invoices and receiving reports for several days before and after year-end
Examine sales invoices and compare them to shipping documents for several days before and after year-end
Determine whether inventory adheres to lower of cost or market principles and whether it is pledged or subject to liens
Examine vendor invoices, direct labor rates, and test the computation of standard overhead rates
RM: Raw Material
DL: Direct Labor
FOH: Factory Overhead: applied consistently and using GAAP

Accounts Receivable Confirmations


Positive Confirmations – request response from the recipient (may be blank)
- Best type of confirmation for large accounts, expect errors and disputes, weak internal controls
- “Blank” confirmations: greater degree of assurance, but may also result in lower response rate
- Non-responses should be followed up with second/third requests, and ask client to intervene
- May perform alternative procedures when confirmation responses are not received
- Provide evidence regarding existence and rights and obligations, NOT provide valuation or completeness

Negative confirmations – recipient is asked to respond only if amount stated is incorrect


- Not as good as positive
- Used when low control risk, small balances, expect customer attention

Accounts Payable Confirmations  Not Required


- Positive confirmations and generally “blank”
- Objective: determine if A/P are understated
- Confirmations of A/P sent when weak internal control
- Vendors with small or zero balances would be selected, b/c we’re looking for understated liabilities and expenses
- Unrecorded liabilities surface when unpaid vendors stop delivering goods
- Search for unrecorded liabilities: 1. Subsequent events, 2. Post balance sheet review

Long-term Investments – auditor must determine:


i. GAAP is consistently applied
ii. Gains and losses are accurately computed and disclosed
iii. Investment income is properly reported
iv. Valuation is fairly stated and disclosed
v. Investments exists and owned by client

Segregation of duties: 1 person authorizes purchase/sale, another person asks as custodian, and third person maintains records

Control risk:
1. Proper authorization and approval
2. Reconciliations to ensure accuracy
3. Continuous monitoring and review

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Confirmation of EXISTENCE and RIGHTS & OBLIGATIONS – Request from custodian for securities to confirm
Independent calculations should be made to determine the validity of recorded gains or losses from security sales and of discount and
premium amortization. Recalculation should be made to determine the accuracy of recorded dividend and interest income. Analytical
procedures may also be used to test the reasonableness of dividend and interest income

Management representation letter required!

Review board minutes  slope limitation if denied access

Payroll and Personnel: Includes payroll (salaried and hourly) and personnel functions

Segregation of duties –
 Authorization to Employ and Pay  ARC  Function of HR to hire new employees
 Supervision  ARC  All pay base data (hours, time off, etc) should be approved by immediate supervisor
 Timekeeping and Cost Accounting  ARC  Data on which pay is based should be accumulated independent of any other function.
Where there are employees who are paid by the hour, it is advisable to use time clocks.
 Payroll Check Preparation  ARC  Payroll department computes salary based on information received (ex. Hours x pay). Responsible
for issuing unsigned payroll checks that are later signed by the treasurer.
 Check Distribution  ARC  Treasury signs checks and distributes, known as paymaster.

Control Procedures:
P – Prenumbering: time cards, checks, and payroll change documents
A – Authorization:
I – Independent Check to Maintain Asset Accountability:
o Accting dept prepares a voucher for amount of payroll based upon input from payroll dept
o Bank reconciliation of the imprest payroll account prepared by individual independent of custody or recordkeeping
functions.
o Unclaimed payroll checks should be returned to an independent individual for follow up
D – Documentation: all changes to payroll should have authorized change documents. Hours worked be documented by approved
time records = Payroll register
T – Timely and Appropriate Performance Reviews:
I – Information Processing Controls:
P – Physical Controls for Safeguarding Assets: treasurer should sign the payroll checks. An imprest payroll account be used
S – Segregation of duties:
o Authorization: operating dept and personnel dept
o Recordkeeping: payroll dept
o Custody (payroll checks): treasurer should sign and distribute checks

See chart on pg. A4-43

Property, Plant, and Equipment: includes acquisitions and disposals and related depreciation expense

Acquisition: a special requisition form is generated for acquisitions, includes description, reason for acquisition, amount, cost, and approval.
Acquisitions are tied to capital budget, which board of directors approve. Board of directors should approve acquisitions.

Detailed information concerning each asset is kept in the subsidiary ledger. (i.e. description, ID #, location, date, cost, depreciation method,
amount of depreciation)

Fixed assets should have identification plates. Serial number on plate should be listed in control account. Physical controls to safeguard
assets from theft be in place.

Written depreciation policies and records be maintained. Specific capitalization policies are also necessary to prevent misstatement of
revenue and expenses.

Retirements of assets should be documented on sequentially numbered work order. Helps in assessing cash and removing asset and
depreciation from subsidiary ledger.

Auditor should vouch down (existence and support) for additions to fixed asset accounts.
Review retirements and recalculate any gains and losses thereon.

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Review repair and maintenance expense accounts to test for completeness of asset additions. This would be to locate items that should
have been capitalized.
Perform cut-off tests to determine whether purchase/sale was recorded in proper period
Confirm the purchase/sale was properly authorized
Determine if appropriate controls are in place to safeguard fixed assets and prevent theft or destruction
Recalculate depreciation
Alert for evidence indicating a lien on assets, such as a missing insurance policy.

 Company do no/cannot insure fixed assets they do not have


 Companies do not pay real estate taxes on property they do not own
 Tour plant and inquire

Liabilities
Examine notes payable, comparing terms and authorization of indebtedness to board approval. Interest expense should be computed
independently.

Investments / Long-term debt:


1. GAAP is consistently applied
2. Interest expense is properly reported
3. Valuation is fairly stated
4. All debt has been recorded
5. For LTD, compare interest expense with bond payable amount

Contingencies:
1. Review bank confirmations for hidden bank loans, discounted drafts, guarantee of notes
2. Discuss long-term purchase commitments
3. Review the status of long-term leases
4. Review status of tax returns for open years
5. Send inquiry letter to client’s attorneys
6. Discuss sales contracts
7. Review the interim FS after year-end
8. Review minutes from board of directors’ and shareholder meetings
9. Obtain client representation letter

Owner’s Equity

Examine all shares of treasury stock and reconcile the number of shares stated in treasury stock account. Transactions should be traced to
accounting records (cash accounts) and to authorization in board meeting minutes

Stock transactions should be vouched to supporting documentation (cash receipts, minutes)

All stock issuances, dividend declarations, treasury stock purchases must be authorized by board of directors.

Articles of incorporations should be in the permanent audit file.

If client uses a stock transfer agent, third-party confirmations should be used to provide evidence. If client uses stock certificate book, then
examine the stubs for proper recording.

Consider whether any appropriations of retained earnings are necessary. Auditor focuses on evaluating the presentation and disclosure of
FS.  classification and understandability

Audit Evidence: Miscellaneous Items

Related Party Transactions


Related Party Transactions  Valuation and Accuracy  make sure properly recorded and dkisclosed
Related parties may include reporting entity’s affiliates, principal owners, management, and members of their immediate families.
Related party transaction is not considered to be an arm’s length transaction.
Objective: properly disclosed in accordance with GAAP.

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Determining the existence of related parties:
 Evaluate company’s procedures and policies for related party transactions
 Inquire management and predecessor auditor
 Revieiw entity’s filings with the SEC, board minutes, and confirmations
 Review material transactions (esp. Investments)
 Compenstating balance arrangements
 Loan guarantees
 Unusual, nonrecurring transactions year year-end

Accounting Estimates
 Management’s responsibilities and are subjective judgements = risk
 Assess management’s written policies and practices of acctng estimates
 Verify that all material estimates have been developed
 Determine that acctng estimates are reasonable
 Ensure that acctng estimates are properly presented and disclosed per GAAP
 Test for reasonableness
 Is management using the same methods/consistency for estimates?
 Past track record of estimates is good?
 Justify any changes in approach

Auditing Fair Values


 For fair values, market value or estimates and valuation methods may be used
 Changes in fair value mearsurement may be treated in different ways under GAAP (net income, comprehense income and equity)
 Management should identify and support any significant assumptions used
 Auditor – assess the risk of material misstatement of fair value measurements
 Auditor – evaluate the sufficiency, competency, and consistency of evidence obtained with respect to fair value measurements and
disclosures
 When auditor tests fair value measurements and disclosures, auditor may determine whether managemetn’s significant assumptions
provide a reasonable basis for fair value measurements.

Litigation, Claims, and Assessments


 Esternal inquiry of entity’s attorney is the auditor’s primary means of obtaining verification of management information about these
issues.
 Ask management about pending or possible litigation and controls adopted to identify, evaluate, and account for such items.
 Review meeting minutes, invoices from lawyers, IRS correspondence
 It is management’s responsiblitiy to identify and account for litigation, claims, and assessments through the entity’s policies.

Letter of Inquiry to Client’s Attorneys

This letter is signed by the cleitn and sent by the auditors to the attorneys.
Lawyer’s response to letter of inquiry should include a professional opinion on the expected outcome of any lawsuit and likely outcome of
any liability, including court costs.

Lawyer refuses to respond  scope limitation  qualified or disclaimer opinion


Client refuses to permit inquiry  disclaimer

***Management is primary source of information regarding litigation, claims, and assessments. Letter sent to client’s lawyer is simply a
means of corroborating information provided by management.

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