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1. A company's management is responsible for its financial statements.

What are the five assertions that a company's management makes about the classes of transactions and events?: The five
assertions made by management regarding the classes of transactions and events are:
1. O = Occurrence.
2. A = Accuracy.
3. C = Cutoff.
4. C = Completeness.
5. C = Classification.
2. A company's management is responsible for its financial statements.
What are the four assertions that a company's management makes about account balances?: The four assertions made by a
company's management about account balances are as follows:
1. Existence - Assets, liabilities, and equity interest exist.
2. Rights and obligations - The company holds or controls the rights to assets and liabilities.
3. Completeness - All assets, liabilities,, and equity interest that should have been recorded have been recorded.
4. Valuation and allocation - Assets, liabilities, and equity interests are included in the financial statements at appropriate amounts and
any resulting valuation or allocation adjustments are appropriately recorded.
3. A company's management is responsible for its financial statements.
What are the four assertions that a company's management makes about presentation and disclosure?: The four
assertions made by a company's management about presentation and disclosure are as follows:
1. Occurrence and rights and obligations - Disclosed events and transactions have occurred and pertain to the company.
2. Completeness - All disclosures that should have been included in the financial statements have been included.
3. Classification and understandability - Financial information is appropriately presented and described and disclosures are clearly
expressed.
4. Accuracy and valuation - Financial and other information is disclosed fairly and at appropriate amounts.
4. An auditor is required to be independent in mental attitude in all matters relating to the audit.
What are the basic rules that establish at least the appearance of auditor independence?: The covered members of an audit
engagement team cannot have any direct financial interest in the client company.
A direct financial interest involves:
1. An ownership of equity shares or other client financial instruments.
2. Any potential financial benefit.
This is virtually the only time in an audit engagement where materiality is not a factor.
In addition, the covered member can have no material indirect financial interest in the client, such as ownership of entity securities through
an investment club or mutual fund.
Any individual associated with a CPA firm who participates in the attest function for a particular client, as well as anyone who can
influence the attest function, is known as a covered member.
5. To be in conformity with generally accepted auditing standards (GAAS), due professional care must be exercised by the
auditor.
What is the standard for evaluating due professional care?: To meet the due professional care standard, the auditor must plan and
perform the audit to obtain sufficient appropriate audit evidence so audit risk will be reduced to an acceptably low level.
6. What is the overall goal of an audit of a set of financial statements?: The auditor seeks to gain sufficient appropriate evidence that
no material misstatements exist in any of the relevant assertions being made by management so that reasonable assurance can be given
that the overall financial statements are presented fairly in accordance with generally accepted accounting principles (GAAP) of the United
States.
CPA Audit - The Auditing Engagement
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7. An auditor is concerned about the presence of material misstatements.
What is meant by the term material?: The term material refers to the presence or nonpresence of an item in a set of financial
statements of a size or type that would influence the judgement of a reasonable outside party who is relying on these statements.
In judging the degree of possible material misstatement, the auditor should base her determination on the likely total amount of
misstatement that is present, rather than the actual amount of misstatement that has been discovered.
8. There are ten basic generally accepted auditing standards (GAAS). These standards are divided into the following three
categories:
1. General Standards.
2. Standards of Field Work.
3. Standards of Reporting.
There are three General Standards. What are they?: The three General Standards within the generally accepted auditing standards
are as follows:
1. The audit must be performed by a person or persons having adequate technical training and proficiency as an auditor.
2. The auditor must maintain independence in mental attitude.
3. Due professional care must be exercised in the performance of the audit.
9. In order to have adequate technical training, the auditor should have sufficient education and experience in order to
evaluate whether any material misstatements might be present in a set of financial statements.
What areas should be covered by this technical training?: The first General Standard is normally interpreted as requiring the
auditor to have formal education in auditing and accounting, adequate practical experience for the work being performed, and continuing
professional education. Recent court cases clearly demonstrate that auditors must be technically qualified and experienced in those
industries in which their audit clients are engaged.
10. An auditor must have adequate technical training in order to meet generally accepted auditing standards (GAAS).
By when does the auditor need this adequate technical training?: The auditor must have adequate technical training by the time
that evaluations and judgements are being made in an audit.
Since evaluations and judgements in an audit begin to be made even prior to the auditor's acceptance of the engagement, the auditor must be
knowledgeable about accounting and auditing matters, the client's industry, and the client company by the time the engagement is accepted.
11. How does an auditor document that an audit has been adequately supervised?: The audit documentation should show that all
work performed by assistants during the course of the audit has been reviewed and approved by a supervising auditor with adequate
technical training.
12. When management presents a set of financial statements to the independent auditor, management is making certain
assertions.
What is the independent auditor's responsibility in connection with these assertions?: The independent auditor wants to
obtain sufficient appropriate evidence to corroborate (substantiate) that no material misstatements exist in any of the relevant assertions
that are being made by management.
13. An auditor is examining an account and believes that the balance is overstated because extra transactions have been
included.
Which assertion should be tested?: According to AU 326, if the auditor is concerned that extra transactions have been included in an
account balance, the auditor should test the existence assertion. The auditor wants to verify that the balances being reported really did exist
for the reporting period under examination.
Beyond AU 326, if there are suspected extra transactions included in the account balance, this situation may be evidence of a cutoff problem.
So, management's cutoff assertion concerning classes of transactions and events should be tested, as well.
14. An auditor is examining a particular account and is concerned that several transactions may have been omitted.
Which assertion should the auditor test?: If an auditor is concerned that transactions or amounts have been omitted from an
account, the auditor should test the completeness assertion.
15. Who should hire a company's independent auditor?: The hiring (and even possible firing) of a company's independent auditor
should be managed by the client's audit committee, which is normally made up of independent members of the company's board of directors
who are not members of management.
Audit committees are generally required for publicly held companies. Nonissuer companies are not required to have an audit committee,
although it is best practice to have one. For these privately held entities, in the absence of the existence of an audit committee, this
responsibility would rest with the board of directors.
16. What are the chief standards that currently provide guidance for attestation engagements other than an audit?: In
attestation guidance for other than an audit engagement, the Statements on Standards for Attestation Engagements (SSAEs) should be
followed by an auditor.
17. An independent auditor seeks to provide reasonable assurance that financial statements contain no material
misstatements.
What is meant by the term misstatement?: There are three types of misstatements that can appear in a set of financial statements:
1. Error - An unintentional mistake.
2. Fraud - An intentional act that results in a misstatement in the financial statements. The misstatement can be either material or
immaterial.
3. Direct-effect illegal act - An action against federal or state law which has an immediate impact on specific financial statement amounts
because these amounts are misstated.
There are also indirect-effect illegal acts, which affect financial statements only indirectly. An indirect-effect illegal act arises from an
illegal act where the company may become liable to pay a penalty or fine for the illegal act, so a contingency exists. However, the company
has not recognized or disclosed this contingent liability for its financial statements.
Auditing standards state that the auditor provides no assurance that indirect-effect illegal acts will be detected.
18. What are the two types of illegal acts that an auditor might encounter?: The auditor might encounter one or both of the following:
1. Direct-effect illegal acts - Actions that cause the actual amounts appearing on the financial statements to be incorrect.
2. Indirect-effect illegal acts - Actions that will only create an impact on the financial statements if the company is investigated and
punished by way of a fine or other penalty. Thus, an indirect-effect illegal act can create a certain contingency, and it should at least be
disclosed.
19. A company has illegally evaded paying its income taxes and has not yet been contacted by the IRS. The same company has
also polluted a local river, but has not yet been fined or even investigated.
Are these acts indirect-effect illegal acts or direct-effect illegal acts?: Evasion of income taxes is a direct-effect illegal act because
several specific accounts will be likely misstated, including Income Tax Expense, Income Taxes Payable, Deferred Income Tax Liability,
and Deferred Income Tax Asset.
Pollution is an indirect-effect illegal act because no specific account is necessarily immediately misstated as a direct result of the act.
However, if the action is ultimately discovered, the company may be fined, penalized, or punished in some other manner. Thus, the indirect-
effect illegal act creates a contingency for the company.
20. In applying the reporting standards, the auditor must be able to state that U.S. generally accepted accounting principles
(GAAP) have been applied.
How does the auditor know which accounting principles should apply?: The Accounting Standards Codification (ASC)
establishes U.S. GAAP. The ASC is the sole source of U.S. GAAP, and it includes all authoritative pronouncements for both nonissuers and
issuers.
21. An auditor renders an opinion for Company X on its Year 1 financial statements on March 1, Year 2 and bills this client
for his audit services. Because of financial difficulties, the audit fee from Year 1 is never paid. At the end of Year 2,
Company X wants to hire the auditor again for audit services and promises to pay the fees for both years. The auditor is
worried that there is a direct financial interest in Company X that causes an independence problem.
To avoid a problem, when does the audit fee for Year 1 have to be paid?: The auditor will be considered independent if the audit
fee for Year 1 is paid prior to the issuance of the audit opinion on the Year 2 financial statements.
22. Fraud is the intentional act that results in a misstatement in financial statements.
What are the two distinct types of fraud?: Fraud can encompass both the following facets:
1. Fraudulent financial reporting - The manipulation of the financial records to make the reporting entity's financial condition and/or
performance appear other than it is in reality.
2. Misappropriation - The theft of assets, which is often covered by manipulation of the financial records. This form of fraud is also referred
to as defalcation.
23. What is the independent auditor's responsibility in connection with misstatements that might exist within a set of
financial statements?: The independent auditor attempts to gain sufficient appropriate evidence in order to provide reasonable assurance
that no material misstatements are present in any of the relevant assertions connected with the financial statements. The term
misstatement includes error, fraud, and direct-effect illegal acts.
24. An auditor attempts to provide reasonable assurance that no material direct-effect illegal acts exist in a set of financial
statements.
What is an independent auditor's overall responsibility in regard to indirect-illegal acts committed by the reporting
entity?: In general, the auditor has no responsibility to specifically search for indirect-effect illegal acts. However, if evidence of a potential
indirect-effect illegal act is uncovered, the auditor must investigate because it may indicate a contingency for the company. If a material
indirect-effect illegal act is discovered, disclosure of this is required in the financial statements.
25. A company produces a set of financial statements.
Who is responsible for these financial statements?: The management of the company is responsible for the financial statements.
The independent auditor can suggest modifications to those financial statements, and the independent auditor can provide an opinion on
them. However, the financial statements themselves are the responsibility of management.
26. In order to give an unqualified opinion, the auditor must follow the ten basic standards. The Auditing Standards Board
produces Statements of Auditing Standards (SAS), which are viewed as a part of the framework of the ten basic
standards.
Does the auditor have to follow the SAS as a requirement for giving an unqualified opinion?: An auditor does not have to
follow a particular SAS if the auditor is able to justify the departure from it in the audit of certain financial statements. GAAS and the SAS
should be looked on by practitioners as minimum standards of performance, rather than maximum standards or ideals. Conversely, the
existence of auditing standards does not mean that the auditor must always follow them blindly, especially if the auditor believes that the
requirement of a standard is impractical or impossible, or if the issue in question is immaterial. However, the burden of justifying the
departures from the standards rests with the auditor.
27. The Auditing Standards Board has issued an interpretation to provide assistance in applying a particular Statement of
Auditing Standards (SAS).
Can an auditor render an unqualified audit opinion if this interpretation is not followed?: An auditor does not have to follow
ASB interpretive guidance if the auditor can still demonstrate compliance with the SAS in question. GAAS and the SAS should be looked on
by practitioners as minimum standards of performance, rather than maximum standards or ideals. Conversely, the existence of auditing
standards does not mean that the auditor must always follow them blindly, especially if the auditor believes that the requirement of a
standard is impractical or impossible, or if the issue in question is immaterial. However, the burden of justifying the departures from the
standards rests with the auditor.
28. What is an attestation?: In an attestation engagement, a CPA reports on the reliability of information or an assertion being made by
another party.
1. Generally, one or more assertions are being made.
2. A CPA performs an examination to see if those assertions can be substantiated.
3. The CPA provides a report that gives some degree of assurance.
An audit of financial statements is one type of attestation. However, attestations also include reviews, reports on internal control over
financial reporting (for public companies), compliance reports, attestation services on information technology, and other services.
29. What are the chief standards that currently comprise generally accepted auditing standards (GAAS) for nonpublic
entities (a.k.a. nonissuers)?: There are ten basic standards that make up the foundation of generally accepted auditing standards.
However, the Statements on Auditing Standards (SAS) that are produced by the Auditing Standards Board (ASB) should be viewed as an
integral part of the framework of the basic standards. These standards cover nonpublic entities and did cover publicly held entities prior to
the Sarbanes-Oxley Act.
As a result of the Sarbanes-Oxley Act of 2002, the Public Company Accounting Oversight Board (PCAOB) was created to enforce auditing,
quality control, and independence standards for audits involving publicly held companies. A separate set of standards exist specifically for
CPAs involved in audit engagements of publicly held entities. PCAOB adopted most the SAS issued by the ASB. At this point in time, the
PCAOB has issued seven audit standards (AS) (including AS 5, which supersedes AS 2) and several interpretations that provide additional
or differing requirements or audits of issuers.
30. An auditor discovers two misstatements of equal size in a set of financial statements. One was the result of an
unintentional error; the other was the result of fraud.
Because they are the same size, will the auditor view these misstatements in the same light when evaluating their
materiality?: The term materiality is related to the auditor's judgement based on both the size of the misstatement and the reason for the
misstatement. In other words, both quantitative and qualitative elements exist in the determination of materiality. Because fraud indicates a
misstatement resulting from a purposeful action, it is considered more significant than an error (an unintentional misstatement) of the
same magnitude.
31. There are ten basic generally accepted auditing standards (GAAS). These standards are divided into the following three
categories:
1. General Standards.
2. Standards of Field Work.
3. Standards of Reporting.
There are three Standards of Field Work. What are they?: The three Standards of Field Work state that:
1. The work must be adequately planned, and any assistants must be properly supervised.
2. A sufficient understanding of the entity and its environment, including its internal control, must be obtained to assess the risk of material
misstatement of the financial statements, whether due to error or fraud, and to design the nature, timing, and extent of further audit
procedures.
3. Sufficient appropriate evidence must be obtained by performing audit procedures to afford a reasonable basis for an opinion on the
financial statements.
32. There are ten basic generally accepted auditing standards (GAAS). These standards are divided into the following three
categories:
1. General Standards.
2. Standards of Field Work.
3. Standards of Reporting.
There are four Standards of Reporting. What are they?: The four Standards of Reporting are:
1. The report must state whether the financial statements are presented in accordance with U.S. generally accepted accounting principles
(GAAP).
2. The report shall identify those circumstances in which GAAP has not been followed consistently.
3. The report shall identify those circumstances in which there is not adequate disclosure.
4. The report shall contain an expression of opinion on the statements taken as a whole or indicate that an opinion cannot be expressed.
33. How does an auditor document that an audit has been adequately planned?: To ensure and document that an audit has been
adequately planned, the auditor must develop an overall audit strategy and an audit plan, which documents and details the nature, timing,
and extent of the audit procedures that are to be performed.
34. To ensure that all audit engagements are performed appropriately, an auditing firm should have a system of quality
control in place.
What are the five elements of quality control for a CPA firm?: The AICPA's Statements on Quality Control Standards contain five
elements:
1. Independence, integrity, and objectivity - Continued assessment of the client and the auditor's relationship with the client.
2. Personal management - Maintaining effective hiring, assignment of personnel, and professional development.
3. Acceptance and continuance of clients - Minimizing the chance of being associated with management which lacks integrity.
4. Engagement performance - Making sure of the proper design and execution of each audit engagement.
5. Monitoring - Making sure that all of the elements of quality control are designed effectively and properly applied.
SAS 25 and SAS 98 (AU 161) covers general quality control obligations of an auditor. However, the primary guidance that is shown above
comes from the Quality Control Standards Committee established by the AICPA in 1978.
35. When does an auditor establish the size component of materiality?: A preliminary judgement of the size component of materiality
is set in the early stages of the planning process as the overall strategy for the audit is being developed. However, this preliminary
judgement is continuously reassessed throughout the actual audit process as evidence in the form of new information is gathered.
36. Some of the nonissuer reporting standards are explicit (i.e., they must be stated), whereas some of these reporting
standards are implicit (i.e., if not mentioned, the reader can assume that there is no problem).
Which standards are explicit and which are implicit?: 1. The nonissuer entity auditor must state in the report whether the
financial statements are presented in accordance with U.S. generally accepted accounting principles (GAAP). This standard is explict.
2. The auditor must express an opinion or indicate that an opinion cannot be given. This standard is explicit.
3. The auditor only mentions consistency if there is a problem. This assurance is implied in an unqualified opinion.
4. The auditor only mentions disclosure if there is a problem. This assurance is implied in an unqualified opinion.
37. What is a peer review?: A peer review is the review of a CPA firm's compliance with its quality control system. The purpose of the review,
which is also called practice-monitoring, is to determine whether the CPA firm has developed adequate policies and procedures for the five
elements of quality control and actually follows them in practice. Unless a firm has a peer review, all members of the CPA firm may lose
their eligibility for AICPA membership. The review is carried out by CPAs from another firm or by a committee of CPAs from several firms.
Peer reviews now are more closely associated with CPA firms not involved with audits of publicly held entities, due to the enactment of the
Sarbanes-Oxley Act of 2002.
Section 104 of the Sarbanes-Oxley Act of 2002 requires the PCAOB to conduct inspections of public accounting firms to assess compliance
with SOX, the PCAOB, the SEC, and professional standards related to audits of public companies. These inspections include an evaluation
of the CPA firm's system of quality control.
38. One of COSCO's Internal Control-Integrated Framework's five components of internal control is risk assessment.
What is meant by risk assessment?: Risk assessment for financial reporting is management's identification and analysis of risks
relevant to the preparation of financial statements in conformity with GAAP. This internal control component covers the company's ability
to anticipate potential problems and efforts to prevent them from occurring. Risk assessment processes include indentifying factors that
affect risks, assessing the significance of various risks and their occurrence, and determining actions necessary to manage these risks.
Assertions in the three categories of management assertions (classes of transactions and other events, account balances, and presentation
and disclosure) must always be satisfied. This term includes the company's ability to anticipate problems in situations such as:
1. Changes in personnel.
2. Installation of new computer systems.
3. Rapid business growth and new technology.
4. Geographical business expansion.
5. Introduction of new products.
39. In assessing control risk in an audit, one particular element under management's control is normally considered to be a
fraud risk factor.
What is this risk element that is viewed as almost always in existence?: In every audit, the possibility that management will
override (has overridden) specific internal controls is viewed as a fraud risk factor, even if no evidence of the occurrence of this is found by
the auditor. The history of most serious fraud cases has shown that management's override of controls is difficult to prevent. Therefore, the
auditor should perform the audit as if this risk is particularly high.
40. A CPA has examined pro forma financial information.
In the CPA's report, what kind of information should be included?: A CPA's report on the examination of pro forma financial
information should include each of the following:
1. Identification of the information.
2. Identification of the historical financial statements that served as the basis for the pro forma information.
3. Identification of the party responsible for the pro forma information.
4. That the examination was conducted in accordance with attestation standards of the AICPA.
5. Objectives and limitations of pro forma information.
6. Opinion as to whether the information has followed certain criteria.
7. Identification of the CPA as being independent.