2014 WILEY CPA excel focus notes auditing

He previously served as a member of the Audit ing Standards Board of the AICPA and as a member of the Accounting and Review Services Committee and the Board of Re gents of the Institut

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10 9 8 7 6 5 4 3 2 1

CONTENTS

Module 2: Engagement Planning, Obtaining an Understanding, and Assessing Risks 22

Module 4: Responding to Risk Assessment: Evidence Accumulation and Evaluation 96

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PREFACE

This publication is a comprehensive, yet simplifi ed study program It provides a review of all the basic skills

and concepts tested on the CPA exam and teaches important strategies to take the exam faster and more

accurately This tool allows you to take control of the CPA exam

This simplifi ed and focused approach to studying for the CPA exam can be used:

• As a handy and convenient reference manual

• To solve exam questions

• To reinforce material being studiedIncluded is all of the information necessary to obtain a passing score on the CPA exam in a concise and

easy-to-use format Due to the wide variety of information covered on the exam, a number of techniques

are included:

• Acronyms and mnemonics to help candidates learn and remember a variety of rules and checklists

• Formulas and equations that simplify complex calculations required on the exam

• Simplifi ed outlines of key concepts without the details that encumber or distract from learning the essential elements

Preface viii

• Techniques that can be applied to problem solving or essay writing, such as preparing a multiple-step income statement, determining who will prevail in a legal confl ict, or developing an audit program

• Pro forma statements, reports, and schedules that make it easy to prepare these items by simply

fi lling in the blanks

• Proven techniques to help you become a smarter, sharper, and more accurate test taker

This publication may also be useful to university students enrolled in Intermediate, Advanced and Cost

Accounting; Auditing, Business Law, and Federal Income Tax classes; or Economics and Finance Classes

Good luck on the exam,Ray Whittington, PhD, CPA

ABOUT THE AUTHOR

Ray Whittington, PhD, CPA, CMA, CIA, is the dean of the Driehaus College of Business at DePaul University Prior to

joining the faculty at DePaul, Professor Whittington was the Director of Accountancy at San Diego State University From

1989 through 1991, he was the Director of Auditing Research for the American Institute of Certifi ed Public Ac countants

(AICPA), and he previously was on the audit staff of KPMG He previously served as a member of the Audit ing Standards

Board of the AICPA and as a member of the Accounting and Review Services Committee and the Board of Re gents of

the Institute of Internal Auditors Professor Whittington has published numerous textbooks, articles, mono graphs, and

continuing education courses.

ABOUT THE CONTRIBUTOR

Kurt Pany, PhD, CPA, is a Professor of Accounting at Arizona State University His basic and advanced auditing

courses provided the basis on which he received the Arizona Society of CPA’s Excellence in Teaching Award and

an Arizona CPA Foundation Award for Innovation in the Classroom for the integration of computer and professional

ethics applications His professional experience includes serving for four years on the AICPA’s Auditing Standards

Board, serving as an academic fellow in the Auditing Division of the AICPA, and prior to entering academe, working

as a staff auditor for Deloitte and Touche.

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Focus on

CODE OF PROFESSIONAL RESPONSIBILITIES

AICPA

General Standards and Accounting Principles

• A CPA must perform with competence and must exercise due care

• Competence implies combination of education and experience

• Due care includes proper supervision and reviewing work of assistants

• Examples of actions that would violate the standard of due care include

• Performing professional services without complying with the appropriate standards

• Expressing an unqualifi ed opinion on fi nancial statements known to be materially misstated

• Failing to report the discovery of fraud to the client’s audit committee

• Interpretation 101-1 is extremely important; it has three major subsections.

A Restricts activities and investments by those involved on the attest engagement—

covered members.

B Restricts investments in the client by all in CPA fi rm

C Restricts positions held in the client by all in CPA fi rm

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Interpretation 101 A: Independence—Those Involved with the Audit

Covered members: The concept of covered members is important since certain independence

requirements apply to them Included as “covered members” are:

• A member of the attest engagement team

• A person who may infl uence the attest engagement (e.g., partner who supervises the partner in charge of the attest engagement)

• A partner in the office in which the lead attest partner practices

• Certain partners or managers who provide nonattest services to the client

• The fi rm, including its benefi t plans

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Interpretation 101 A: Independence—Those Involved with the Audit

(continued)

A member in public practice shall be independent in the performance of professional responsi bilities

• Independence impaired if a covered member

• Had committed to acquire any direct or material indirect fi nancial interest in the client

• Was a trustee or executor for estate that had/committed to acquire any direct or rial indirect fi nancial interest in the client in excess of 10% of assets

mate-• Had a material joint closely held investment

• Had a loan to or from the client, officer, director of the client, or any individual own ing 10% or more of client’s capital (there are some exceptions to this)

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Interpretation 101 B Investments that Impair Independence

• Partner or professional employee of the fi rm, his or her immediate family owned more than 5% of capital

• Was associated with the client as a(n)

• Director, officer, or employee, or in any capacity equivalent to that of a member of management

• Promoter, underwriter, or voting trustee

Interpretation 101 C Activities that Impair Independence

• Independence impaired by

• Supervising client’s personnel

• Signing client’s checks

• Acting as client’s stock transfer agent

• Entering into lease with client

• Accepting gifts from client

• Obtaining material loan from client, even if fully collateralized (except by cash balances)

Immediate family (spouse, spousal equivalent or dependent): Restrictions generally same as for

accountant Exceptions relate to those in other than a key position with a client and certain benefi t

plans

Close relatives (parent, sibling, or nondependent child): Independence not impaired unless close

relative has a key position with client or a material fi nancial interest of which the accountant is

aware

Other relatives and friends: Independence not impaired unless a reasonable person aware of the

facts would conclude there is an unacceptable risk

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Independence—Unpaid Fees

• Unpaid fees may impair independence

• May not extend beyond one year

• Audit may be performed, but report may not be issued until prior year fees paid

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Independence—Auditor on Engagement Considers or Takes

Employment with Audit Client

• Individual must inform the audit fi rm when seeking or discussing potential employment with client

• Individual’s independence impaired (should be taken off job) until employment by client is

no longer being considered by that individual

• Once individual accepts employment with audit client, the audit fi rm should consider the need to mod ify the audit plan or change members of the audit

• In any audit performed within a year of the professional joining the client, a member of the audit fi rm with no connection to the audit must review all work to ensure it takes into account independence issues

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Independence—Nonattest Services

• May provide advice, research materials, and recommendations

• Client must accept responsibility for making all decisions

• Specifi c client personnel must be designated to oversee services

• Client must be responsible for establishing and maintaining all internal controls and may not “outsource” such services to the auditor

• An understanding of the objectives of the engagement and client responsibilities must be documented prior to performing the nonattest services for an attest client

A member shall maintain objectivity and integrity, shall be free of confl icts of interest, and shall not

knowingly misrepresent facts or subordinate his or her judgment to others

• Misrepresentation of facts: Member is forbidden to knowingly (or let someone else)

• Make materially false and misleading entries

• Fail to correct fi nancial statements or records that are materially false and misleading

• Sign a document containing materially false and misleading information

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Independence—Nonattest Services (continued)

• A confl ict of interest may exist if member performing a service and the member/ member’s

fi rm has a relationship that could in the member’s judgment be viewed as impairing the member’s objectivity For example,

• Suggest that the client invest in a business in which he or she has a fi nancial interest

• Provide tax services for several members of a family who may have opposing interests

• Have a signifi cant fi nancial interest or infl uence with a major competitor of a client

• Obligations of a member to his or her employer’s external accountant

• Must be candid and not knowingly misrepresent facts or knowingly fail to disclose material facts

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Responsibilities to Clients 

A member in public practice shall not

• Disclose any confi dential client information without the specifi c consent of the client

• Accept a contingent fee for

• An audit or review of a fi nancial statement

• A compilation of a fi nancial statement

• An examination of prospective fi nancial information

• Prepare an original or amended tax return or claim for a tax refund for a contingent fee for any client

A CPA must maintain client information as confi dential May disclose client information to

• Comply with a subpoena

• Cooperate with a quality control review

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Other Responsibilities and Practices

A CPA should not perform acts discreditable to the profession, such as

• Retaining client records

• Understating anticipated fees for services

• Accepting a commission in relation to an attest client

• Practice under a misleading name

A CPA shall be competent

• Agreeing to perform professional services implies that the member has the necessary competence to complete those professional services but is not infallible

• Involves both the technical qualifi cations of the member and staff and the ability to vise and evaluate the quality of the work performed

super-• If the member does not have the necessary competence, may perform additional research

or consult with others

• But if cannot attain competence, should recommend client seek help from someone else

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Tax Preparer

Actions by an accountant preparing a client’s tax return can result in penalties for

• Not providing client with copy of return

• Failing to sign return as a preparer

• Endorsing and cashing client’s refund check

• Failing to fi le a timely return

• Not advising client of tax elections

• Neglecting evaluation of joint versus separate returns

A CPA performing tax services

• May not recommend a tax position that lacks merit

• Must make a reasonable effort to answer applicable questions on the return

• May rely on client information when preparing the return

• Must make reasonable inquiries about questionable or incomplete information

• May use estimates

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Standards for Consulting Services

When performing consulting services, a CPA must adhere to certain general standards

• Professional competence

• Due professional care

• Planning and supervision

• Obtaining sufficient relevant data

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GAO Code of Ethics

Federal auditors, or CPA fi rms auditing federal dollars, should not perform management functions

or make management decisions

Federal auditors, or CPA fi rms auditing federal dollars, should not audit their own work

Federal auditors, or CPA fi rms auditing federal dollars, should not provide nonaudit services that

are material to the subject matter of an audit

Emphasis:

• Accountability of government officials to the Congress

• Accountability of the auditor to conduct work professionally

• No requirement to evaluate management controls

• Executive leadership of the audited agencies is not the primary customer

• Management input not solicited as part of the audit process

• Management input not solicited in development of solutions

• Management is presented with “fi ndings” to which it must “respond”

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Institute of Internal Auditors Code of Ethics

The IIA Standards focus on improvement of risk management, control and governance processes

within an organization so that issues of concern can be identifi ed and corrected be fore they

become persistent or pervasive problems

• Mandate organizational independence of the audit department and mandate individual auditor objectivity

• Internal auditors (IA) must report to a level within the organization that permits the au dit department to fulfi ll its responsibilities

• IA must not perform management functions or make management decisions

• IA must not audit their own work

• IA must determine the nature and scope of their work

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Sarbanes-Oxley Act

Regulation S-K requires companies to disclose:

• Whether they have a written code of ethics that applies to their CEO, CFO, Controller, or persons performing similar functions

• Any waivers of the code of ethics for these individuals

• Any changes to the code of ethicsCode must be designed to promote:

• Honest and ethical conduct, including the ethical handling of actual or apparent confl icts

of interest

• Full, fair, accurate, timely, and understandable disclosure in company fi lings and publica tions

• Compliance with applicable governmental laws, rules, and regulations

• Prompt internal reporting of violations of the code to the appropriate person or persons identifi ed

• Accountability for adherence to the code

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Sarbanes-Oxley Act (continued)

Audit committee (AC) responsible for the appointment, compensation, and oversight of audit fi rm

• Each member of the AC is a member of the board of directors and independent

• One fi nancial expert required on AC

• AC reports directly to BoardCEO and CFO must certify accuracy and truthfulness of fi nancial statements

• Civil ($5,000,000) and criminal (10 years) liability

• Any person who knowingly attempts to or commits fraud in sale of securities has civil and criminal liability (up to 25 years)

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International Ethics Standards

The International Ethics Standards Board for Accountants (IESBA) is a standard-setting body

within the International Federation of Accountants (IFAC) that issues ethical standards for

accoun-tants throughout the world The IESB Framework applies to all professional accounaccoun-tants

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Department of Labor Independence Requirements for

Employee Benefi t Plans

An accountant is not independent with respect to the plan if he/she

• Has direct fi nancial interest or any material indirect fi nancial interest in the plan or plan sponsor

• Is a promoter, underwriter, investment advisor, voting trustee, director, officer, or employee

of the plan

• Maintains fi nancial records for the employee benefi t plan

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International Auditing and Assurance Standards

International auditing standards are developed by the International Auditing and Assurance

Standards Board (lAASB) of the International Federation of Accountants (IFAC)

• International standards do not require an audit of internal control, while PCAOB standards

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Financial Statement Assertions

• Management’s responsibility

• Assertions themselves

Transaction Classes Account Balances Disclosures

Rights and obligations Rights and obligations

Cutoff

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Audit Risk (AR)

AR is risk that material errors or fraud exists resulting in an inappropriate audit report

• Auditor uses judgment in establishing acceptable level of AR

• Lower acceptable level of AR achieved through obtaining more audit evidence

AR consists of inherent risk (IR), control risk (CR), and detection risk (DR)

IR acknowledges that certain items are more susceptible to risk

• May be due to complexity of transactions or calculations, ease of theft, or lack of available objective information

• IR is beyond control of auditor and generally beyond control of entity

CR acknowledges that misstatements may not be prevented or detected by entity’s internal control

• Entity’s internal control may be poorly designed or poorly executed

• CR is beyond control of auditor but within control of entityThe combination of IR and CR is referred to as the “risk of material misstatement”

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Audit Risk (continued)

DR acknowledges that auditor may not detect material misstatement

• Auditor may not properly plan audit procedures

• DR is within control of auditor

Audit Risk = Risk of material misstatement Risk Auditor Fails to Detect Misstatements

Detection Risk Audit Risk = Inherent Risk * Control Risk

*

*

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Components of Audit Risk

Increases risk Decreases risk

Lack of working capitalHigh rate of obsolescence

More profi table than industry averageLow management turnover

Control risk Ineffective internal controls

Weak management oversight

Effective internal controlStrong management oversightDetection risk Decrease substantive testing

Perform tests early in year

Increase extent of substantive proceduresSelect more effective tests

Perform tests near year-end

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Applying Audit Risk Model

AR = IR × CR × DR

To apply model

Establish acceptable level of audit risk

Assess inherent risk based on internal and external factors

Establish planned assessed level of control risk based on discussing internal control with

management

• May set control risk at maximum level

• If control risk set below maximum, must perform tests of controls to verify assessmentCompute necessary level of detection risk

DR = AR ÷ (IR × CR)Determine if planned nature, timing, and extent of substantive tests are adequate to provide appro-

priate level of detection risk

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Materiality

Magnitude of omission or misstatement that makes it probable that the judgment of a

reason-able person relying on the information could have been changed or infl uenced by the omission or

misstatement

Recognizes relative importance of items to fair presentation of fi nancial statements

• Items may be material due to high dollar amount (Quantitative)

• Items may be material due to nonmonetary signifi cance (Qualitative)Determining materiality

• Auditors should determine materiality for fi nancial statements as a whole

• Also, particular transactions, accounts, or disclosures may require lower levels

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Materiality (continued)

Materiality is matter of professional judgment

• Must plan audit to obtain reasonable assurance that fi nancial statements are not misstated

• Misstatements could be material individually or collectively

• Materiality measurement based on smallest aggregate level

• Performance materiality, ordinarily smaller than materiality, is used to determine that small misstatements do not total a material amount