ACCTG 5510 1st Edition Lecture 5 Outline of Last Lecture I II CPA Responsibility to serve the public What is the product of the CPA III AICPA Code of Professional Conduct IV PCAOB and SEC Independence Outline of Current Lecture I Audit preparation II Cycles III Setting Audit Objectives IV Financial Statement Assertions V Audit Decisions VI Documentation Current Lecture I Audit preparation a Overall objective of an audit is to gain reasonable assurance that the financial statements are stated fairly and are free from material misstatement b Management is responsible for the preparation presentation and disclosure of financial statements i The CEO and CFO certify the annual report as required by the Sarbanes Oxley Act c Auditors are responsible to perform the audit in accordance with standards set by the PCAOB called GAAP generally accepted accounting principles i GAAP only applies to publically traded companies These notes represent a detailed interpretation of the professor s lecture GradeBuddy is best used as a supplement to your own notes not as a substitute ii Private companies use GAAS generally accepted audit standards II Cycles a A company s financials are broken into cycles that have no beginning or end Examples would include the sales cycle which would include several general ledger accounting including cost of goods sold revenue inventory and receivables b Other cycles would be payroll and personnel inventory and warehousing capital acquisition and repayment etc c Each cycle affects both the income statement and the balance sheet with the cash account being impacted by almost every cycle III Setting Audit Objectives a To test balance sheet balances Are debits overstated Are credits understated b Additionally the income statement is tested in the same way Are debits understated Are credits overstated IV Financial Statement Assertions a Existence or Occurrence does the asset exist or did the transaction occur i Direction financial statements FS general ledger GL source documents ii This assertion deals with the potential for overstatement usually deals with asset accounts and credits on the income statement b Completeness did all the items get recorded and are all liabilities presented i Direction source documents GL FS ii The assertion deals with potential understatement credit balances on the balance sheet and debit balances on the income statement 1 Ex Expenses payables liabilities accounts payable c Valuation Allocation Gross net Accuracy i Gross is it really valued properly Historical cost Inventory held at standard cost is that the true gross value of the inventory Are receivables valued correctly ii Net lower of cost or market impaired Is it really worth what they say it is Net realizable value accuracy are the amounts properly valued 1 Collectability of receivables and the amount of allowance for doubtful accounts must be evaluated in a valuation iii Accuracy are quantities accurate Are prices or costs accurate Are extended values correct Footing errors d Cutoff are all the items for the reporting period end included Are out of period items included in the financials Did the records cutoff at midnight on December 31 2010 e Rights Obligations does the company have the right to the assets Does the company have an obligation for a liability not presented Is there an unrecorded liability Is there a purchase commitment with a vendor f Presentation Disclosure Adequacy of disclosures in accordance with GAAP Are accounts classified correctly V Audit Decisions a Procedures to use b Sample size c Method of selection from population d Timing of procedures e Evidence is it believable independent reliable and or relevant i Relevance related to the audit objective Are we going in the right direction depending on the assertion being tested ii Reliable does the evidence come from an independent source Are there effective internal controls Has direct evidence been obtained Are individuals qualified iii Types of audit evidence include 1 Physical examination examine assets and observe inventory 2 Confirmation third party representations attorney letters confirmations SAS 67 sent out to verify cash balances accounts receivable and legal contingencies 3 Inspections viewing customer and vendor invoices Vouching test existence from the GL to the source documents Tracing test for completeness goes from the client document to the GL 4 Analytic procedures comparing data from different periods and obtaining an explanation for extreme changes required during planning and completion also used for substantive testing a might perform a ratio analysis horizontal analysis or vertical analysis view items as a percentage of sales 5 Inquiries of the client 6 Re performance Re calculation 7 Observation iv The most expensive type of evidence is confirmation and observation 1 The least expensive is analytics and inspections v Evidence on accounting estimates 1 Review managements rationale for the estimates presented 2 Test subsequent events to verify collectability 3 This is a very risk area to test as estimates are subjective vi Evidence on related party transactions 1 related parties include officers directors principle owners immediate families of executives and affiliates 2 Are related parties providing services for not charge Are there any significant transactions with related parties that need to be disclosed VI Documentation a If you did not document a needed item on a work paper it is like it never happened b Work papers they are owned by the firm and are not shared with anyone unless needed for legal reasons c Current file has the overall audit program planning procedures internal control documentation of understanding engagement letters time budgets correspondence a working trial balance the client financial statements passed adjust journal entries and the management representation letter i There are also audit programs for each account documentation and work paper d Permanent file articles of incorporation by laws contracts