1324 Regulation Auditing & Financial Business Accounting

589 Pages·2011·4.97 MB·English

by  Carol Demers

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3 
Auditing 
and 
Attestation 

by Vincent W. Lambers, MBA, CPA 
Richard DelGaudio, MBA, CPA 
Ronald LaPlante, CPA, CMA, CIA 

Published by 

Copyright © 2012 by LearnForce Partners, LLC
All rights reserved. No part of this publication
may be reproduced in any form without the
written permission of the publisher.
Good Luck! You have selected a CPA course designed for success. You have all the materials needed for a program
that will prepare you for taking the Auditing section of the CPA examination. These materials are up-to-date and
designed to facilitate effecti ve study. Our instructors are thoroughly familiar with the material and the CPA
examination.
We have endeavored to produce an error-free set of materials. However, we are aware that sometimes errors creep in
when we least expect it. Should you notice any errors, omissions, or have any suggestions, please discuss email
Lambers CPA Review at [email protected].
______________________________________________________________________

Chapter Subjects of Volume 3—AUDITING and ATTESTATION
Chapter One
INTRODUCTION, GENERAL AND FIELD STANDARDS
Chapter Two
THE THIRD STANDARD OF FIELD WORK—EVIDENCE
Chapter Three
STANDARDS OF REPORTING
Chapter Four
ATTESTATION STANDARDS, GOVERNMENT AUDITING STANDARDS, QUALITY CONTROL
STANDARDS
Chapter Five
REVIEWS, COMPILATIONS, SPECIAL REPORTS AND OTHER REPORTS
Chapter Six
THE AUDIT SAMPLING PROCESS
Chapter Seven
AUDITING WITH TECHNOLOGY
Chapter Eight
PROFESSIONAL RESPONSIBILITIES
Chapter Nine
AUDITING UPDATES AND INTERNATIONAL STANDARDS

Material from Uniform CPA Examination Questions and Unofficial Answers, copyright © 1977
through 2012 by the American Institute of Certified Public Accountants, Inc., is reprinted (or
adapted) with permission.
____________________________________________________________________________________________

ACKNOWLEDGMENTS
It would be impossible to write a CPA examination book of any kind without the assistance of the Am erican
Institute of Certified Public Accountants, and their various operating divisions, in granting permission to use various
materials. We respectfully acknowledge and thank those persons in the American Institute who promptly answered
our inquiries.
Those areas of the book for which we received permission to use copyrighted material from the American Institute are:
• CPA Examination Questions, Problems and Solutions
• Opinions of the Financial Accounting Standards Board and Predecessor Bodies
• Adaptations, Quotations, Case Examples and Tables from "An Auditor's Approach to Statistical Sampling"
• Statements on Auditing Standards issued by AICPA
• Statements on Standards for Accounting Review Services issued by AICPA
• Statements on Standards for Attestation Engagements issued by AICPA

Richard DelGaudio, CPA
January 2012
Chapter One
Introduction, General and Field Standards

INTRODUCTION

OBJECTIVE OF THE ORDINARY EXAMINATION OF FINANCIAL STATEMENTS
To express an opinion on reliability and fairness of management prepared financial statements by means of the
auditor's report.

STANDARD SHORT-FORM AUDITOR'S REPORT—UNQUALIFIED
(Note: Audit reports are covered in detail in Chapter 3. Discussion here is for quick reference purposes only.)

The form of the standard report on financial statements covering a single year is as follows:

Independent Auditor's Report

Board of Directors
X Corporation

We have audited the accompanying balance sheet of X Company as of December 31, 20XX, and the
related statements of income, retained earnings, and cash flows for the year then ended. These financial
statements are the responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.

We conducted our audit in accordance with auditing standards generally accepted in the United States of
America. Those standards require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our audit provides a reasonable
basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the
financial position of X Company as of (at) December 31, 20XX, and the results of its operations and its
cash flows for the year then ended in conformity with accounting principles generally accepted in the
United States of America.

(Date of completion of audit)
(Firm Name and Signature) (Italics added for emphasis)

Briefly, the auditors standard report may be modified and take one of the following forms:

Qualified Report—Usually issued when the auditor takes exception to a material item or items in the financial
statements because of departures from GAAP. A qualified opinion may also be issued when the auditor's
examination is restricted with respect to an item in the financial statements. This type of report communicates to the
reader of the financial statements that management's financial reports are fairly presented "except for" a departure
from GAAP, which is material enough to mention but not pervasive enough to render the financial statements
misleading when taken as a whole.

Adverse Report—Issued when the auditor feels that the departures from GAAP are serious enough to render the
statements misleading. In this case, the CPA was able to apply auditing procedures, but discovered material and
pervasive departures from GAAP that the client refused to correct. Thus, the dividing line between "except for"
(qualified) opinion and an adverse opinion is one of materiality and pervasiveness of the departure from GAAP.

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Disclaimer Report—Issued when the auditor's examination was incomplete (scope restricted because of nature of
examination or other audit restrictions) to the point where he was unable to express an opinion on the financial
statements or where the uncertainties have a pervasive and material effect on the financial statements. Thus, a
disclaimer can result from inadequate auditing procedures or material uncertainties.

A complete discussion of the auditor's reporting function is in Chapter 3.

DISTINCTION BETWEEN RESPONSIBILITIES OF AUDITOR AND MANAGEMENT
1. Fairness of the representations contained in financial statements is part of management's responsibility.
2. Management is responsible for development of adequate controls, safeguarding of assets, sound accounting
policies that will produce proper statements (i.e., internal control).
3. Auditor's responsibility is confined to the expression of an opinion, and the adequacy of auditing procedures.
4. Purpose of the ordinary examination is not primarily the detection of fraud. Auditor is aware that fraud may
exist and as such may affect the financial statements. The auditor must assess the risk that fraud may have
affected the financial statements, and as such, the auditor would appropriately modify the audit procedures.

SAS NO. 102: DEFINING PROFESSIONAL REQUIREMENTS IN
STATEMENTS ON AUDITING STANDARDS

Requirements of SAS No. 102
The statement defines categories of professional requirements which are identified by specific terms, to describe the
extent of responsibility they impose on auditors, as follows:
a. Unconditional requirements: The auditor is required to comply with an unconditional requirement in all cases
in which the circumstances exist to which the unconditional requirement applies. An unconditional
requirement is indicated by the words "must" or "is required. "
b. Presumptively mandatory requirements: The auditor is required to comply with a presumptively mandatory
requirement in all cases in which the circumstances exist to which the presumptively mandatory requirement
applies. A procedure or action within a SAS that uses the word "should" would be categorized under the
presumptive mandatory requirements. However, in rare circumstances, the auditor may depart from a
presumptively mandatory requirement provided the auditor documents his or her justification for the departure
and how the alternative procedures performed in the circumstances were sufficient to achieve the objectives of
the presumptively mandatory requirement.
c. Explanatory material and other references is descriptive and not imperative. The auditor is required to
understand the procedures and actions. Whether the auditor carries out the procedures or actions is based on his
or her professional judgment based on the engagement objective. Procedure, action or explanatory material that
includes terms such as "may, might, could."
d. Use of the term "should consider": If a SAS provides that a procedure or action is one that the auditor "should
consider," the consideration of the procedure or action is presumptively required, but carrying out the
procedure or action is not.

GENERALLY ACCEPTED AUDITING STANDARDS
Auditing "standards" differ from auditing "procedures" in that procedures relate to acts to be performed, whereas
standards deal with measures of the quality of the performance of those acts and the objectives to be attained by the
use of the procedures undertaken. The generally accepted auditing standards, which are interdependent and
interrelated, are represented by the general standards, field standards, and reporting standards from the time the
Auditing Standards Board of the AICPA will issue interpretations of the standards in publications known as
Statements on Auditing Standards (SAS's).

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General Standards
1. The audit must be performed by a person or persons having adequate technical training and proficiency as an
auditor.
2. In all matters relating to the assignment an independence in mental attitude is to be maintained by the auditor
or auditors.
3. Due professional care is to be exercised in the performance of the examination and the preparation of the
report.

Standards of Field Work
1. The auditor must adequately plan the work and must properly supervise any assistants.
2. The auditor must obtain a sufficient understanding of the entity and its environment, including its internal
control, 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. 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.

Standards of Reporting
1. The report shall state whether the financial statements are presented in accordance with generally accepted
principles of accounting.
2. The report shall identify those circumstances in which such principles have not been consistently observed in
the current period in relation to the preceding period.
3. Informative disclosures in the financial statements are to be regarded as reasonably adequate unless otherwise
stated in the report.
4. The report shall either contain an expression of opinion regarding the financial statements, taken as a whole, or
an assertion to the effect that an opinion cannot be expressed. When an overall opinion cannot be expressed,
the reasons therefor should be stated. In all cases where an auditor's name is associated with financial
statements the report should contain a clear-cut indication of the character of the auditor's examination, if any,
and the degree of responsibility he is taking.
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OVERVIEW OF THE AUDIT PROCESS
Decision Criteria
1. Independence
Decision to Rule 101 Code
A.
Accept Client of Conduct
GAAS
2. Competency
Rule 201 Code
of Conduct
General Standards
3. Predecessor Auditor
B.

Document Engagement Understanding
(Engagement Letter)

Plan Audit
C.
1. Understand the entity Decision on Audit Risk
and its environment: a. Potential for Errors
a. Management b. Potential for Illegal Acts
b. Industry c. Potential for Fraud
c. Regulation
d. Economy
e. Outside pressure

2. Perform Analytical Review
3. Initial Understanding of Internal Control
4. Audit Program
1) Preliminary based upon
1-3 and planned level of reliance on
Internal Controls
2) Detail nature, timing and extent
of Tests

Consider Internal Controls
D.
Outcomes

Planned level Confirms
of Reliance Planned
needs to level of
be modified reliance

Update Planned Go with
Audit Program original plan
Developed in as developed
C4 above in C4 above

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E. Assess the Risk of Material Misstatement Due to Errors or Fraud

F. Identify Specific Risks

G. Modify Planned Audit Program to Address Specific Risks

H. Perform
Substantive
Audit Tests

A Extraordinary Results Nothing
1. Errors extraordinary
2. Fraud encountered
3. Illegal Acts

Update Programs
after discussions
with client

I. Obtain
Representation
Letter

J. Propose Necessary
Adjusting Entries

Rejected Accepted
By client By client

Modify Issue
opinion unqualified
appropriately opinion

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DECISION TO ACCEPT A CLIENT

The decision to accept an engagement is made by reference to the General Standards of G.A.A.S. and by
consultation with the predecessor auditor, if applicable.

GENERAL STANDARDS
The general standards are concerned with the professional training and conduct of the auditor. Specifically, there are
three general standards:
1. The audit must be performed by a person or persons having adequate technical training and proficiency as an
auditor.
2. In all matters relating to the assignment, an independence in mental attitude is to be maintained by the auditor
or auditors.
(Since the auditor is attesting to the fairness of the financial statements, it is important that he have no bias
towards the client. If the CPA is not independent of his client he must disclaim an opinion.)
3. Due professional care is to be exercised in the performance of the examination and the preparation of the
report.

COMMUNICATIONS BETWEEN PREDECESSOR AND SUCCESSOR AUDITORS
(SAS NO. 84)

The purpose of the communication between predecessor and successor auditors when a change of auditors is in
process is to help the successor auditor in deciding to accept the client. The term "predecessor auditor" refers to an
auditor who has resigned or who has been notified that his services have been terminated. The term "successor
auditor" refers to an auditor who has accepted an engagement or an auditor who has been invited to make a
proposal for an engagement. This statement applies whenever an independent auditor has been retained, or is to be
retained, to make an examination of financial statements in accordance with generally accepted auditing standards.

The initiative in communicating rests with the successor auditor. The communication may be either written or
oral. Both the predecessor and successor auditors should hold in confidence information obtained from each other.
This obligation applies whether or not the successor accepts the engagement.

Communications Before Successor Accepts Engagement
Inquiry of the predecessor auditor is a necessary procedure because the predecessor may be able to provide the
successor with information that will assist him in determining whether to accept the engagement. The successor
should bear in mind that, among other things, the predecessor and the client may have disagreed about
accounting principles, auditing procedures, or similarly significant matters.

Request for Permission of Client to Authorize Disclosure
The successor auditor should explain to his prospective client the need to make an inquiry of the predecessor and
should request permission to do so. Except as permitted by the Rules of Conduct, an auditor is precluded from
disclosing confidential information obtained in the course of an audit engagement unless the client consents. The
successor auditor should ask the prospective client to authorize the predecessor to respond fully to the
successor's inquiries. If a prospective client refuses to permit the predecessor to respond or limits the response, the
successor auditor should inquire as to the reasons and consider the implications of that refusal in deciding
whether to accept the engagement.

The successor auditor should make specific and reasonable inquiries of the predecessor regarding matters that the
successor believes will assist him in determining whether to accept the engagement. His inquiries should include
specific questions regarding, among other things, facts that might bear on the integrity of management, on
disagreements with management as to accounting principles, auditing procedures, or other similarly
significant matters, and on the predecessor's understanding as to the reasons for the change of auditors.

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The predecessor should respond promptly and fully, on the basis of facts known to him, to the successor's
reasonable inquiries. However, should he decide, due to unusual circumstances such as impending litigation,
not to respond fully to the inquiries, he should indicate that his response is limited. If the successor auditor
receives a limited response, he should consider its implications in deciding whether to accept the engagement.

Other Communications
When one auditor succeeds another, the successor auditor must obtain sufficient competent evidential matter to
afford a reasonable basis for expressing his opinion on the financial statements he has been engaged to examine as
well as on the consistency of the application of accounting principles in the current year as compared with the
preceding year. This may be done by applying appropriate auditing procedures to the account balances at the
beginning of the period under examination and in some cases to transactions in prior periods. The successor auditor's
examination may be facilitated by (a) making specific inquiries of the predecessor regarding matters that the
successor believes may affect the conduct of his examination, such as audit areas that have required an inordinate
amount of time or audit problems that arose from the condition of the accounting system and records, and (b)
reviewing the predecessor auditor's working papers. In reporting on his examination, however, the successor
auditor should not make reference to the report or work of the predecessor auditor as the basis, in part, for
his own opinion.

The successor auditor should request the client to authorize the predecessor to allow a review of the
predecessor's working papers. It is customary in such circumstances for the predecessor auditor to make himself
available to the successor auditor for consultation and to make available for review certain of his working papers.
The predecessor and successor auditors should agree on those working papers that are to be made available
for review and those that may be copied. Ordinarily, the predecessor should permit the successor to review
working papers relating to matters of continuing accounting significance, such as the working paper analysis of
balance sheet accounts, both current and noncurrent, and those relating to contingencies. Valid business reasons,
however, may lead the predecessor auditor to decide not to allow a review of his working papers. When more than
one successor auditor is considering acceptance of an engagement, the predecessor auditor should not be
expected to make himself or his working papers available until the successor has accepted the engagement.

Financial Statements Reported On by Predecessor
If, during his examination, the successor auditor becomes aware of information that leads him to believe that
financial statements reported on by the predecessor auditor may require revision, he should request his client to
arrange a meeting among the three parties to discuss this information and attempt to resolve the matter. If the client
refuses or if the successor is not satisfied with the result, the successor auditor may be well advised to consult with
his attorney in determining an appropriate course of further action.

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