Auditing & Assurance Service Exam 3 potential essay questions

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Ch #17:

1.What is meant by the term ?contingency? and under what circumstances must a contingent loss be accrued (under what circumstances must a contingent loss instead be disclosed)?What evidence gathering procedures would an auditor normally perform to detect the existence of contingencies having financial statement impact?

2.What procedures would an auditor normally perform to identify those lawyers to whom a letter of inquiry should be sent regarding litigation, claims, and assessments?

3.If an attorney receives a letter of inquiry regarding litigation, claims, and assessments that omits an ?asserted claim,? what should the lawyer do?

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STUDY GUIDE (Potential Essay Questions) for Final Exam: Ch #17: 1. What is meant by the term \"contingency\" and under what circumstances must a contingent loss be accrued (under what circumstances must a contingent loss instead be disclosed)? What evidence gathering procedures would an auditor normally perform to detect the existence of contingencies having financial statement impact? 2. What procedures would an auditor normally perform to identify those lawyers to whom a letter of inquiry should be sent regarding litigation, claims, and assessments? 3. If an attorney receives a letter of inquiry regarding litigation, claims, and assessments that omits an \"asserted claim,\" what should the lawyer do? 4. If an attorney receives a letter of inquiry regarding litigation, claims, and assessments that omits an \"unasserted claim,\" what should the lawyer do? 5. What effect would a lawyer's failure to respond to the auditor's inquiry regarding litigation, claims, and assessments have on the auditor's report? 6. Specifically for \"asserted claims,\" what information does the auditor request from the lawyer? 7. Define the term \"subsequent event\" affecting the financial statement presentation. 8. What evidence gathering procedures would an auditor normally perform to identify subsequent events that are material to the financial statements? 9. What is the purpose of obtaining a \"management representation letter\" that is required by AICPA professional standards? Who must sign the management representation letter and when must it be dated? 10. Identify 5 specific matters that are typically included among the representations in the management representations letter. 11. What is meant by the term \"related party transaction\" and what evidence gathering procedures would an auditor normally perform to identify the existence of related party transactions having financial statement impact? [See textbook regarding this issue.] Ch #18: 1. We discussed a number of circumstances whereby an auditor might issue an unqualified (\"unmodified\") audit report having an explanatory paragraph following the opinion paragraph. Identify and briefly discuss 3 such circumstances that would warrant the addition of an \"emphasis-of-matter paragraph\" and/or an \"other-matter paragraph\" without changing the unqualified opinion. 2. Describe the auditor's responsibilities with respect to \"other information\" when the audit report and financial statements are included in a client-submitted document that includes other information (such as management's discussion and analysis). 3. What are the auditors' responsibilities when they conclude that there is \"substantial doubt about the entity's ability to continue as a going concern\"? 4. Describe the various circumstances that would warrant a \"modified\" audit report (that is, express an audit opinion different than an unqualified opinion). 5. Given a sample audit report, identify the deficiencies (organized by paragraph). 6. Give 2 examples of an \"other comprehensive basis of accounting\" (other than GAAP) that is now referred to as a \"special-purpose framework\" for financial reporting. Ch #21: 1. Identify the 2 basic professional services associated with \"Statements on Standards for Accounting and Review Services.\" What evidence gathering procedures, if any, would the CPA perform with respect to these 2 types of professional services? 2. Given a sample review report (or a sample compilation report), identify the deficiencies. 3. What is meant by the term \"attest engagement\" as the AICPA uses the term? 4. Identify and briefly describe the specific attestation services that constitute the \"usual\" menu of attestation engagements, as discussed in class. 5. Identify (that is, state or accurately paraphrase) the 11 criteria formerly known as \"attestation standards\". Compare and contrast the attestation standards with GAAS. What similarities and differences exist? 6. What is meant by the term \"prospective\" financial information? Identify and briefly describe the 2 basic categories of prospective financial statements. Identify and briefly describe the types of attestation engagements that are permitted with respect to prospective financial statements. (In other words, what is the \"menu\" of attestation engagements involving prospective financial statements?) 1 STUDY GUIDE (Potential Essay Questions) for Final Exam: Ch #17: 1. What is meant by the term \"contingency\" is a future event or circumstance that is possible but cannot be predicted with certainty. And under what circumstances must a contingent loss be accrued (under what circumstances must a contingent loss instead be disclosed)? (1) Information available prior to the issuance of the financial statements indicates that it is probable that a liability has been incurred at the date of the financial statements, and (2) the amount of the loss can be reasonably estimated. What evidence gathering procedures would an auditor normally perform to detect the existence of contingencies having financial statement impact? a. Reconcile the amounts included in the statement of cash flows to the other financial statements' amounts. b. Vouch a sample of cash receipts and disbursements for the last few days of the current year. c. Reconcile the cutoff bank statement to the proof of cash to verify the accuracy of the year-end cash balance. d. Confirm the amounts included in the statement of cash flows with the entity's financial institution. 2. What procedures would an auditor normally perform to identify those lawyers to whom a letter of inquiry should be sent regarding litigation, claims, and assessments? Ordinarily, a two-week period should be allowed between the specified effective date of the lawyer's response and the latest date by which the response should be sent to the auditor. Clearly stating the relevant dates in the letter and specifying these dates to the lawyer in a timely manner will allow the responding lawyer an adequate amount of time to complete his review procedures and assist the auditor in coordinating the timing of the completion of his field work with the latest date covered by the lawyer's review. Further, the lawyer should be requested to specify the effective date of his response. If the lawyer's response does not specify an effective date, the auditor can assume that the date of the lawyer's response is the effective date. 3. If an attorney receives a letter of inquiry regarding litigation, claims, and assessments that omits an \"asserted claim,\" what should the lawyer do? The lawyer should provide a professional opinion about the expected outcome of existing lawsuits and the likely amount of the liability, including court costs. 4. If an attorney receives a letter of inquiry regarding litigation, claims, and assessments that omits an \"unasserted claim,\" what should the lawyer do? 2 The lawyer should provide a professional opinion about the expected outcome of existing lawsuits and the likely amount of the liability, including court costs. 5. What effect would a lawyer's failure to respond to the auditor's inquiry regarding litigation, claims, and assessments have on the auditor's report? It would lead to the formulation of a qualified or modified opinion by the auditor. This will be so to state categorically that the auditor has reservations on certain matters that were not clarified by the lawyer and hence a true and fair representation of the state of affairs of the firm is not reached. 6. Specifically for \"asserted claims,\" what information does the auditor request from the lawyer? The auditor relies on the attorney's expertise and knowledge of the client's legal affairs to provide a professional opinion about the expected outcome of existing lawsuits and the likely amount of the liability, including court costs. The attorney is also likely to know of pending litigation and claims that management may have overlooked. 7. Define the term \"subsequent event\" affecting the financial statement presentation. is an event that occurs after a reporting period, but before the financial statements for that period have been issued or are available to be issued. Depending on the situation, such events may or may not require disclosure in an organization's financial statements. 8. What evidence gathering procedures would an auditor normally perform to identify subsequent events that are material to the financial statements? Cutoff and valuation tests of various balances and related transactions; e.g., sales cutoff tests Inquire of management Correspond with attorneys Review internal statements prepared subsequent to the balance sheet date Review records prepared subsequent to the balance sheet date Examine minutes of meetings of board of directors and stockholders subsequent to the balance sheet date Obtain a letter of representation 3 9. What is the purpose of obtaining a \"management representation letter\" that is required by AICPA professional standards? Who must sign the management representation letter and when must it be dated? The purpose of management representation letter is to reduce the possibility of a misunderstanding concerning management's responsibility for the financial statements. It should be signed by the members of the management and should be signed at time of acceptance. 10. Identify 5 specific matters that are typically included among the representations in the management representations letter. 11. Management's acknowledgment of its responsibility for the fair presentation in the financial statements of financial position, results of operations, and cash flows in conformity with generally accepted accounting principles Management's belief that the financial statements are fairly presented in conformity with generally accepted accounting principles Availability of all financial records and related data Completeness and availability of all minutes of meetings of stockholders, directors, and committees of directors Communication from regulatory agencies concerning noncompliance with or deficiencies in financial reporting practices What is meant by the term \"related party transaction\" and what evidence gathering procedures would an auditor normally perform to identify the existence of related party transactions having financial statement impact? [See textbook regarding this issue.] A related party transaction is a transfer of resources, services, or obligations between related parties, regardless of whether a price is charged. Evidence gathering procedures would an auditor normally perform to identify the existence of related party transactions Obtaining a written representation letter from the client's management Examining documents to detect illegal acts having a material effect on the financial statements Considering whether the client's accounting estimates are reasonable in the circumstances Determining the extent of involvement of the client's internal auditors 4 Ch #18: 1. We discussed a number of circumstances whereby an auditor might issue an unqualified (\"unmodified\") audit report having an explanatory paragraph following the opinion paragraph. Identify and briefly discuss 3 such circumstances that would warrant the addition of an \"emphasis-of-matter paragraph\" and/or an \"other-matter paragraph\" without changing the unqualified opinion. -uncertainties such as going-concern: this arises when the auditor is uncertain about the operations of the company under the going concern principle due to a number of factors such as high gearing ratio and low liquidity position. -inconsistency of application of GAAP: this arises when the company diverts from application of generally accepted accounting principles in the preparation of accounting books and financial statements. -emphasis of a matter: this varies with the degree of misstatement that is made in the financial statements by the company having identified by the auditor. 2. Describe the auditor's responsibilities with respect to \"other information\" when the audit report and financial statements are included in a client-submitted document that includes other information (such as management's discussion and analysis). (a) Determine, through discussion with management, which document(s) comprises the annual report, and the entity's planned manner and timing of the issuance of such document(s); (b) Make appropriate arrangements with management to obtain in a timely manner and, if possible, prior to the date of the auditor's report, the final version of the document(s) comprising the annual report; and (c) When some or all of the document(s) determined in (a) will not be available until after the date of the auditor's report, request management to provide a written representation that the final version of the document(s) will be provided to the auditor when available, and prior to its issuance by the entity, such that the auditor can complete the procedures. 3. What are the auditors' responsibilities when they conclude that there is \"substantial doubt about the entity's ability to continue as a going concern\"? The auditor's responsibility is to evaluate whether there is substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time. The auditor's evaluation is based on the auditor's knowledge of relevant conditions or events that exist at, or have occurred prior to, the date of the auditor's report. 4. Describe the various circumstances that would warrant a \"modified\" audit report (that is, express an audit opinion different than an unqualified opinion). 1. The scope of the audit has been restricted. One example is when the client will not permit the auditor to confirm material receivables. Another example is when 5 the engagement is not agreed upon until after the client's year-end when it may be impossible to physically observe inventories. 2. The financial statements have not been prepared in accordance with generally accepted accounting principles. An example is when the client insists upon using replacement costs for fixed assets. 3. The auditor is not independent. An example is when the auditor owns stock in the client's business. 5. Given a sample audit report, identify the deficiencies (organized by paragraph). During the course of the audit we identified some areas in which there were significant deficiencies in the internal controls and accounting systems. We now outline what those deficiencies were, an explanation of their potential effects and our recommendation for improvement. Deficiencies are: Complex, non-routine transactions Unusual transactions Transactions outside the normal course of business 6. Give 2 examples of an \"other comprehensive basis of accounting\" (other than GAAP) that is now referred to as a \"special-purpose framework\" for financial reporting. Income-tax-basis financial statements Cash-basis and modified-cash-basis financial statements Ch #21: 1. Identify the 2 basic professional services associated with \"Statements on Standards for Accounting and Review Services.\" What evidence gathering procedures, if any, would the CPA perform with respect to these 2 types of professional services? Preparing the income statement and balance sheet for one year in the future based on client expectations and predictions. An engagement to report on compliance with statutory requirements. Gathering procedures Prospective financial statements (PFSs) present expected financial position, results of operations, and cash flows. They include forecasts and projections. A forecast is based on the responsible party's assumptions reflecting the conditions it expects to exist and the course of action it expects to take. Furthermore, a review is not permitted to be performed with regard to a forecast or projection. However, a practitioner may compile, examine, or apply agreed-upon procedures to a partial presentation, that is, a presentation of prospective financial information that omits one or more items required by the minimum presentation guidelines for PFSs. 6 2. Given a sample review report (or a sample compilation report), identify the deficiencies. During the course of the audit we identified some areas in which there were significant deficiencies in the internal controls and accounting systems. We now outline what those deficiencies were, an explanation of their potential effects and our recommendation for improvement. Deficiencies are: Complex, non-routine transactions Unusual transactions 3. What is meant by the term \"attest engagement\" as the AICPA uses the term? An attestation engagement is defined as an arrangement with a client where an independent third party makes investigations and reports on the subject matter created by a client. 4. Identify and briefly describe the specific attestation services that constitute the \"usual\" menu of attestation engagements, as discussed in class. 1 . Training: \"The practitioner must have adequate technical training and proficiency to perform the attestation engagement. \" 2. Knowledge: \"The practitioner must have adequate knowledge of the subject matter.\" 3. Criteria: \"The practitioner must have reason to believe that the subject matter is capable of evaluation against criteria that are suitable and available to users.\" 5. Identify (that is, state or accurately paraphrase) the 11 criteria formerly known as \"attestation standards\". Compare and contrast the attestation standards with GAAS. What similarities and differences exist? General Standards 1. The practitioner must have adequate technical training and proficiency to perform the attestation engagement. 2. The practitioner must have adequate knowledge of the subject matter. 3. The practitioner must have reason to believe that the subject matter is capable of evaluation against criteria that are suitable and available to users. 4. The practitioner must maintain independence in mental attitude in all matters relating to the engagement. 5. The practitioner must exercise due professional care in the planning and performance of the engagement and the preparation of the report. Standards of Fieldwork 6. The practitioner must adequately plan the work and must properly supervise any assistants. 7. The practitioner must obtain sufficient evidence to provide a reasonable basis for the conclusion that is expressed in the report. Standards of Reporting1 8. The practitioner must identify the subject matter or the assertion being reported on and state the character of the engagement in the report. 7 9. The practitioner must state the practitioner's conclusion about the subject matter or the assertion in relation to the criteria against which the subject matter was evaluated in the report. 10. The practitioner must state all of the practitioner's significant reservations about the engagement, the subject matter, and, if applicable, the assertion related thereto in the report. 11. The practitioner must state in the report that the report is intended solely for the information and use of the specified parties under the following circumstances: Similarities When the criteria used to evaluate the subject matter are determined by the practitioner to be appropriate only for a limited number of parties who either participated in their establishment or can be presumed to have an adequate understanding of the criteria. When the criteria used to evaluate the subject matter are available only to specified parties. When reporting on subject matter and a written assertion has not been provided by the responsible party. When the report is on an attestation engagement to apply agreed upon procedures to the subject matter Differences The objective of an independent, external audit in accordance with generally accepted auditing standards (GAAS) is to express an opinion on (attest to) whether an entity's financial statements present fairly, in all material respects, its financial position, results of operations, and cash flows in conformity with generally accepted accounting principles (GAAP). 2. Assertions a. Financial statements implicitly or explicitly include management's assertions about the fair presentation of information, that is, about its recognition, measurement, presentation, and disclosure. Most audit work consists of obtaining and evaluating evidence about these assertions. 6. What is meant by the term \"prospective\" financial information? Financial information based on assumptions about events that may occur in the future and possible action by the entity. Identify and briefly describe the 2 basic categories of prospective financial statements. Financial forecast -presents a company anticipated future financial position, results of operations and cash flows. Financial projection - present, given one or more hypothetical assumptions, an company's expected future financial, operations outcomes and cash flow. Identify and briefly describe the types of attestation engagements that are permitted with respect to prospective financial statements. (In other words, what is the \"menu\" of attestation engagements involving prospective financial statements?) Examination (positive assurance) -The AICPA has made it vibrant that the consultant is not attesting to the accurateness of the forthcoming financial 8 statements. In its place, the focus is on investigative the fundamental assumptions and the grounding and presentation of the projection. Compilation with no assurance Agreed-upon procedures on what they are in agreement. An engagement to review a forecast or projection is not permitted