3
Auditing and
Attestation
by Vincent W. Lambers, MBA, CPA and
Richard DelGaudio, MBA, CPA
Published by
Copyright © 2006 by Lambers CPA Review.
All rights reserved. No part of this publication may be reproduced in any form without the
written permission of the publisher.
2006
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 effective 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 them with your instructor or write to:
Lambers CPA Review Attn: Richard DelGaudio, CPA Coordinator, Auditing Programs
203 Turnpike Street, Suite 120 North Andover, MA 01845
______________________________________________________________________
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
Material from Uniform CPA Examination Questions and Unofficial Answers, copyright © 1977 through 2005 by the American Institute of Certified Public Accountants, Inc., is reprinted (or adapted) with permission.
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ACKNOWLEDGMENTS
It would be impossible to write a CPA examination book of any kind without the assistance of the American 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 North Andover, Massachusetts
Welcome to the CPA Exam!
If you have taken the CPA exam before, you are now facing a new exam format, including some new material. However, you should know that overall the exam content has not changed very much, probably less than 20%. What definitely has changed is the schedule for the CPA examination, not only in May and November, but offered at various times during the four quarters of the year.
The CPA Examination
The CPA exam is a computer-based test (CBT). There are four sections: Auditing &
Attestation (AUD), Financial Accounting & Reporting (FAR), Regulation (REG), and Business Environment & Concepts (BEC). Each section includes sets of multiple-choice questions (testlets). In addition, all sections, except the newest section, Business Environment and Concepts, contain a new case study component called “simulations.” Simulations provide a set of facts and require candidates to complete related tasks and access authoritative literature.
Signing up and taking the exam:
Candidates have significant flexibility in where and when they take the CPA examination.
The exam is administered at Prometric Test Centers. There are some 300 test centers throughout the United States; however, not all of them offer CPA exam testing. Candidates may take the exam five days a week during any testing window. Weekday hours are 9am to 6pm. Many locations have extended hours, and some test centers offer weekend testing.
International candidates are required to test within the 54 jurisdictions that currently administer the CPA examination.
There are four testing windows per year: January-February, April-May, July-August and October-November. In most jurisdictions, candidates are able to take any or all sections of the exam during any testing window; however, the candidate is not allowed to take the same section more than once during any testing window.
The Application Process. Requirements to take the CPA examination vary from state to state. Therefore, candidates should contact the state board in their jurisdiction when requesting an application to sit for one or more parts of the CPA exam. After being determined by a state board to be eligible to take the exam, the candidate will receive a Notice to Schedule (NTS) and can then make an appointment with Prometric on their web site, www.prometric.com/cpa, or by phone, or in person at a test center. Candidates are encouraged to schedule at least 45 days in advance. No candidate will be scheduled fewer than five days before testing
.
Call 1-800-CPA-EXAM if you are applying to:
Colorado, Connecticut, Delaware, Florida, Georgia, Hawaii, Indiana, Iowa, Kansas, Louisiana, Maine, Massachusetts, Michigan, Minnesota, Missouri, Montana, Nebraska, New Hampshire, New Jersey, New Mexico, New York, Ohio, Pennsylvania, Puerto Rico, Rhode Island, South Carolina, Tennessee, Utah, Vermont, Virginia, or Wisconsin.
Call the Board of Accountancy if you are applying to:
Alabama, Alaska, Arizona, Arkansas, California, District of Columbia, Guam, Idaho, Illinois, Kentucky, Maryland, Mississippi, Nevada, North Carolina, North Dakota, Oklahoma, Oregon, South Dakota, Texas, U.S. Virgin Islands, West Virginia, or Wyoming.
Call Castle Worldwide at 1-800-655-4845 if applying to Washington.
Notice to Schedule (NTS). Your NTS will contain an “examination password” that you must enter on the computer as part of the log-in process. You will not be admitted to the test center without the NTS, and all exam fees will be forfeited for that section. Be sure your identification exactly matches the name on the NTS. Also, do not apply for the exam until you are ready to take it, because the NTS could expire in six months, won’t be extended and all fees lost. A six-month NTS validation period has been established in all jurisdictions except the following:
TEXAS CALIFORNIA NORTH DAKOTA SOUTH DAKOTA LOUISIANA 3 MONTHS 9 MONTHS 12 MONTHS 12 MONTHS 18 MONTHS
EXAMINATION SECTIONS
New Section Length Hours Old exam counterpart Auditing and Attestation 4.5 Auditing
Regulation (1) 3.0 Law & Professional Responsibility Financial Accounting and Same – See note below
Reporting (2) 4.0
Business Environment & Managerial and Cost Accounting
Concepts (3) 2.5
The entire CPA examination length is 14 hours.
(1) Includes Federal Income Tax 60%, Law and Professional Responsibility 40%
(2) Includes Fund Accounting and Not-for-Profit Organizations 20%
(3) Includes several new subjects, such as economic concepts and information technology, and traditional exam subjects, but in greater depth.
(See Content Specifications at the end of this section.)
Candidates take different, equivalent exams consisting of items from a pool of test questions according to defined specifications. The specifications ensure that the results are comparable. The test package delivered to the test centers contains the test items, and also the rules for administering the tests. All items are classified according to content and statistical properties before they are administered in an operational test. The testing software ensures that each candidate’s test contains appropriate content coverage and difficulty.
RECOGNITION OF PARTIAL CREDIT UNDER OLD EXAM FORMAT
For those who have conditioning credit after the last paper and pencil exam in November 2003, credit is recognized for the new exam as follows:
Credit on Paper-based Exam Will earn CBT credit
Auditing AUD Auditing & Attestation
Law and Professional Responsibility LPR Business Environment & Concepts Accounting & Reporting ARE Regulation
Financial Accounting & Reporting FARE Financial Accounting & Reporting
RELEASE OF GRADES
Distribution of grades is the responsibility of the state boards of accountancy. Advisory grades and diagnostic information will be provided to state boards at the end of the third month of each testing cycle or testing window. For example, grades should be available to state boards for the April-May testing period at the end of June. The passing standard for the computer-based version of the Uniform CPA Examination is set at a scaled score of 75.
Once you pass a section(s) of the examination, you will likely be allowed a maximum of 18 months to pass all remaining sections in order to retain credit on the passed section(s).
AICPA EXAM TUTORIAL
A CPA examination tutorial prepared and tested by the CBT exam Steering Group is available at www.cpa-exam.org. The tutorial covers the revised exam’s look, feel, and functionality, as well as offers both guided and self-directed instructions. The tutorial does not replace practice materials according to the CBT Steering Group of the AICPA.
Candidates are strongly advised to review the tutorial before taking the computer-based CPA examination.
TYPES OF QUESTIONS ON THE CPA EXAMINATION MULTIPLE-CHOICE QUESTIONS AND SIMULATIONS
I. The majority of the computer-based CPA exam (70-80 percent) is made up of multiple- choice questions. Each section of the examination consists of “testlets” which are the multiple-choice questions (24-30 questions), and 2 “simulations.” Part Four, Business Environment and Concepts (BEC), has only multiple-choice questions. BEC simulations will be added later.
The testlets will be “tracked” in that the second and third testlet will be adjusted by the computer to an easier or harder version. This will be based on the candidate’s performance on the first testlet. The candidate won’t know what version is on his/her computer screen.
The third testlet may or may not be adjusted up or down. The system is equitable because the grading is also adjusted according to the track of the questions; if the student has a hard track, fewer questions need to be answered correctly; likewise, an easy track requires that more answers be correct.
During the exam, within each testlet, you may review and change any of your answers.
Once you have exited the testlet, you will not be able to access your answers to any of the questions. The same is true for the simulations portion of the exam. Note that the
time clock on the screen is “cumulative” and indicates the time left for the entire exam, not just a portion.
II. While the majority of the test is multiple-choice questions, a key part of the exam is the
“simulation” question. According to the AICPA web site, simulations “are condensed case studies that will test candidates’ knowledge and skills using real life work- related situations.” The CPA exam candidate can expect two simulations to appear in each section with the exception of Part Four-Business Environment and Concepts. The simulations will take an estimated 35-45 minutes to complete, and will require the following:
“CPA candidates are expected to know how to use common spreadsheet and word processing functions, including writing formulae for spreadsheets. They must also have the ability to use a four-function calculator or a spreadsheet to perform standard financial calculations. In addition, candidates will be asked to use online authoritative literature. Many of the question types used in the simulations are based on familiar computer interface controls (e.g., text entry, mouse clicks, highlighting, copy and pasting).
In order to become familiar with the electronic tools provided for research questions, further practice may be required.”1
Available resources during the test will depend on the simulation that the candidate receives. Incorporated into the simulation portion of the exam is an assessment of written communication skills. The exam tests typical communications an entry-level CPA would write on the job, such as memoranda, client letters, etc.
The AICPA web site displays “screen shots” utilized for the simulations. The work tabs on top of the screen direct the tasks to be performed and are highlighted by a pencil which becomes shaded once the task is complete. Simulations typically include multiple-choice questions and/or written elements such as correspondence to a client. To become familiar with navigating the computerized exam screen, it is strongly advised that the candidate visit the AICPA web site tutorial.
The CPA Exam consists of the following:
Auditing & Attestation: 3 MCQ testlets and 2 simulations Regulation: 3 MCQ testlets and 2 simulations Financial Accounting & Reporting: 3 MCQ testlets and 2 simulations Business Environment & Concepts: 3 MCQ testlets
AICPA web site on simulations: Visit this site to become familiar with the computer format of simulated problems on the new CPA exam:
http://www.cpa-exam.org/lrc/exam_tutorial.html
1 AICPA web site
Entry-level CPA skills to be measured:
Analysis: The ability to organize, process, and interpret data to develop options for decision making.
Judgment: The ability to evaluate options for decision-making and provide an appropriate conclusion.
Communication: The ability to effectively elicit and/or express information through written or oral means.
Research: The ability to locate and extract relevant information from available resource materials.
Understanding: The ability to recognize and comprehend the meaning and application of a particular matter.
Writing skills to be graded:
1. Coherent Organization. Candidates should organize responses so ideas are arranged logically and the flow of thought is easy to follow. Generally, short paragraphs composed of short sentences, with each paragraph limited to the development of one principal idea, can best emphasize the main points in the answer. Each principal idea should be placed in the first sentence of the paragraph, followed by supporting concepts and examples.
2. Conciseness. Candidates should present complete thoughts in the fewest possible words while ensuring important points are covered adequately. Short sentences and simple wording also contribute to concise writing.
3. Clarity. A clearly written response prevents uncertainty about the candidate’s meaning or reasoning. Clarity involves using words with specific meanings, including proper technical terminology. Well-constructed sentences also contribute to clarity.
4. Use of Standard English. Responses should be written using Standard English.
Standard English is used to carry on the daily business of the nation. It is the language of business, industry, government, education, and the professions.
Standard English is characterized by exacting standards of punctuation and capitalization, by accurate spelling, by exact diction, by an expressive vocabulary, and by knowledgeable choices.
5. Responsiveness to the Requirements of the Question. Answers should address the requirements of the question directly and demonstrate the candidate’s awareness of the purpose of the writing task. Responses should not be broad expositions on the general subject matter.
6. Appropriateness for the Reader. Writing appropriate for the reader takes into account the reader’s background, knowledge of the subject, interests and concerns.
Some questions may ask candidates to prepare a document for a certain reader, such as an engagement memorandum for a CPA’s client.
M
ENTAL ANDT
ECHNICALP
REREQUISITES FORS
UCCESS ON THECPA E
XAMThe exam is a test of your overall technical competency, a test to measure judgment and intelligence in the application of accounting principles, auditing standards, and procedures to practical problems, and to evaluate professional ethics. You are being tested on a basic level of knowledge in a broad spectrum of areas.
Your preparation should be geared to obtaining three things:
A Basic Technical Knowledge in All Areas. The emphasis here is on basics. You don’t need to know all the intricacies involved in any particular subject. What you do need to know are the major issues involved and you need to have a solid understanding of the underlying principles and concepts so you can respond to different types of questions and unfamiliar fact patterns.
Exam-Taking Skills. You need weapons. You need exam-taking skills and techniques for each subject area. These will allow you to win the maximum amount of points in the shortest amount of time. The only way you can develop your skill is to PRACTICE by working hundreds of exam questions in each topic area so that answering them correctly becomes second nature. Also, don’t forget to demonstrate good writing skills on all essay responses.
Confidence. When you walk into that exam, you must be confident. This confidence will come as a by-product of the above two elements. To quote a former successful Lambers student, “Study the material,……solve as many multiple-choice questions as your schedule permits. Although this is a very difficult exam, do not get discouraged.
If you are prepared….you will pass this exam.”
Strategies for Answering Objective Questions
1.) Cover (or do not look) at the answers. They are sometimes misleading and may confuse you before you have worked the question. Covering the answers keeps you from turning one simple question into four true or false questions. Also, in many cases, two or more choices may look plausible (and in fact, both may be technically correct), but you are asked to pick the best answer. For these reasons, it is critical that you cover the answers so you can think and formulate your own response first.
2.) Read the last sentence first. Generally, this will tell you the requirements.
3.) Decide on your answer or perform the appropriate calculations if a numerical response is required--still not looking at the answers.
Read the alternatives. If one agrees with yours, select it and move on. If your answer is close, see if it is due to a procedural error. If your answer is totally out of line, reread the requirements and body to see what was missed. If all else fails, try to eliminate any answer choices and make your best guess.
General Comments and Pitfalls to Avoid
1.) Work individual questions in order. Make sure you answer everything.
Remember, there is no penalty for guessing.
2.) Watch for wrong-choice indicators; words like, “always,” “never,” “only,”
“under no circumstances,” “identical,” etc. These words are usually there for a reason…and that’s to indicate the incorrect answer.
3.) Watch for negatively stated questions. For example, “Which of the following is not a characteristic of effective internal control?”
Goal Setting: Your goal is to become a CPA, a professional. That will mean financial security, the opportunity for more fulfilling positions, possibly the opportunity to start your own firm. Keep your ultimate goals in mind as you begin. You must stay focused throughout your preparation period, and work every day to make that goal a reality.
Visualize your Goal: In the flux of daily life, it’s easy to lose sight of your goals. As the saying goes, “When you’re knee-high in alligators, it’s easy to forget your objective was to drain the swamp.” You need to visualize your goals on a daily basis. Picture yourself sitting in a plush office as the CFO of a major company, or imagine yourself owning your own firm.
Expect to achieve your goal; keep a positive attitude.
Organization and Focus: Focus on your objective; do not let minor things distract you.
Organize your life to accommodate the time you need to devote to preparation.
Discipline: This means studying when you feel like it and when you don’t. Passing the CPA exam is earned day in and day out. You cannot neglect studying and cram for the exam.
One more helpful hint…..do you really want to go through the whole process over again if you don’t stick with it and do it right the first time?
Make the commitment, and good luck with your studies!
Benefits of Becoming a CPA
First, a little background on the Certified Public Accountant (CPA) designation. The first CPA examination was offered in the state of New York in 1896* and shortly thereafter other states offered an examination for candidates aspiring to be CPA’s. Now all states and territories offer examinations for those wishing to become CPA’s. Unlike many other professional designations, CPA’s are licensed by the state(s) to practice the “attest to”
function. This allows the CPA to attest, in the form of an opinion, as to the condition of the financial statements provided by management. The CPA’s opinion may vary from outright refusal to be associated with the statements to acceptance of the statements as fairly representing the financial condition of the enterprise. In carrying out the attest function and other work, the CPA must adhere to certain auditing standards of performance including, but not limited to, independence and designated audit procedures.
The attest function carries with it a heavy responsibility because the CPA’s opinion is heavily relied upon by leaders, investors and others who have an interest in the condition of a particular enterprise. Besides the attest function, the CPA’s association with other work, such as tax work, carries with it a presumption of excellence because of the standards that are required of CPA’s.
Individuals who are CPA’s are looked up to in the world of finance and industry especially where accountability is a factor, which is almost always the case. Whether the CPA is in public practice or in an executive position, the designation is recognized as a standard of excellence. Naturally, enterprises in general are willing to pay for the presumption of excellence that the CPA demonstrates, which for the individual results in increased income.
Using the world-famous cliché, the “bottom line” is that the CPA enjoys prestige, higher income, financial security and independence to a much greater extent than the same person without it.
Vincent W. Lambers
President, Lambers CPA Review
*An excerpt from the New York State Certified Public Accountant Examination, December 1896, a Theory of Accounts question with full answer:
I. State the essential principles of double entry bookkeeping and show wherein it differs from single entry bookkeeping.
The essential principles of double entry bookkeeping are, (1) The record of every transaction involving the transfer of money or its equivalent must appear on both the debit and credit side of the ledger, thus maintaining it in balance. (2) Provision must be made for the constant differentiation under properly classified accounts of capital and revenue income and expenditure. (3) As resulting therefrom, the profit or loss determined from the collection of the preponderance of the balance of the revenue accounts must be proved by the excess of the assets over the liabilities as exhibited in the balance sheet.
The fundamental difference between single and double entry bookkeeping is this: In single entry the income and expenditure accounts are not kept, and the profit or loss for any given period is determinable solely from a comparison of the assets with the liabilities—the excess of the one over the other showing the profit or loss; the proof of the accuracy of same, though the same result being arrived at through the profit and loss account being entirely wanting.
Of minor importance also is the fact that the mathematical accuracy of the posting is in single entry bookkeeping undemonstrable in trial balance form, as in double entry.
CPA EXAMINATION: CONTENT SPECIFICATION OUTLINE
AUDITING & ATTESTATION CONTENT SPECIFICATION OUTLINE
I. PLAN THE ENGAGEMENT, EVALUATE THE PROSPECTIVE CLIENT AND ENGAGEMENT, DECIDE WHETHER TO ACCEPT OR CONTINUE THE CLIENT AND THE ENGAGEMENT, AND ENTER INTO AN AGREEMENT WITH THE CLIENT (22%- 28%)
A. Determine nature and scope of engagement
1. Auditing standards generally accepted in the United States of America (GAAS)
2. Standards for accounting and review services 3. Standards for attestation engagements
4. Compliance auditing applicable to governmental entities and other recipients of governmental financial assistance
5. Other assurance services
6. Appropriateness of engagement to meet client’s needs
B. Assess engagement risk and the CPA firm’s ability to perform the engagement 1. Engagement responsibilities
2. Staffing and supervision requirements 3. Quality control considerations
4. Management integrity
5. Researching information sources for planning and performing the engagement
C. Communicate with the predecessor accountant or auditor
D. Decide whether to accept or continue the client and engagement
E. Enter into an agreement with the client about the terms of the engagement F. Obtain an understanding of the client’s operations, business, and industry G. Perform analytical procedures
H. Consider preliminary engagement materiality
I. Assess inherent risk and risk of misstatements from errors, fraud, and illegal acts by clients
J. Consider other planning matters
1. Using the work of other independent auditors 2. Using the work of a specialist
3. Internal audit function
4. Related parties and related party transactions 5. Electronic evidence
6. Risks of auditing around the computer
K. Identify financial statement assertions and formulate audit objectives
1. Significant financial statement balances, classes of transactions, and disclosures
2. Accounting estimates
L. Determine and prepare the work program defining the nature, timing, and extent of the procedures to be applied.
II. CONSIDER INTERNAL CONTROL IN BOTH MANUAL AND COMPUTERIZED ENVIRONMENTS (12%-18%) A. Obtain an understanding of business processes and information flows
B. Identify controls that might be effective in preventing or detecting misstatements C. Document an understanding of internal control
D. Consider limitations of internal control
E. Consider the effects of service organizations on internal control F. Perform tests of controls
G. Assess control risk
III. OBTAIN AND DOCUMENT INFORMATION TO FORM A BASIS FOR CONCLUSIONS (32%-38%) A. Perform planned procedures
1. Applications of audit sampling 2. Analytical procedures
3. Confirmation of balances and/or transactions with third parties 4. Physical examination of inventories and other assets
5. Other tests of details
6. Computer-assisted audit techniques, including data interrogation, extraction and analysis
7. Substantive tests before the balance sheet date 8. Tests of unusual year-end transactions
B. Evaluate contingencies
C. Obtain and evaluate lawyers’ letters D. Review subsequent events
E. Obtain representations from management
F. Identify reportable conditions and other control deficiencies G. Identify matters for communication with audit committees
H. Perform procedures for accounting and review services engagements I. Perform procedures for attestation engagements
IV. REVIEW THE ENGAGEMENT TO PROVIDE REASONABLE ASSURANCE THAT OBJECTIVES ARE ACHIEVED AND EVALUATE INFORMATION OBTAINED TO REACH AND TO DOCUMENT ENGAGEMENT CONCLUSIONS
(8%-12%)
A. Perform analytical procedures
B. Evaluate the sufficiency and competence of audit evidence and document engagement conclusions
C. Evaluate whether financial statements are free of material misstatements
D. Consider whether substantial doubt about an entity’s ability to continue as a going concern exists
E. Consider other information in documents containing audited financial statements
F. Review the work performed to provide reasonable assurance that objectives are achieved V. PREPARE COMMUNICATIONS TO SATISFY ENGAGEMENT OBJECTIVES (12%-18%)
A. Reports
1. Reports on audited financial statements
2. Reports on reviewed and compiled financial statements 3. Reports required by Government Auditing Standards 4. Reports on compliance with laws and regulations 5. Reports on internal control
6. Reports on prospective financial information 7. Reports on agreed-upon procedures
8. Reports on the processing of transactions by service organizations 9. Reports on supplementary financial information
10. Special reports
11. Reports on other assurance services 12. Reissuance of reports
B. Other required communications 1. Errors and fraud 2. Illegal acts
3. Communications with audit committees
4. Other reporting considerations covered by statements on auditing standards and statements on standards for attestation engagements
C. Other matters
1. Subsequent discovery of facts existing at the date of the auditor’s report 2. Consideration after the report date of omitted procedures
FINANCIAL ACCOUNTING & REPORTING CONTENT SPECIFICATION OUTLINE I. CONCEPTS AND STANDARDS FOR FINANCIAL STATEMENTS (17%-23%)
A. Financial accounting concepts
1. Process by which standards are set and roles of standard-setting bodies 2. Conceptual basis for accounting standards
B. Financial accounting standards for presentation and disclosure in general-purpose financial statements
1. Consolidated and combined financial statements 2. Balance sheet
3. Statement(s) of income, comprehensive income and changes in equity accounts 4. Statement of cash flows
5. Accounting policies and other notes to financial statements
C. Other presentations of financial data (financial statements prepared in conformity with comprehensive bases of accounting other than GAAP)
D. Financial statement analysis
II. TYPICAL ITEMS: RECOGNITION, MEASUREMENT, VALUATION, AND PRESENTATION IN FINANCIAL STATEMENTS IN CONFORMITY WITH GAAP(27%-33%)
A. Cash, cash equivalents and marketable securities B. Receivables
C. Inventories
D. Property, plant, and equipment E. Investments
F. Intangibles and other assets G. Payables and accruals H. Deferred revenues I. Notes and bonds payable J. Other liabilities
K. Equity accounts
L. Revenues, cost, and expense accounts
III. SPECIFIC TYPES OF TRANSACTIONS AND EVENTS: RECOGNITION, MEASUREMENT, VALUATION, AND PRESENTATION IN FINANCIAL STATEMENTS IN CONFORMITY WITH GAAP(27%-33%)
A. Accounting changes and corrections of errors B. Business combinations
C. Contingent liabilities and commitments D. Discontinued operations
E. Earnings per share
F. Employee benefits, including stock options G. Extraordinary items
H. Financial instruments, including derivatives I. Foreign currency transactions and translation J. Income taxes
K. Interest costs
L. Interim financial reporting M. Leases
N. Non-monetary transactions O. Related parties
P. Research and development costs Q. Segment reporting
R. Subsequent events
IV. ACCOUNTING AND REPORTING FOR GOVERNMENTAL ENTITIES (8%-12%) A. Governmental accounting concepts
1. Measurement focus and basis of accounting 2. Fund accounting concepts and application 3. Budgetary process
B. Format and content of governmental financial statements 1. Government-wide financial statements
2. Governmental funds financial statements
4. Proprietary fund financial statements 5. Fiduciary fund financial statements 6. Notes to financial statements
7. Required supplementary information, including management’s discussion and analysis
8. Comprehensive annual financial report (CAFR)
C. Financial reporting entity including blended and discrete component units D. Typical items and specific types of transactions and events:
recognition, measurement, valuation and presentation in governmental entity financial statements in conformity with GAAP
1. Net assets
2. Capital assets and infrastructure 3. Transfers
4. Other financing sources and uses 5. Fund balance
6. Non-exchange revenues 7. Expenditures
8. Special items 9. Encumbrances
E. Accounting and financial reporting for governmental not-for-profit organizations V. ACCOUNTING AND REPORTING FOR NONGOVERNMENTAL NOT-FOR-PROFIT ORGANIZATIONS (8%-12%)
A. Objectives, elements and formats of financial statements 1. Statement of financial position
2. Statement of activities 3. Statement of cash flows
4. Statement of functional expenses
B. Typical items and specific types of transactions and events:
recognition, measurement, valuation and presentation in the financial statements of not- for-profit organizations in conformity with GAAP
1. Revenues and contributions 2. Restrictions on resources
3. Expenses, including depreciation and functional expenses 4. Investments
REGULATION CONTENT SPECIFICATION OUTLINE I. ETHICS AND PROFESSIONAL AND LEGAL RESPONSIBILITIES (15%-20%)
A. Code of Professional Conduct
B. Proficiency, independence, and due care C. Ethics and responsibilities in tax practice
D. Licensing and disciplinary systems imposed by the profession and state regulatory bodies E. Legal responsibilities and liabilities
1. Common law liability to clients and third parties 2. Federal statutory liability
F. Privileged communications and confidentiality II. BUSINESS LAW (20%-25%)
A. Agency
1. Formation and termination
2. Duties and authority of agents and principals 3. Liabilities and authority of agents and principals B. Contracts
1. Formation 2. Performance
3. Third-party assignments
4. Discharge, breach, and remedies C. Debtor-creditor relationships
1. Rights, duties, and liabilities of debtors, creditors, and guarantors 2. Bankruptcy
D. Government regulation of business 1. Federal securities acts
2. Other government regulation (antitrust, pension and retirement plans, union and employee relations, and legal liability for payroll and social security taxes) E. Uniform commercial code
1. Negotiable instruments and letters of credit 2. Sales
3. Secured transactions
4. Documents of title and title transfer F. Real property, including insurance
III. FEDERAL TAX PROCEDURES AND ACCOUNTING ISSUES (8%-12%) A. Federal tax procedures
B. Accounting periods
C. Accounting methods including cash, accrual, percentage of completion, completed contract, and installment sales
D. Inventory methods, including uniform capitalization rules IV. FEDERAL TAXATION OF PROPERTY TRANSACTIONS (8%-12%)
A. Types of assets B. Basis of assets
C. Depreciation and amortization
D. Taxable and nontaxable sales and exchanges
E. Income, deductions, capital gains and capital losses, including sales and exchanges of business property and depreciation recapture
V. FEDERAL TAXATION – INDIVIDUALS (12%-18%) A. Gross income—inclusions and exclusions
B. Reporting of items from pass-through entities, including passive activity losses C. Adjustments and deductions to arrive at taxable income
D. Filing status and exemptions
E. Tax computations, credits, and penalties F. Alternative minimum tax
G. Retirement plans
H. Estate and gift taxation, including transfers subject to the gift tax, annual exclusion, and items includible and deductible from gross estate
VI. FEDERAL TAXATION—ENTITIES (22%-28%)
A. Similarities and distinctions in tax reporting among such entities as sole proprietorships, general and limited partnerships, Subchapter C corporations, Subchapter S corporations, limited liability companies, and limited liability partnerships
B. Subchapter C corporations
1. Determination of taxable income and loss, and reconciliation of book income to taxable income
2. Tax computations, credits, and penalties, including alternative minimum tax 3. Net operating losses
4. Consolidated returns
5. Entity/owner transactions, including contributions and distributions C. Subchapter S corporations
1. Eligibility and election
2. Determination of ordinary income, separately stated items, and reconciliation of book income to taxable income
3. Basis of shareholder’s interest
4. Entity/owner transactions, including contributions and liquidating and nonliquidating distributions
5. Built-in gains tax D. Partnerships
1. Determination of ordinary income, separately stated items, and reconciliation of book income to taxable income
2. Basis of partner’s interest and basis of assets contributed to the partnership
3. Partnership and partner elections 4. Partner dealing with own partnership 5. Treatment of partnership liabilities 6. Distribution of partnership assets
7. Ownership changes and liquidation and termination of partnership E. Trusts
1. Types of trusts
2. Income and deductions
3. Determination of beneficiary’s share of taxable income
BUSINESS ENVIRONMENT & CONCEPTS CONTENT SPECIFICATION OUTLINE I. BUSINESS STRUCTURE (17%-23%)
A. Advantages, implications, and constraints of legal structures for business 1. Sole proprietorships and general and limited partnerships
2. Limited liability companies (LLC), limited liability partnerships (LLP), and joint ventures
3. Subchapter C and subchapter S corporations B. Formation, operation, and termination of businesses
C. Financial structure, capitalization, profit and loss allocation, and distributions
D. Rights, duties, legal obligations, and authority of owners and management (directors, officers, stockholders, partners, and other owners)
II. ECONOMIC CONCEPTS ESSENTIAL TO OBTAINING AN UNDERSTANDING OF AN ENTITY’S BUSINESS AND INDUSTRY (8%-12%)
A. Business cycles and reasons for business fluctuations
B. Economic measures and reasons for changes in the economy, such as inflation, deflation and interest rate changes
C. Market influences on business strategies, including selling, supply chain, and customer management strategies
D. Implications to business of dealings in foreign currencies, hedging and exchange rate fluctuations
III. FINANCIAL MANAGEMENT (17%-23%)
A. Financial modeling, including factors such as financial indexes, taxes and opportunity costs, and models such as economic value added, cash flow, net present value, discounted payback, and internal rate of return
1. Objectives 2. Techniques 3. Limitations
B. Strategies for short-term and long-term financing options, including cost of capital and derivatives
C. Financial statement and business implications of liquid asset management
1. Management of cash and cash equivalents, accounts receivable, accounts payable, and inventories.
2. Characteristics and financial statement and business implications of loan rates (fixed vs. variable)and loan covenants
IV. INFORMATION TECHNOLOGY (IT) IMPLICATIONS IN THE BUSINESS ENVIRONMENT (22%-28%) A. Role of business information systems
1. Reporting concepts and systems 2. Transaction processing systems 3. Management reporting systems 4. Risks
B. Roles and responsibilities within the IT function
1. Roles and responsibilities of database/network/Web administrators, computer operators, librarians, systems programmers and applications programmers 2. Appropriate segregation of duties
C. IT fundamentals
1. Hardware and software, networks, and data structure, analysis, and application, including operating systems, security, file organization, types of data files, and database management systems
2. Systems operation, including transaction processing modes, such as batch, on- line, real-time, and distributed processing, and application processing phases, such as data capture, edit routines, master file maintenance; reporting, accounting, control, and management; query, audit trail, and ad hoc reports; and transaction flow
D. Disaster recovery and business continuity, including data backup and data recovery procedures, alternate processing facilities (hot sites), and threats and risk management E. Financial statement and business implications of electronic commerce, including electronic
fund transfers, point of sale transactions, internet-based transactions and electronic data interchange
V. PLANNING AND MEASUREMENT (22%-28%) A. Planning and budgeting
1. Planning techniques, including strategic and operational planning 2. Forecasting and projection techniques
3. Budgeting and budget variance analysis B. Performance measures
1. Organizational performance measures, including financial and nonfinancial scorecards
2. Benchmarking, including quality control principles, best practices, and benchmarking techniques
C. Cost measurement
1. Cost measurement concepts (standard, joint product, and by-product costing)
2. Accumulating and assigning costs (job order, process, and activity-based costing)
3. Factors affecting production costs
Chapter One
Introduction, General and Field Standards
INTRODUCTION
OBJECTIVE OF THE ORDINARY EXAMINATION OF FINANCIAL STATEMENTS ... 1-1 STANDARD SHORT-FORM AUDITOR'S REPORT —UNQUALIFIED... 1-1 DISTINCTION BETWEEN RESPONSIBILITIES OF AUDITOR AND MANAGEMENT ... 1-2 GENERALLY ACCEPTED AUDITING STANDARDS ... 1-2 OVERVIEW OF THE AUDIT PROCESS ... 1-3
DECISION TO ACCEPT A CLIENT
GENERAL STANDARDS ... 1-4 COMMUNICATIONS BETWEEN PREDECESSOR AND SUCCESSOR AUDITORS
(SAS No. 84) ... 1-5
DOCUMENT ENGAGEMENT UNDERSTANDING
OVERVIEW... 1-6 SAMPLE ENGAGEMENT LETTER... 1-7
PLANNING THE ENGAGEMENT
THE FIRST STANDARD OF FIELD WORK ... 1-8
REVIEW AND EVALUATION OF THE INTERNAL CONTROL STRUCTURE (SAS No. 55 as amended)
THE SECOND STANDARD OF FIELD WORK
Definition of Internal Control and Components ... 1-9 Objectives of Internal Control ... 1-10 Limitations of an Entity's Internal Control ... 1-10 Consideration of Internal Control in Planning an Audit - Auditor's Responsibility ... 1-10 Auditor's Responsibility—Documentation of Understanding of Controls ... 1-13 Auditor's Responsibility—Assessing Control Risk ... 1-14 Transaction Cycles and Internal Control Components ... 1-17 Application to Small and Mid-sized Entities ... 1-26 Effect of Information Technology – Auditor’s Consideration of Internal Control... 1-26 Communication of Internal Control Related Matters Noted in an Audit (SAS No. 60) ... 1-27
CONSIDERATION OF FRAUD IN A FINANCIAL STATEMENT AUDIT (SAS No. 99)
DESCRIPTION AND CHARACTERISTICS OF FRAUD... 1-28 DISCUSSION OF THE RISKS OF MATERIAL MISSTATEMENT DUE TO FRAUD ... 1-29 RESPONDING TO THE RESULTS OF THE ASSESSMENT ... 1-32 EVALUATING AUDIT TEST RESULTS ... 1-32 COMMUNICATING ABOUT FRAUD TO MANAGEMENT, THE AUDIT COMMITTEE,
AND OTHERS ... 1-33 DOCUMENTING THE AUDITOR'S CONSIDERATION OF FRAUD ... 1-34
ILLEGAL ACTS BY CLIENTS (SAS No. 54)
DEFINITION OF ILLEGAL ACTS ... 1-34 RELATION OF ILLEGAL ACTS TO THE FINANCIAL STATEMENTS... 1-34 EFFECTS ON AUDITOR'S REPORT... 1-35
THE AUDITOR’S CONSIDERATION OF THE INTERNAL AUDIT FUNCTION IN AN AUDIT OF FINANCIAL STATEMENTS (SAS No. 65)
REQUIREMENTS ... 1-36 REVIEWING THE COMPETENCE AND OBJECTIVITY OF INTERNAL AUDITORS ... 1-36 EVALUATING THE WORK OF INTERNAL AUDITORS ... 1-37 ARRANGEMENTS WITH INTERNAL AUDITORS... 1-37 USING INTERNAL AUDITORS TO PROVIDE DIRECT ASSISTANCE TO THE
INDEPENDENT AUDITOR... 1-37 JUDGMENTS ON AUDIT MATTERS... 1-37
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 on 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.
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.
(See S.A.S. No. 82 for a complete discussion of the auditor's responsibility to detect fraud.)
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).
General Standards
1. The examination is to 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 work is to be adequately planned, and assistants, if any, are to be properly supervised.
2. The auditor should obtain a sufficient understanding of the internal control structure to plan the audit and to determine the nature, timing, and extent of tests to be performed.
3. Sufficient competent evidential matter is to be obtained through inspection, observation, inquiries, and confirmations to afford a reasonable basis for an opinion regarding the financial statements under examination.
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.
OVERVIEW OF THE AUDIT PROCESS
Decision Criteria 1. Independence
Decision to Rule 101 Code
Accept Client of Ethics
GAAS
A
.2. Competency Rule 201 Code
Of Ethics GAAS
3. Predecessor Auditor Document Engagement Understanding
B.
(Engagement Letter)
Plan Audit
1. Obtain Information on:
a. Management
C.
b. Industry 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 Outcomes
Plan level Confirms
of Reliance Planned
needs to level of
be modified reliance
Decision on Audit Risk a. Potential for Errors b. Potential for Illegal Acts c. Potential for Fraud
D.
Update Planned Go with
Audit Program original plan
Developed in as developed
C4 above in C4 above
Perform Substantial Audit Tests
E.
A Extraordinary Results Nothing 1. Errors extraordinary
2. Fraud encountered
3. Illegal Acts Update Programs
after discussions with client
Obtain
Representation Letter
F.
Propose Necessary Adjusting Entries
G.
Rejected Accepted
By client By client
Modify Issue opinion unqualified
appropriately opinion
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 examination is to be performed by a person or persons having adequate technical training and proficiency in auditing.
(This is normally interpreted to mean that the auditor has adequate formal training and a knowledge of the accounting principles used by the client.)
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.
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.
