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What is meant by the term level of assurance? How does the level of assurance differ for an audit of historical financial statements, a review, and a compilation?
What is negative assurance? Why is it used in a review engagement report?
Distinguish between compilation and review of financial statements. What is the level of assurance for each?
Distinguish the three forms of compilation reports that a CPA can provide to clients.
List five things that are required of an auditor by SSARS for a compilation.
What steps should auditors take if during a compilation engagement they become aware that the financial statements are misleading?
What procedures should the auditor use to obtain the information necessary to give the level of assurance required of reviews of financial statements?
What should auditors do if during a review of financial statements they discover that applicable accounting standards are not being followed?
What are the differences between the review reports for a private company under SSARS and for the interim financial statements of a public company?
Explain why a review of interim financial statements for a public company may provide a greater level of assurance than an SSARS review.
Define what is meant by attestation standards. Distinguish between attestation standards and auditing standards.
List the five Trust Services principles and explain whether a WebTrust licensed CPA can report on an entity's compliance with those principles individually or in combination.
Describe the purpose of a SysTrust assurance services engagement.
An audit client has engaged a third party service organization to host its payroll software package on servers located at the service organization. What options do you have to obtain assurance about the controls embedded in the payroll application?
Explain what is meant by prospective financial statements and distinguish between forecasts and projections. What four things are involved in an examination of prospective financial statements?
State the reporting requirements for statements prepared on a basis other than GAAP.
The Absco Corporation has requested that Herb Germany, CPA, provide a report to the Northern State Bank as to the existence or nonexistence of certain loan conditions. The conditions to be reported on are the working capital ratio, dividends paid on preferred stock, aging of accounts receivable, and competence of management.
This is Herb's first experience with Absco. Should Herb accept this engagement? Substantiate your answer.
Multiple Choice Questions
The following are miscellaneous questions about compilation and review services. Choose the best response.
a. It is acceptable for a CPA to be associated with financial statements when not independent with respect to the client and still issue a substantially unmodified report for which of the following:
(1) Audits of companies following GAAP.
(2) Audits of companies on a comprehensive basis of accounting other than GAAP.
(3) Review of financial statements following GAAP.
(4) Compilation of financial statements following GAAP.
b. A CPA is performing review services for a small, closely held manufacturing company.
As a part of the follow-up of a significant decrease in the gross margin for the current year, the CPA discovers that there are no supporting documents for $40,000 of disbursements. The chief financial officer assures her that the disbursements are proper. What should the CPA do?
(1) Include the unsupported disbursements without further work in the statements on the grounds that she is not doing an audit.
(2) Modify the review opinion or withdraw from the engagement unless the unsupported disbursements are satisfactorily explained.
(3) Exclude the unsupported disbursements from the statements.
(4) Obtain a written representation from the chief financial officer that the disbursements are proper and should be included in the current financial statements.
c. Which of the following best describes the responsibility of the CPA in performing compilation services for a company?
(1) The CPA has to satisfy only himself or herself that the financial statements were prepared in conformity with accounting standards.
(2) The CPA must understand the client's business and accounting methods and read the financial statements for reasonableness.
(3) The CPA should obtain an understanding of internal control and perform tests of controls.
(4) The CPA is relieved of any responsibility to third parties.
Multiple Choice Questions
The following questions concern attestation engagements.
Choose the best response.
a. Which of the following professional services is considered an attestation engagement? (1) A management consulting engagement to provide IT advice to a client.
(2) An income tax engagement to prepare federal and state tax returns.
(3) An engagement to report on compliance with statutory requirements.
(4) A compilation of financial statements from a client's accounting records.
b. A Type 1 service auditor's report on internal controls at a service organization
(1) Includes an opinion about the suitability of the design of controls at the service organization.
(2) Is based on the performance of tests of controls and substantive tests of transactions at the service organization.
(3) Contains an opinion about the operating effectiveness of internal controls at the service organization.
(4) Provides an opinion about the fair presentation of the service organization's financial statements in accordance with accounting standards.
c. Which of the following statements concerning prospective financial statements is correct?
(1) Only a financial forecast is normally appropriate for limited use.
(2) Any type of prospective financial statement is normally appropriate for limited use.
(3) Only a financial projection is normally appropriate for general use.
(4) Any type of prospective financial statement is normally appropriate for general use.
Multiple Choice Questions
The following questions concern reports issued by auditors, other than those on historical financial statements. Choose the best response.
a. An auditor is reporting on cash basis financial statements. These statements are best referred to in the opinion of the auditor by which of the following descriptions?
(1) Cash receipts and disbursements and the assets and liabilities arising from cash transactions.
(2) Financial position and results of operations arising from cash transactions.
(3) Balance sheet and income statements resulting from cash transactions.
(4) Cash balance sheet and the source and application of funds.
b. Which of the following statements with respect to an auditor's report expressing an opinion on a specific item on a financial statement is correct?
(1) Such a report can be expressed only if the auditor is also engaged to audit the entire set of financial statements.
(2) Materiality must be related to the specific item rather than to the financial statements taken as a whole.
(3) The attention devoted to the specified item is usually less than it would be if the financial statements taken as a whole were being audited.
(4) The auditor who has issued an adverse opinion on the financial statements taken as a whole can never express an opinion on a specified item in these financial statements.
c. When asked to perform an audit to express an opinion on one or more specified elements, accounts, or items of a financial statement, the auditor
(1) May not describe auditing procedures applied.
(2) Should advise the client that the opinion can be issued only if the financial statements have been audited and found to be fairly presented.
(3) May assume that the first standard of reporting with respect to GAAP does not apply.
(4) Should comply with the request only if they constitute a major portion of the financial statements on which an auditor has disclaimed an opinion based on an audit.
Evaluate the following comments about compiled financial statements: "When CPAs associate their name with compiled financial statements, their only responsibility is to the client and that is limited to the proper summarization and presentation on the financial statements of information provided by the client. The opinion clearly states that the auditor has not conducted an audit and does not express an opinion on this fair presentation. If users rely on compiled financial statements, they do so at their own risk and should never be able to hold the CPA responsible for inadequate performance. Users should interpret the financial statements as if they had been prepared by management."
You are doing a review services and related tax work engagement for Murphy Construction Company. You have made extensive inquiries of management about their financial statements and have concluded that management has an excellent understanding of its business and is honest, but lacking in knowledge of technical accounting issues. In doing the review you determine the following:
1. Repairs and maintenance expense has increased significantly compared to the preceding year. The president states that this seems to have been a year with a lot of repairs, in part because their equipment is getting older.
2. Property tax expense is the same as last year even though Murphy purchased a new building, including the land. The president states that there are no real estate taxes on the new building and land until next year.
3. Based on your knowledge of the construction industry you know that the pipes Murphy uses in construction have had a decrease in selling price to construction companies near the end of the current year. The president states that even though they have a large pipe inventory it will all be used in the next year or two, so the current price doesn't matter because they won't need to buy any.
4. Accounts receivable has increased almost 25% compared to the previous year, but the allowance for uncollectible accounts has stayed the same. The president states that even though receivables have increased, they still expect uncollectible accounts to be less than the stated allowance.
5. In discussions with the president you determine that there is a material uninsured lawsuit against the company from a former customer. The president believes it is a frivolous lawsuit and will not permit a footnote about it for fear that it will result in similar lawsuits from other customers.
a. Beyond inquiries and analytical procedures, what are the accountant's responsibilities in performing review service engagements?
b. Describe what you should do in each of the preceding situations, assuming each one is material.
SSARS contain several procedures that are required when engaged to perform a compilation or review engagement. Below are ten statements that may or may not be relevant to a compilation or review engagement. For each of the ten statements, indicate whether the procedure is to be performed in a compilation or reviewengagement.
In an engagement to review the financial statements of a nonpublic company, SSARS require the accountant to obtain review evidence that is primarily based on inquiries and analytical procedures. The nature of the accountant's inquiries is a matter of judgment. For example, the accountant may consider the nature and materiality of the items, likelihood of misstatement, how the items may be affected by management's judgment, qualifications of client personnel, among other matters.
Below are several inquiry procedures for the sales and collection cycle:
1. Are revenues from the sale of major products and services recognized in the appropriate period?
1. Has an adequate allowance been made for doubtful accounts?
2. Have receivables considered uncollectible been written off?
3. If appropriate, has interest been reflected?
4. Has a proper cutoff of sales transactions been made?
5. Are there any receivables from employees and related parties?
6. Are any receivables pledged, discounted, or factored?
7. Have receivables been correctly classified between current and noncurrent?
a. What other information about accounts receivable and revenue, besides the items listed, will the accountant have to obtain?
b. Compare the illustrative procedures for review services and those commonly performed for audits. What are the major differences?
c. Of whom should the accountant make inquiries in a small, closely-held company?
d. Under what circumstances will procedures beyond those illustrated likely be performed? Be specific.
e. Compare the levels of achieved assurance for review services and audits. Is the achieved level much higher for audits, somewhat higher, or approximately the same? Give reasons for your answer.
2) Lucia Johnson, of Johnson and Lecy, CPAs, has completed the first-year audit of Tidwell Publishing Co., a publicly held company, for the year ended December 31, 2011. She is now working on a review of interim financial statements for the quarter ended March 31, 2012. Johnson has never done an interim review of a public company, but her firm does extensive compilation and review work. She therefore has one of her most experienced assistants, Fred Blair, do the work. She instructs him to follow the firm's standard review services procedures for SSARS reviews and to do high-quality work because Tidwell is a high-risk client. Blair completes the review of Tidwell's statements and Johnson carefully reviews Blair's work. No exceptions are found. Each page of the client's financial statements is marked "reviewed." The following report is issued.
SECURITIES AND EXCHANGE COMMISSION
We have reviewed the accompanying balance sheet of Tidwell Publishing Co. as of March 31, 2012, and the related statements of income, retained earnings, and changes in financial position for the year then ended, in accordance with the standards of the Public Company Accounting Oversight Board (United States). All information included in these financial statements is the representation of the management of Tidwell Publishing Co.
A review consists principally of inquiries of company personnel and analytical procedures applied to financial data. It is substantially less in scope than an audit in accordance with the standards of the Public Company Accounting Oversight Board, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should be made to the accompanying financial statements in order for them to be in conformity with generally accepted accounting principles.
Johnson & Levy, CPAs
March 31, 2012
a. Is it appropriate to do a review service for a publicly held company? Explain.
b. Evaluate the approach taken by Johnson and Blair on the engagement.
c. Evaluate the report.
Each of the following represents different client requests for engagements related to WebTrust and SysTrust assurance services.
a. Ware Hospital Systems, Inc. is in the process of developing a new patient records system. Management has approached a licensed SysTrust accountant to perform a SysTrust engagement on its new system. Specifically, management wants the CPA to examine the system's processing integrity using the Trust Services processing integrity principle and criteria. The examination will be scheduled prior to the new system's implementation.
b. MoonBay.com's management requested that their auditor perform a WebTrust assurance service on their assertion about MoonBay.com e-commerce policies' compliance with the five Trust Services principles and criteria. Although the auditor is not a registered WebTrust provider, the CPA firm is a member of the AICPA.
c. The board of directors of Ferguson Hardware Company has requested that their auditor perform a SysTrust assurance services engagement on its information technology system. The board has requested that the auditor, who is a licensed SysTrust provider, report solely on the company's IT availability policies and controls using the Trust Services availability principle and criteria.
d. Management of Greenshield Technology, Inc. requested that its auditors perform a
WebTrust assurance services engagement on its e-commerce security policies. The CPA firm performed the WebTrust services as of April 30, 2011, and has not updated its work. Management wants its WebTrust seal to stay posted on its Web site through May 31, 2012.
Consider each request separately. Describe whether the requested assurance service can be performed.
Carl Monson, the owner of Major Products Manufacturing Company, a small, successful, longtime audit client of your firm, has requested you to work with his company in preparing 3-year forecasted information for the year ending December 31, 2012, and two subsequent years. Monson informs you that he intends to use the forecasts, together with the audited financial statements, to seek additional financing to expand the business. Monson has had little experience in formal forecast preparation and counts on you to assist him in any way possible. He wants the most supportive opinion possible from your firm to add to the credibility of the forecast. He informs you that he is willing to do anything necessary to help you prepare the forecast.
First, he wants projections of sales and revenues and earnings from the existing business, which he believes can continue to be financed from existing capital.
Second, he intends to buy a company in a closely related business that is currently operating unsuccessfully. Monson states that he wants to sell some of the operating assets of the business and replace them with others. He believes that the company can then be made highly successful. He has made an offer on the new business, subject to obtaining proper financing. He also informs you that he has received an offer on the assets he intends to sell.
a. Explain circumstances under which it is and is not acceptable to undertake the engagement.
b. Why is it important that Monson understand the nature of your reporting requirements before the engagement proceeds?
c. What information will Monson have to provide to you before you can complete the forecasted statements? Be as specific as possible.
d. Discuss, in as specific terms as possible, the nature of the report you will issue with the forecasts, assuming that you are able to properly complete them.
You have been requested by the management of J. L. Lockwood Co. to issue a debt compliance letter as a part of the audit of Taylor Fruit Farms, Inc. J. L.
Lockwood Co. is a supplier of irrigation equipment. Much of the equipment, including that supplied to Taylor, is sold on a secured contract basis. Taylor Fruit Farms is an audit client of yours, but Lockwood is not. In addition to the present equipment, Lockwood informs you they are evaluating whether they should sell another $500,000 of equipment to Taylor Fruit Farms.
You have been requested to send Lockwood a debt compliance letter concerning the following matters:
1. The current ratio has exceeded 2.0 in each quarter of the unaudited statements prepared by management and in the annual audited statements.
2. Total owners' equity is more than $800,000.
3. The company has not violated any of the legal requirements of California fruit-growing regulations.
4. Management is competent and has made reasonable business decisions in the past 3 years.
5. Management owns an option to buy additional fruit land adjacent to the company's present property.
a. Define the purpose of a debt compliance letter.
b. Why is it necessary to conduct an audit of a company before it is acceptable to issue a debt compliance letter?
c. For which of the five requested items is it acceptable for a CPA firm to issue a debt compliance letter? Give reasons for your answer.
Bengston, CPA, is conducting the audit of Pollution Control Devices, Inc. In addition, a supplemental negative assurance report is required to a major mortgage holder. The supplemental report concerns indenture agreements to keep the client from defaulting on the mortgage. Total assets are $14 million and the mortgage is for $4 million. The major provisions of the indentures are as follows:
1. The current ratio must be maintained above 2.3 to 1.
2. The debt/equity ratio must be maintained below 3.0.
3. Net earnings after taxes must exceed dividends paid by at least $1 million.
a. Write the appropriate supplemental report if all three indenture agreement provisions have been satisfied.
b. How would the supplemental report change if net earnings after taxes were $1,010,000 and dividends paid were $60,000?
c. Assume the same situation as in part b and also assume that the client refuses to modify the financial statements or disclose the violation of the indenture agreement provisions on the grounds that the amount is immaterial. What is the nature of the appropriate auditor's report?
d. What is the nature of the appropriate supplemental report if all the indenture agreement provisions have been satisfied but there is a lawsuit against the company that has resulted in disclosure of the lawsuit in a footnote to the financial statements?
Jones, CPA, has completed the audit of Sarack Lumber Supply Co. and has issued a standard unqualified report. In addition to a report on the overall financial statements, the company needs a special audited report on three specific accounts: sales, net fixed assets, and inventory valued at FIFO. The report is to be issued to Sarack's lessor, who bases annual rentals on these three accounts. Jones was not aware of the need for the report on the three specific accounts until after the overall audit was completed.
a. Explain why Jones is unlikely to be able to issue the audit report on the three specific accounts without additional audit tests.
b. What additional tests are likely to be needed before the report on the three specific accounts can be issued?
c. Assuming that Jones is able to satisfy all the requirements needed to issue the report on the three specific accounts, write the report. Make any necessary assumptions.
The Accounting and Review Services Committee (ARSC) is responsible for issuing standards for compilations and reviews of financial statement issued by nonpublic companies. Visit the AICPA website (www.aicpa.org) and answer the following questions about the operations of this committee:
a. How many individuals serve on the ARSC and how are they chosen to serve?
b. What is the nature of the due process ARSC follows when developing and establishing new standards?
c. How long must an exposure draft of a new standard (i.e., a new SSARS) be made available for public comment?
d. How many affirmative votes are required before an exposure draft of a proposed or final SSARS can be issued?
e. Are meetings of the ARSC open to the public?
Explain the role of internal auditors for financial auditing. How is it similar to and different from the role of external auditors?
What is the nature of the two categories of standards in the IIA International Standards for the Professional Practice of Auditing?
Explain the difference between the independence of internal auditors and external auditors in the audit of historical financial statements. How can internal auditors best achieve independence?
Explain how governmental financial auditing is similar to and different from audits of commercial companies. Who does governmental auditing?
Explain what is meant by the Single Audit Act. What is its purpose?
In what ways is the Yellow Book consistent with generally accepted auditing standards, and what are some additions and modifications?
Identify the primary specific objectives that must be incorporated into the design of audit tests under the Single Audit Act.
Identify the key required reports of the Single Audit Act and OMB Circular A-133.
Describe what is meant by an operational audit.
Identify the three major differences between financial and operational auditing.
Distinguish between efficiency and effectiveness in operational audits. State one example of an operational audit explaining efficiency and another explaining effectiveness.
Distinguish among the following types of operational audits: functional, organizational, and special assignment. State an example of each for a not-for-profit hospital.
Explain why many people think of internal auditors as the primary group responsible for conducting operational audits.
Explain the role of government auditors in operational auditing. How is this similar to and different from the role of internal auditors?
Under what circumstances are external auditors likely to be involved in operational auditing? Give one example of operational auditing by a CPA firm.
Explain what is meant by the criteria for evaluating efficiency and effectiveness. Provide five possible specific criteria for evaluating effectiveness of an IT system for payroll.
Identify the three phases of an operational audit.
Explain how planning for operational auditing is similar to and different from financial auditing.
What are the major differences between reporting for operational and financial auditing?
Multiple Choice Questions
The following questions deal with independence of auditors. Choose the best response.
a. The operational auditor's independence is most likely to be compromised when the internal audit department is responsible directly to the
(1) Vice president of finance.
(4) Executive vice president.
(5) Audit committee of the board of directors.
b. The independence of the internal audit department will most likely be assured if it reports to the
(4) Audit committee of the board of directors.
(5) Vice president of finance.
c. You have been asked to assess the organizational independence of an internal audit activity. You should consider all of the following factors except
(1) Functional reporting to the board and administrative reporting to the chief executive officer.
(2) The criteria of education and experience considered necessary when filling vacant positions on the internal audit staff.
(3) The degree to which internal auditors assume operational responsibilities.
(4) A limitation on the scope of objectives for the engagements included in the review.
Multiple Choice Questions
The following questions deal with governmental auditing. Choose the best response.
a. A governmental audit may extend beyond an examination leading to the expression of an opinion on the fairness of financial statement presentation to include
b. When engaged to audit a governmental entity in accordance with Government Auditing Standards, an auditor prepares a written report on internal control
(1) On all audits, regardless of circumstances.
(2) Only when the auditor has noted material weaknesses.
(3) Only when requested by the governmental entity being audited.
(4) Only when requested by the federal government funding agency.
c. Ward is auditing an entity's compliance with requirements governing a major federal financial assistance program in accordance with the Single Audit Act. Ward detected noncompliance with requirements that have a material effect on the program. Ward's report on compliance should express
(1) No assurance on the compliance tests.
(2) Reasonable assurance on the compliance tests.
(3) A qualified or adverse opinion.
(4) An adverse opinion or a disclaimer ofopinion.
Multiple Choice Questions
The following questions deal with operational auditing.
Choose the best response.
a. Which of the following best describes the operational audit?
(1) It requires constant review by internal auditors of the administrative controls as they relate to the operations of the company.
(2) It concentrates on implementing financial and accounting controls in a newly organized company.
(3) It attempts and is designed to verify the fair presentation of a company's results of operations.
(4) It concentrates on seeking aspects of operations in which waste would be reduced by the introduction of controls.
b. The evaluation of audit field work of an operating unit should answer the following questions:
1. What are the reasons for the results?
2. How can performance be improved?
3. What results are being achieved?
What is the chronological order in which these questions should be answered?
c. The purpose of governmental effectiveness or program auditing is to determine if the desired results of a program are being achieved. The first step in conducting such an audit is to
(1) Evaluate the system used to measure results.
(2) Determine the time frame to be audited.
(3) Collect quantifiable data on the program's success or failure.
(4) Identify the legislative intent of the program being audited.
Multiple Choice Questions
The following questions deal with internal auditing. Choose the best response.
a. Which of the following is generally considered to be a major reason for establishing an internal auditing function?
(1) To relieve overburdened management of the responsibility for establishing effective systems of internal control.
(2) To ensure that operating activities comply with the policies, plans, and procedures established by management.
(3) To ensure the accuracy, reliability, and timeliness of financial and operating data used in management's decision making.
(4) To evaluate and improve the effectiveness of control processes.
b. The scope of an internal auditing engagement is initially defined by the
(1) Engagement objectives.
(2) Scheduling and time estimates.
(3) Preliminary survey.
(4) Engagement work program.
c. With regard to corrective action on audit results, which of the following is not the internal auditor's responsibility?
(1) Soliciting auditees' suggestions for corrective actions.
(2) Recommending possible alternative corrective actions.
(3) Directing the corrective actions.
(4) Determining that the corrective actions are responsive to the audit results.
(5) Evaluating new policy statements to determine whether they address the unsatisfactory conditions disclosed in the audit results.
Lajod Company has an internal audit department consisting of a manager and three staff auditors. The manager of internal audits, in turn, reports to the corporate controller. Copies of audit reports are routinely sent to the audit committee of the board of directors as well as to the corporate controller and the individual responsible for the area or activity being audited.
The manager of internal audits is aware that the external auditors have relied on the internal audit function to a substantial degree in the past. However, in recent months, the external auditors have suggested there may be a problem related to the objectivity of the internal audit function. This objectivity problem may result in more extensive testing and analysis by the external auditors.
The external auditors are concerned about the amount of nonaudit work performed by the internal audit department. The percentage of nonaudit work performed by the internal auditors in recent years has increased to about 25% of their total hours worked. A sample of five recent nonaudit activities are as follows:
1. One of the internal auditors assisted in the preparation of policy statements on internal control. These statements included such things as policies regarding sensitive payments and standards of control for internal controls.
2. The bank statements of the corporation are reconciled each month as a regular assignment for one of the internal auditors. The corporate controller believes this strengthens internal controls because the internal auditor is not involved in the receipt and disbursement of cash.
3. The internal auditors are asked to review the budget data in every area each year for relevance and reasonableness before the budget is approved. In addition, an internal auditor examines the variances each month, along with the associated explanations.
These variance analyses are prepared by the corporate controller's staff after consultation with the individuals involved.
4. One of the internal auditors has recently been involved in the design, installation, and initial operation of a new computer system. The auditor was primarily concerned with the design and implementation of internal accounting controls and the computer application controls for the new system. The auditor also conducted the testing of the controls during the test runs.
5. The internal auditors are often asked to make accounting entries for complex transactions before the transactions are recorded. The employees in the accounting department are not adequately trained to handle such transactions. In addition, this serves as a means of maintaining internal control over complex transactions. The manager of internal audits has always made an effort to remain independent of the corporate controller's office and believes that the internal auditors are objective and independent in their audit and nonaudit activities.
a. Define objectivity as it relates to the internal audit function.
b. For each of the five situations outlined, explain whether the objectivity of Lajod Company's internal audit department has been materially impaired. Consider each situation independently.
c. The manager of audits reports to the corporate controller.
(1) Does this reporting relationship result in a problem of objectivity? Explain your answer.
(2) Would your answer to any of the five situations in requirement b have changed if the manager of internal audits reported to the audit committee of the board of directors? Explain your answer.*
Weston Corporation has an internal audit department operating out of the corporate headquarters. Various types of audit assignments are performed by the department for the eight divisions of the company. The following findings resulted from recent audits of Weston Corporation's White Division:
1. One of the departments in the division appeared to have an excessive turnover rate.
Upon investigation, the personnel department seemed to be unable to find enough workers with the specified skills for this department. Some workers are trained on the job. The departmental supervisor is held accountable for labor efficiency variances but does not have qualified staff or sufficient time to train the workers properly. The supervisor holds individual workers responsible for meeting predetermined standards from the day they report to work. This has resulted in a rapid turnover of workers who are trainable but not yet able to meet standards.
2. The internal audit department recently participated in a computer feasibility study for this division. It advised and concurred on the purchase and installation of a specific computer system. Although the system is up and operating, the results are less than desirable. The software and hardware meet the specifications of the feasibility study, but there are several functions unique to this division that the system has been unable to accomplish. Linking of files has been a problem. For example, several vendors have been paid for materials not meeting company specifications. A revision of the existing software is probably not possible, and a permanent solution probably requires replacing the existing computer system with a new one.
3. One of the products manufactured by this division was recently redesigned to eliminate a potential safety defect. This defect was discovered after several users were injured. At present, there are no pending lawsuits because none of the injured parties has identified a defect in the product as a cause of the injury. There is insufficient information to determine whether the defect was a contributing factor.
The director of internal auditing and assistant controller is in charge of the internal audit department and reports to the controller in corporate headquarters. Copies of internal audit reports are sent routinely to Weston's board of directors.
a. Explain the additional steps in terms of field work, preparation of recommendations, and operating management review that ordinarily should be taken by Weston Corporation's internal auditors as a consequence of the audit findings in the first situation (excessive turnover).
b. Discuss whether there are any objectivity problems with Weston Corporation's internal audit department as revealed by the audit findings. Include in your discussion any recommendations to eliminate or reduce an objectivity problem, if one exists.
c. The internal audit department is part of the corporate controllership function, and copies of the internal audit reports are sent to the board of directors.
(1) Evaluate the appropriateness of the location of the internal audit department within Weston's organizational structure.
(2) Discuss who within Weston should receive the reports of the internal audit department.*
Haskin Company was founded 40 years ago and now has several manufacturing plants in the Northeast and Midwest. The evaluation of proposed capital expenditures became increasingly difficult for management as the company became geographically dispersed and diversified its product line. Thus, the Capital Budgeting Group was organized in 2010 to review all capital expenditure proposals in excess of $100,000.
The Capital Budgeting Group conducts its annual planning and budget meeting each September for the upcoming calendar year. The group establishes a minimum return for investments (hurdle rate) and estimates a target level of capital expenditures for the next year based on the expected available funds. The group then reviews the capital expenditure proposals that have been submitted by the various operating segments. Proposals that meet either the return on investment criterion or a critical need criterion are approved to the extent of available funds.
The Capital Budgeting Group also meets monthly, as necessary, to consider any projects of a critical nature that were not expected or requested in the annual budget review. These monthly meetings allow the Capital Budgeting Group to make adjustments during the year as new developments occur.
Haskin's profits have been decreasing slightly for the past 2 years despite a small but steady sales growth, a sales growth that is expected to continue through 2012. As a result of the profit stagnation, top management is emphasizing cost control and all aspects of Haskin's operations are being reviewed for cost reduction opportunities.
Haskin's internal audit department has become involved in the companywide cost reduction effort. The department has already identified several areas where cost reductions could be realized and has made recommendations to implement the necessary procedures to effect the cost savings. Tom Watson, internal audit director, is now focusing on the activities of the Capital Budgeting Group in an attempt to determine the efficiency and effectiveness of the capital budgeting process.
In an attempt to gain a better understanding of the capital budgeting process, Watson decided to examine the history of one capital project in detail. A capital expenditure proposal of Haskin's Burlington Plant that was approved by the Capital Budgeting Group in 2011 was selected randomly from a population of all proposals approved by the group at its 2010 and 2011 annual planning and budget meetings.
The Burlington proposal consisted of a request for five new machines to replace equipment that was 20 years old and for which preventive maintenance had become expensive.
Four of the machines were for replacement purposes, and the fifth was for planned growth in demand. Each of the four replacement machines was expected to result in annual maintenance cost savings of $20,000. The fifth machine was exactly like the other four and was expected to generate an annual contribution of $30,000 through increased output. Each machine had a cost of $110,000 and an estimated useful life of 8 years.
a. Identify and discuss the issues that Haskin Company's internal audit department must address in its examination and evaluation of Burlington Plant's 2011 capital expenditure project.
b. Recommend procedures to be used by Haskin's internal audit department in the audit review of Burlington Plant's 2011 capital expenditure project.*
Lecimore Company has a centralized purchasing department that is managed by Joan Jones. Jones has established policies and procedures to guide the clerical staff and purchasing agents in the day-to-day operation of the department. She is satisfied that these policies and procedures are in conformity with company objectives and believes there are no major problems in the regular operations of the purchasing department.
Lecimore's internal audit department was assigned to perform an operational audit of the purchasing function. Their first task was to review the specific policies and procedures established by Jones. The policies and procedures are as follows:
• All significant purchases are made on a competitive bid basis. The probability of timely delivery, reliability of vendor, and so forth, are taken into consideration on a subjective basis.
• Detailed specifications of the minimum acceptable quality for all goods purchased are provided to vendors.
• Vendors' adherence to the quality specifications is the responsibility of the materials manager of the inventory control department and not the purchasing department. The materials manager inspects the goods as they arrive to be sure that the quality meets the minimum standards and then sees that the goods are transferred from the receiving dock to the storeroom.
• All purchase requests are prepared by the materials manager based on the production schedule for a 4-month period.
The internal audit staff then observed the operations of the purchasing function and gathered the following findings:
• One vendor provides 90% of a critical raw material. This vendor has a good delivery record and is reliable. Furthermore, this vendor has been the low bidder over the past few years.
• As production plans change, rush and expedite orders are made by production directly to the purchasing department. Materials ordered for cancelled production runs are stored for future use. The costs of these special requests are borne by the purchasing department. Jones considers the additional costs associated with these special requests as "costs of being a good member of the corporate team."
• Materials to accomplish engineering changes are ordered by the purchasing department as soon as the changes are made by the engineering department. Jones is proud of the quick response by the purchasing staff to product changes. Materials on hand are not reviewed before any orders are placed.
• Partial shipments and advance shipments (that is, those received before the requested date of delivery) are accepted by the materials manager, who notifies the purchasing department of the receipt. The purchasing department is responsible for follow-up on partial shipments. No action is taken to discourage advance shipments.
Based on the purchasing department's policies and procedures and the findings of Lecimore's internal audit staff,
a. Identify deficiencies and/or inefficiencies in Lecimore Company's purchasing function.
b. Make recommendations for those deficiencies/inefficiencies that you identify.* Use the following format in preparing your response:
Superior Co. manufactures automobile parts for sale to the major U.S. automakers. Superior's internal audit staff is to review the internal controls over machinery and equipment and make recommendations for improvements when appropriate. The internal auditors obtained the following information during the assignment:
• Requests for purchase of machinery and equipment are normally initiated by the supervisor in need of the asset. The supervisor discusses the proposed acquisition with the plant manager. A purchase requisition is submitted to the purchasing department when the plant manager is satisfied that the request is reasonable and that there is a remaining balance in the plant's share of the total corporate budget for capital acquisitions.
• Upon receiving a purchase requisition for machinery or equipment, the purchasing department manager looks through the records for an appropriate supplier. A formal purchase order is then completed and mailed. When the machine or equipment is received, it is immediately sent to the user department for installation. This allows the economic benefits from the acquisition to be realized at the earliest possible date.
• The property, plant, and equipment ledger control accounts are supported by computerized depreciation lapse schedules organized by year of acquisition. These lapse schedules are used to compute depreciation as a unit for all assets of a given type that are acquired in the same year. Standard rates, depreciation methods, and salvage values are used for each major type of fixed assets. These rates, methods, and salvage values were set 10 years ago during the company's initial year of operation.
• When machinery or equipment is retired, the plant manager notifies the accounting department so that the appropriate entries can be made in the accounting records.
• There has been no reconciliation since the company began operations between the accounting records and the machinery and equipment on hand.
Identify the internal control deficiencies and recommend improvements that the internal audit staff of Superior Co. should include in its report regarding the internal controls over fixed assets. Use the following format in preparing your answer:*
The Institute of Internal Auditors (IIA) is an international professional association of more than 170,000 members with global headquarters in Altamonte Springs, Florida. Throughout the world, The IIA is recognized as the internal audit profession's leader in certification, education, research, and technical guidance. Visit the IIA's website (www.theiia.org) to answer questions about the IIA and certification of internal auditors.
a. Why should an organization have an internal auditing department?
b. What are the six steps to receiving a certification in internal auditing?
c. What certifications are available to internal auditors?
d. What are the four parts of the CIA exam? How are the requirements for passing the CIA exam similar to and different from the CPA exam?
Explain the relationships among audit services, attestation services, and assurance services, and give examples of each.
Discuss the major factors in today's society that have made the need for independent audits much greater than it was 50 years ago.
Distinguish among the following three risks: risk-free interest rate, business risk, and information risk. Which one or ones does the auditor reduce by per-forming an audit?
Identify the major causes of information risk and identify the three main ways information risk can be reduced. What are the advantages and disadvantages of each?
Explain what is meant by determining the degree of correspondence between information and established criteria. What are the information and established criteria for the audit of Jones Company's tax return by an internal revenue agent? What are they for the audit of Jones Company's financial statements by a CPA firm?
Describe the nature of the evidence the internal revenue agent will use in the audit of Jones Company's tax return.
In the conduct of audits of financial statements, it would be a serious breach of responsibility if the auditor did not thoroughly understand accounting.
However, many competent accountants do not have an understanding of the auditing process. What causes this difference?
What are the differences and similarities in audits of financial statements, compliance audits, and operational audits?
List five examples of specific operational audits that can be conducted by an internal auditor in a manufacturing company.
What knowledge does the auditor need about the client's business in an audit of historical financial statements? Explain how this knowledge may be useful in performing other assurance or consulting services for the client.
What are the major differences in the scope of the audit responsibilities for CPAs, GAO auditors, IRS agents, and internal auditors?
Identify the four parts of the Uniform CPA Examination.
Explain why CPAs need to be knowledgeable about information technology, including e-commerce technologies.
Multiple Choice Questions
The following questions deal with audits by CPA firms. Choose the best response.
a. Which of the following best describes why an independent auditor is asked to express an opinion on the fair presentation of financial statements?
(1) It is difficult to prepare financial statements that fairly present a company's financial position, operations, and cash flows without the expertise of an independent auditor.
(2) It is management's responsibility to seek available independent aid in the appraisal of the financial information shown in its financial statements.
(3) The opinion of an independent party is needed because a company may not be objective with respect to its own financial statements.
(4) It is a customary courtesy that all stockholders of a company receive an independent report on management's stewardship of the affairs of the business.
b. Independent auditing can best be described as
(1) A branch of accounting.
(2) A discipline that attests to the results of accounting and other functional operations and data.
(3) A professional activity that measures and communicates financial and business data.
(4) A regulatory function that prevents the issuance of improper financial information.
c. Which of the following professional services is an attestation engagement?
(1) A consulting service engagement to provide computer-processing advice to a client.
(2) An engagement to report on compliance with statutory requirements.
(3) An income tax engagement to prepare federal and state tax returns.
(4) The compilation of financial statements from a client's financial records.
d. Which of the following attributes is likely to be unique to the audit work of CPAs as compared to the work performed by practitioners of other professions?
(1) Due professional care.
(4) Complex body of knowledge.
Multiple Choice Questions
The following questions deal with types of audits and auditors. Choose the best response.
a. Operational audits generally have been conducted by internal auditors and governmental audit agencies but may be performed by certified public accountants. A primary purpose of an operational audit is to provide
(1) A means of assurance that internal accounting controls are functioning as planned.
(2) A measure of management performance in meeting organizational goals.
(3) The results of internal examinations of financial and accounting matters to a company's top-level management.
(4) Aid to the independent auditor, who is conducting the audit of the financial statements.
b. In comparison to the external auditor, an internal auditor is more likely to be concerned with
(1) Internal administrative control.
(2) Cost accounting procedures.
(3) Operational auditing.
(4) Internal control.
c. Which of the following best describes the operational audit?
(1) It requires the constant review by internal auditors of the administrative controls as they relate to the operations of the company.
(2) It concentrates on implementing financial and accounting control in a newly organized company.
(3) It attempts and is designed to verify the fair presentation of a company's results of operations.
(4) It concentrates on seeking aspects of operations in which waste could be reduced by the introduction of controls.
d. Compliance auditing often extends beyond audits leading to the expression of opinions on the fairness of financial presentation and includes audits of efficiency, economy, effectiveness, as well as
(3) Adherence to specific rules or procedures.
(4) Internal control.
The list below indicates various audit, attestation, and assurance engagements involving auditors.
1. A report on the effectiveness of internal control over financial reporting as required by Section 404 of the Sarbanes-Oxley Act.
2. An auditor's report on whether the financial statements are fairly presented in accordance with International Financial Reporting Standards.
3. A report stating whether the company has complied with restrictive covenants related to officer compensation and payment of dividends contained in a bank loan agreement.
4. An electronic seal indicating that an electronic seller observes certain practices.
5. A report indicating whether a governmental entity has complied with certain government regulations.
6. A report on the examination of a financial forecast.
7. A review report that provides limited assurance about whether financial statements are fairly stated in accordance with U.S. GAAP.
8. A report on management's assertion on the company's level of carbon emissions.
9. A report about management's assertion on the effectiveness of controls over the availability, reliability, integrity, and maintainability of its accounting information system.
10. An evaluation of the effectiveness of key measures used to assess an entity's success in achieving specific targets linked to an entity's strategic plan and vision.
a. Explain or use a diagram to indicate the relationships among audit services, attestation services, and assurance services.
b. For each of the services listed above, indicate the type of service from the list that follows.
(1) An audit of historical financial statements.
(2) An attestation service other than an audit service.
(3) An assurance service that is not an attestation service.
Busch Corporation has an existing loan in the amount of $4.5 million with an annual interest rate of 5.5%. The company provides an internal company-prepared financial statement to the bank under the loan agreement. Two competing banks have offered to replace Busch Corporation's existing loan agreement with a new one. United National Bank has offered to loan Busch $4.5 million at a rate of 4.5% but requires Busch to provide financial statements that have been reviewed by a CPA firm. First City Bank has offered to loan Busch $4.5 million at a rate of 3.5% but requires Busch to provide financial statements that have been audited by a CPA firm. Busch Corporation's controller approached a CPA firm and was given an estimated cost of $20,000 to perform a review and $45,000 to perform an audit.
a. Explain why the interest rate for the loan that requires a review report is lower than that for the loan that did not require a review. Explain why the interest rate for the loan that requires an audit report is lower than the interest rate for the other two loans.
b. Calculate Busch Corporation's annual costs under each loan agreement, including interest and costs for the CPA firm's services. Indicate whether Busch should keep its existing loan, accept the offer from United National Bank, or accept the offer from First City Bank.
c. Assume that United National Bank has offered the loan at a rate of 4.0% with a review, and the cost of the audit has increased to $55,000 due to new auditing standards requirements. Indicate whether Busch should keep its existing loan, accept the offer from United National Bank, or accept the offer from First City Bank.
d. Discuss why Busch may desire to have an audit, ignoring the potential reduction in interest costs.
e. Explain how a strategic understanding of the client's business may increase the value of the audit service.
Consumers Union is a nonprofit organization that provides information and counsel on consumer goods and services. A major part of its function is the testing of different brands of consumer products that are purchased on the open market and then the reporting of the results of the tests in Consumer Reports, a monthly publication. Examples of the types of products it tests are middle-sized automobiles, residential dehumidifiers, flat-screen TVs, and boys' jeans.
a. In what ways are the services provided by Consumers Union similar to assurance services provided by CPA firms?
b. Compare the concept of information risk introduced in this chapter with the information risk problem faced by a buyer of an automobile.
c. Compare the four causes of information risk faced by users of financial statements as discussed in this chapter with those faced by a buyer of an automobile.
d. Compare the three ways users of financial statements can reduce information risk with those available to a buyer of an automobile.
James Burrow is the loan officer for the National Bank of Dallas. National has a loan of $325,000 outstanding to Regional Delivery Service, a company specializing in delivering products of all types on behalf of smaller companies. National's collateral on the loan consists of 25 small delivery trucks with an average original cost of $24,000.
Burrow is concerned about the collectibility of the outstanding loan and whether the trucks still exist. He therefore engages Samantha Altman, CPA, to count the trucks, using registration information held by Burrow. She was engaged because she spends most of her time auditing used automobile and truck dealerships and has extensive specialized knowledge about used trucks. Burrow requests that Altman issue a report stating the following:
1. Which of the 25 trucks is parked in Regional's parking lot on the night of June 30, 2011.
2. Whether all of the trucks are owned by Regional Delivery Service.
3. The condition of each truck, using the guidelines of poor, good, and excellent.
4. The fair market value of each truck, using the current "blue book" for trucks, which states the approximate wholesale prices of all used truck models, and also using the poor, good, and excellent condition guidelines.
a. For each of the following parts of the definition of auditing, state which part of the preceding narrative fits the definition?
(2) Established criteria
(3) Accumulating and evaluating evidence
(4) Competent, independent person
(5) Reporting results
b. Identify the greatest difficulties Virms is likely to have doing this audit.
Five college seniors with majors in accounting are discussing alternative career plans. The first senior plans to become an internal revenue agent because his primary interest is income taxes. He believes the background in tax auditing will provide him with better exposure to income taxes than will any other available career choice. The second senior has decided to go to work for a CPA firm for at least 5 years, possibly as a permanent career. She believes the variety of experience in auditing and related fields offers a better alternative than any other available choice. The third senior has decided on a career in internal auditing with a large industrial company because of the many different aspects of the organization with which internal auditors become involved. The fourth senior plans to become an auditor for the GAO because she believes that this career will provide excellent experience in computer risk assessment techniques. The fifth senior plans to pursue some aspect of auditing as a career but has not decided on the type of organization to enter. He is especially interested in an opportunity to continue to grow professionally, but meaningful and interesting employment is also a consideration.
a. What are the major advantages and disadvantages of each of the four types of auditing careers?
b. What other types of auditing careers are available to those who are qualified?
In the normal course of performing their responsibilities, auditors often conduct audits or reviews of the following:
1. Federal income tax returns of an officer of the corporation to determine whether he or she has included all taxable income in his or her return.
2. Disbursements of a branch of the federal government for a special research project to determine whether it would have been possible to accomplish the same research results at a lower cost to the taxpayers.
3. Computer operations of a corporation to evaluate whether the computer center is being operated as efficiently as possible.
4. Annual statements for the use of management.
5. Operations of the IRS to determine whether the internal revenue agents are using their time efficiently in conducting audits.
6. Statements for bankers and other creditors when the client is too small to have an audit staff.
7. Financial statements of a branch of the federal government to make sure that the statements present fairly the actual disbursements made during a period of time.
8. Federal income tax returns of a corporation to determine whether the tax laws have been followed.
9. Financial statements for use by stockholders when there is an internal audit staff.
10. A bond indenture agreement to make sure a company is following all requirements of the contract.
11. The computer operations of a large corporation to evaluate whether the internal controls are likely to prevent misstatements in accounting and operating data.
12. Disbursements of a branch of the federal government for a special research project to determine whether the expenditures were consistent with the legislative bill that authorized the project.
a. For these 12 examples, state the most likely type of auditor (CPA, GAO, IRS, or internal) to perform each.
b. In each example, state the type of audit (financial statement audit, operational audit, or compliance audit).
Dave Czarnecki is the managing partner of Czarnecki and Hogan, a medium-sized local CPA firm located outside of Chicago. Over lunch, he is surprised when his friend James Foley asks him, "Doesn't it bother you that your clients don't look forward to seeing their auditors each year? Dave responded, "Well, auditing is only one of several services we provide. Most of our work for clients does not involve financial statement audits, and our audit clients seem to like interacting with us."
a. Identify ways in which a financial statement audit adds value for clients.
b. List other services other than audits that Czarnecki and Hogan likely provides.
c. Assume Czarnecki and Hogan has hired you as a consultant to identify ways in which they can expand their practice. Identify at least one additional service that you believe the firm should provide and explain why you believe this represents a growth opportunity for CPA firms.
Individuals are licensed as CPAs by individual states. Information on the requirements for each state can be found on the National Association of State Boards of Accountancy (NASBA) web site (www.nasba.org). The Uniform CPA Examination is administered by the American Institute of Certified Public Accountants (AICPA), and information on CPA examination requirements can be found on the AICPA web site (www.aicpa.org).
a. Identify the education requirements to be eligible to sit for the CPA exam in your state. Include any specific educational content requirements.
b. List any frequently asked questions (FAQ) for your state, if there are any.
c. What are the Elijah Watts Sells awards?
d. What was the passing rate for each exam section in the most recent quarter?
State the four major types of services CPAs perform, and explain each.
What major characteristics of the organization and conduct of CPA firms permit them to fulfill their social function competently and independently?
What is the role of the Public Company Accounting Oversight Board?
Describe the role of the SEC in society and discuss its relationship with and influence on the practice of auditing.
What roles are played by the American Institute of Certified Public Accountants for its members?
What are the purposes of the AICPA Statements on Standards for Attestation Engagements?
Who is responsible for establishing auditing standards for audits of U.S. public companies? Who is responsible for establishing auditing standards for U.S. private companies? Explain.
Distinguish between generally accepted auditing standards and generally accepted accounting principles, and give two examples of each.
The first standard of field work requires the performance of the audit by a person or persons having adequate technical training and proficiency as an auditor.
What are the various ways in which auditors can fulfill the requirement of the standard?
Generally accepted auditing standards have been criticized by different sources for failing to provide useful guidelines for conducting an audit. The critics believe the standards should be more specific to enable practitioners to improve the quality of their performance. As the standards are now stated, some critics believe that they provide little more than an excuse to conduct inadequate audits. Evaluate this criticism of the 10 generally accepted auditing standards.
Describe the role of International Standards on Auditing. What is the relationship between International Standards on Auditing and U.S. Generally Accepted Auditing Standards?
What is meant by the term quality control as it relates to a CPA firm?
The following is an example of a CPA firm's quality control procedure requirement: "Any person being considered for employment by the firm must have completed a basic auditing course and have been interviewed and approved by an audit partner of the firm before he or she can be hired for the audit staff." Which element of quality control does this procedure affect and what is the purpose of the requirement?
State what is meant by the term peer review. What are the implications of peer review for the profession?
What are the two AICPA resource centers to which CPA firms may belong? What are the primary purposes of the two centers?
Multiple Choice Questions
The following questions deal with auditing standards. Choose the best response.
a. International Standards on Auditing are established by the
(1) International Accounting Standards Board.
(2) International Auditing and Assurance Standards Board.
(3) Auditing Standards Board.
(4) Global Auditing Standards Board.
b. Which of the following best describes what is meant by U.S. generally accepted auditing standards?
(1) Acts to be performed by the auditor.
(2) Measures of the quality of the auditor's performance.
(3) Procedures to be used to gather evidence to support financial statements.
(4) Audit objectives generally determined on audit engagements.
c. The general group of U.S. generally accepted auditing standards includes a requirement that
(1) Field work be adequately planned and supervised.
(2) The auditor's report state whether or not the financial statements conform to generally accepted accounting principles.
(3) Due professional care be exercised by the auditor.
(4) Informative disclosures in the financial statements be reasonably adequate.
d. What is the general character of the three generally accepted auditing standards classified as standards of field work?
(1) The competence, independence, and professional care of persons performing the audit.
(2) Criteria for the content of the auditor's report on financial statements and related footnote disclosures.
(3) The criteria of audit planning and evidence gathering.
(4) The need to maintain an independence in mental attitude in all matters pertaining to the audit.
Multiple Choice Questions
The following questions concern quality control standards. Choose the best response.
a. A CPA firm is reasonably assured of meeting its responsibility to provide services that conform with professional standards by
(1) Adhering to generally accepted auditing standards.
(2) Having an appropriate system of quality control.
(3) Joining professional societies that enforce ethical conduct.
(4) Maintaining an attitude of independence in its engagements.
b. The nature and extent of a CPA firm's quality control policies and procedures depend on
c. Which of the following are elements of a CPA firm’s quality control that should be considered in establishing its quality control policies and procedures?
d. One purpose of establishing quality control policies and procedures for deciding whether to accept a new client is to
(1) Enable the CPA firm to attest to the reliability of the client.
(2) Satisfy the CPA firm’s duty to the public concerning the acceptance of new clients.
(3) Provide reasonable assurance that the integrity of the client is considered.
(4) Anticipate before performing any field work whether an unqualified opinion can beissued.