AUD CPA Exam Review Cram Course

Welcome to Bisk CPA review comprehensive CPA review materials for the CPA exam. To let you customize your own review programs to meet your individual learning style and ensure your success

worried about finding the time to study. Our customizable learning system allows you to study anytime, anywhere 24 seven to fit your busy lifestyle and ensure your success on the exam. Looking for a particular way to prepare structured. Professor led online reviews to independent self study programs on CD-ROM video, audio and text.

Our interrelated products are designed to meet your individual learning style. Wondering how you're going to master the CPA Examcontent. Our unique learning management system ensures that you will master the CPA review material. Yeah.

And features such as exam preparation, tips, streaming, video lectures, and a computerized personal trainer actually reduce your study time.

concerned about the computer-based exam format. The online classic and software versions of this CPA review, accurately mirror, the real life experience of a computer-based exam, including multiple choice simulation and written communication questions. It's all about passing. Each of our products has been specifically designed to ensure your success.

On the CPA exam with this CPA review, you will have the confidence and knowledge to pass it.

Hello, and welcome to the bisque CPA review course and our coverage of the auditing and attestation section of the CPA exam. My name is Bob Monette. I'll be your instructor in this cpa exam prep class. And in this AUD cpa review course, we're going to be talking about a very important and heavily tested area in the auditing exam. And that is the area of audit evidence.

Now, before we begin the class, let me just say a word or two about the way to get the most out of this cpa exam prep class. The most important thing. Is to try to avoid sitting back, just passively watching this cpa exam prep class, take good notes, be an active participant later in the class. When we do problems from past exams, it's important that you shut the class down, get all your answers to the problems before you come back to the class and we discuss the problems together.

You'll find if you do these simple things, you get much more out of the class. And it's what we both want. Now, as I said, In this cpa exam prep class, we're going to be discussing audit evidence. So maybe we should start by defining exactly what audit evidence is. Audit evidence refers to all the information gathered by the auditor during the audit, which forms a basis for an opinion on the financial statements, audit evidence refers to all the information gathered by the auditor through observation inquiry analysis.

Examination, whether it's in documentary form or electronic form, which serves as a basis for the opinion on the financial statements. That's what audit evidence is. And I think to really get us started and get us in the mood, we should go through the basic steps in the audit process.

As I'm sure, there are six basic steps in the audit process. In step one, we have to establish an understanding with the client. We have to lay out the objectives of the engagement, the services that will be performed, any limitations on the engagement. We're going to lay out as clearly as we can, the auditor's responsibilities, the client's responsibilities.

And remember we document our understanding with the client in the engagement letter. And the engagement letter really is the first piece of evidence in an audit because the engagement letter will be in our work papers. It's required under generally accepted auditing standards that we have an engagement letter.

So really that is our first piece of evidence in any audit. Now in step two, we enter the planning phase of the audit. In the planning phase, we have to obtain an understanding of the client and its environment, including internal control. So that's what we're doing in the planning phase, obtaining an understanding of the entity, its environment, including internal control in the second step of the audit process, we're performing risk assessment procedures.

Our basic risk assessment procedures, our observation inquiry. We look, we ask, we inspect inspection, analytical procedures, like ratios, trying to identify, what's changed from the last accounting period to the current accounting period in the, in step two, we're identifying the specific controls we're going to rely on for specific assertion.

And in the second step of the audit process where identifying items that have a high degree of inherent risk, what inherent risk is? It's the risk that a given account by its very nature could be misstated. It's the risk that a given account by its very nature is subject to errors and fraud, cash.

There's a lot of inherent risk. So in step two, we're identifying the items that have a lot of inherent risk. And as I say, we're identifying. What's changed from the last accounting period to the current accounting period, we're comparing budgeted results to actual results. And of course the risk assessment procedures that we use depend on the size of the client, the complexity of the client, our previous experience with their every year and in the second step of the audit process, we discuss with the audit team.

How susceptible the financial statements are to errors and fraud. How susceptible the financial statements are to material misstatement. In step three, we evaluate the risk of material misstatement, the probability of material misstatement related to particular assertions. Now we're getting right down to it in step three, we're evaluating the probability, the risk of material misstatements related to particular surgeons, the risk of errors and fraud.

We're going to use in step three, we're going to use our understanding of the entity and its environment, including internal control to determine the risk of material misstatements in particular assertions. And then ultimately we're going to use our evaluation of the risk of material misstatement in a particular assertion to determine the nature, the extent and the timing.

Of our audit procedures and E T the nature, the extent and the timing and E T the net. I always tell my students, imagine auditors are on a sea of transactions, and they're going to throw out their net nature extent and timing of audit procedures. Why would the auditor's evaluation of the risk of material misstatement in a particular assertion affect the nature of the evidence?

That we're going to gather on the audit. Because if the risk of material misstatement is low in a particular assertion, we're going to rely on client records. But if the risk of material misstatement in a particular assertion is high, we're going to need more outside evidence, more outside corroboration.

So notice our evaluation of the risk of material misstatement in a particular session does affect the nature of the evidence. We're going to gather on the audit also. It'll affect the extent of the evidence. And why, if the risk of material misstatement is high, we're going to lead up. We're going to need a lot of evidence.

We're gonna need a lot of evidence to support our opinion. But if the risk of material misstatement is low, we'll need less evidence. So notice that valuation of the risk of material misstatement in a particular assertion will affect the extent of the evidence that we gather. And then finally timing is affected as well.

Because if our evaluation of the risk of material misstatement in a particular assertion is low, we can do more interim testing. If our evaluation of the risk of material misstatement in a particular assertion is high. We're going to do our testing after year end. So just remember that our evaluation of the risk of material misstatement, the risk of errors and fraud in a particular assertion.

Will affect the nature of the evidence that we gather on the audit, the extent of the evidence that we gather on the audit, and also the timing of the evidence that we gather on the audit. Then we move into step four.

In the fourth step of the audit process, we design and perform our audit procedures to address this risk of material misstatement in a particular assertion. This is step four. We are really getting down to it. We're designing and performing our audit procedures to address the risk of material misstatement in particular assertions, our audit procedures are going to include both tests of controls and substantive testing.

What are your basic tests of controls, observation, inquiry, inspection, and. Re performance. We may, re-perform some transactions. Those are your basic tests of controls, observation inquiry. You look, you ask inspection. And as I say, we may also re perform some transactions. The, there are two types of substantive tests.

There are analytical procedures and there are tests of details. Those are the two types of substantive tests, analytical procedures, and. Tests of details. We're going to examine the journals, the ledgers, the schedules of our client. We're going to examine all the underlying accounting data that supports the financial statements.

We're gathering all this evidence to evaluate management's assertions about account balances, transactions. Totals and even disclosures. That's why we're gathering all this evidence to SU to see if we can support management's assertions about account balances, transactions, totals, disclosures, as I'm sure, a set of financial statements is nothing more than a set of assertions.

That's what it is. Men as a management is asserting. This is our cash balance management is asserting. These are our liabilities. Management is asserting. This is our capital structure. Management is assert isn't management is asserting. These are our disclosures,

and also our audit evidence will include outside corroboration accounts, receivable, confirmations, bank cutoff statements. So audit evidence also includes outside corroboration as well. We're not just using the accounting records of the client as a basis for our opinion on the financial statements.

And it's important to remember that under us generally accepted auditing standards on audit must include both clients records and outside  remember that's required under generally accepted auditing standards. An audit must include both the accounting records of the client and outside corroboration and another requirement you are required under us, generally accepted auditing standards to perform substantive tests on all material assertions that's required as well.

Remember, the word required is an unforgiving word. You're either required to do something or you're not. And under us generally accepted auditing standards. Substantive tests are required for all material assertions. We move into step five in the fifth step of the audit process. Now we evaluate all the audit evidence and determine whether there are any material misstatements in the financial statements, are there misstatements in the financial statements?

That are material enough that a reasonable person would be misled. That's our determination in step five, when we're evaluating this audit evidence, that's the objective of gathering all this evidence to determine if there are any errors and fraud in the financial statements that are so material that a reasonable person should be misled, that the financial statements are not fairly stated.

And of course, if the financial statements are not fairly stated, the client's going to have to make an adjustment. And if a client refuses to make an adjustment, we're going to have to modify our opinion, the sixth and final state, the sixth and final step of the audit process is for the auditor to form their opinion and issue their audit report.

So you'll notice by going through those six steps in the audit process, you can see that all through the audit process, the auditor is gathering evidence and evaluating evidence. Now. How is an auditor supposed to evaluate evidence

under us, generally accepted auditing standards. Here's how the auditor has to evaluate evidence. Evidence must be both sufficient. And appropriate. These are very important terms under us, generally accepted auditing standards. Evidence must be both sufficient and appropriate. This is how an auditor is supposed to evaluate evidence.

Is it sufficient and appropriate? What's sufficient means enough. Is it enough to serve as a basis for an opinion. And of course, that, that depends on auditor's judgment. And once again, we get back to the auditors of valuation. Notice auditor's judgment is used here. What is the auditor's judgment about the risk of material misstatements in a particular session?

Because if the auditor's judgment of the risk of material misstatement is high in a particular assertion, you're going to need more evidence to be sufficient. If the risk of material misstatement is low in a particular assertion, The auditor will need less. So when it comes to sufficiency, it depends on auditor's judgment.

Also. It depends on the quality of the evidence that's been gathered by the auditor. If the quality is high, the auditor will not need as much evidence to support the opinion. But if the quality of the evidence is low, the auditor is going to require more evidence. So that's the first test sufficiency.

And the auditor's judgment is the evidence sufficient to form an opinion. And then the evidence also has to be appropriate. What does appropriate mean? To be appropriate, the evidence has to be both relevant and reliable. Let me say that again, to be appropriate. The evidence has to be both relevant and reliable.

What does relevant mean? Relevant means the evidence has to be related to the audit purpose. It has to be related to the assertion you're testing. Now they're just not off the wall. If I'm testing, the management's assertions about investments, I'm not looking at the client's purchase orders, it's not relevant. So to be relevant, it has to be related to the assertion you're testing. It has to be related to the audit purpose.

What does reliable mean? Because remember appropriate evidence is both relevant and reliable. Reliable means persuasive. Not it doesn't have to be conclusive beyond any doubt. That's not what reliable means. It has to be persuasive again, not conclusive beyond all doubt, no persuasive. And.

Once again, auditor's judgment will come into this because the auditor's judgment about, the inherent risk in a particular assertion will mean that the auditor demands more reliability in the evidence. In other words, the more inherent risk, the more materiality in an assertion, then.

The auditors going to demand more evidence that's more persuasive now in the exam, they'll have multiple choice and even simulations where they'll ask you to evaluate evidence and decide what evidence is more reliable. In other words, they could ask you in the exam, what's more reliable a bank statement or the client's purchase order.

They could ask you in a multiple choice, what's more reliable, what's more persuasive, an accounts receivable confirmation, or the client's receiving report. So how do you answer questions like this? What is the scale of persuasiveness? What's the scale of reliability? I'm going to give you a scale.

I'm going to give you five levels of reliability from the highest to the lowest. That way, when you're in the exam, you got a question where they ask you to evaluate what's more reliable this or that. You can always answer that question.

Here are the five levels of reliability persuasiveness, your highest level. Of reliability for evidence is the auditor's direct personal knowledge about something. That's your highest level of persuasiveness. Your highest level of reliability would be that we'll call that level one highest level. That's the auditors personal knowledge, obtained through observation inquiry, the auditors.

Direct personal knowledge about something would be your highest level of reliability level. Too little less reliable would be evidence that's externally generated and also externally circulated again, level two, a little less reliable, a little less persuasive would be information that's externally generated and also externally circulated level three, a little less.

Reliable would be evidence that's externally generated, but internally circulated that's externally generated, but internally circulated level for a little less reliable would be evidence that's internally generated, but externally circulate. And then finally, level five, the least reliable, the least persuasive would be evidence that's internally circulated and also internally.

Internally generated and also internally circulated both that would be level five, the least reliable, the least persuasive evidence that's internally generated and also internally circulated. So what does all this mean? Let me give you some examples. Let's go to level two. What do I mean by evidence that's externally generated and also externally circulated?

An example of level two would be a bank cutoff statement, a bank cutoff statement. Is a statement that is mailed from the bank directly to the auditor. About 30 days after year end notice the bank cutoff statement is externally generated. It's sent from the bank and it's also externally circulated.

It goes directly to the CPA directly to the auditor. In other words, my client never gets their hands on it. That's level two, very persuasive. How about level three? How could evidence be externally generated, but internally circulated? A bank statement would be an example. A bank statement comes from the bank.

It's externally circulated, but it's mailed to my client. So it's internally circulated and then level four. How could you have evidence that's internally generated, but externally circulated, I canceled check. I canceled check was written by my client. It's internally generated, but it did go to the bank.

It has bank markings on it. It's externally circulated. And then finally level five internally generated internally. Circulated would be my client's purchase orders. My client's receiving reports. They're internally generated. They're all. Written by my client and they've never left my client. They've always been in my client's hands.

They are internally generated and internally circulated. I think you see what this table's all about. Generally speaking

evidence is more reliable, more persuasive if it comes from outside rather than inside, just as general parameters, generally speaking, evidences. More reliable, more persuasive. If it comes from outside sources, rather than inside, it's more persuasive, more reliable. If it's obtained directly by the auditor, it's more reliable.

If it's an original document rather than a copy. Let me ask you this. If I'm an auditor on an audit, can I use level five evidence? Of course, don't misunderstand me. In an audit, we use anything. We can get our hands on level one, level, two level three, level four, level five, all five levels of evidence are used in an audit.

There's nothing wrong with any level of evidence. Evidence is evidence. The auditor wants to look at everything. So why do we get so specific about the levels? Because you're in an exam and an exam can ask you what's more reliable, what's more persuasive. A client purchase order or a bank statement, you're in an exam and they ask questions like that.

So if you memorize that table, those five levels, you should be able to answer anything they ask about that.

Remember that there are basically two types. Of accounts receivable confirmations. There are positive confirmations and there are negative confirmations with a positive confirmation. The customer has to respond whether or not they agree with the balanced. Let me say that again, with a positive confirmation, the customer has to respond.

They're asked to respond whether or not they agree with the balance. Now, generally you use positive confirmations. When there's a small number of accounts with large dollar values and may, maybe weak internal control, weaker, internal control, a lot of disputed accounts. This is why you would lean towards positive confirmations.

If there's a small number of accounts, large dollar values, we can turn on control over receivables, a lot of disputed accounts. The problem with. Positive confirmations is that, people of course may not respond, but with a positive confirmation, if customers don't respond, remember they were asked to respond whether or not they agree and if they don't respond, and this is one of the strengths of positive confirmation, the auditor has to follow up.

The auditor has to contact the client and get to the bottom of it. You don't assume anything. So remember that. With a positive confirmation, like with any confirmation, you may not get a response, but with a positive confirmation, if you don't get a response, the CPA has to follow up. It has to contact the customer and get to the bottom of it.

Now with a negative confirmation, of course, what's coming with a negative confirmation. The customer only responds if they disagree with the balance. So you tend to use negative confirmations when you have a large number of accounts. Small dollar values, not a large number of accounts, small dollar values, strong internal control over receivables, very few disputed accounts.

That's willing to use negative confirmation. And of course, with a negative confirmation, you're asking the customer to respond only they disagree. So what does a non-response really mean? You would assume that a customer will protect their own interests so that. If the account is greatly overstated, the customer will say something.

If the customer thinks they owe a thousand dollars and the confirmation we send them sends says that we, that they owe us a hundred thousand, they're going to respond. You assume that they'll protect their own interests, but what if the error is in their favor? It's really hard to know, if a non-response really means anything, that's why they're a little less useful.

But as I say, you tend to use negative confirmations when you have a large number of accounts, small dollar values, strong internal control, very few disputed accounts. And again, in either case, whether it's positive or negative confirmations, it's going to be mailed by the auditor directly to the customer and the customer mails it back to the CPA, back to the auditor.

So it is externally generated and it's externally circulated. It is level two.

Welcome back. Let's do these 10 questions together. And number one, they ask which of the following procedures would provide the most reliable audit evidence. What's the most reliable audit evidence. How about AA says inquiries of the client's internal audit staff held in private? Of course that's all internal.

Isn't it? That's all internal information. Be inspection of a pre-numbered client purchase order filed in the vouchers payable department. Wouldn't that be classic internally generated and in terminally circulated. Would all be internal information, level five. It can be used in an audit. No problem, but they want to know most reliable C analytical procedures performed by the auditor on the entities trial balance.

If you're just pulling information off the end of each trial balance, the entities trial balance is internally generated and internally circulated that's really level five. Of course the answer is D. Inspection of bank statements obtained directly from the client's financial institution. If the bank statements are obtained directly from the client's financial institution, then it's externally generated.

It's mailed from the bank and it's, it comes directly to the auditor. So it's externally circulated that's level two. That's a very high level of reliability persuasiveness. And of course the answer is D. Number two negative confirmations. So important to know what that means. Negative confirmation of receivables is less effective than positive confirmation because of what ACE says.

A majority of recipients usually lack the willingness to respond. Now you can't, that's not necessarily true, but he says some recipients may report incorrect balances that require extensive. Follow up now that there's no evidence of that. Remember they only respond if they disagree. So when they disagree, there might be some followup, but to say they report a lot of incorrect information.

That's not necessarily true. D says negative confirmations do not produce evidential matter. That is statistically quantifiable. Now it's statistically quantifiable. It's considered a valid way to confirm accounts receivable. Statistically viable, but the reason why arguably negative confirmations are less effective than positive is answer C the auditor can not infer that all non-respondents have verified their information.

That's true. That's why it's a little weaker because they only respond. If they disagree, what can you really infer from a non-response? Can you infer? They agree what the error is in their favor? No, they say nothing. So that's why they are a little weaker than positive confirmations. And the answer is C number three,

for which of the following judgements may an independent auditor share responsibility with the entities internal auditor, who is assessed to be both competent and objective. When the client's internal audit staff has been assessed to be both. Competent and objective there's no problem. When the external auditor, the independent auditor uses the internal audit staff to help out in the audit.

As an independent auditor, you can use the internal audit staff to help with tests of controls, substantive testing, what you cannot use, the internal audit staff for his assessments of any kind assessment of inherent risk assessment of control risk. It's double. No, you can't. Assessments of risk would be up to the external auditor up to the independent auditor, any kind of assessments that's.

Now we're talking about auditor's judgment. You can't ask the internal audit staff to make any judgements. The independent auditor makes all the judgments, all the assessments. Number four. In audit the accounts receivable, the negative form of confirmation requests most likely would be used when we've talked about this.

When do we use negative confirmations? When there's a large number of accounts, small dollar values, very few disputed accounts. Internal control is strong. So the is B you're going to more likely to use negative confirmations when B the combined. Assess level of inherent risk and control risk is low.

Remember control. What control risk is the risk that internal controls are not functioning well. So you want that with negative confirmations to be low, you want it to be a low risk that the internal controls are not functioning well. In other words, you want strong internal control, a low risk that internal controls is not functioning well, and you want a.

Low level of inherent risk, very few disputed accounts, small dollar values, a lot of accounts. That's when you use negative confirmations, number five, an independent auditor asked a client's internal auditor to assist in the preparation of a standard financial institution. Confirmation. You could ask the internal audit staff to help in the preparation of.

A financial institution, con confirmation that's okay. For a payroll account that had been closed during the year under audit, after the internal auditor prepared the form, the controller signed it and mailed it to the bank. What was the major flaw in this procedure? Sure. He went right to it. Answer B the form was mailed by the controller member.

I don't care. What kind of confirmation you're talking about? An accounts receivable confirmation, a confirmation to a financial institution. Confirmations are always mailed by the CPA, mailed by the auditor and mailed back to the auditor. I don't care what kind of confirmation it is that happened to the financial institution confirmation, but whatever it is, it's always mailed by the auditor and the institution, the customer, the client's attorney, whatever you confirming information with whoever you're confirming information with has to mail the confirmation directly back to the auditor.

Number six, the blank form of accounts receivable confirmations blank form means you ask the customer to fill in the amount. You just send him a blank confirmation and ask the customer to fill it in. What is the amount, according to your records that you owe us? The blank form may be less efficient than the positive form, because the answer is C because you get more non-responsive.

Anytime you ask customers, did go out and go out of their way?  You go to your records and you figure out what you owe us, you're out, and you fill this in and you mail it back. You will get less responses. The more you ask recipients to do, it's just the nature of this kind of confirmation.

I'm afraid.

Number seven, which of the following procedures would yield the most appropriate evidence. What's the most reliable, what's the most persuasive a says a scanning of the trial balance. You scan your client's draw balance. Welcome to bisque CPA review comprehensive CPA exam review materials for the CPA exam.

To let you customize your own review programs, to meet your individual learning style and ensure your success

worried about finding the time to study. Our customizable learning system allows you to study anytime, anywhere 24 seven to fit your busy lifestyle and ensure your success on the exam. Looking for a particular way to prepare from structured professor lead online reviews to independent self-study programs on CD-ROM video, audio, and text.

Our interrelated products are designed to meet your individual learning style. Wondering how you're going to master the CPA Examcontent. Our unique learning management system ensures that you will master the CPA review material

such as exam preparation, tips, streaming, video lectures, and a computerized personal trainer actually reduce your study time.

Learned about the computer-based exam format. The online classic and software versions of this CPA review, accurately mirror, the real life experience of a computer-based exam, including multiple choice simulation and written communication questions. It's all about passing. Each of our products has been specifically designed to ensure your success.

On the CPA exam with best CPA review, you will have the confidence and knowledge to pass it.

Hello, and welcome to the bisque CPA review course and our coverage of the auditing and attestation section of the CPA exam. My name is Bob Monette, and I'll be your instructor for this cpa exam prep class. And in this cpa exam prep class, we're going to be discussing a very heavily tested topic in the auditing exam. And that is reporting issues.

Now, before we begin, I just want to say a word about the way to get the most out of this cpa exam prep class. The important thing. Is to avoid just sitting back passively and watching the class B be an active participant, take notes later in the class. When we do problems, shut the class down, get your answers to the problems before you come back to me and we discuss the problems together.

If you do these simple things, I think you'll get much more out of the class. And that's what we both want. Now, as I say, in this cpa exam prep class, we're going to be discussing reporting issues. But before we start into reporting issues, just to get us started, get us warmed up. Let's go over the basic steps in the audit process, as I'm sure there are six basic steps in the audit process.

Let's run through them in step one. The auditor has to establish an understanding with the client. We have to establish an understanding with the client about the objectives of the engagement, any limitations on the engagement, the services we're going to perform. We lay out the auditor's responsibility, the client's responsibility.

We're clear about any fees, any staffing requirements, any space requirements. And as I'm sure it is required that we document. Our understanding with the client in the engagement letter, that in step two, the planning phase in the planning phase, we obtained an understanding of the entity and its environment, including internal control.

In the planning phase, we perform risk assessment procedures to obtain this understanding of the entity and its environment and the internal control. And of course the risk assessment procedures that we perform. Depends on the size of the company, the size of the entity, it's complexity, our previous experience with the client.

And in the planning phase, we discuss with the audit team, how susceptible the financial statements are to material misstatement. In step three, we evaluate the risk of material misstatement related to specific assertion.

And we evaluate the probability of material misstatement related to particular assertions, always keeping in mind materiality. Then in step four, we design and perform our audit procedures. We're going to perform tests of controls, compliance, testing, substantive tests of details. And

all of these audit procedures are designed to to address the risk of material misstatement in particular assertions in step five, we evaluate all the audit evidence and in step six, we form our opinion and issue our audit report. And as I'm sure this AUD cpa exam review course. Is all about the sixth and final step in the audit process where we form our opinion and issue our audit report

in any audit, what the client wants is a clean opinion, an unmodified opinion. That's what the client wants. So let's talk about this. How would your client deserve an unmodified opinion? How would your client earn an unmodified opinion? There's really six requirements. If your client meets these six requirements, they deserve an unmodified opinion, a clean opinion.

Let's go over the six requirements first. There can't be any significant departure. From generally accepted accounting principles or whatever financial reporting framework you're testing. I first, whatever the financial framework is, that's being tested in this AUD cpa review course. We'll generally assume it's us generally accepted accounting principles, but that's the first requirement that they can't be any significant departures from us.

Gap. Number two, generally accepted accounting principles. Have been consistently applied between accounting periods and number three, there is adequate and complete disclosures. Now, if in your notes, you bracket those three together. Let me summarize them. What we're saying in the first three, no significant departures from us gap.

Us gap has been consistently applied between accounting periods. Adequate and complete disclosures. What we're saying in the first three is there can't be any problem with the financial statements. That's the net result. That can't be any problem with the financial statements. Now the last three, number four, there can't be any significant uncertainties.

Number five, there can't be any significant

scope limitations. No significant scope, limitations. And number six, there can't be any significant going concern problems. Those are the final three, no significant uncertainties, no significant scope, limitations, and no significant going concern problems. And we can bracket the last three and summarize them this way.

There can't be any problems with the audit. That's really what it comes down to. If there's no problems with the financial statements and there's no problem with the audit, your client deserves a clean opinion. An UN modified opinion seems simple enough, just six requirements.

Now, if you look in your viewers guide and you go to exhibit number one, you'll see an example of an unmodified opinion, the standard unmodified opinion. And you probably know what I'm going to say. You have to memorize it. The unmodified opinion, you really begin your study of reporting issues by memorizing the standard unmodified opinion.

Because once you get that down, Pat, it really helps your study in this area. Because from that point on, all you have to study are the modifications you make to the unmodified opinion in certain situations. Once you get down, once you get this down cold, but let's take a look at it. Notice the heading.

Independent auditor's report. Remember to provide any type of assurance on financial information. The auditor has to be independent, in fact, independent in a parents. And remember the goal of an audit is to provide reasonably positive assurance. That the financial statements are free of material misstatement, reasonably possible assurance that the financial statements are free of material errors and fraud.

That's the goal of an audit. And as I say, to provide any assurance of any type on financial information, the auditor has to be independent. So right away in the heading of the report, independent auditor's report, it's addressed to the company, the board of directors to shareholders. But never management.

Now the report starts with the introductory paragraph. It says we have audited notice. We make the level of service clear right away. This is not a review. This is not a compilation. We have audited the accompanying financial statements of XYZ company, which comprised the balance sheet as of December 31 year one.

And the related statements of income. Changes in stockholders' equity and cash flows for the year that ended and the related notes to the financial statements. So the introductory paragraph makes it very clear. We've done an audit. Then what the audit report is going to do is lay out very clearly management's responsibilities and the auditor's responsibilities.

So notice the next paragraph is titled. Management's responsibility for the financial statements. We make it very clear. Management is responsible for the financial statements. What we're going to always refer to in this auditing cpa exam prep course as the management responsibility paragraph, let's take a look at it. It says management is responsible for the preparation and fair presentation of these financial statements in accordance with accounting principles generally accepted in the United States of America.

This includes the design implementation and maintenance of internal control, relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error. So we've laid out management's responsibilities and then the next paragraph auditor's responsibilities.

Our responsibilities is our responsibility is to express an opinion on these financial statements based on our audit, that's pretty clear. We conducted our audit in accordance with auditing standards, generally accepted in the United States of America. Now there might be more than one set of standards.

This might say we conducted our audit in accordance with auditing standards, generally accepted in the United States of America and in accordance with. Standards of the public company, accounting oversight board, if it's an issuer or we might add in accordance with auditing standards generally accepted in the United States of America.

And in accordance with international standards of audit, it could be more than one set of standards that we're following.

These standards require that we plan and perform the audit. To obtain reasonable assurance. Remember that's the goal of an audit to provide reasonable assurance that the financial statements are free of material fraud and error to provide reasonable assurance about whether the financial statements are free from material misstatement on audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statement.

The procedures selected, depend on the auditor's judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error in making those risk assessments, the auditor considers internal control relevant to the entities, preparation and fair presentation of the financial statements in order to design the audit procedures.

That are appropriate in the circumstance, but not for the purpose of expressing an opinion on the effectiveness of the entities, internal control accordingly, we express no such opinion. So we're not expressing an opinion on internal control. Audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management as well as evaluating the overall.

Presentation of the financial statements. And then the last sentence is critical. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. That's the bottom line. And then finally the opinion paragraph, in our opinion, the financial statements referred to above present fairly.

This is a clean opinion. This is an unmodified opinion. Present fairly in all material respects the financial position of XYZ company as of December 31 year one, and the results of its operations and its cash flows for the year, then ended in accordance with accounting principles, generally accepted in the United States of America.

It's signed either manually or by the printed signature of the firm. It's dated. Remember the audit report is dated no earlier. Then the date on which the auditor has obtained sufficient, appropriate audit evidence to support the opinion. No. Earlier than that. Now I want to mention that in international standards, a couple of little differences in the unmodified opinion in international standards, in the introductory paragraph, they also refer to the summary of significant accounting policy.

And other explanatory information that's referred to in the introductory paragraph again in international standards, the introductory paragraph would be a little different because the introductory paragraph would refer to the summary of significant accounting policies and other explanatory information in international standards.

The auditor's responsibility paragraph would be a little different because in international standards, The auditor's responsibility paragraph would also refer to the fact that the auditor is required to comply with ethical requirements. And then one more significant difference in the international standards, you can refer to the fair presentation of financial statements or financial statements that give a true and fair view.

Now immediately after the opinion, paragraph, the auditor could add an emphasis of matter paragraph. Now, an emphasis of matter paragraph could be required. There are circumstances where an emphasis of matter paragraph is required, or it can be added at the auditor's discretion. Now, the emphasis of matter paragraph is for information that is fully disclosed in the financial statements, fairly presented in the financial statements, but emphasis is added because it's essential to the user's understanding of the financial statements.

That's why we have. An emphasis of matter paragraph. This is information that's recorded in the financial statements properly it's fully disclosed properly, but emphasis is added to be an emphasis is added because it's essential to the user's understanding of the financial statements. And as I say, an emphasis of matter, paragraph can be required or at the auditor's discretion, let's go over.

The cases were an emphasis of matter. Paragraph is required. If you go on your viewers guide, you'll see the list. Notice there are four cases where an emphasis of matter paragraph is required. Number one, anytime there's a substantial doubt about the entities ability to continue as a going concern, an emphasis of matter paragraph is required.

And we'll say more about going concern problems later in this AUD cpa exam study course. Number two. If there's been a justified change in accounting principle that has a material effect on the financial statements that requires an emphasis of matter paragraph. I'm sure you know what we're referring to here.

Anytime, a company changes from an old generally accepted accounting principle to a new generally accepted accounting principle for the same transactions for the same set of circumstances. That's a change in principle. And if they can justify that's going to require. In other words, what the auditor concurs with the change it's justified, that's going to require an emphasis of matter paragraph, by the way, this would include a change in entity.

Say a parent and sub have always issued separate statements. This year, they're going to issue consolidate statements. That's a change in entity that would be a justified change in principle that requires. An emphasis of matter paragraph,

this would include correcting an error. Also we would include a correcting an error if it involves a principle, they've misapplied a principle. Now that's the cause for the error. Now they have to correct that error. If it involves misapplying a principal, it would be included as a required emphasis of matter paragraph, not a change in estimate.

A change in estimate does not require an emphasis of matter paragraph. It does not. However, a change in estimate inseparable from a change in principle would require an emphasis of matter paragraph. And of course the classic case of a change in estimate inseparable from a change in principle is a change in depreciation methods.

So a change in depreciation methods that has a material effect on the financial statements. That's going to require an emphasis of matter. Paragraph number three, when financial statements have been prepared in accordance with an applicable special purpose framework, that requires an emphasis of matter paragraph, by the way, other than, regulatory basis, that's intended.

For general use that's not included if it's regulatory basis intended for general use, and that's not what we're talking about, but if the financial statements have been prepared under a special purpose framework, that would require an emphasis of matter paragraph. And then finally, number four, if there are subsequently discovered facts that lead to a change, in opinion, anytime there was subsequently discovered facts that lead to a change in opinion.

That would be an emphasis of matter paragraph now at the audit at the auditor's discretion, that can either be an emphasis of matter paragraph or an other matter paragraph, which we'll get to in a moment. It's the, it depends on the auditor's judgment of its importance. That can go either way, depending on the auditor's judgment of the importance of the item, that can either be an emphasis of matter paragraph or an other matter paragraph.

All right now, an emphasis of matter paragraph may be necessary with an uncertainty, with a major catastrophe, with significant related party transactions and with a significant subsequent event, which we'll talk about later.

Let's talk about an other matter. Paragraph. The other matter, paragraph follows the emphasis of matter paragraphs. So if there's an other matter paragraph, it's going to follow the emphasis of matter paragraph. Now, when do we use an emphasis? Excuse me, when do we use an other matter paragraph? And other matter paragraph can either be required or at the auditor's discretion.

And an other matter, paragraph describes matters that are relevant to the user's understanding of the audit report or the auditor's responsibilities. That's when you use an other matter paragraph it's. To describe matters that are relevant to the user's understanding of the audit report or the auditor's responsibilities.

If you look in your viewers guide, you'll see the nine examples of when an other matter paragraph is required. Number one, it's required to use an other matter paragraph. When the auditor is going to restrict use of the audit report, you have to have it. Number two, if there are subsequently discovered facts that lead to a change in the audit opinion, remember we said that can either be an emphasis of matter paragraph or an other matter paragraph, depending on the auditor's judgment of its significance, but one way or another either if there are subsequently discovered facts that have led to a change in audit opinion, it either has to be an emphasis of matter paragraph.

Or an other matter paragraph depending on its importance, but it would be required one way or another. Number three, if the financial statements of the prior period have been audited by a predecessor auditor and the predecessor auditor's report has not been reissued, that would be another matter.

Paragraph number four, if the current period financial statements have been audited and presented in comparison, With compiled or reviewed financial statements for prior periods or presented in comparison with prior periods, statements that have not been compiled or reviewed or audited number five, if there's a material inconsistency in other information and management refuses to revise it, we'll say more about other information later.

Number six. If the auditor chooses to report on supplemental information in the audit report, rather than a separate report, that would be another matter paragraph. And we'll say more about supplemental information later as well. Number seven, if the auditor wants to re refer to required supplementary information, that's an other matter.

Paragraph number eight, if the auditor is going to restrict the use of the report. When a special purpose when special purpose financial statements are being presented in accordance with contractual or regulatory basis, again, unless regulatory basis is intended for general use. So anytime the auditor's going to restrict the use of the report, when special purpose financial statements have been prepared, either using contractual basis or regulatory basis, again, not regulatory basis, that's intended for general use, that would be an other matter paragraph.

And then finally, Number nine, a report on compliance. Anytime a report on compliance is included with the audit report that's required of the matter paragraph. And then you can see in the viewers guide, there are a few cases where you may use it's not required, but you may use an other matter paragraph.

You may use an other matter paragraph to explain why the auditor cannot withdraw from an engagement. When there's been a management imposed scope limitation, you may use an other matter paragraph. And we'll say more about scope limitations later. You may use an other matter paragraph when either the auditor is required or permitted to provide further explanation of the auditor's responsibility.

And then finally, you may use the other matter paragraph. If the auditor is engaged to report on more than one set of financial statements with different with, and the statements have different, a different general purpose framework. That's another case. All right, I've thrown a lot at you at the outset of this AUD cpa review course.

Now let's do some questions. What I'd like you to do is shut this AUD cpa study course down, do the first six multiple choice questions and your viewers guy, get your answers. And then. Come back and we'll go through them together. And you may have noticed that in the viewer's guide, there's no answers to the questions.

That's my doing. I don't want answers to the questions in the viewers guide, because I know if you go to look one up, you'll notice the answer for the next three. Don't lie to me. That's what you'll do. And I'd rather, you didn't know. It's like you're taking an exam. So answer the first six questions come back and we'll go through them together.

Welcome back. Let's look at these questions together. Number one, they say, which of the following representations does an auditor make explicitly and which implicitly. When issuing an unmodified opinion. How about the first column conformity with gap now that's explicit. That's explicit in the opinion paragraph, it says, in our opinion, the financial statements referred to above present fairly in accordance with accounting principles, generally accepted in the United States of America.

That's explicit. How about the adequacy of disclosures? That's implicit. The answer is D because when you say in the opinion, paragraph that the financial statements present fairly in accordance with accounting principles generally accepted in the United States of America. Us gap requires that all disclosures be adequate and complete.

So if the financial statements are presented fairly in accordance with us gap, it is implied. That is all disclosures must be adequate and complete. That's not explicit. It's not stated. So the answer is D number two. Okay. When subsequently discovered facts lead to a change in the auditor's opinion, which of the following must be added to the auditor's unmodified opinion.

Answer a. Do we have to add an emphasis of matter paragraph B an other matter, paragraph C either an emphasis of matter or other matter paragraph or D basis for unmodified opinion paragraph. I hope you recognized right away. There's no such thing as D there is no such thing as a basis for unmodified opinion, paragraph, it doesn't exist.

So hopefully knock that out right away. So now you're down to a, B or C. And you may remember that this is a case where it is answer C it's either going to be an emphasis of matter paragraph or an other matter paragraph up to the judgment of the auditor. How important does this auditor judge this item to be the more important it is?

They would lean towards an emphasis of matter paragraph. If the auditor deems it, not quite as important, it would be an other matter paragraph. It had, there has to be a paragraph. There does have to be either you are required to have either an emphasis of matter paragraph or an other matter paragraph, one of the other, but it's up to the auditor's judgment and the answer is C and of course the, whether it's an emphasis of matter paragraph.

Or another matter paragraph, remember those paragraphs are after the opinion paragraph because we're not modifying the opinion. That's always the case that an emphasis of matter paragraph or an other matter paragraph would always be after the opinion paragraph. Because again, you're not modifying the opinion.

Number three, how does an auditor make the following representations when issuing an unmodified opinion? On comparative financial statements. How about the first column consistent application of accounting principles? Is that explicit or implicit? That's implicit. Once again, when you say that the financial statements are presented fairly in accordance with the us gap requires that.

Generally accepted accounting principles be applied consistently. That's not stated, but it is implicit. How about the second column? Auditor considers internal control. The answer is, Hey, that's explicit. Remember in the auditor's responsibility paragraph. It does state explicitly that the auditor considers internal control relevant to the entities preparation and fair presentation of the financial statements in order to design or in order to design audit procedures that is explicit in the auditor's responsibility.

Paragraph number four. If a client makes a change in accounting principle, that is inseparable from a change in estimate. So this is an estimate effected by a change in principal or a principal in separable from a change in estimate this material event, it is a material event. It has a material effect on the financial statements should be handled in the accounting records as a change in while.

Remember. That a change in estimate effected by a change in principal, a change in estimate inseparable from a change in principal in the accounting records, it's always handled as a change in estimate. Again, the classic example is a change in depreciation methods. A change in depreciation methods is a change in estimate that is inseparable from a change in principal.

In the accounting records, it's always handled as a change in estimate you don't touch prior periods. You just adjusted going forward member prospective only. So when they ask in this question, how's it handled in the accounting records, it can't be C or D it's not handled as a change in principle. So that knocks out C and D right away.

So now you're down to a, or B, is it a change in estimate? And the auditor would add an other matter paragraph? To the audit report? No, it's B it's handling the accounting records as a change in estimate, and the auditor would add an emphasis of matter paragraph to the auditor's report.

Remember, this is a required emphasis of matter paragraph when there's a justified change in principle. And even though this is handled in the accounting records is a change in estimate it for auditing purposes in terms of your audit report. It's treated as a justified change in principle that had a material effect on the financial statements.

So it is a required emphasis of matter paragraph. So I know that's confusing in the accounting records. It's changed an estimate, but in terms of your audit report, because it's a change in estimate effected by a change in principle inseparable from a change of principle, but the audit report, it is handled as a justified change in principle.

And it's a required emphasis of matter paragraph. How about it just to change an estimate? Does that require an emphasis of matter paragraph and other matter paragraph? No, it does not. So if you change the estimate of life, you used to think a machine would last seven years. Now, you think it's going to last nine, that doesn't affect your audit report at all?

In number five, they say the following emphasis of matter paragraph was included in an auditor's report to indicate a justified lack of consistency, a justified lack of consistency. And they say that as discussed in note T. To the financial statements. The company changed its method of accounting for long-term contracts in year two.

How should the auditor report on this matter, if the auditor concurred with the change it's justified the auditor concurs with the change type of opinion on modified, be an unmodified opinion. So now you're down to a, or B, it's not a qualified opinion that knocks out C and D. It's an unmodified opinion.

Now where would this emphasis of matter paragraph B before the opinion paragraph or after, it's answer B it's after the opinion paragraph, because we're not modifying the opinion, it's an on modified opinion. Number six, an emphasis of matter paragraph. Following the opinion, paragraph of an auditor's report described an uncertainty.

As follows as discussed in note X to the financial statements, the company is a defendant in a lawsuit and so forth and so on. So what we have here is an uncertainty and the auditor has added an emphasis of matter paragraph. Is that required? Would this be a required emphasis of matter paragraph? No, this is up to the auditor's judgment is not required with an uncertainty.

But the auditor may add an emphasis of matter paragraph for an uncertainty and that's what's been done. What type of opinion, where the auditor express, the answer it's D it's unmodified, this emphasis of matter paragraph followed the opinion. Paragraph it didn't modify the opinion. It's an UN modified opinion.

Now before we leave the standard unmodified opinion. I just wanted to mention that if the auditor is going to address other responsibilities, other reporting responsibilities in the audit report. Other than generally accepted auditing standards. Then in the unmodified opinion, above the introductory paragraph, you would have a heading report on the financial statement.

I'll say it again. If the auditor is going to address other reporting responsibilities in the audit report, other than generally accepted auditing standards, then above the introductory paragraph, you would have a heading report on the financial statements. And then after the opinion paragraph, then you would have.

A report on other legal and regulatory requirements that would follow the opinion paragraph in that case. Now up, up until this point in class, all we've talked about is an unmodified opinion. There've been no significant departures from gap has been consistently applied, adequate and descend, complete disclosures.

Which is to say no problem with the financial statements. Also no problems with the audit, no significant uncertainties, no significant scope, limitations, no significant going concern problems. And I modified opinion. Now let's say that there is a problem with the financial statements. Let's start there.

Let's say there's a problem with the financial statements. Let's say that us gap has been violated or again, if it's not us gap, whatever the applicable financial reporting framework is that you're testing. Maybe heifers, who knows, but we'll stick with us gap. What if there had been significant departures from us gap?

Us gap has been violated. What if us gap has not been consistently applied? What if disclosures are not adequate and complete? In other words, what if there's a gap disclosure problem, or if there's a problem with the financial statements? If there's a material problem with the financial statements, if there's a material gap, problem, You issue a qualified opinion, but if it's very material, if it's pervasive, it's, if it's all encompassing, if it's pervasive, that's an adverse opinion.

Now, if you look in your viewers guy, you'll see, exhibit number two would be an example of an except for qualified opinion. When you have a material gap or disclosure problem notice. In this case, the introductory paragraph is exactly the same. The management responsibility paragraph is exactly the same.

Isn't it good that you memorize the unmodified opinion? If you can just focus in on the changes that have to be made. So introductory paragraph exactly the same management responsibility paragraph. Exactly the same. Now the auditor's responsibility paragraph is changed a little bit. Notice the auditor's responsibility.

Paragraph concludes by saying we believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our qualified opinion. And now we add an explanatory paragraph before the opinion paragraph. Why is it before the opinion paragraph? Because we're going to modify the opinion.

And we have a heading basis for qualified opinion. And again, that when you see that basis for qualified opinion, that's always before the opinion paragraph because we're modifying the opinion. So we have basis for qualified opinion, the company's financial statements do not disclose significant related party transactions.

In our opinion, disclosure of this information is required by accounting principles generally accepted in the United States of America. And now of course, we also modify our opinion paragraph in our opinion, except for this is an except for qualified opinion, in our opinion, except for the omission of the information described in the basis for qualified opinion, paragraph the financial statements referred to above present fairly it's an except for qualified opinion.

So remember if you have a material. Gap problem, gap disclosure, problem. It's an except for qualified material. What if it's very an except for qualified opinion? What if it's very material? What if it's pervasive? What if it's all encompassing? You have a gap problem. That's pervasive. You must issue an adverse opinion.

And if you look again and your viewers guide, exhibit number three, you'll see an example of the adverse opinion. And once again, notice introductory paragraph unchanged management responsibility, paragraph unchanged, but now the accountant's responsibility paragraph concludes by saying we believe that the audit evidence we have obtained is sufficient appropriate is sufficient and appropriate to provide a basis for our adverse opinion.

Now we added an explanatory paragraph before the opinion paragraph, because we're modifying the opinion and the title we're going to put on this explanatory paragraph basis for adverse opinion, as described in note X to the financial statements, the company carries its property, plant and equipment and appraise values whatever the gap disclosure problem is.

And then the opinion paragraph of course is modified. Of course it is. In our opinion because of the significance of the matter discussed in the basis for adverse opinion, paragraph the financial statements referred to above do not present fairly, it's an adverse opinion. So remember if there's a problem with the financials, but there's a problem in the financial statements, a gap disclosure problem.

If it's material an except for qualified opinion. If it's very material, if it's pervasive, adverse opinion.

Now how about a problem with the audit? Maybe we could have a problem with the audit.

Let's start with a scope limitation. What does scope limitation? What's that mean? It means that the auditor was not able to obtain evidence. That's what it means. That's what a scope limitation is. It's a limitation on the auditor's ability to obtain evidence, insufficiency of data, inadequate records.

What if the auditor is not able to observe the beginning or the ending inventory, something like that? If you have a material scope problem, if it's material an except for qualified opinion, if it's very material, if it's pervasive, it's all encompassing. The auditor has to disclaim an opinion.

One more time. If there's a material scope problem, the auditor issues on except for qualified opinion, if it's very material. If it's pervasive, the auditor has to disclaim an opinion. Now, what if it's a client imposed scope limitation? What if the client won't let you confirm their accounts receivable?

Won't let you do it. That's a client imposed scope limitation. Here again, if it's client imposed, the auditor has to ask a question. If it's material and pervasive. Material and pervasive. The auditor is either going to disclaim an opinion or withdraw, and by the way, international standards of auditing in that case would require withdrawal.

So again, if it's a client imposed scope, limitation and it's material and pervasive, the auditor is either going to disclaim an opinion or withdraw international standards of auditing in that case would require the auditor to withdraw now. In your viewers guide, you'll see an example, exhibit number four of a qualified opinion.

When there's a material scope limitation. Remember if it's material not pervasive, a material scope limitation is an except for qualified opinion. Look at exhibit number four, introductory paragraph. Exactly the same management responsibility paragraph. Exactly the same unchanged, but now. The auditor's responsibility.

Paragraph concludes by saying, we believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our qualified opinion. And now, what's coming next now because we're modifying the opinion. That has to be an explanatory paragraph before the opinion paragraph the heading on this will be basis for qualified opinion.

In this example, it says. We were not engaged as auditors of the company until after December 31 year one. And therefore we're unable to observe the counting of the physical inventory at the beginning or end of the year. As a result, we were unable to determine whether any adjustment might've been necessary in respect to recorded inventories and the elements making up the statements of income changes in stockholders' equity and cash flows.

And then the opinion paragraph in our opinion, except for this is an except for qualified opinion, in our opinion, except for the possible effects of the matter described in the basis for qualified opinion, paragraph the financial statements referred to above present fairly. So just remember if you have a material scope problem, that's an except for qualified.

Opinion. What if it's very material? If you have a scope problem, that's very material it's pervasive. It's all encompassing. The auditor must disclaim an opinion. And if you look at your viewers guide, exhibit number five, you'll see an example of a disclaimer of opinion because of a very material scope limitation.

Notice the introductory paragraph now is modified. Now the introductory paragraph says we were engaged to audit the accompanying financial statements of XYZ company management responsibility. Paragraph unchanged. Now the auditor's responsibility paragraph is changed. Notice it says now our responsibility is to express an opinion on these financial statements based on conducting the audit.

In accordance with auditing standards generally accepted in the United States of America because of the matters described in the basis for disclaimer of opinion paragraph. However, we were not able to obtain sufficient and appropriate audit evidence to provide a basis for an audit opinion. And then an explanatory paragraph before the opinion paragraph notice the heading on it basis for disclaimer.

Basis for disclaimer, of opinion, due to the introduction of a new computerized accounts receivable system, there were a number of misstatements and accounts receivable. We were unable to confirm by alternate means accounts receivable, which total X as X in the balance sheet at December 31 year one. And then.

Notice now our opinion paragraph is actually headed disclaimer, of opinion, because of the significance of the matters described in the basis for disclaimer of opinion, paragraph, we have not been able to obtain sufficient, appropriate audit evidence to provide a basis for an audit opinion. Accordingly, we do not express an opinion on these financial statements.

We just gleaned. That's a very material, a pervasive. Scope limitation.

How about an uncertainty? Let me say right off the bat, that if there's an uncertainty that's fully disclosed in the financial statements and the auditor was able to obtain. Sufficient evidence sufficient appropriate evidence about that. Uncertainty, the auditor would just issue an unmodified opinion and may add they're not required to, but may add an emphasis of matter paragraph, right?

That's how generally, how it uncertainties handled. Assuming that it's fully disclosed, the auditor is able to obtain sufficient, appropriate audit evidence about the uncertainty. The auditor would just issue a standard. Unmodified opinion. And may, if the auditor decides to may add an emphasis of matter paragraph.

Now, if an uncertainty, just maybe I should say this, if an uncertainty causes material misstatements in the financial statements then it's a violation of gap. So if it's material a material gap problem, except for qualified opinion, if it's very material adverse, you know that, but here's. What you have to worry about a little bit in the exam.

What if it's an uncertainty? Because the auditor is not able to gather sufficient, appropriate audit evidence on this issue. It's really another type of scope problem. Isn't it. There could be an uncertainty caused by the fact that the auditor, the reason why there's an uncertainty, the auditor is not able to obtain sufficient, appropriate audit evidence about this uncertainty.

It's just another example of a scope limitation. So you know what to do. If there's an uncertainty that's caused by the inability of the auditor to obtain sufficient, appropriate audit evidence. If it's material an except for qualified opinion, if it's very material, you know what to do disclaim, and I should mention that international standards of auditing allow for the fact that the interaction of several uncertainty.

Could mean that the audit is not able to form an opinion international standards of auditing allow for that, that it's possible that the interaction of several uncertainties could mean that the auditor is unable to form an opinion, even though the auditor has obtained sufficient, appropriate evidence, they're not able to form an opinion.

So in that case, in international standards, you would disclaim, but remember in U S. Generally accepted auditing standards. The auditor only disclaims with an uncertainty, if they're not able to obtain sufficient appropriate audit evidence like over that again in international standards of auditing, it's possible that the interaction of several uncertainties would cause the auditor to be in a situation where they're not able to form an opinion and the auditor could disclaim in that case.

They just, not even though they have obtained sufficient, appropriate audit evidence. They're just not able to form an opinion. So international standards would say that the auditor could disclaim. That's not true when generally accepted auditing standards, U S generally accepted auditing standards in us, generally accepted auditing standards.

An auditor would only disclaim an opinion with an uncertainty if they are not able to obtain sufficient, appropriate audit evidence about that uncertainty, the only time that they would disclaim that's swimming, it's pervasive.

How about a going concern problem? Let's say we're staying with problems with the audit. How about going concern? Problem? I think, you know that the auditor is responsible to evaluate all the audit evidence. Gathered during the audit and determine whether or not there's a substantial doubt about the company's ability to continue as a going concern.

The auditor has that responsibility to evaluate all the audit evidence. And that light is to determine, is there a substantial doubt about the company's ability to continue as a going concern for a reasonable period of time? Not to exceed one year? You don't have to go beyond that, not to exceed one year from the date of the financial statements.

That's a reasonable period of time. You're not required as an auditor to project out 20 years. No reasonable period of time, not to exceed one year from the date of the financial statements. Now how would it, let's just talk about this for a moment. How would an auditor evaluate.

The company's ability to continue as a going concern. The kind of evidence the auditor would want to look at auditor would want to look at minutes of meetings, legal letters that you'd certainly want to look at letters from the client's attorney, subsequent events. And if you go in your viewers guide, you'll see a list of negative trends.

You know what? If there are recurring losses, negative cash flow. Adverse ratios. They're defaulting on loans. Make sense, right? These are not good signs. Denial of usual trade credit. That's a very bad sign, a rearages and dividends. There's pending legal proceedings. They've lost a key patent. Those are negative trends about the company's ability to continue as a viable entity, but there are mitigating factors.

What if they start disposing assets that actually can be a good sign. They start disposing of unproductive assets and focus in on their productive assets. What if they are restructuring their debt? It's again, a mitigating factor. They reduce or delay expenditures. They increase stockholders' equity. They raise more capital.

That's a good sign. It's a mitigating factor. And they are able to reduce their dividend requirements. So you look at negative trends. You look at mitigating factors, you look at letters from the client's attorney. You look at minutes of meetings and let's say you have decided there, there is substantial doubt about the company's ability to continue as a going concern.

Again, it's a problem with the audit, not a problem. The financial statements are fairly stated, but now we have a doubt. About whether this entity can continue. Here's the bottom line. If there's a material going concern, problem. If there's a material going concern, problem, assuming it's fully disclosed in the financial statements, not a disclosure problem.

If there's a material going concern, problem, the auditor will issue an unmodified opinion with a required emphasis of matter paragraph. Remember, that's one of the required ones. So that's how it's handled. If there's a material going concern, problem, assuming it's fully disclosed auditors, going to issue an unmodified opinion, but where they required emphasis of matter paragraph, having the language, you see an example in your viewers guide, you see that language raising substantial doubt about the entities ability to continue as a going concern.

That language is very important. So the emphasis of matter paragraph we'll have that language raising substantial doubt about the entities ability to continue as a going concern. What if it's very material? If it's a very material pervasive going concern, problem disclaim,

you would have to disclaim an opinion.

All right. So let me summarize you're in the exam. You're always thinking with the basic structure we started with, if there's no problems with the financial statements, no problems with the audit, it's an unmodified opinion. Now what, if there is a problem with the financial statements, what if there's a gap disclosure problem?

If it's a material gap, disclosure problem, what are you going to do on, except for qualified opinion, if it's very material, if it's pervasive and it's all encompassing adverse opinion. How about a problem with the audit, having a problem with the audit? Let's start with, let's go problem. The auditor is not able to obtain evidence.

You know what to do if there's a material scope problem, an except for qualified opinion, if it's very material, if it's pervasive, disclaim, how about an uncertainty? There's an uncertainty caused by the auditor's inability to obtain sufficient appropriate audit evidence. That's what we're saying.

There's an uncertainty caused by the inability of the auditor to obtain sufficient appropriate audit evidence. Wealth is a material uncertainty caused by that problem. An except for qualified opinion, very material disclaim. It's really, exactly the same. Exactly the same way we handle scope problems.

Isn't it? Because it is a scope problem. Ultimately, that's what the uncertainty is. You're not able to gather enough evidence to settle your mind about this uncertainty, to inability, to gather evidence. Isn't it. It's another scope problem, really. And then finally going concern problems. How do we handle going concern problems?

If there's a material going concern problem, the auditor is going to issue an unmodified opinion with it. A required are required. Yes. This is of matter paragraph having that language. Raising substantial doubt about the entities ability to continue as a going concern. If it's very material, if you have a very material pervasive going concern, problem disclaim.

So that's how you take the CPA Examis a problem with the financials or is it the audit always divided up that way in your mind? The problem with the financial statements, is it a gap problem? Or is it a problem with the audit, a gas problem, generally accepted auditing standards, problem, gap, problem, or gas problem, gap, problem, or gas problem.

It's a good way to divide it up in your mind. Let's do some more questions. I'd like you to shut the class down, do seven to 20, and then come back. We'll talk about them together.

Welcome back. Let's look at these questions together in number seven, an auditor, most likely would express most likely would express an unmodified opinion and would not add an emphasis of matter paragraph. Or an other matter paragraph in what case? AA says when they wish to emphasize that the entity had significant transactions with related parties.

You may remember that would be a possible emphasis of matter paragraph. So to say that they most likely would not get, say that if it's significant related party transactions, it will be up to the auditor's judgment. They most likely would add an emphasis of matter paragraph. It's not required, but that's one they may add and probably would, if they're significant related party transactions, B says they concur with the entities change in its method of accounting for inventory.

You know what that is. That's a justified change in principle, going from five photo life, a life on a FIFO five photo weighted average for inventory costing. That's a required emphasis of matter. Paragraph C says. They discover that supplementary information required by the FASBI has been omitted while that would be a required other matter paragraph, but answer D they believe there's a remote likelihood of a material loss from an uncertainty.

Remember with an uncertainty, assuming it's fully disclosed didn't cause any material misstatement, the auditor just issues, an unmodified opinion and. They may add an empty, this is of matter paragraph, but not in this case, if they think the chance of a loss is remote. I don't think that it's likely they would in the question was they would most likely add most likely in an, in a remote uncertainty, they would not add an emphasis of matter paragraph number eight, for which of the following events would an auditor.

Issue a report that omits any reference to consistency about a change in the method of accounting for inventory that we just spoke about it, that would be a required emphasis of matter. Paragraph, a justified change in principle, be a change from an accounting principle that is not generally accepted to one that is generally accepted.

If you go from an unacceptable principle to an acceptable principle, what is that? When you go from an unacceptable principle to an acceptable principle, you know what that is? That's correcting an error, but it's correcting an error that involves a principle. So it would be a required emphasis of matter.

Paragraph

D says management's lack of reasonable justification for a change in accounting principle. If it's unjustified what's that if it's unjustified, it's a gap problem. So it's either a qualified opinion or adverse. Because if it's just a material gap problem, except for qualified opinion, but if it's very material, if it's pervasive, it's going to be an adverse opinion.

So in a, B and D, there would have to be a reference to consistency, but answers see a change in the useful life of assets. A change in the estimate of life, change an estimate. That would be an unmodified opinion without any reference to consistency whatsoever. Number nine on auditor concludes that there is a substantial doubt about an entity's ability to continue as a going concern for a reasonable period of time.

If the entities financial statements adequately disclose. The financial difficulties and the auditors report, the auditor's report is required to include an emphasis of matter paragraph that specifically uses the phrase reasonable period of time, not to exceed one year. Now that phrase is not in the emphasis of matter paragraph, right?

That the key phrases raise raises substantial doubt about the entities ability to continue as a going concern, nothing about a reasonable period of time. That's not in there. Is the phrase going concern mentioned. It is raising substantial doubt about the entities ability to continue as a going concern.

So the phrase going concern would be mentioned in the emphasis of matter paragraph. So the answer is C no. Yes.

Number 10, which of the following conditions or events most likely would cause an auditor to have substantial doubt about the entities ability to continue as a going concern? The auditor has an obligation to examine all the audit evidence. To determine if there is a doubt about the entities ability to continue as a going concern.

So what would raise a doubt here? How about a significant related party transactions they're pervasive? That would be something that should be disclosed. It's something, no doubt that would require an emphasis of matter paragraph. Not require it, but no doubt, an emphasis of matter paragraph would be added if there's significant related party transactions, but that does not necessarily say anything about the company's ability to continue as a going concern.

So it's not a C says arrearages in preferred stock. Dividends are paid. That's a good sign. If they're paying the dividends in arrears, there they have cashflow. If anything, that would be a good sign about their ability to continue as a going concern. D says restrictions on the disposal of principal assets are present.

That can be a problem because if there was restriction on disposal of assets, it may restrict your ability to dispose of unproductive assets, but it isn't necessarily evidence of a going concern problem. But answer B is not a no doubter. If usual trade credit from suppliers is denied, that tells you something usual crate trade credit being denied is a warning sign about a company's ability to continue as a going concern.

So the answer is B number 11, which of the following phrases you see why it's so important to know the unmodified opinion word for word. Because these questions are picky. The questions are asking you word for word, which of the following phrases would be included in the opinion paragraph, when an auditor expresses a qualified opinion.

How about when read in conjunction with note X? What was anything like that? No. With the foregoing explanation? No, the answers date. Remember when there's. Unqualified opinion. The opinion paragraph is going to say in our opinion, except for the possible effects of the matter described in the basis of a qualified opinion, paragraph, the financial statements referred to above present fairly, but these phrases are not in the qualified opinion.

It's double no answer D number 12 when qualifying an opinion because. Of an insufficiency and audit evidence, a scope problem. An auditor should refer to the situation in the introductory paragraph. No. Remember introductory paragraph is exactly the same member management responsibility. Paragraph is exactly the same, although they didn't ask.

How about the auditor's responsibility paragraph second column. Oh, you want, yes. In that column answer D because remember now the. Auditor's responsibility. Paragraph does have to be changed. Now you're going to say at the conclusion of the auditor's responsibility paragraph, we believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our qualified opinion.

It has to be referred to because you're qualifying your opinion. 13, an auditor may reasonably issue an except for qualified opinion for a scope limitation. Yes. If it's material, but not pervasive. Yes. An except for qualified opinion, an unjustified accounting change. Yes. It's double yes. Answer C because if it's an unjustified accounting change, it's a gap problem.

It's a gap problem. It's problem with the financial statements, it's a material and except for qualified opinion.

14 due to a scope limitation on auditor, disclaimed, an opinion on the financial statements taken as a whole, but the auditor's report included a statement. That the current asset portion of the balance sheet was fairly stated. This inclusion, the inclusion of this statement is, it's a, it's not appropriate.

This is a piecemeal opinion. It's a piecemeal opinion. You can't issue an adverse opinion or a disclaimer of opinion on the financial statements as a whole, but then say, yeah, but the balance sheet is fairly stated. Why? Because as he says, It's not appropriate because it may tend to overshadow the auditor's disclaimer or adverse opinion.

That's the problem with a piecemeal opinion. So once again, you can't issue an adverse opinion or a disclaimer of opinion on the financial statements as a whole, but say, but the property plant and equipment is fairly stated that could overshadow the main point, which is it's an adverse opinion. It's a disclaimer on the financial statements taken as a whole B says it's not appropriate because the auditor is.

Prohibited from reporting on only one basic financial statement. That's not true. You can report, you can have limited reporting objectives. You could report just on the balance sheet, as long as there are no scope limitations, as long as you have access to everything in the audit, but you can have limited reporting objectives.

See says it's appropriate. Provided the auditor's responsibility. Paragraph describes the scope limitation. No, that's not. It's not appropriate. Period. And D says it's appropriate. Provided that. The statement is in a basis of disclaimer, of opinion, paragraph preceding the disclaimer. And that would not be true either.

It's just answer a not appropriate it's piecemeal opinion. Number 15, Harris CPA has been asked to audit and report on the balance sheet of Fox company, but not on the statements of the income retained earnings or cash flows. Harris will have access to all information underlying the basic financial statements, no scope limitations.

Under these circumstances. Harris answer C may accept the engagement because just limited report objectives, 16,

an auditor qualifies an opinion because of inadequate disclosures. You have a gap disclosure problem here. Probably on the financial statements, the auditor should describe the nature of the omission in the basis for qualified opinion, paragraph and modify. What do we modify the introductory paragraph?

No, it's unchanged. Do we modify the auditor's responsibility paragraph? We do. We do that as a yes. In that column, right? Because now. We conclude the auditor's responsibility paragraph by saying, we believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our qualified opinion.

It is modified isn't it. And of course the opinion paragraph would be modified it because now it's except for the matter described in the basis for qualified opinion, paragraph the financial statements referred to above present fairly. So the answer is C. No. Yes. Yes.

17. In which of the following circumstances, when an auditor, most likely express an adverse opinion. Most likely express an adverse opinion. How about a, the chief executive officer refuses the auditor access to minutes of board meetings. You know what that is? That's a client imposed scope limitation, right?

Client imposed. If it's material and pervasive, the auditor is either going to disclaim an opinion or withdraw, but not an adverse opinion. B says, tests of controls show that the entities internal control structure is so poor. It can't be relied upon. Generally what that means is you're going to have to do extensive substantive testing.

When internal controls are poor, you have to do much more substantive testing of details because you can't rely on the system. I know it may possibly mean that. The company can't be audited. You can't gather enough evidence, then you'd have a scope problem. So you'd either qualify or disclaim, but not necessarily an adverse opinion.

We're just going to have to do a lot more substantive testing D says information that comes to the auditor's attention that raises substantial doubt about the company's ability to continue as a going concern. The possibilities there, if it's material. Unmodified opinion with a required emphasis of matter paragraph, very material, pervasive disclaim, but no adverse opinion here.

Now, the possible adverse opinion is answers. See the financial statements are not in conformity with gap regarding the capitalization of leases. It's a gap problem. If it's very material, if it's pervasive, it would be an adverse opinion. 18. If a company issues, financial statements that purport to present the financial position and results of operations, but omits the statement of cash flows.

This company has admitted the statement of cash flows. You know what, that's a gap problem, right? Statement of cash flows is required under us gap. So what you have here is a gap problem, and certainly a material one. Unlikely. It would be pervasive, almost always. That would be a qualified opinion.

Answer B usually almost automatically a qualified opinion. If you could argue it was a pervasive problem, but generally omitting the statement of cash flows. It's a gap problem. It's material unaccept for qualified opinion. 19 in the first year of an, of a client, an auditor was not able. To gather sufficient evidence about the consistent application of accounting principles between the current and prior year, as well as the amounts of assets or liabilities.

At the beginning of the current year, this is a mess. This was due to the client's record retention policies must be just nonexistent. If the amounts in question. Could materially affect the current operating results. The auditor would, what answer a be unable to express an opinion. This is a very material scope limitation.

You can't gather evidence. They would no doubt disclaim an opinion. Number 20, an auditor would express. An unmodified opinion with an emphasis of matter paragraph added to the auditor's report. Four. How about the first column? N justified County change? If it's unjustified, that's a gap problem. And if it's material, it's a qualified opinion.

If it's very material, if it's pervasive, it's an adverse opinion, not going to be an unmodified opinion, not if there's an unjustified accounting change. You got to have a no in that column. So it would not be an unmodified opinion. It would either be qualified or adverse. How about a material going concern problem.

That's not a material going concern problem. It would be an unmodified opinion with a required emphasis of matter paragraph. So that's a yes in that column. And the answer is C I hope he did really well in that group of question.

What I want to talk about. Next is subsequent events. A subsequent event is an event that occurs after the balance sheet date, but before we issue the statements. That's a subsequent event. It's an event that occurs after the balance sheet date, normally December 31, but before we issue the statements, now the tricky thing with subsequent events is that there are two types and you have to be very careful on this type one with a type one subsequent event, the conditions did exist.

The conditions did exist on the balance sheet date. So for example, let's say the balance sheet date. Is December 31 year one. And when we did the balance sheet dated December 31 year one, the company was involved in a lawsuit and they thought with this lawsuit, it was reasonably possible that they would lose the suit and settle for a hundred thousand dollar loss.

As that's a reasonably possible contingency. Our lawyer thinks it's reasonably possible. We'll lose the suit. And settled for a hundred thousand. So with a reasonably possible contingency, there would be a footnote. There would be a footnote in the year, one statements because it's not probable right.

The loss isn't probable. It wouldn't be on the income statement, but it would be a footnote as a reasonably possible contingency. Now let's say that the suit is settled on February 9th, year two, after the balance sheet date. But before we issue the statements, what if they settle the suit on February 9th for $500,000.

Now, before I move off this for a moment, I want to make sure you see why it's a type one. Why am I saying that the conditions did exist on the balance sheet date? Wasn't this lawsuit pending. On December 31 year one on the balance sheet date. So the conditions did exist on the balance sheet date. So here's the point because this is a type one subsequent event because the conditions did exist on the balance sheet date.

We would have to go back and adjust the year. One statements. We would have to put a $500,000 loss, a lawsuit loss on the year one income statement and a $500,000 liability on the year one balance sheet. And of course there would also be a footnote. But the point is this lawsuit was pending on December 31 year one.

The conditions did exist on the balance sheet date. So you'd have to go back and adjust the year. One statements. Now with a type two subsequent event, the conditions did not exist based on the balance sheet date. So once again, let's say that the balance sheet date is December 31 year one. And on February 9th, year two, after the balance sheet date, But before we issue the statements on February 9th, there was a fire.

There was a huge fire loss for the company. Now you see the difference. This is a subsequent event, but the conditions did not exist in the balance sheet. Take this buyer was not raging on December 31 year one. The conditions did not exist in the balance sheet date. So a type two subsequent event. Would just be a footnote.

You would not go back and adjust the Yuan statements. It would only be a footnote in the year, one statements, but there would be no adjustment in the year. One statements. All right. So how do, how does this affect our audit report? Now? Let's say that before the subsequent event, our audit report was dated January 26th, year two.

That was the date we had acquired sufficient appropriate audit evidence. To form a basis for our opinion. So we originally were going to date the audit report January 26th, year two. Now what should I do? If I date the report February 9th, because of the subsequent event, if I now just date the report February 9th, year two, that means the auditor is responsible for all subsequent events up to.

February 9th year two. So the way around this is to do what is called dual data. Now, what it's really better to dual date the report. So the best way to handle this, if you dual date, the report is to say, now the date of the report is January 26th, year two, except as to note X, which is at as of February 9th.

When you dual date, the report like that. Now the auditor's responsible up to February 9th, year two for just that event only that's the purpose of dual dating. Let me ask you this. What if the auditor discovers facts that have a material effect on the year? One statements that they audited, but they don't discover the facts until after the audit report is issued.

After the financial statements are issued, when the audit report is issued. Remember, the auditor is not obligated to make inquiries after the financial statements are issued after the audit report is issued. But what if there are subsequently discovered facts that have a material effect on the year, one statements after the financial statements have been issued after they've released the audit report?

In that case, the auditor should advise the client to issue revised financial statements. With a new audit report. That's what the auditors should do. Advise the client to issue revised financial statements with a brand new audit report. What if the client refuses? If the client refuses, then you notify the client that the audit report must no longer be associated with those financial statements.

Again, you would have to notify the client that the audit report must no longer be associated with those financial statements. You would also notify regulatory agencies and you would also do your best to notify. Those who you know, are relying on the financial statements. So watch out for that situation.

I'd like you to shut the class down to 21, 22 and 23, and then come back.

Let's do these questions together. And number 21, they say on August 13th, a CPA obtained, sufficient appropriate audit evidence to support an opinion on a client's financial statements for the year ended June 30th. Then on August 27th, notice it's going to be after the balance sheet date, but before the statements issued on August 27th, an event came to the CPA's attention that should be disclosed in the notes to the financial statements.

In other words, A type two subsequent event. We're not going to make an adjustment to the prior statements, but they should be footnoted. It says that the event was properly disclosed by the entity, but the CPA decided not to dual date. They're not going to do a date. The report, the auditor's report has been dated August 27th.

You know what that means. If you don't dual date, the report, if you just date the report, August 27th, they say under these circumstances, the CPA was taking responsibility for what answer a all subsequent events up to August 27th. The reason you dual date is so that you only take responsibility for this particular event up to a certain date.

If you just date the report as they did August 27th. Now the auditor has responsibility for all subsequent events. Up to that date answer a 22 zero corporation suffered a loss that would have had a material effect on the financial statements on an uncollectable account receivable due to a customer's bankruptcy.

This occurred suddenly because of a natural disaster. This is a type two subsequent event. The conditions did not exist on the balance sheet date. Just stop and think. Casualty losses like this natural disasters. If you sell off a component of your business, if you purchase another component of your business, if you issue shares, if you issue debt after the balance sheet date, but before they issue the statements, these are tight classic type two subsequent events that just require a footnote.

So the. But that occurred suddenly due to a natural disaster, 10 days after the balance sheet date. But one month before the issuance of the statements and the auditor's report being issued under the circumstances, what's the answer? How about the financial statements should be adjusted? No. First column.

No, it's a type two. Subsequent event is gonna be a footnote. Only next column. The event requires financial statement disclosure. But no adjustment. Yes. That's what we do with a type two subsequent event disclosure, no adjustment. And then the last column, the auditors report should be modified for lack of consistency.

This is not a consistency problem. So the answer is no. Yes, no answer date, nothing to do with consistency. 23 after issuing. The auditors report, an auditor has no obligation to make continue increase. That's true concerning audited financial statements unless a says information about a material transaction that occurred just after the auditor's report was issued is deemed to be reliable.

That, again, that's just the following year's transaction. Auditor would have no obligation for that. He says a final resolution is made of a contingent liability. That had been disclosed in the financial statements. You know what that is a subsequent event, but yeah, this is after the audit report was issued.

So the audit would have no obligation there. After the audit report is issued no obligation to continue making inquiries about the prior statements. Dee says an event occurs just after the auditor's report was issued. That affects the entity's ability to continue as a going concern. Again, That is the following year's event that would not require disclosure or adjustment in the prior statements, but answers see information that existed at the report.

Date information that existed back in the year that the audit report was referencing to and may affect the report itself, comes to the auditor's attention. That's what we're worried about. Answer. See now the auditor will have an obligation it's come to, it's not that they have an obligation to make inquiries about it, but if it comes to their attention and it could have a material effect on the statements, they audited on the audit report that was issued.

Now they have an obligation. They have to inform the client that the financial statements and the audit report can no longer be relied on. And the statement should be revised. Now there's an obligation because the auditor knows about this information.

I want to talk for a minute about audits of a group of financial statements, like a parent subsidiaries financial statements. What very often happens. In a situation where you're auditing a group of financial statements, apparent and subs financial statements is that one of the components, one of the subsidiaries may be audited by a component auditor apart from the group engagement team that happens very often in a case like this, where the subsidiary is being audited by a component auditor, not connected to the group engagement team.

Now, assuming that the component auditor is independent, it's competent. Now the group engagement team has a decision. Should they assume responsibility for the work of the other auditor or divide responsibility? If you look in your viewers guide, you'll see an example of. What the audit report would look like if they decide to divide responsibility, notice if they divide responsibility, the introductory paragraph is exactly the same.

The management's responsibility paragraph is exactly the same, but notice now we modify the auditor's responsibility. Paragraph notice. Now the auditor's responsibility paragraph would say we did not audit the financial statements of X company. A wholly owned subsidiary whose assets constitute X. We show the magnitude.

These statements were audited by other auditors whose report has been furnished to us. So we have to modify the auditor's responsibility paragraph. And of course we have to modify the opinion. Paragraph you look at the opinion paragraph in our opinion, based on our audit and the report of the other auditors, the financial statements referred to above.

Present fairly, this is how you divide responsibility. Now that's one possibility where the group engagement team decides to divide responsibility. What if the group engagement team decides to assume the responsibility, they've gone over the Workpapers of the component, auditor. They know the reputation of the component.

Auditor they're satisfied. If they're going to assume the responsibility for the work of the other auditor now there would be no reference made in the audit report to the other auditors. If because of reference is made to the component auditor that could be misinterpreted. So if you assume responsibility, you would just issue the unmodified opinion without any changes and make no mention whatsoever of the component.

Auditor, please do 24 and 25 and come back.

Welcome back. Let's look at these questions together. And number 24, it says the auditor's responsibility. Paragraph of an auditor's report contains the following sentences. We did not audit the financial statements of easy, Inc. A wholly owned sub, which statements reflect total assets and revenues, constituting 27%, 28% respectively of the related consolidated totals.

Those statements were audited by other auditors. And remember you don't name the other auditors, but other auditors whose report has been furnished to us. You know what? This is answer a. They've divided responsibility. So you'd modify the auditor's responsibility paragraph and you'd modify the opinion paragraph.

As that's a division of responsibility. 25 Pell CPA decides to serve as the principal auditor in the audit of the financial statements of tech consolidated Smith's CPA audits, one of techs subsidiaries. So Smith is a component auditor. In which situation would Pell make reference to Smith's audit.

Remember you only going to make reference if there's a division of responsibility, if Pell assumes responsibility, no reference would be made to the work of the other auditors. So you're looking at when they would divide responsibility because they want to know when would Pell make reference dismiss audit.

When would they divide responsibility? How about number one? Pell reviews. Smith's work papers and assumes responsibility. If they assume responsibility, no mention is made of the component. Auditor none. So that's not it. Number two, Pell is unable to review Smith's work papers. However Pell's inquiries indicate that Smith has an excellent reputation for professional competence and integrity.

You know what that means. They're going to divide responsibility. You're not going to assume responsibility for the work of another auditor. If you can't look at their work papers, it's that simple. So they're going to divide responsibility. So they would make reference to Smith's audit in number two, only answer B.

Let's say that we are engaged as auditors for the year two statements where the successor auditors, the year one statements were audited by a predecessor auditor. So we are the successor auditor for the year two statements, but year one was audited by a predecessor auditor. In that case, one way to handle this is for the predecessor auditor to reissue their audit report, just reissue their audit report, swimming it's still appropriate.

So if the predecessor auditor is going to just reissue their audit report, what obligations does the predecessor, what obligations do they. What obligations does the predecessor auditor have? The predecessor auditor would have to read the current year's financial statements, compare the current year's financial statements with the prior year and make sure that there have been no material changes.

They have to be aware of nothing that would have, that would affect the year. One statements. They have to obtain a letter of representation by the successor auditor. Th the predecessor auditor needs a letter of representation from the successor auditor

stating whether or not the current audit revealed any matters that in the successor auditor's opinion would have had a material effect on the year. One statements or would have had been disclosed in the year. One statements. They also, the predecessor auditor also has to obtain. Management representation letter by management stating if any previous representations need to be modified, the letter has to state that there have been no subsequent events that require an adjustment to the year.

One statements, or should have been disclosed in the year. One statements. Now, if the predecessor auditor, reissues their report, unrevised. The report would be data just using the original report date. If the original audit report from the predecessor auditor is revised, then they would duel date. What if the predecessor auditor's audit report is not reissued?

If the predecessor auditor's report is not reissued, then in the current year statements in the year, two statements in the year two audit report. There would be a required other matter paragraph, a required other matter paragraph stating that the financial statements of the prior period were audited by a predecessor, auditor not named, but you would state in the other matter paragraph again, a required other matter paragraph that the financial statements of the prior period were audited by a predecessor auditor.

You would state the type of opinion, any modifications and the nature of any emphasis of matter paragraphs. And the date of the predecessor auditor's report.

What if we want to update an opinion? Let's say the prior year we issued a qualified opinion and the client has now restated the prior statement. So a qualified opinion is no longer appropriate. And we want to change the opinion from qualified to unmodified. Remember, this is the case sub subsequently discovered facts, which lead to a change.

In opinion, we talked about this. This is that weird situation. Subsequently discovered facts that lead to a change in opinion. This can either be handled. In an emphasis of matter paragraph or an other matter paragraph at the auditor's discretion, depending on the auditor's judgment about the importance of the item, but whether there's an emphasis of matter paragraph or an other matter paragraph, basically that paragraph is going to state the date of the previous audit report, the type of opinion that was issued.

The reason for the qualified opinion, the change that has occurred and a statement that now the opinion is different than one expressed in the previous report. What if a prior period, we're auditing the current period and what if the prior period was not audited? What if the prior period was reviewed or compiled.

We're all, we've been engaged to audit the year two statements, but year one was not audited year. One was reviewed or compiled. If the prior period was reviewed or compiled and the report of the prior period is not reissued. If it's not reissued, that's going to be a required other matter paragraph.

Stating the service that was performed in the prior period. Was it a review? Was it a compilation? The date of the prior year's report, a description of any material modifications described in the report. And you'd have to state that a review, a compilation is less in scope than an audit and does not provide a basis for an opinion.

What if the prior period was not audited, not reviewed or compiled, we're auditing the year two statements. What if your one was not, audited was not reviewed, was not compiled? Then we just make sure that those statements are clearly marked and it's another required. Other matter paragraph stating that we did not audit review or compile the prior period, and we assume no responsibility for the statements, please try 26 and 27 and come back.

Welcome back. Let's look at these questions together. And number 26, the predecessor auditor, who is satisfied after properly communicating with the successor auditor has re-issued their audit report because the audit client wants to. Have comparative financial statements, the predecessor auditor's report should make notice a, B and C say that the predecessor auditor's report should make a reference to the work of the successor auditor.

Never. No. The answer is D when the predecessor auditor reissues their report, they're not making any reference to the work of the successor audit ever answer D 27. A former client requests that a predecessor auditor, reissue their audit report on a prior period financial statements, the financial statements are not restated and the report is not revised well, if the report's not revised and they ask, what date would the predecessor auditor use on the reissued report?

The original day answer a, the original date of the prior period report would not be dual data. It would just be the original date of the prior period report.

What I want to talk about next is other information that's presented in documents that contain the audited financial statements. For example, Audited financial statements are included in the annual report to shareholders. Now, I think, that generally speaking, the auditor is not responsible for determining if the other information is properly stated.

That's not the auditor's responsibility to determine if other information is properly stated. The only obligation the auditor has is to read the other information, determine if there's any material inconsistencies. With the audited financial statements, by the way, we're not talking about the website.

We're not talking about press releases. This is other information that's presented in a document with audited financial statements. Again, not the website, not press releases. What if the auditor does identify a material inconsistency in the other information and inconsistency with the audited financial statements?

If the financial statements have to be revised and management refuses, The auditor has to modify their opinions. That's simple. Again, if the financial statements now need to be revised and the client refuses, that's going to result in the CPA, modifying their opinion, the auditor would qualified opinion, maybe even adverse.

What if the other information requires revision and management reviews? If the other information requires revision and management refuses, then you communicate the problem with those charged with governance and to the audit report, you would add a required other matter paragraph describing the inconsistency.

And of course you could also withhold use of the report. The auditor could do that. Withhold use of the report. They, the auditor could even withdraw if there was fraud involved. If the other information was misleading, the auditor may also in the other matter, paragraph disclaiming, any opinion on the other information.

Let's talk about supplemental information. Supplemental information is information outside the basis, financials, the basic financial statements, supplemental information outside the basic financial statements that would be presented in. A document with the audited financial statements. Now we bring this up because an auditor might be engaged to report on the supplemental information in relation to the financial statements taken as a whole.

That's a possible engagement. So in that case, if the auditor is engaged to report on the supplemental information, And it's relation to the financial statements as a whole. The auditor has two objectives. One to evaluate the presentation of the supplemental information in relation to the financial statements and number two, to report on the supplemental information, whether or not it's barely stated in all material respects in relation to the financial statements, those are the objectives evaluate whether it's supplemental information, evaluate the presentation of the supplemental information.

In relation to the financial statements and report on if the supplemental information is fairly stated in material, in all material respects in relation to the financial state,

by the way, the financial statements must have been audited by the auditor to do a report on supplemental information. The financial statements must have been audited by the auditor, and there can't have been an adverse opinion or a disclaimer of opinion can not have been. Now, in this case, what's management's responsibilities while the management would be responsible for a management representation letter related to the supplemental information and the, and management would be required to include the audit report on the supplemental information, in any document that contains the supplemental information that would be required.

That management would include the audit report on supplemental information in any document. That includes the supplemental information. Now, if the auditor is engaged to report on the supplemental information and its relation to the financial statements taken as a whole, what are the basic audit steps?

Five basic audit steps here, the audit steps. Number one. The auditor would inquire of management, the purpose of the supplemental information, any significant assumptions that are being made. Number two, obtain a management representation letter about the supplemental information. Number three, evaluate the form and the content of the supplemental information with respect to establish criteria for reconcile, the supplemental information to the financial statements and five evaluate the supplemental information in terms of.

Completeness and the appropriateness of the supplemental information. And in terms of the report on supplemental information, this can either be in an other matter, paragraph, this report on supplemental information could be in another matter paragraph or in a separate report. What if there's a miss material misstatement in the supplemental information?

And management refuses to revise the supplemental information. The auditor would modify their opinion on the supplemental information. And if they're handling this with a separate report, not just with an other matter paragraph, if they hadn't handled the report on supplemental information as a separate report, they could withhold the report.

What if supplemental information is required? If there's required supplemental information, the auditor has to. Has to perform limited audit procedures when there's required supplemental information, auditor's going to have to perform limited audit procedures. Basically they have to inquire of management about the preparation of the supplemental information with established criteria guidance and whether or not it's consistent with the financial statements.

And the auditor would obtain a management representation letter. About the supplemental information. Remember the auditor is not required to actually audit required supplemental information that's not required. And they would not remember. They would also be a required other matter paragraph.

They would be required. Other matter paragraph saying that required supplemental information has been included or admitted if it's admitted that. The auditor applied the required procedures, any material departures from the criteria, any unresolved issues or doubts and the auditor, if they want to can disclaim on the supplemental information.

Now, the auditor also could be engaged to report on required supplemental information in relation to the financial statements as a whole. If it's an engagement. Then you'd follow the same five audit steps I talked about before you would inquire of management, the purpose of the supplemental information and any significant assumptions that have been made you obtain always a management representation letter about the supplemental information you evaluate the form and the content of the supplemental information with established criteria, you'd reconcile the supplemental information to the audited financial statements, and you would evaluate.

The completeness and the appropriateness of the supplement supplemental information. And once again, it could be handled as either a separate report or it could be handled in an other matter paragraph. And if there's a material misstatement in the supplemental information, you're back to the same choices.

If management refuses to revise the supplemental information, the auditor can modify the opinion on the supplemental information. And remember if it's a separate report, they can withhold the report.

Please do 28, 29 and 30. And come back.

Welcome back. Let's look at these questions. 28 on auditor concludes. That there is a material inconsistency in the other information, in an annual report to shareholders containing audited financial statements, the auditor believes that the financial statements do not require revision, but the client is unwilling to revise or eliminate the material inconsistency in the other information under these circumstances, what action will the auditor most likely take?

AA says consider the matter closed, that's not it. But he says issue an except for qualified opinion. No, not on the financial statements. This is the other information. So he says disclaim an opinion on the financial statements. Financial statements are fine. It's the other information? That's the problem?

No, the answer is D what the auditor would do is revise the auditor's report to include a separate other matter paragraph, a required other matter paragraph describing the material inconsistency 29. What is the auditor's responsibility for supplementary information, such as the disclosure of pension information, which is outside the basic financial statements, but is required by the Gasby it's required supplementary information.

A says the auditor should apply substantive tests, no members. Limited audit procedures. B says the auditor should apply certain limited procedures to the supplementary information and include an other matter paragraph in the audit report to refer to the required supplementary information. Of course, that's the answer V and then finally, number 30 under which of the following circumstances would an expression of a disclaimer of opinion, be inappropriate.

When would a disclaimer be inappropriate? How about a. The auditor is unable to obtain the audited financial statements of a consolidated investee. That's a sculpt limitation. If it's a material scope limitation, except for qualified opinion, if it's very material, if it's proven passive, it could be a disclaimer, right?

It would be a disclaimer. So disclaimer might be appropriate. C says the company failed to make account of its physical inventory. During the year, the auditor is unable to apply alternative procedures. To verify inventory quantities, sculpt limitation, if it's material and except for qualified opinion, very material could be a disclaimer might be appropriate depending on the severity of it.

D says management refuses to allow the auditor to have access to the canceled checks and the bank statements. It's a scope limitation if it's material and except for qualified opinion, it's very material. If it's pervasive, it could be, and it would be a disclaimer. A disclaimer could be appropriate in that case.

But how about big management does not provide reasonable justification for a change in principle? If it's an unjustified change in principle, that's a gap problem. And if it's a material gap, problem, an except for qualified opinion, if it's very material, if it's pervasive, adverse opinion, no, a disclaimer would not be appropriate for answer B.

That concludes our discussion of our introduction to reporting issues and from all of us at bisque CPA review, we want to wish you the best of luck on the exam. Study hard and do a great job.

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Hello and welcome to the bisque education hotspot video for audit sampling. My name is Rick Birkbeck. I'm a CPA, but I've been a full-time educator for 35 years. Teaching auditing and financial accounting. And I'm very pleased to be your instructor for this hotspot video on audit sampling a couple of points before we begin.

First of all, get the maximum benefit from this course be proactive. We're going to follow the viewer's guide. Follow along with the viewers guide. Take notes. When we stopped to do multiple choice questions, turn the video off. Do the multiple choice questions as if you were taking them on the CPA exam, give your best effort, come back to the video and we'll discuss the answers.

I'm confident that the combination of this video and the viewer's guide and your effort will get you prepared for the audit sampling portion of the exam. Secondly, this is audit sampling. You might think, Oh, lots of computations. That's true. We'll have some. But most of our time will be spent understanding definitions and concepts, definitions, and concepts for two reasons.

Number one, many of the questions on the CPA exam test, just that definitions and concepts, no numbers. And number two, the computational questions on the CPA Examrequire a thorough understanding of definitions and concepts. So here we go. Our first point is audit sampling. What's the definition of audit sampling is simply auditing less than a hundred percent of the population.

And from that audit of a sample, you draw a conclusion about an internal control or an account balance. Let's face it in auditing. It's impossible to audit 100% of transactions or 100% of the accounts it's too costly. We can't do it. We must use audit sampling. And the theory of audit sampling is you have a population.

And if you pick a sample that's representative keyword representative, you pick a representative sample from that population. You audit that sample. And from that auditing, you draw a conclusion about the population. If your sample was representative, it works. That's audit sampling. We need audit sampling in the profession.

We're not going to cover three pairs of concepts, three pairs of definitions. The first pair talks about refers to audit sampling, two kinds of audit sampling. First statistical sampling. I'll call it stat sampling with stat sampling. What can you do? You can quantify the risk level in your conclusion.

When you come up with a conclusion about an account balance, let's say, and you say the account balance is fairly stated. You can quantify the risk level. It might be 5% or 2%, which means you're 95% confident or 98% confident about your conclusion. So stat sampling allows you to quantify a risk level from your procedures.

Also, stat sampling allows you to measure. The sufficiency of evidence, stat sampling allows you to measure the sufficiency of evidence. That means you can determine in order to say you're 95% confident, 98% confident with your conclusion, you can determine what your sample size has to be. How much evidence do you need?

You can measure the sufficiency of evidence. And also with stat sampling is unbiased. It's unbiased because we're going to use random selection techniques. We want to be unbiased when we're using stat sampling. We want our sample to be randomly selected. That is stat sampling. Now what's the other type of audit sampling.

The other type of audit sampling is non-stat sampling, non statistical sampling. It's more judgmental. It's biased. At this point, you might say, how can the professional allow non-stat sampling? It's biased. It's judgmental. The answer has to do with the theory of auditing. I think when you're auditing, what are you looking for?

You're looking for errors. And if you close your eyes and pick your sample randomly you might not be picking the right items. Non-stat sampling allows you to do this. Non-stat sampling says, keep your eyes open. Pick the items that have the greatest chance of being wrong, pick the items that might represent errors.

That's what you're looking for. So non-stat sampling is allowed both stat and non-stat sampling are acceptable. Don't let the CPA exam try and fool you into thinking. Stat is better than non-stat. They're both acceptable. They both are efficient and effective. They're acceptable. And one more thing with stat and non-stat sampling judgment is used in both sure with non-stat sampling, there's more judgment, but don't let the CPA Examfool you again.

With stat sampling judgment is used. We'll have many things in stat sampling that are subjectively determined, judgment used in both stat and non-stat sampling. Both are acceptable. That's our first pair of concepts. The second pair of concepts deals with a very important word in auditing. The word is risk.

What is audit risk in general? Audit risk is the auditor hands over an audit opinion unqualified, and there's a risk level. The auditor is not 100% sure of that conclusion. Unqualified opinion risk level is very important for auditing. We of course, need to keep it very low. So let's talk about two types of risk for audit sampling.

The first is called sampling risk is caused by one thing. And one thing only sampling risk is caused by the sample, not being representative of the population. The sample might not be representative of the population, and if it's not, the auditor comes up with an erroneous conclusion and that's sampling risk.

The auditor cannot avoid or eliminate sampling risk. You can decrease it, but you can't avoid it because why you're taking a sample. You're always going to have sampling risk. You can decrease it though with what 12 it's based on the sample, not being representative. So decrease sampling risk with a bigger, better sample, a larger, better sample will decrease sampling risk that sampling risk.

The other type of risk is called non-sampling risk. Non-sampling risk. Is everything else? Everything else that could happen that could go wrong. Nine sampling risk. I call it the human element. Non-sampling risk is based on the auditor, making a mistake. How could the auditor to make a mistake in sampling?

Computing, the sample size, the auditor could make a wrong computation. The auditor could not recognize maybe an error. Let's say the auditor is testing cash disbursements, and we're looking at checks and we hold in our hand a check that represents an error and we don't recognize it. That's due to non-sampling risk the auditor, not recognizing an error.

Again, you cannot eliminate this risk, but you can decrease it. How can you decrease? Non-sampling risk, better auditors. Increased competence, better planning, better supervision of auditors. Decrease non-sampling risk. Our final pair, our third pair of concepts, definitions to begin. We have two types of sampling plans and these two relate to when do you use sampling in auditing?

We're going to use sampling in two important stages phases of the audit. The first is when we test controls. Sampling with test of controls is called attributes sampling on the CPA exam. When you see that phrase, attributes, sampling, think test of controls. And when you're testing controls, what are you doing?

You're sampling transactions, you're sampling documents, and you're not concerned about the dollar value you're concerned with this. What percent of the time did the control work or not work? With test of controls, attributes, sampling. You're concerned with percentages. What percent of the time did the control not work?

The focus is on percentages and not dollars. That's attribute, sampling, and second variable sampling relates to another stage of the audit. These substantive tests, the tests on account balances at the end of the year. With variable sampling. See that on the CPA exam. Think substantive.

Yes. What are we sampling? What are we testing? We're sampling and testing account balances. We're concerned with what we're concerned with, what dollar amount the account should be, or we're concerned with the dollar error in the account. The focus here is on dollars, not percentages. That's variable sampling.

Very good. Our first three pairs of concepts we have covered. Let us stop the video right now and try the first set of multiple choice questions.

Come back our first multiple choice question. Talks about the advantage of stat sampling overnight and stat sampling. Once again, don't let the CPA Examtrick. You  don't letthe CPA Exam make you think that stat sampling is better than non-stat sampling. There's a difference, but that's not, it let's look at the answers.

How about answer a eliminate errors much too strong, and also it implies. That's death sampling can do something non-stat sampling can not do. It's not answer a answer B reduce audit, risk and materiality. Reducing audit risk can be done by both stat and non-stat sampling. One is not better than the other.

And also an answer B the concept of materiality does not apply to this topic stat versus non-stat. It's not answer B. Answer C measure, sufficiency of audit evidence obtained. That's what stat sampling can do versus non-state sampling. The answer is C and D. Once again, implies that stat sampling may be better than non-stat sampling, minimizing failure to detect errors.

It's not answer D. The next multiple choice question. See, in the question, attribute, sampling automatically think test of controls. Percentages. Look at the answers. Answer a selecting receivables for confirmation, a very good procedure, but that's testing a balance. That's variables sampling. Now the answer here B.

B as a classic procedure for testing controls for testing payroll inspecting the time cards, looking for approval. The answer to this question is B that relates to test of controls that relates to attribute sampling C and D C and D. Once again, relate to variables sampling. It relates to the account balances.

Answer C talks about inventory. Estimate of inventory for the balance sheet, the account balance variable sampling answer D valuation, the fixed asset additions leading up to the fixed asset balance sheet accounts, variable sampling. The answer was B to this question, it related to attribute sampling

the next multiple choice. Once again, you see the phrase attribute sampling in the question before we look at this question in the four answers, let me remind you one thing. The CPA exam in the directions does not say select the correct answer. The CPA exam says select the best answer. Only one is best.

You might think all four answers are correct, but only one is best. You might think all four answers are incorrect. Only one is best. So it's a good, it's a good idea to answering when you're answering multiple choice to look at all four answers very carefully. Don't just jump at the first one. That you like there might be one coming up that is better.

Let's look now at the four answers. Answer a is good. Answer is a good answer. It talks about posting to incorrect accounts. It talks about the accounting process posting, and that certainly would be part of a test of control that certainly does relate to attribute sampling, but the word accounts is in there.

And that bothers me. It makes me think maybe it relates to variable sampling. So I like answer a, because it does relate to testing entries, test of controls, but let's look at B, C and D. How about be estimating the amount expense account balance? Definitely variable sampling, not the answer, answer C depreciation expense, the amount being reasonable.

Definitely variable sampling. Definitely not. The answer C is not talking about your choice of depreciation methods. C is talking about the dollar account balance of depreciation expense and answer D a classic test. For receivables, variable sampling testing the account balance. So answer a, is the correct answer, answer a is the correct answer.

It's not the best answer I could have thought of, but given the four choices, it's the best answer. The answer is a.

We now move on to a more thorough discussion of an important concept audit risk. And for that, we look at the audit risk formula, the audit risk formula left to right audit risk. Equals inherent risk times control risk times detection risk, a very important formula for auditing an important formula for audit sampling.

I went to cover this formula left to I like to cover it chronologically because we sent audit risk. First. That's the ultimate goal in the audit. Think of the CPA, the auditor handing over an audit opinion. There's a risk level involved and we hope it's low. The CPA would set this risk level low 10%, 5%.

1% audit risk is set by the CPA. It's judgmental, that's audit risk. Then we subjectively assess inherent risk. What is inherent risk? Inherent risk is the chance that the numbers and the financial statements will be wrong. Based on the company, the client, the complexities of the year and the accounting to understand that let's imagine two companies, company, a company B company a this year had two transactions, two cash sales, a very simple year.

Inherent risk is very low. There's a very small chance that the statements will be wrong. Based on the transactions, two cash sales, however, company B just the opposite many transactions, mergers, acquisitions, accounting, department failures, all kinds of things that would think, Oh, maybe the statements are going to be wrong because of our accounting department, because of our company, because of the year it had.

So inherent risk is based on the company. And the complications, the auditor assesses inherent risk. Now moving on to the two factors in the formula very important for audit, sampling, control, risk and detection risk. What is control? Risk control risk is the risk. The chance that internal controls will fail to prevent errors in the financial statements.

The auditor must assess. Control risk. The auditor wants to assess control risk. The auditor hopes controls are very strong. That means as a probability, the resulting balances are correct. The auditor assesses control risk by performing test of controls, assesses control, risk high or low. If the auditor finds controls are very weak, weaker than we thought they were going to be.

The assessment of control risk will be high. There's a good chance controls will have failed. However, we hope the auditor assesses control risk low controls are very strong and will prevent errors. So audit risk inherent risk control risk. What's the unknown in this formula. The plug in this formula, the plug in this formula is detection.

Risk detection. Risk is the risk, the chance that the auditor's substantive procedures. That's the auditors tests on the account balances end of the year will not detect errors, detection risk. Again, the auditor's substantive procedures will not detect errors and that dictates our audit procedures at the end of the year.

What's the effect. If detection risk is low, that means we have to audit the accounts with only, let's say a 1% chance of missing something material. Pressure's on us. We would like the detection risk to be higher. If detect detection risk is 10%, 20%. That means we can audit the accounts with a 10% or 20% chance of missing something.

That's easier for us. Our procedures can be lighter and our sample size can be smaller for right now, understanding this very important relationship between control, risk and detection risk. There's an inverse relationship between control and detection, risk inverse relationship between control, risk and detection risk.

If the auditor thinks controls are poor control risk is high inverse relationship detection risk will be low detection risk will be low pressures on the auditor and the substantive procedures to be very thorough. If controls are very good. The auditor assesses control risk. Very low controls are very good.

That allows inverse relationship that allows the text and risk to be high. And the auditor in performing substantive procedures can relax a little bit and take a smaller sample size. So control risk detection, risk and major focus for our discussion here. Now let's talk about two aspects of sampling risk for attribute sampling, attribute, sampling, test of controls percentages.

There's two things that could go wrong. And before we look at the two things, remember you're assessing control risk. Let's say I'm the partner in the firm and you're the staff auditor. And I say to you go out and assess control risk at this company at this client. You're going to perform test of controls.

And I say to you, go out, assess control risk, and come back and be 95% sure. Therefore 5% risk level. That dictates this may maybe how many procedures you have to perform and it dictates maybe your sample sizes. All right. Let's change that. I'm the partner. I say, forget that. Forget the 5% risk level assess control risk.

Come back with only a 1% chance of being wrong. What just happened to your procedures? They must increase sample size, must increase. So control risk is the ultimate goal here, but don't forget as you start your test of controls, you have to have an allowable risk level, 5%, 10%, 1%. It should be low and allow the risk level for dictating your audit procedures.

So here we go. What could go wrong? Risk number one, risk. Number one is the risk of assessing control, risk too low. The risk of assessing control, risk wrong, which way too low. What happens? You can assess control risk too low. You could over rely on the controls. You think the controls are good, but they're not good.

Your assessment of control risk is because you think the controls are good. The assessment is very low. But that's too low. They're not that good. Troll risk set too low detection risk ends up to be too high. If detection risk is high, too high. In this case, you don't perform enough substantive procedures on the balance sheet accounts and income statement accounts.

If detection risk is too high, not enough substantive procedures are performed. And probably in that case, you're going to miss something. You're not performing enough tests on the account balances. You're going to miss errors that are material. The result, you hand over an opinion unqualified, and there are errors in the financial statements.

The risk of assessing control risk too low relates to audit effectiveness. In this case, your opinion was wrong. The audit was not effective. Again, the risk of assessing control risk, too low relates to audit. Effectiveness in stat sampling circles. This is called the beta risk B ETA beta risk. Just remember beta.

This is bad. Beta bad. The audit was not effective. Risk. Number two, let's go the other way with our assessment risk. Number two, the assessment of control risk is too high. The auditor comes back and assesses control risk too high. Why? The auditor is under relying on the controls. The controls are good, but the auditor does not believe it.

Control risk should be low, but the auditor assesses control risk too high. If control risk is too high detection risk is too low. Detection risk low means what more substantive procedures are performed than needed. You're doing too much. You don't need to perform all those tests on the account balances because the controls were good resulting in good account balances, but detection risk is too low.

You perform many procedures. You don't need to perform. The good news is here. The good news is you get the right answer. You end up saying, Oh, the account balances are okay. They're fine. The opinion is correct. But what happened? You were not efficient. You spent more time than you needed. So the risk of assessing control risk too low relates to audit efficiency.

The risk of assessing control risk too low relates to audit efficiency. This is called the alpha risk,

same theories and move on to variables, sampling, substantive tests, same theories. Same theory for variables for variable sampling. As the attribute sampling. Your question is it could happen in this case. Risk. Number one, the risk of incorrect acceptance. You incorrectly accept an account balance. The account balance is misstated, but you think it's just fine.

This is bad. Your audit is not effective. You came up with the wrong conclusion. The risk of incorrect acceptance relates to audit effectiveness. It's called the beta risk beta bad. Let's go the other way. Without account balance assessment, the risk of incorrect rejection. You incorrectly reject an account balance.

It's good, but you don't think so. The account balance is fairly presented, but you reject the balance. You think it's wrong based on your audit perf performance of techniques. What happens in this case, if we use audit sampling and we conclude the account balance is not fairly presented, we don't then hand over the qualified opinion to the client.

No, we use the sampling. We want to be more sure before we do something like that. So if we, at first incorrectly reject an account balance, what do we do? Usually? We expand our sample. We sample more items for that account. And hopefully in most cases, because the account really is fairly presented, we eventually discover, Oh, the account balance is fairly presented.

We rejected it at first, but with a bigger, better sample, we say the account balance is okay, we accept the account balance. We got the right answer, but what happened? We took more time than necessary to get that right answer. So the risk of incorrect rejection, the risk of incorrect rejection relates to audit efficiency.

This risk relates to audit efficiency, and it's called the alpha risk. Those are some tough concepts. We now move on to a new set of multiple choice questions. Once again, stop the video. Do as best as you can come back and we will discuss.

Welcome back. Let's talk about some multiple choice questions with this question. The question relates to two risks, one risk of incorrect acceptance. That's what that's variable sampling. Test of accounts balances, and to the likelihood of assessing control risk too low that's attribute sampling test of controls.

So the answer we're looking for must apply to both variable sampling and attribute sampling. Look at answers a and B answer a tolerable misstatement, answer B materiality. Those both relate to account balances. Those cannot be the answer. And in addition, they don't relate to the question so you can hopefully knock out answers a and B you're down to answers C and D.

And now the question is which two of the four that we talked about, which two of the four are represented here. Let's go back to the question. The risk of incorrect acceptance. That's the bad one. That's where you incorrectly accept an account balance it's wrong. And you think it's correct. And assessing control risk too low.

That's the bad one. Once again, control risk too. Low detection, risk too high. You relax too much. You miss something. The answer to this question is D the effectiveness of the audit. Those two items in the question relate to the effectiveness of the audit, not the efficiency. The efficiency are the other two risks not represented here in this question.

The next multiple choice talks about test of details. Now realize test of details. That's referring to what variables sampling substantive tests, testing accounts. So automatically the question relates to test of details. What's happening in the question? The auditor determined the results. Support the conclusion that the account balance was wrong was misstated.

In fact, the account balance was just fine. It was not misstated. Look at your four answers. Once again, you should be able to knock out two of the four answers right away. A N B a and B relate to attribute sampling, not variable sampling. So the answer is C or D. And then once again, your question is which one?

What have we done in this problem? We have determined the account was misstated. In fact, it was just fine. The answer is C. This is called the incorrect rejection of an account balance. The account balance is correct, and we incorrectly reject the account balance. The next question, a long answer question.

Let's take it part by part. And I think you'll see answers. The three of the answers can be once again, eliminated this question talks about what control risk too high assessing control risk too high. What's the definition of assessing control risk too high. If we assess control risk too high, that means we think controls are not effective, but they are we've assessed control, risk too high look carefully at answer a.

Looking at the question, plus, answer a, what do you have the sample selected to test controls does not support the plan assessed level of control risk. When they go into a test of control, we have a planned level of control risk that we hope for. So in this case, our sample does not support our plan level of control risk, and we determine all controls are not working.

Control risk has to be high. Keep reading, answer a, when the true operating effectiveness of the controls justifies such an assessment, answer a describes what we're looking for. Answer a is the answer. If we assess control risk too high, we think controls are bad, but really they're good. They're just fine.

That's answer a answer. B C N D. Look at key words and answer B, C N D. B misstatements dollar amounts that sampling for variables, not this question. SI monetary errors, dollar amounts, sampling for variables, not the answer and D tolerable error. Once again, a dollar amount error, not the answer here.

So far, we've covered some very conceptual definitions. Now let's change something I hope is more tangible. We're going to cover sample selection methods. We're going to talk about four methods of sample selection. The first two are preferred. The first method is random. With random selection, you would use a software program or random number tables to get random numbers.

You would also always use a random starting point with a software program. Let's say you're testing cash, disbursements, and you're testing checks. You would get the check numbers for the year. Let's say the check numbers. This year started at 842. They went to 10,059. You would to the software program, submit the parameters.

The check numbers ask for a sample size of let's say a hundred and the program spits back a hundred numbers, check numbers, randomly selected, or use a random number table it random number table is simply pages and pages of numbers. Once again, close your eyes, choose a random starting point and the numbers on the table that correspond with the check numbers you would select for your sample.

Let's talk for a second. About the theory of this, the theory of random selection, key point with random selection theory, each item in the population has an equal chance of being selected with random selection. Each item in the population has an equal chance of being selected. Now one thing about this, it might be a disadvantage.

The population must be numbered. You have to have numbers on your checks or invoices that you're selecting. And one more point it has to do with two new definitions sampling without replacement versus sampling with replacement auditors, usually choose sampling without replacement and not sampling with replacement.

Do you know what they are sampling without replacement means? If you have a barrel of the population, a barrel of invoices, each time you select something from the barrel, it does not go back in. It cannot be selected again. And that's good because if I want you to sample a hundred invoices, a hundred different invoices.

So if you take an invoice out and leave it out, you'll end up with a hundred different invoices by putting your hand in there. 100 times that sampling without replacement sampling with replacement means what. Each time you select an item, it goes back in the barrel. It could be selected again. So a sample size of a hundred that you desire.

You put your hand in there a hundred times and pick something out. You might end up with 99 or 98 invoices. So that's why sampling with replacement usually is not used in audit. If the sample size is 100, we want a hundred different items to be sampled from the population. The second selection method systematic selection.

You're taking every inf that's spelled N T H oomph. You're taking every item from the population. And again, use a random starting point. An example will help you understand systematic selection. Let's say your sample size is 200 and your population is 50,000. 50,000 items in the population you want to select 200, your computation, I think is fairly simple.

You would take the number of population units in this case, 50,000 divide by your sample size desired. In this case, 250,000 divided by 200 is every 250th item. It's two 50, every 250th item. You'll select from the population. So once again, your formula to determine a uniform interval number of population units divided by sample size gives you the interval gives you the no advantage of systematic sampling.

One advantage it's clear. It could be just a stack of documents. The population does not have to be pre-numbered. You can just pick every 250th item from the stack of documents. Another advantage. The population here does not have to be finalized if you're testing controls for the whole year. And the client only has from January through October, ready for you to test you say fine.

Give me January through October, I'll start picking every 250th item and then finish the rest later. So advantages here, the population need not be pre-numbered or finalized to use systematic sampling. Now systematic sampling has one major disadvantage, often tested on the CPA exam with systematic sampling, beware.

A pattern may exist in the population. A pattern may exist in the population and you selecting every item you fall into that pattern you coincide with that pattern. The result is a bad sample. That's not representative. Do you remember this? An easy example? Let's say you're testing controls over payroll and you're selecting payroll checks and you're selecting from beginning to end of the year, every 250th payroll check.

And in this company, there are 250 employees. The result you choose the same employee over and over again. Your sample is not representative. You have destroyed the randomness. Of your sample. There's a big disadvantage for a systematic sampling, the pattern of the population and you fall into it. Our third selection method is the least desirable method it's called block sampling.

Block sampling is simple as simply a sample of contiguous or consecutive units or transactions. Example of block sampling is you choose one week in April, all the transactions one week in April. That might be the week everybody was sick or on vacation. That might be the week. The company went through some major transactions, never before and never again.

So block sampling is dangerous. You're saying sample may not be representative of the entire population. It's the least desirable method and our fourth and final method judgemental selection, also called haphazard selection. Judgemental selection is only used in non-stat sampling the auditor determines what items to select.

Very good concepts. We just covered about sample selection. Now the next multiple choice set, turn off the video and come back.

And welcome back again. Our first question deals with the advantage of systematic selection, advantage of systematic selection. Let's look at the answers, answer a it's saying. Population items that include errors will not be overlooked well, that's due to your audit procedures. That's not due to your systematic selection.

The answer is not a, how about B and B? You get excited because the word pattern appears what does be saying. The population item may occur in a systematic pattern, thus making the sample more representative. No, the pattern is possibly going to make the sample less representative. This is bad. This is a disadvantage.

The answer to this question is not B C may occur more than once in a sample is the answer that somehow deals with sampling with replacement, a good concept, but not appropriate for this question. The answer is D I think you knew the answer was D. The advantage here with systematic, you don't need a pre numbering system for the auditor to use systematic the next multiple choice.

Once again, systematic looking for a disadvantage, looking for a disadvantage. How about answer a items in the population must be systematically replaced in the population. Once again, that's relates to the sampling with replacement, not appropriate for this question. Answer B the disadvantage may occur in a systematic pattern.

The disadvantages that the population items may occur in a pattern thus destroying the sample randomness. The answer here is B that your major disadvantage with a systematic method, there might be a pattern in the population you fall into it and destroys the sample randomness. It's not a good random sample answers.

C and D C. We hope not. We hope the items in the population are not recorded in a systematic pattern. The answer is not C and D again, relates to sampling with replacement, not appropriate for this question.

We now turn to a thorough coverage of attributes, sampling testing controls. We're going to go from the planning stage. Welcome to Bisk CPA review comprehensive CPA exam review materials for the CPA exam. To let you customize your own review programs, to meet your individual learning style and ensure your success.

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Hi, I'm Jennifer. And I'll be the facilitator for the hotspot entitled auditing standards and planning. Before we begin the materials, I'd like to give you a few study hints. The first one is to treat this course as if you were in a live course situation. What that means is that when we stop periodically to have you do some self analysis with some study questions, it would really be beneficial for you to actually attempt the question and not just skip to the debrief which I will provide after I've given you a moment to answer the questions.

This will ensure that you will really focus on where it is that you need to dedicate your study efforts. What that also means is that we need to treat this like a job you need to dedicate the sufficient time that's necessary in order to get through the materials, have a plan, look at the content and break the content down into manageable chunks.

It's not something that you want to just delve in all at once and just do in one fell swoop. You really want to make sure that you're breaking things into smaller chunks so that you have a chance to absorb the information and increase the likelihood that you will retain the information that I'm going to be providing to you.

You also want to balance this course with your lifestyle. We need to make sure that we're taking breaks as needed so that you can have the mental energy to really focus and make sure that you're absorbing and retaining the information that will end up giving you success for passing the CPA Examin the longterm.

There are a few things that you are going to want to commit to memory. One of the areas is there's something called a quality control system and there's some required elements that need to be built into that system of quality control, which we'll discuss. There also is a formula called the audit risk model.

You want to commit that formula to memory when we get to that segment of the materials. There in addition, we'll be six assertions related to financial statements that management makes about the fair presentation of their financial statements. And you want to commit those six assertions to memory.

There's going to be various other topics that we're going to discuss that you do need to know and be familiar with. To briefly give you an outline of some of the materials that were going to be, become, be covering during this course. One of them is going to be what are management's responsibilities in a financial statement, audit and contrast that with what the auditor's responsibilities are.

There also are built into the auditing standards, themselves, some professional requirements that will be defined to know what auditor's responsibilities are, things that they must do versus should do versus things that they could do. There also are some pre-conditions that must exist in order for an audit engagement to even it'll be accepted.

When we do have, I have a financial statement audit. Sometimes it is a situation where the previous set of financial statements were audited by somebody else. So there's a predecessor auditor and a successor auditor. We'll talk about the required communications that a successor auditor has to have with that predecessor auditor.

When that situation does exist. We also are going to talk about the things that have to happen very early in the audit process. There are some preliminary planning activities and some risk assessment procedures that have to be performed in order for us to really gain an understanding about the entity and its environment in order to really plan a successful financial statement audit in and of themselves.

Part of that understanding is going to lead us to be able to actually assess audit risk. And we'll talk about the relationship of risk to each other when we're establishing audit risk. And we'll talk about the evidence that has to be obtained in order to get sufficient and appropriate evidence in a financial statement, audit to enable us to issue a financial statement opinion at the end of the day.

Part of the key judgments that an auditor has to make is looking at materiality and being able to assess risk and material misstatement, and to be able to evaluate the audit results in order to give that financial statement, audit opinion. We need to be alert for where there could be problems in those financial statements, both due to error where there's just mistakes, as well as where there could be fraud or illegal acts.

And when we do come across fraud and illegal acts, what are requirements with communicating those issues as well as other types of things that we might encounter during the course of the audit that should be communicated to John, just management, but to those charged with governance, as it's associated with that audited entity.

Let's take a moment to talk about management's responsibilities in a financial statement, audit. Management as well as those charged with governance, those charged with governance would either be an individual like an owner, or it could be a group of individuals, say a board of directors or an audit committee or an executive management team that are responsible for the preparation and the fair presentation of the financial statements, including any footnotes that might be associated with that set of financial statements.

They're responsible for the preparation and fair presentation in accordance with an applicable financial reporting framework. Now that applicable financial reporting framework could be something that is considered to be gap. So it could be something that is the general accepted accounting principles established by the FASBI.

It could be a international set of financial standards ifrifrst or it could be an special purpose framework like cash basis or income tax basis, or some other basis of accounting. But ultimately management and governance are responsible for determining what the applicable financial reporting framework is, and then prepare and present fairly the financial statements in accordance with that framework.

So the financial statements are ultimately a representation of management and they have to look at what their options are within that applicable financial reporting framework, to make sure that they're developing and applying the accounting policies that would be most appropriate for their organization in conformance with that framework, which may include having to select amongst alternatives that they might have with how they treat certain financial statement, transactions and events.

Importantly, they're also responsible for designing, implementing, and maintaining a system of internal controls over reliable financial reporting. This is going to also include their ability to be able to know what it is that I have to be in compliance with as it relates to applicable laws and regulations, and to make all of our financial records and the related information available to the auditor in the audit process.

Since the financial statements are primarily the responsibility of management and governance management also has to provide what's called a management representation letter. That representation letter is going to affirm certain things to the auditor. Like I've provided you all the books and records.

I have notified you of any fraud or illegal acts that I'm aware of. There's going to be a whole series of things that will be associated with representations from management because of the fact that they are primarily responsible for the preparation and fair presentation of the financial statements.

Even if the auditor's involved in assisting the client, ultimately it is the management's responsibility to adjust the financial statements to correct for material misstatements. Even if those misstatements were identified by the auditor in the audit process. They also are responsible for ensuring that any estimates that are built into the financial statement audits are also reasonable while the auditor may give advice about the reasonableness from their perspective and their judgment about how certain transactions and events should be treated.

Management's responsible for the preparation and fair presentation of the financial statements in accordance with whatever the applicable financial reporting framework is that they're applying in drafting those financial statements.

Take a few moments now to talk about what the auditor's responsibilities are in a financial statement audit the auditor does have to make sure that they're in compliance with their code of professional conduct that is put out by the AICPA. Part of that code of conduct says that we shouldn't be doing an audit.

If we don't think that we're competent and capable to be able to provide that service, we have to make sure that we're independent, that we're objective, that we can comply with all the ethical requirements that are associated with our code of professional conduct. But we also have to make sure that we're comfortable, that we're applying what's called professional skepticism that we use professional judgment.

That we're looking at what management is asserting to us, and that we're looking at it with a critical eye to be a second set of eyes, to not just take what management says for granted, but to make sure that we're gaining sufficient and appropriate evidence to push back and test to ensure that what they're representing to us, what they're asserting to us appears to be reasonable at the end of the day.

Now, when we talk about giving a financial statement opinion, we're really talking about. Getting a sense of high assurance, but it's not absolute. We can't say with absolute certainty that a set of financial statements, even at the conclusion of a financial statement, audit are not misstated. One of the concepts that we talk about in a financial statement opinion is this concept of materiality.

There's going to be some things that individually and in the aggregate may be wrong with a set of financial statements. But we still can give an opinion to say that it's not materially wrong. Meaning that even though we know it's not a hundred percent accurate or a hundred percent in compliance with what's required in the applicable financial reporting framework, that it wouldn't cause somebody to make a different economic choice.

So how do you being a financial statement audit doesn't mean that there's nothing wrong with the financial statements. It means that we have a basis for saying that it's reasonable, that there's nothing materially wrong. Now, ultimately we may not be able to give a unqualified unmodified opinion. It might be that once an auditor's gone through the audit process, that they have to do something like qualifying opinion and say, except for this one particular area, we think everything else is okay.

It might be that we have an emphasis of matter. Where we say the financial statements appear to be reasonable and not materially misstated, but yet you should be aware that we have a going concern issue that this entity may not be able to maintain as a going concern for a reasonable period of time.

There also may be situations where just qualifying opinion or highlighting something emphasizing a matter is not sufficient inappropriate. It might be that we actually have to disclaim an opinion or give an adverse opinion. So it, ultimately, it might be that we're unable to actually issue report because we're not able to complete the audit satisfactorily in conformance with the code of professional conduct, as well as the generally accepted auditing standards.

And if we're not able to get what we need in order to form an opinion, then there are options and alternatives in that in the generally accepted auditing standards for how an auditor should handle that. Emphasizing an auditor's responsibility is to plan and perform audit procedures in order to give reasonable assurance that the financial statements are free from material misstatement, that misstatement could be due to fraud or error.

And in subsequent sections, we'll be talking about fraud and error, but ultimately they have to go through the process of understanding what is considered to be a material misstatement, quantitatively, or qualitatively for this particular set of financial statements, based on how these financial statements are going to be used, how much the intended user users are going to be relying on these financial statements to make economic decisions.

There's some judgment involved with establishing a sense of materiality. And then it's up to the auditor's professional judgment to also assess risk of material misstatement. Where do we think that there's a likelihood that there could be fraud or error that exists in these financial statements that actually could be consequential.

That could be material. Ultimately it's the auditor's responsibility to get sufficient and appropriate audit evidence to support their opinion. If I'm going to give an unmodified unqualified opinion. I have to have sufficient and appropriate evidence to support that opinion. If I'm going to give a scope limitation or qualifying opinion I have to have sufficient and appropriate evidence to give that type of opinion.

So whatever the opinion is that you're going to be giving you still have to have sufficient appropriate evidence to support that opinion. A key thing to remember about what an auditor's responsibilities are, is in a financial statement audit. We're not required to search for internal control deficiencies.

We may come across things that are called significant deficiencies in internal controls, over financial reporting or material weaknesses in internal controls, over financial reporting. And if we come across those things, then we're required to tell somebody we're required to tell management and to tell governance to say you should be aware that you have these flaws in your system.

But what an auditor is doing is despite any flaws that might exist in a system of internal controls, they're taking that information and they're building it into their risk assessment process. If I have a deficiency in internal controls that I'm aware of then that's going to increase my risk. And I'm going to have to gather more evidence for me to have sufficient and appropriate audit evidence in order to issue my audit opinion and have support for that opinion at the end of the day.

Let's debrief our question. The question was, which of the following statements is correct concerning an auditor's responsibilities regarding the financial statements, a. Stated an auditor may not draft an entities. Financial statements based on information from management, accounting B says B adoption of sound accounting policies is an implicit part of an auditor's responsibilities.

C stated that an auditor's responsibilities for audited financial statements are confined to the expression of the auditor's opinion. And D stated that making suggestions that are adopted about an entity's internal control environment, impairs an auditor's independence, the correct answer is C an auditor's responsibilities for the audited financial statements are confined to the expression of the auditor's opinion.

The auditor may assist the audit with CIS management, with drafting the financial statements based on information that's provided by management and from their accounting system. They also can assist in giving advice about accounting policies. That might be part of them making their decisions about how to apply their applicable financial reporting framework.

But the auditor cannot take responsibility for making the choices about what to adopt, manage. The auditor is allowed to make suggestions about. How to apply an applicable financial reporting framework, how to draft the financial statements, how to design a system of internal controls in order to enhance the likelihood that there would be a set of financial statements that are free of material fraud and error, but all of those decisions are left with management as being responsible for deciding whether or not to take the auditor's advice.

Auditors are allowed to advise research and recommend. But their responsibility is to actually express the auditor's opinion at the end of the day.

Let's now talk about an overview of generally accepted auditing standards. Within the general accepted auditing standards are gas with two A's in it. One of the first things that they address in those standards is to define what are an auditor's professional requirements. Carry out the standards.

There's going to be certain things that are considered to be unconditional requirements. Those unconditional requirements will be identified because they'll say that an auditor must do this, or an auditor is required to do this. This means that you actually have to do this in all circumstances. There are other things where it's going to be, what they call presumptively mandatory, a presumptively mandatory requirement.

We'll have words such as should or should consider in front of the requirement. What that means is that it's presumed that the auditor is going to do these things, but there may be certain rare situations where a departure from that requirement. Could be necessary. And so there might be alternative procedures that are performed in order to achieve the objective of what that fundamental requirement is.

The third level of professional requirement is what's called explanatory information. When you're looking at the generally accepted auditing standards. And there's something that says that an auditor may do something or they might, or they could, what that means is that they're giving you advice on how to actually accomplish the things that you must do.

The things that are unconditional, as well as the things that are presumptively mandatory. So it's the additional explanatory information and how to apply the things that are unconditional. And they're also beyond generally accepted auditing standards. There are other sets of auditing standards that a financial statement auditor may find him or herself complying with.

For example, if they're doing a financial statement, auditor of an issuer, then there's something called the public company, accounting oversight board that establishes auditing standards in that situation. If you're doing a financial statement audit, that's going to be used overseas. It might be that this audit is done under new, underneath international standards of auditing.

There also might be an organization that has to follow what's called government auditing standards, because they might be a not-for-profit or a governmental type entity that because of the fact that they're receiving federal money, that they're required to have an audit under governmental auditing standards.

There also might be jurisdictional standards that would fall outside of those previous examples that still may apply in all cases. What the auditor is looking at is to look to see, are there any situations, regardless of the auditing standards that I'm complying with, that would limit my ability to accomplish my responsibilities and satisfy my objectives.

There may be some inherent limitations because of the fact that we're applying that judgment and that there is uncertainty, there may be practical or legal limitations that keeps us from being able to give absolute assurance, regardless of the auditing standards that are being followed, there is still going to be reasonable, not absolute assurance about whether or not there's material misstatement that is contained within a set of financial statements.

Ultimately that's the auditor's responsibility to ensure that they are comfortable, that they've gathered sufficient and appropriate evidence in order to make that opinion,

which of the following best describes what is meant by the term generally accepted auditing standards. The first option was procedures to be used, to gather evidence, to support the financial statements. Option B stated measures of the quality of the auditor's performance option C said pronouncements that are issued by the auditing standards board and option D said rules acknowledged by the accounting profession because of their universal application.

The term that the situation that best describe generally accepted auditing standards is B Hey, generally accepted auditing standards are there to ensure that financial statement auditors are following some minimal requirements to ensure that they're doing a high quality audit engagement. Hey, they're not considered to be procedures or pronouncements or rules that are acknowledged just because they're universally applied.

It's because they have put some criteria of those things where we're talking about what an auditor must do or presume to do in order to actually do a high quality audit engagement. Generally accepted auditing standards. Then if we're talking about gas requires the auditor to document in work papers, the justification for a departure from a presumptively mandatory requirement.

What language indicates a presumptively mandatory requirement. If something says that it must or is required to be done, that's an unconditional requirement. If something says that we may consider something or that we could consider something that is an alternative procedure, the correct answer in this case would be D if something things says that it should or should consider that's a presumptively mandatory requirement, that if we're not going to comply with that requirement, that there has to be documentation in the work papers to justify that departure.

Another question was because an audit in accordance with generally accepted auditing standards is influenced by the possibility of material misstatements. The auditor should conduct the audit with an attitude of, and your options were objective judgment, conservative advocacy, professional, responsiveness.

Or professional skepticism. The term that you want to commit to memory is the term professional skepticism has to be applied in every financial statement, audit situation to ensure that we're not just taking things for granted, that management is representing to us, but that we are taking a second set of eyes and a fresh perspective to make sure that we're gathering sufficient and appropriate evidence to support our conclusions about what management is attempting to assert to us.

Let's now talk about quality control. There is something called quality control standards. And there is also something that's issued that talks about statements of quality control standards. Those statements, a quality control standards will apply to any CPA firm or individual practitioner that is doing services that are considered to be accounting or add test.

In those services. A financial statement audit is considered to be an ad test service because we're issuing a report at the end of the day. Other types of ad test services would include compilations or reviews or agreed upon procedures, but with a financial statement audit, that's what generally accepted auditing standards directly relate to.

So gas or generally accepted auditing standards relates to the conduct of an individual audit engagement, but that individual audit engagement also has to be performed in accordance with our statements of quality control standards or the sq CSS. The auditing standards themselves actually referenced the key elements that are included within a quality control system and talks about what an audit firm is responsible for in order to give that reasonable assurance.

That they are complying with whatever the auditor's professional and regulatory requirements are in order to even conduct that ad test engagement of a financial statement audit. And they also want to make sure that there's quality control standards in place in order for them to issue an appropriate report in the given circuit stances leadership, the engagement partner at the end of the day is ultimately responsible for quality control.

Within the auditing standards. That's one of the elements of the quality control standards that they discuss is leadership responsibilities. Ultimately it's the engagement partner, as well as whatever the rest of the governance structure might be of a CPA firm to make sure that they're establishing a culture that is recognizing that quality in doing our ad test services is essential.

That means that they have to have within the CPA firm policies and procedures to support that culture, that we have to devote sufficient and appropriate resources to ensure that we can be successful in doing quality work. And there needs to be things like evaluations and advancement policies and procedures that are also committed to ensuring that people are following the policies and procedures that they're laying out.

In order to ensure that we are doing quality work, which includes making sure that any commercial considerations do not override our ability to ultimately comply with our quality control standards. There's leadership responsibilities. And then there's also relevant ethical requirements, which would be another element of a system of quality control.

There is the code of professional conduct that is issued by the AICPA. That's going to lay out what's necessary to ensure that a financial statement auditor is operating within a context of integrity, objectivity independence, due care to ensure that they're operating. In thinking about the public's interest when we're issuing our financial statement, audit opinions that we're not so focused on just serving our clients, but that we're also thinking about the CPA profession as a profession.

And that is accountable and responsible for thinking about how these financial statements are being used from a general perspective, and to remain alert for where we may not be in compliance with the independence rules too, to identify and evaluate independence threats. So that we could apply appropriate safeguards to make sure that we're mitigating or eliminating those threats to an acceptable level where a prudent official or the general public would look at our situation and say that it still makes sense that we're providing ad test services for this client, despite the fact that we might have a threat to our independence.

So it's not that we have to be absolutely independent in what it is that we're doing in servicing our clients. But we do have to look at whether or not we're both independent in fact, and appearance to ensure that from a, the public interest standpoint, that there could be some reliance, not absolute, but reasonable assurance that we conducted our engagement in a way that would be reliable as far as the outcome that we're issuing a quality engagement at the end of the day.

The other element that we want to discuss in a system of quality control is our ability to accept and continue with clients appropriately. We have to make sure that we're associating ourselves with a client that has a good sense of integrity. That it's somebody that we want to associate our name with.

We also want to make sure that from the auditor's perspective, that we're competent to perform the engagement. We have to make sure that we have the capability as well as the resources, to be able to satisfactorily complete that financial statement audit in a high quality way. We have to make sure that we're in compliance with our legal and ethical requirements and that we have an enough of an understanding when we take on a client to know what's the nature and the scope of the services that we're going to be performing.

And are there any limitations in our ability to deliver those services in a high quality way? Yeah. If we have any issues and concerns with independence or with our ability to be objective, or do we think that we have the competency and the resources to be able to provide a service upfront in the engagement and acceptance determination?

We need to make sure that we're documenting the fact that we had this concern and how it is that we resolved it so that we felt  as we're approaching this engagement that we actually can comply with the quality control rules. Even after we've accepted and engagement, we have to constantly be looking for new information that had we known about that information back when we originally accepted the client that maybe would come to a different conclusion.

And so even throughout the audit process, we have to be focused on, do we want to continue with this client? Or is there something that's come to light with new information that might actually have us consider withdrawing from this client? We always have to follow our statement of quality control standards, and we always have to follow our code of professional conduct.

Let's talk about a few more essential elements of a quality control system. One of the things that we have to do as a CPA or a CPA firm is to make sure that when we're assigning engagement teams. So we assign a team to be the financial statement, audit team. For example, we have to make sure that we are looking at whether or not we need to bring in outside resources.

So we could have our core engagement team, but we also might need to bring in specialists to assist us with certain issues or transactions or events to make sure that collectively we have the capability and the competence and the time to be able to do a high quality engagement. We have to ensure that as we're assigning these engagement teams, that the teams are going to enable us to comply with professional legal and regulatory requirements, and also enable us to give the appropriate report.

Given the circumstances of the ad test engagement. Ultimately the control standards are focused on is the auditor able to give the appropriate report? To be able to support their opinion. If they're giving a financial statement, audit opinion, and that we assign the engagement to set us up for success with that, we also have to make sure that even after we assign the engagement team, that we're having policies and procedures to direct and supervise the performance of that engagement.

So engagement performance is another critical element of a system of quality control. The engagement partner, once again is primarily responsible for making sure that they have, that the engagement team has gathered sufficient and appropriate audit evidence on or before, whatever the audit report date is.

So the date of the audit report is the day that we have sufficient and appropriate evidence to support our opinion. Our quality control standards specifically require the engagement partner to be satisfied that they've gathered that sufficient and appropriate evidence. The engagement partner is also responsible for making sure that we've consulted with internal, external specialists as needed that there has been a resolution, if there's any differences among the engagement team.

As far as a difference of opinion on how to handle a transaction or event or whether or not we've gathered sufficient and appropriate evidence, it's the engagement partner that is accountable for making sure those differences are documented and resolved. And that the engagement as a whole has gone through system of quality control review to make sure that we've satisfactory, completed everything that needs to be done.

Under our legal professional and regulatory standards prior to the report release date, the report release date is the day that we actually tell the client, you can now associate our audit opinion with the set of financial statements. So the report release date is different than the audit report date.

The audit report date is the day that we've gathered sufficient and appropriate audit evidence. The report release date is the day that we released that opinion and enable the client to use it along with their financial statements. Monitoring critical element of a system of quality control monitoring is going to make sure that there is an evaluation of our policies and procedures and our quality control things that we're doing to make sure that not just that we have a system of quality control established, but that those policies and procedures are actually being followed as intended.

So we have to make sure that in a CPA firm even if there's just a sole practitioner, that there is somebody that's evaluating to see whether or not all of our requirements and a system of quality control are actually being followed. And if there's any deficiencies. If there's any inconsistencies that those things are identified and communicated to the proper people so that we can take what's called remedial action.

Remedial action just means that we fix the problem, right? So we have to monitor our own system of internal controls around supporting our ad test services to ensure that we're doing the right things within our organization to issue a high quality engagement at the end of the day. So we have to look at monitoring that system and looking at the results of that monitoring to make sure that we are fixing the things that need to be fixed in our system of quality control and that we're also identifying where those deficiencies and how we handle quality control within our organization, how those things may affect a specific ad test engagement, which may be a specific financial statement audit.

From a quality control standpoint, it's important to have engagement documentation. We have to document if there were any concerns about our ethical considerations, like independence and objectivity that we document any threats to our independence and how it is that we mitigated or eliminated those threats to an acceptable level.

What was the thinking that we went through in accepting or continuing with the client. And if we did consult with outside experts, either outside of the engagement team, but still within our CPA firm or experts that were outside of our firm in and of itself, we have to talk about the nature and the scope of those consultations, including any resulting conclusions that came about from those consultations.

There has to be documentation of a firm's compliance with the quality control standards. As much as there needs to be documentation about the audit evidence that we gather in giving our financial statement, audit opinion.

Yeah, multiple choice question said one of the CPA firms, basic objectives is to provide professional services that conform with professional standards, reasonable assurance of achieving this basic objective is provided through what. Your options were a system of quality control, be a system of peer review C continuing professional education and di compliance with generally accepted auditing standards.

When we're talking about a reasonable assurance about providing our professional objectives, we are looking at a system of quality control. So our statement of quality control standards, as well as the quality control requirements that are built into the generally accepted auditing standards.

It's the system of quality control. That's going to make sure that we're fulfilling our basic audit objectives, peer review, and continuing education, and the generally accepted auditing standards themselves all support our ability to be able to issue a high quality engagement at the end of the day.

Another question said, which of the following is an element of a CPA firms, quality control policies and procedures applicable to a firm's accounting and auditing process. Your options were a compliant with laws and regulations. Be using statistical sampling techniques, see relevant ethical requirements and D considering audit risk and materiality.

Your correct answer in this case was see relevant ethical requirements, looking at your ethical requirements and your code of professional conduct and compliance with those professional requirements is critical as an element of a system of quality control. All those other options are something that an auditor must do to be in compliance with generally accepted auditing standards to make sure that we're in compliance of laws and regulations that we document our sampling appropriately and that we assess risk and materiality, but those are more directly related to the auditing standards themselves, as opposed to an element of the firm's quality control system or their policies and procedures.

Yes.

They'll talk about establishing and understanding what the client meaning, the terms of engagement, generally accepted auditing standards. Actually give some preconditions that must exist. In order for a CPA to take on a financial statement audit. One of the preconditions is that management has to define what is the applicable financial reporting framework.

That's going to be used to pre prepare these financial statements because management's responsible for the selection of their applicable financial reporting framework. The auditor has to feel comfortable that whatever framework management selected is acceptable given the current given circumstances.

So if they're asking you to do a financial statement, audit of financial statements prepared under international financial reporting standards, the auditor has to feel as if yes, that framework would be acceptable based on the intended use of these financial statements. Management also has to explicitly acknowledge that they understand their responsibility for the preparation and fair presentation of the financial statements for providing access to the records and the information that's necessary for the auditor to complete a financial statement audit and thirdly, for designing, implementing, and maintaining a system of internal controls over reliable financial reporting.

Management has to explicitly acknowledge that they understand that they're responsible for those things. We also in determining whether or not we can even accept an audit engagement. We have to be aware of any limitations that management might be imposing on us. If we know that management is going to impose, for example, a scope limitation on us.

For example, maybe we're not going to be able to observe the inventory account at the end of the year. We have to know that going in. If it's likely that we're going to have to end up disclaiming an opinion because of that scope limitation, then we can't accept that engagement to start with.

Right now, there may be information that as we, after we start the audit that we become aware of some limitations, that being opposed imposed by management, and that may have us go back and revisit whether or not we should withdraw or continue with the client. But upfront, if we know it's likely that we're going to disclaim an opinion, we're not allowed to accept that client to start with.

We also have to be aware of circumstances where a particular entity may be required to have an audit by law regulation. The auditing standards do recognize that there are circumstances where sometimes an auditor would not accept a client, or they would withdraw from a client. If they could do but by law regulation, they're not able to.

And so we have exceptions to the rule in that case. So it's one of those things where we should not accept the engagement. If there's going to be a management impose limitations. But if by law regulation we're required to take this engagement, then there'll be a set of standards that will guide us through that process.

And establishing and understanding what the client, this is typically done through something called an engagement letter. The engagement letter is going to set out what are management's responsibilities? What are the auditor's responsibilities? What are the objectives of this engagement? And what's going to be the scope of what it is that we're going to be looking at in this engagement.

So we want to understand what is the expected form and content of these reports that are going to be issued in conjunction with this ad test engagement. Let's reemphasize management is responsible for identifying and applying the financial reporting framework. They're responsible for their system of internal controls over reliable financial reporting.

And they're responsible for making sure that they are giving sufficient access to the auditor as far as the books and the records and the information and the people that are necessary to conduct our audit, the auditor, ultimately. Our responsibility is to express an opinion on those financial statements to conduct our audit in accordance with generally accepted auditing standards, to comply with our code of professional conduct, to ensure that we have a system of quality control, and we're going to gain an understanding of internal controls related to these financial statements and a financial statement audit in order for us to plan the audit.

But our goal is not to. Give an opinion about the system of internal controls it's designed are operating effectively. Ultimately there's inherent limitations in an audit and there's inherent limitations in a system of internal controls. So what's important about communicating to the client upfront in establishing relationship that for doing a financial statement audit is to make sure that management understands that there might be material misstatements that are not.

Detected through the audit process because of the fact that we can't give absolute assurance, that there's always going to be some level of uncertainty that internal controls, for example, can be overwritten by management or there could be fraud. But we're going to gather sufficient and appropriate evidence to give reasonable assurance that there's not material misstatement.

We discussed briefly how an auditor may be required to take on an audit engagement by law or regulation. The format of the report also might be stipulated by law regulation. So sometimes the auditor's report is prescribed by law regulation. There may be a specific layout or form or wording that they want you to use.

As opposed to the templates that are provided with the financial statement reports that are given in the general accepted auditing standards themselves, the auditor with certain criteria can take on these types of audit engagements. What they have to do is to look at the layout or the form of awarding of this report that's being prescribed by law regulation.

And to make sure that it wouldn't be something that would be misleading. So we have to look at what's the risk that the financial statement users might misunderstand the intent and the nature, this report. And is there a way that we can mitigate any risk of misunderstanding? If we can't mitigate that risk, then we shouldn't accept the engagement once again, unless it's required by law regulation for us to take on this engagement.

And then there are certain criteria that are laid out in the standards to make sure that the financial statement users understand that there's a limitation.

One of your multiple choice questions stated which of the following statements would least likely appear in an auditor's engagement letter? A was fees for our services are based on our regular. Per diem rates plus travel and other auto pocket expenses. That certainly is something that could be in an engagement letter to lay out.

When we're talking about the scope of the services to lay out our fee arrangement, option B said during the course of our audit, we may observe opportunities for improvement in internal controls over your operations. That might be one of the alternatives that we may give them. What's called a management letter to communicate things that we happen to encounter during the course of the financial statement, audit that we would give to them as an additional service option.

C said our engagement is subject to the risk that material errors or irregularities, including fraud. And defalcation, if they exist will not be detected. Okay. That is something that we may communicate to let them know that we are giving only reasonable, but not absolute assurance. So there may be material misstatement.

There may be material weaknesses and internal controls. There may be fraud that exists that we're not going to encounter and identify through the audit process. The answer that would be least likely to appear in an auditor's engagement letter was D. After performing our preliminary analytic procedures, we will discuss with you the other procedures we consider necessary to complete the engagement while that's something that we may do during the course of the audit process, it might be part of our preliminary planning activities.

It's not something that's typically going to be included in the engagement letter itself. Okay,

another question said, which of the following procedures would an auditor most likely include in the initial planning of a financial statement audit? So at the early stages, are we likely to a, get a written representation letter from management? That's not correct because we don't do that until the end of the audit, because we need to know what it is that we need them to represent to us based on the results of our audit procedures.

Your second choice B was exactly any documentation to detect illegal acts, having a material effect on the financial statements. We're going to do that, but once again, we're going to do that as part of the audit process itself. Part of our further audit procedures are going to be looking at actual documentation.

Option C said, considering whether the client's accounting estimates are reasonable in the circumstances. Once again, we're going to do that, but it's going to be a part of the actual audit process itself. Option D said determining extent of involvement of the client's intent auditors. That is the correct answer.

We need to, in our initial planning of a financial statement, audit, determine who is going to be on our engagement team, what work are we going to potentially be using other people that could be a specialist, or it could be the use of the clients internal auditors. And we're going to build that into our audit plan upfront to determine the nature time and extent of our further audit procedures.

All the other options that were listed in this multiple choice question were really the things that we're doing as part of those further audit procedures.

It's another element of establishing the terms of the engagement that's related to initial and recurring audits. When we have an audit of a client where they have been audited in the past, there's what's called a predecessor auditor. The predecessor auditor could be the auditor that reported on the most recent set of financial statements, but it also could be an auditor that was engaged to perform a financial statement audit, but did not complete the audit for whatever reason.

So it could be that there is an actual audit opinion that we could turn to as far as the audit that was completed, or it might be that there was an auditor that resigned or was terminated prior to the completion of an audit engagement. Ultimately both of those situations are considered to be a predecessor auditor.

Hey, it does not include if there was an accountant that did accomplish in a review. Of the most recent financial statements it's that it was an auditor, that there was an audit situation that was engaged to be performed. If there was a predecessor auditor, the general accepted auditing standards require that the auditor has some communication as the successor auditor with the predecessor auditor.

Before we accept the engagement, because we want to make sure that we understand. Why is it that relationship has been terminated? Or why is it that, that predecessor auditor resigned? It's going to give us a basis for understanding the client's integrity and to understand perhaps what are some of the issues that we might be encountering?

Because if we feel that there's going to be remember earlier, we talked about management might put some limitations on our ability to perform an audit. And if we feel that those limitations are going to result in us, Having to disclaim an opinion, then we shouldn't even be taking that client on to start with.

Ultimately, we want to talk to the predecessor auditor and consider their responses in our determined of whether or not we should even accept this engagement. If management puts limitations on our ability to talk to a predecessor auditor, then we have to think about why is it that management doesn't want us to talk to this predecessor auditor?

What is it they're trying to perhaps hide from us? And should we even be associated with this client to start with any communications that are held between the successor auditor and the predecessor auditor should be kept confidential. All right. Regardless of whether or not we ultimately accept the engagement.

We still need to keep those communications confidential. And we want to make sure that we have enough interaction with that predecessor auditor, to be able to assess the client's integrity, whether there were any disagreements with management, why it is that relationship is terminated. Is the predecessor auditor aware of any fraud or illegal acts that we should be alert to and deciding whether or not to accept or continue with this client?

There also is a requirement that the successor auditor should review the predecessor auditor's work papers. Part of it is to make sure that we understand that there, if we're going to do comparative financial statements, that there's consistency in the application of the policies and procedures that have been laid out, as far as their accounting policies and procedures, particularly when there's elections that can be made within an applicable financial reporting framework.

Looking at a predecessors work papers does not replace the need for the successor auditor to actually test the beginning balances. Now it might be that we just analytically look at the balances cause we're looking at consistency of application. It's the starting point for our beginning balances, but the successor auditor, when there's comparative financial statements that are being released needs to make sure that we're comfortable.

Around the sufficiency and appropriateness of the evidence that was obtained for those beginning balances that were, we cannot make right France to a predecessors work as a basis for our audit opinion. So we do have to use the information that we're getting from that predecessor auditor, in order for us to assume some responsibility for those beginning balances in a financial statement, audit.

In a recurring audit. So even after we've accepted a client and we're past the stage of talking to a predecessor auditor, we do have a responsibility for looking at each year's audit and determining whether or not the terms of the engagement require revision. The auditing standards require there. Be documentation.

To remind the management and governance of an audit identity around what are the key terms of this engagement. And if there's changes in the terms of the engagement after we've started an engagement, we have to make sure that we have proper documentation of that. And if management wants to change the terms of the engagement, we have to look at whether it's reasonably justified for us to do that.

If they're going to change the scope, or maybe they want to change to a lower level of service. I wanted to go from an audit to a review or a compilation. It's important to evaluate. What's the reason why management wants to do this. And do I think that there's reasonable justification? And if not, should I withdraw from this engagement unless I'm prohibited to do so underneath law regulation?

One of your multiple choice questions said before accepting an engagement to audit a new client, a CPA is required to obtain which of the following your first option was an understanding of the prospective clients, industry and business. B said a management representation letter C was a preliminary understanding of the prospective client's control environment and option D was those prospective clients consent to make inquiries of the predecessor auditor before accepting an engagement?

There is a responsibility to ask the client, am I allowed to talk to the predecessor auditor? One, one of those existed. So D is your best choice in this given situation, you are going to gain an understanding of the client's entity and an environment, including its internal controls, and you are going to get a representation letter, but all of those things can happen after you've accepted the engagement.

The key critical element here in this question is what has to happen before you can accept the engagement.

Another one of your questions said a successor auditors inquiries of the predecessor auditor prior to accepting the engagement should include questions about which of the following your first choice was the predecessors of valuation of audit risk and judgment about materiality. B said subsequent events that occurred since the predecessor auditor's report was issued.

See said the predecessors understanding as to the reasons for the change in auditors and D said the predecessor's knowledge of accounting matters of continuing significance. The thing that has to be asked about prior to accepting it engagement is going to be why is it that the client is changing auditors?

So the correct answer in this case is C. The predecessor's understanding as to the reason for the change in auditors. The other options that are there you may ask about, but there is no option to ask those questions. And in fact, the predecessor auditor may not know about subsequent events that occurred since they issued their report, because they're not responsible for subsequent events after the audit report date to go and continually look for those things.

We also, as we're talking about their evaluation of risk and materiality eat, those things are a matter of professional judgment. And so your judgment about materiality may be different than what the predecessor context was for audit risk and materiality. So you may ask questions around various number of different topics, but the thing that you are obligated to ask about that you should ask about.

Is why it is that they've terminated the relationship or why is it that the auditor resigned? And so what's the reason for the change in the auditors.

Now talk about some preliminary planning activities. Things that happen after we've accepted the audit engagement. And now we're in the preliminary stages of the financial statement, audit, preliminary engagement activities are going to include looking at any events or circumstances that may adversely affect the auditor's ability to plan and inform the engagement.

So is there anything that's going to pose an unacceptable level of risk to the auditor? Part of this is going to be looking at continuing client relationships that already existed. We're going to be looking at our ability to comply with our code of professional conduct, including our ethical requirements and independence rules.

So even with a recurring type engagement, our preliminary engagement activities are going to revisit. Our decision about whether or not we should continue to be associated with this ad test client. And are we still in compliance with our professional standards and our requirements that might exist in whatever auditing standards it is that we're complying with another element out of all, this is to come up with what's called an overall audit strategy.

The overall audit strategy is a big picture. Look at the engagement and it makes sure that the person that's primarily responsible for the audit engagement being the engagement partner is comfortable that they have the right resources to be able to perform the engagement that they understand the scope of the engagement and the characteristics of the engagement, so that we can clearly define what those reporting objectives are.

Defining our reporting objectives would include not just the types of required communications that are going to have to be released as a part of this engagement by our regulatory and professional standards. But also what's going to be the timing of this engagement and what type of deadlines are we working at?

So we can make sure that we have adequate resources to meet those reporting deadlines. We also want a preliminary basis in this overall audit strategy are going to figure out what are the areas of audit focus that we need to delve into. We have to think about materiality and our preliminary risk of material misstatement.

And how many locations perhaps do we need to visit for this audit engagement? Certainly at this point in time, as I said, it's a big picture perspective. When we talk about the overall audit strategy, to make sure that we understand the characteristics, the scope, the reporting objectives, the resources that are necessary in order for us to start the audit process.

After we have an overall audit strategy, then we can move into what's called the detailed audit plan. The detailed audit plan goes through and thinks about identifying and evaluating risk so that we can make sure that we design the procedures necessary to sufficiently come to conclusions about whether or not there is material misstatement in these financial statements due to fraud or error.

So our detailed audit plan includes some risk assessment procedures to identify and assess risk as well as the further audit procedures that we're going to be performing. Say in our audit work programs that we'll talk about the tests that we're doing for the relevant assertions within each material, class of transactions or balances or disclosures that we feel we need to gather sufficient and appropriate audit evidence about in order to support our conclusions about the financial statements.

So our detailed audit plan includes our risk assessment procedures. Our further audit procedures and then any other procedures that we're required to perform in order to be in compliance with generally accepted auditing standards. The other thing that you're going to do in a preliminary engagement phase of the engagement is to make sure that we do think about whether we need to bring in specialists.

The use of an auditor specialist is going to be either somebody that is within our firm, but outside of the engagement team, Or it could be somebody external to the firm that we need to bring in order to make sure that we're gathering sufficient and appropriate evidence to support our opinion.

Just multiple choice questions that during the initial planning phase of an audit. A CPA would likely do, which of the following your first option was to identify specific internal control activities that are likely to prevent fraud. Option B said evaluate the reasonableness of the client's estimates option C stated discuss the timing of the audit procedures with clients management and option D stated inquire of the client's attorney as to whether any unrecorded claims are probable of assertion.

All of those options are things that an auditor will do at some point during the course of the audit engagement. However, you may have to look at the question that says what would happen during the initial planning phase of the audit. Looking in that context, your best choice is option C at your initial planning phase is when you're going to be putting together your overall audit strategy and your detailed audit plan.

Which will include discussing the timing of the audit procedures with clients management, all the other alternatives, a B, and D are all things that will happen after the initial planning phase of the engagement.

Let's now talk about some risk assessment procedures. The purpose of the financial statement audit is to give reasonable assurance that there's not material misstatement due to fraud or error. Part of the reason why we go through a risk assessment phase of the audit is to give us a basis for identifying, assessing where it is that the financial statements could be misstated to look at a risk of material misstatement at both.

What's called the financial statement level, as well as the relevant assertion level, your risk assessment procedures. Aren't going to be sufficient and appropriate for you to issue an audit opinion all by themselves. There still has to be a combination of risk assessment procedures and further audit procedures in order for you to have sufficient and appropriate evidence, even though sometimes your risk assessment procedures may give you further audit evidence.

The beginning part of this with the risk assessment is primarily focused on identifying and evaluating risk at the relevant assertion level so that I can make sure that the nature, timing and scope of my further audit procedures. Are going to be sufficient, inappropriate to meet my audit objective, which is to a pine on the financial statements to give reasonable assurance.

There's not material misstatement due to fraud, right? When we are performing our risk assessment procedures, we're going to continue. We're going to consider. All the information that's available to us, what we've gathered this year, as well as information that we obtained in previous years, because previous year information can help us identify risks this year as well.

If it has continuing significance and relevance, part of our risk assessment procedures are going to be to talk to people. So we have to make, we should make inquiries to management and others within the organization, within the audited entity a varying levels of responsibility and authority to really be able to identify risk.

So management and those charged with governance as well as potentially an internal audit director, or maybe we even get outside of finance and accounting and talk to somebody that might be the VP of sales or other individual. Management and governance being that there would be a should that we talk to those people.

And then we may my could talk to additional information, other individuals, depending on what we think is necessary in order for us to assess risk on that engagement. So there is some level of subjectivity involved and who we make our inquiries to, but the fundamental requirement of doing inquiries exists within the auditing standards themselves beyond just talking to management and others as appropriate.

We also need to do some analytics. So we do, what's called our preliminary analytic review to assist us in understanding the entity and its environment to enable us to better identify the areas that might have risk of material misstatement associated with them. Our risk assessment analytics, our preliminary analytics.

Do you require us to have some expectations about plausible relationships that should exist and to look for where there might be unusual unexpected relationships that might be an indicator of risk? It's not that we're looking specifically for misstatement at this point, because we're doing this analysis at a very high level.

It's only going to give us a broad understanding. About where risk of material misstatement exists, as opposed to identifying the specific risk or a specific audit adjustment that might be made. Let's give an example. If I know from talking to management and governance, that they raised their prices this year on all their products and services, you would reasonably expect that there may be an increase in sales.

If there ends up being a decrease in sales compared to previous years, then that would be an unusual relationship that I might go and look at completeness of my sales as being an identified risk. I don't know if that's true. I don't know by how much it might be misstated, but I've identified that there is a potential problem there that I need to design an audit procedure around in order for me to gather sufficient and appropriate evidence inquiry.

Preliminary analytics. And then just basically the observation and inspection that I do as I'm gathering, understanding about the entity and its environment I'm going to observe the activities of my client. I'm going to read. Minutes that they may have of their board or audit committee meetings or executive management team meetings.

I'm going to gain an understanding around just the design of their internal controls over financial reporting to better enable me to assess risk. The goal of your risk assessment procedures is. To better identify where there is a greater likelihood of there being risk of some magnitude that I need to design an audit program step to address that risk.

Now talk specifically about the engagement team discussion in and of itself, the general accepted auditing standards. Say that in a financial statement, audit that we should have and engagement team discussion. During our risk assessment phase of the engagement to really go through and analyze the susceptibility of the financial statements to material misstatement, whether that material misstatement is due to fraud or err, so ultimately what we're doing there is we're getting all critical people in the engagement team together.

Most specifically the person with final audit authority, which is the engagement partner to allow the more experienced members of the team to share their insights and their knowledge with the less experienced members of the team. It could be somebody that's new to that client, new to that industry, or just new to auditing altogether.

But we want to make sure that there's a robust and open dialogue about what the business risks are of this audited entity and what could be these financial reporting risks that we might want to identify in order for us to put together an audit plan. That's going to address those risks. Ultimately, we need to make sure that we're using our professional skepticism.

Upfront during risk assessment, but also throughout the engagement, it might be that in our initial engagement team discussion, we didn't think that there was a particular risk around misappropriation of cash. But once we get into auditing cash, we might identify some things that's caused us to have a concern about that.

And so we may need to change our plan. It's a critical element about the risk assessment process and this engagement team discussion is it's not just a one and done situation. Risk assessment should happen throughout the financial statement audit process. It starts up at the risk assessment phase at the initial part of the engagement, but assessing risk is going to continue all the way through the audit report date.

Critical issues that should be discussed though, in this engagement team discussion are any areas of audit risks that we have specifically identified. And where is it that we think if management were to override controls and manipulate the financial statements, potentially creating fraudulent financial statements.

Where would that likely happen? And are there any unusual transactions or accounting procedures that our client is using that makes them more susceptible to fraud or error? And what are the important internal controls and the design of our client's systems, that's helping manage those bigger risks.

Ultimately, the engagement team discussion has to focus on a sense of materiality. What would we consider a material misstatement to be for this given client, given the current circumstances that exist this time for recurring clients, you need to have an engagement team discussion, every audit period, because risk changes, the people involved changes your operating environment changes.

And so we need to take into account for recurring engagements. What's changed about the entity and its environment and its controls that might be altering. Maybe previous year's assessments of risk. So every year there's this obligation to go through this robust and open dialogue.

One of the questions said, which of the following procedures would an auditor most likely perform in planning a financial statement audit. So once again, with this one it's planning during the planning phase option a said inquiry of the client's legal counsel considering pending litigation, that typically doesn't happen until the end of the audit option.

B said comparing the financial statements to anticipated results. C said searching for authorized transactions that may add in detecting unrecorded liabilities. And D stated examining computer generated exception reports to verify the effectiveness of internal controls, your best response for something that happens during the planning phase of a financial statement audit is be comparing the financial statements to anticipated results, which would be your preliminary analytic review or your risk assessment analytics.

All of the other options are things that would occur during the course. So the audit process, but they're going to happen after planning. I'm actually going to be testing the operating effectiveness of controls or searching for unrecorded liabilities, or sending out an attorney's letter. Having conversations with the client's legal counsel, that's all things that would be these further audit procedures that happen after my risk assessment.

Another question said audit programs should be designed so that a most of the required procedures can be performed as interim work be inherent. Risk is assessed at a sufficiently low level C the auditor can make constructive suggestions to management or D the audit evidence gathered supports the auditor's conclusions.

Ultimately your detailed audit plan, the goal of your audit program is to gather sufficient and appropriate audit evidence to support your opinion and your conclusions. You may or may not choose to use interim work, right? You may or may not give management recommendations to the client about how they could be more effective and efficient.

Those are things that you may or may not do. And the audit program isn't going to be specifically designed to do that. And audit programs aren't designed for inherent hit risk to be assessed at sufficiently low level. We'll talk about inherent risk with the risk of material misstatements segment of these materials, but inherent risk is going to be low, moderate, or high, depending on the circumstances.

The design of the audit program has nothing to do with altering inherent risk.

Talk about understanding the entity and its environment. There are certain critical things that are important for the auditor to gather information about in order to properly assess risk. So part of the risk assessment phase of the engagement or the planning of the engagement is going to be gathering understanding of the entity and its environment, including relevant internal controls over financial reporting.

When we talk about the entity and its environment, we're talking about the industry that they operate in the regulatory environment that they operate in, as well as things like general economic conditions that also could have an influence on where it is. There's likely to be fraud or error in these financial statements.

Our understanding of the operating environment is going to come from past experience with the client, or might come from discussions that we have with the predecessor auditor. But it's also going to come from other sources, like our ability to stay abreast of what's happening with the industry through industry audit guides or other types of publications, the operating environment is important, but also the specific nature of the entity itself.

What's the ownership structure. How are they governed? How are they financed? What's their major types of investments. How are they structured? Do they have related parties understanding the nature of the entity itself? In addition to the environment that operates in allows us to better assess risk. Our understanding of the nature of the entity is also going to come from.

Reviewing prior work papers and talking with predecessor auditors, but it's also going to come from talking to the client and touring their facilities and reading some of their documentation, like perhaps their accounting policies and procedures, manuals, minutes, tax returns, regulatory reports, any information that we believe is important for us to really understand the nature of the entity itself.

Which is an addition to the environment that operates in.

Let's talk a little bit further about understanding the entity and its environment. When we're talking about understanding that any AIDS environment it's critical that the financial statement auditor understand the strategic direction of the company. And what are the business risks that are associated with this organization?

Why are they in operation? What is their strategic plan and their goals and objectives. This is because some of these risks that are associated with just who the entity is and what their goals are, can affect the financial statements in the current period, or it could have long-term consequences. For example, I may have a client when I'm looking at their strategic and business operational risks, I might decide that there is a going concern there that there's some uncertainty about the entities ability to continue as a going concern for a reasonable period of time.

And I may need to perform some specific audit procedures to further evaluate that risk. I also need to know about their own. Financial measurement and performance. So measurement and review, as far as looking at the financial performance, highlights that the management and governance of this organization, monitors to look at those things because they may create pressure for management or governance.

To perpetrate, fraudulent financial reporting, anything that's anybody's held accountable for. I give I'm held accountable for meeting particular gross profit percentages or coming in on budget or to show a growing revenue stream those expectations. As far as the financial performance measures that are managed by the organization, create a motivation potentially for management and others to intentionally deceive us.

To override systems in order to meet the expectations for performance that are being imposed upon them. So we want to understand what are the key performance indicators for this organization and what is it that is measured and managed as far as financial performance, what is held to be important to this organization with financial performance?

Because there may be greater risk of fraud or err, associated with those areas. Those are the critical areas of the organization's financial statements. And so there's a greater risk of there being a material issue. There may be inappropriate reliance on the financial statements. If there is misstatement due to fraud or error in those particular areas.

Another thing that we have to gather information about and understanding the entity its environment is not just what is the client's applicable financial reporting framework. But if there's options available to them and selecting and applying that applicable financial reporting framework, we need to understand the appropriateness and the consistency of how those standards are applied.

If the client is changing an accounting policy, we need to understand the reason for that change. And is that change appropriate? Given the context of what the applicable financial reporting framework says, they're allowed to do the last element of what we're going to gather and understanding about is the design and implementation of internal controls.

So we're going to understand the relevant, significant controls within the COSO integrated framework and use that information to also help us better identify where there could be risk of material misstatement in the financial statements, because there's just a weakness on how the design of the system of internal controls is even set up to function in the first place.

Choice question that you were presented with stated that in the planning and planning, the audit, the auditor's knowledge about the design of relevant internal control policies and procedures should be used to a. Identify the types of potential misstatements that could occur be assessed. The operational efficiency of internal control.

See, determine whether controls have been circumvented by collusion or D document the assessment, a level of control risk in the risk assessment phase of the engagement in planning, the audit, our knowledge about the design of internal controls is going to be used to help us better assess risk. So given that context, the best response out of the options that were presented to you would be a, to identify the types of potential misstatements that could occur.

Ultimately, we may take this knowledge that we have about the design of the system, and we might decide to test controls for operational efficiency. We may also look at those controls and determine, is there any deficiencies and The controls that relates to fraud and ultimately document that assessed level of control risk after we've performed a test of controls if that's relevant.

But the primary objective in planning is to identify the types of things that could go wrong.

Let's now talk about audit risk. Fundamentally is the risk that the auditor unknowingly fails to modify their opinion and on a set of financial statements that. Potentially are materially misstated or where the audit opinion should be modified in some way. So we want to reduce the risks that we give the wrong audit opinion.

Audit risk is going to be looked at in two different levels. The first level is looking at things at the overall financial statement level, big picture risk. Is, are they a going concern? Are they highly regulated? Have they had turnover in key management? Your second level of risk is going to be what's called the relevant assertion level.

The relevant assertion level is going to be what are the things that could specifically go wrong with my accounts, classes of transactions and disclosures. So for example, am I concerned about the completeness of my cash or the existence of my cash or the valuation of my cash? The formula for audit risks that you need to memorize is inherent risk times control risk.

Times detection risk equals audit risk. So audit risk is a combination of inherent risk control, risk and detection risk. You also are going to hear the term risk of material, misstatement risk and material misstatement is the combination of inherent risk and control risk. Once I've established my risk of material misstatement, which is a combination of inherit and control risks.

I then am going to design my audit plan. That's going to address the detection risk. What else is there for me to do in order to satisfy my requirements? As it relates to audit risk as audit risk goes up, the nature time and extent of my audit procedures necessary to address any identified risks also is going to go up.

So the more risk I have, the more evidence I need to get in order for me to be satisfied that I've gathered sufficient and appropriate evidence in order to support my audit opinion. And my conclusions inherent risk is the risk that there's material misstatement in my financial statements, just because it's a gut reaction.

It's something that's beyond the control of the client. It's beyond the control of the auditor. So regardless of internal controls, which will be assessed when we look at control risk, inherent risk is just because of the nature of the account itself, the complexity of the calculations or accounting policies that are required, the amount of subjectivity that's involved.

These types of things could create a situation where if I were to just have my gut reaction, my gut instincts about where there could be problems in the financial statements, I'm going to pinpoint the areas that have the highest inherent risk. It might be that I have a really high risk associated with misappropriation of my cash because I had a lot, I have a lot of cash, like actual cash that comes through to my organization.

It might be that I have a lot of bill and hold sales, so I might. Make the existence of my revenues be a higher inherent risk. Just the nature of the account, the transactions, the subjectivity. You're just looking at those things, absent internal controls. Where is it that I think there's this greater risk of having problems?

The second element of assessing audit risk is control risk. Now the control risk is the risk that internal controls will not prevent. Or detect and correct material misstatement due to fraud or error on a timely basis. Control risk is a function of two parts. Part one is that I have to have a well-designed system.

And part two is that I have to have evidence to show that well-designed system is operating effectively. Design effectiveness and operating effectiveness are two really separate conclusions that both go into evaluating control risk. Just because I have a well-designed system of controls based on my understanding of the entity that I gathered back when I was doing risk assessment doesn't mean that I, it can reduce control risk.

The only way I can reduce control the risk is if I actually have evidence to show that I've tested that well-designed system to show that it's happening consistently in a quality way throughout audit period, in order for me to rely on that system, to reduce my audit risk. Ultimately with control risk there's inherent limitations and internal control.

There could be systematic breakdowns. There could be management override. There could just be human error that I transpose a number. So with control risk, if I were to try to assess it at less than high, there's always going to be some inherent limitations in the system of internal controls. So therefore, even if I test controls.

I still need to do some detective procedures. My risk assessment of inherent risk and control risk in and of itself is generally not considered to be sufficient and appropriate evidence in and of itself. Now the lower, my risk is the less persuasive my audit evidence needs to be with my detective procedures, but I'm still going to form some level of detective procedures at the end of the day.

Risk of material. Misstatement is going to be a combination of my inherent risk that is outside of the control of the entity and the auditor. And it also is going to take into account any reliance that the auditor can place on the system based on what the client does, what you know, what they're doing as it relates to their internal controls.

So it's independent of what the auditor is going to do in their detailed audit plan, the control system, while I may test controls. Internal controls and controllers going in itself is really under the control of management and governance, because they're responsible for designing and implementing and maintaining a system of internal controls.

That's not a responsibility auditor. The auditor is going to potentially test to see how good of a job are they doing at that. But ultimately our risk of material misstatement is going to be a judgment call. It's not a precise measurement, but it's going to be assessed by the auditor. At the relevant assertion level to give us a basis for designing what our further audit procedures are going to be to satisfy our detection risks

more about audit risk. And focusing more on the concept of detection, risk detection risk is the risk that my audit tests will not detect material misstatement that does exist at the relevant assertion level. So I'm not going to detect the risk that my cash is not complete or that it doesn't exist or it's not properly valued.

It's not. Going to be something that I'm going to be able to give absolute assurance about. Remember we're giving reasonable assurance is a high level of assurance, but not absolute. Even if we were to look at a hundred percent of our transactions through our detective procedures, we still couldn't give absolute assurance because there still could be something around subjectivity where there's uncertainty, or there could be collusion or fraud.

There's could be misapplication of an accounting principle. Our detective procedures with our detection risk is how much audit work do I need to do around the nature, timing and extent of testing accounts, classes, and transactions and disclosures. In order for me to satisfy my audit, objective of giving reasonable assurance that there's not material misstatement due to fraud or error, the effectiveness of my audit procedure is going to be based on the auditor's assessment of risk and material misstatement.

So what I'm doing is I'm looking at my risk of material misstatement. And as my risk of material misstatement gets lower than I. So I have low risk of material misstatement. That means that I have more leeway with the design of the nature and extent of my audit procedures to get less persuasive evidence.

It means that there's the greater detection risk that I'm willing to accept, because I think there's lower risk of material misstatement from the outset, the higher my risk of material misstatement. The less risk that I'm willing to accept that my detective procedures aren't going to detect material fraud and error.

And so I'm going to increase the nature time and extent of my audit procedures. So in essence, it's something that my response that I'm going to design with my tests of details and my substantive analytic procedures is going to have an inverse relationship with my risk of material misstatement. The higher, the auditor assesses, inherent risk or the higher I leave my control risk because I'm not relying on my client's system of internal controls to reduce audit risk.

The more work I have to do. Okay. And so that means that I need to lower my detection risk, which means it's the less risk when we say lower detection risk. It means that there's less leeway that I'm giving in my willingness to accept that sufficiency inappropriate. So on my audit evidence, I have to do more detailed work.

I can have a, I need to have more persuasive sources of evidence. I need to do my audit procedures closer to period, and I'm going to have bigger sample sizes and get greater coverage of my accounts that I'm testing the lower, the detection risk. That means the less risk I'm willing to accept that my procedures will not be sufficient, inappropriate to find problems.

So that means that I'm going to increase the persuasiveness of my audit procedures, the nature of the timing, the extent, the lower my risk of material misstatement means that I can have. Higher detection risk, which means I have a greater willingness to assess risk so I can do less detailed tests and more analytics.

I can do more interim work. I can have smaller scopes and smaller sample sizes, and still say that I have sufficient and appropriate evidence to support my audit opinion at the end of the day.

Let's now talk about audit risk in a little bit more detail by discussing the relevant assertions. When we talk about assessing risk at the relevant assertion level, there's fundamentally six different assertions that management is representing about when they're giving us these financial statements.

When they're responsible management is for preparing and fairly presenting the financial statements. They're in essence, asserting that. Their financial information exists. So if they have certain fixed assets that are listed on their balance sheet, we can feel comfortable that's fixed. Those fixed assets are complete, that they exist, that the entity has rights to those fixed assets that the fixed assets are properly valued with the depreciation method and the useful lives.

So my net book value of those fixed assets, it's fairly reflective. That my fixed assets are properly classified in the right line item on the financial statements that I have proper cutoff of my fixed assets, all my additions and disposals. It's a proper cutoff at period end. Every single line item in the financial statements has a, has these assertions associated with them.

Now, some of these assertions are going to be more relevant than others. So that's why they say relevant. Assertions. Cause it might be for example, with cash. If I have a small owner managed business here in the United States, all of their cash might be in us dollars, so they don't have any foreign currency.

And so therefore a valuation of cash might not be. Something that's particularly relevant for that client. I don't need to really focus on testing that because it's not really a concern, but for cash in that circumstance, I still may be concerned about the existence and completeness of Mike and the cutoff of it and their ability to be able to do their bank reconciliations properly for period and cutoff.

It's up to the auditor to understand the six different assertions existence, or occurrence, completeness rights and obligations. Valuation and allocation, accuracy, and classification and cutoff. Those are your six assertions. You need to memorize those six different assertions and understand what differentiates those assertions from each other.

Some of them are pretty much self-explanatory, but the ones that I want to talk about more specifically are valuation and allocation and accuracy and classification, valuation, and allocation means that the year that the transactions. Are accord recorded at the proper amount and that the financial information, as well as properly disclosed, if there's any footnotes associated with it, accuracy and classification is going to be focused on the appropriate recording of amounts in the proper account.

And in the and that we're talking about the proper presentation and disclosure, as far as the specific line item that is built into it. So valuation allocation is focused on if I have disclosures at the information that's included in that disclosure, if there's financial information that it's at the proper amount that the proper adjustments have been recorded to reflect the dollars, accuracy and classification is more around what account in line item is it presented in and are the disclosures clearly expressed and properly presented in context of not being materially misleading?

One of the multiple choice. Questions said that inherent risk and control risk differ from detection risk. In what way? So how is inherent risk and control is different from detection risk. Your first choice was inherent risk and control risk are functions of the client and its environment while detection risk is not.

Your second choice was that inherent risk and control risk are changed at the auditor's discretion while detection risk is not. Your third choice was inherent and control. Risk are considered at the individual account balance level while detection risk is not. And your final choice was inherent and control risk are elements of audit risk.

While detection risk is not the only answer up here. That is an appropriate answer is a, your inherent risk and your control risk are a function of the client. It's an environment. Detection risk is a function of what the does the auditor need to do at their discretion in order to gather sufficient, appropriate audit evidence, inherent risk and control risk cannot be changed at the auditor's discretion.

Those things are outside of the auditor's control. They are going to evaluate them and take that into account with their judgment. But detection risk is what's changed at the auditor's discretion and your risk of material misstatement and your detection risk are all assessed at the relevant assertion level for each individual account class of transaction and disclosure.

So all three of them are elements of audit risk, and all three of them are considered at the individual account balance level. So that is why option C and D were incorrect.

Another multiple choice question said holding other planning, considerations equal a decrease in the amount of misstatement in a class of transaction than an auditor could tolerate most likely would cause the auditor to do what. So if it's decreasing my tolerance, what will I do in response to that is the correct answer.

A. Apply the plan substantive tests prior to the balance sheet date, would that give me better audit evidence, option B, perform the plan audit procedures closer to the balance sheet. Date C increase the assessed level of control risk for relevant financial statement, assertions or D decrease the extent of audit procedures to be applied to the class of transaction, a decrease.

In the amount of misstatement that I'm willing to tolerate would mean that I want to get a higher level of audit evidence. I want to get more persuasive evidence in the nature, timing extent of my audit procedures. The only answer up there that's consistent with that goal is be to perform my procedures closer to the balance sheet date.

If I do them prior to the balance sheet date, I'm accepting more risk that I don't think could be wrong. If I'm decreasing the extent of my audit procedures, that's being applied, I'm getting less evidence. So a and D would be the opposite direction of what I want to do. If my tolerance for risk is such that I want to get better evidence answer.

See, talking about control, risk control risk has nothing to do with the auditor detailed audit plan. Control risk is a separate assessment as part of the audit risk formula.

Another well, choice questions said on the basis of audit evidence gathered an auditor decides to increase the assessed level of control risk from what we originally planned to achieve the same overall audit risk the auditor would do, which of the following. So if I started out saying that I was going to.

Decreased control risks. I was going to rely on my client's system of internal controls to reduce audit risk. But after I went through the process, I decided that my tests of internal controls didn't support that conclusion. So therefore, I've got to go back and revisit my plan. If I'm going to take my control risk and put it in, increase it, put it back up to high.

My risk of material misstatement now is going to be higher. Therefore, what would I do ultimately in order to get the same audit objective? Am I going to a decrease? My substantive testing? No, that's not the answer. I actually am going to have to increase it. Am I going to be decreased? My detection risk decreasing your detection risk means inversely I'm increasing my procedures.

So B would be a correct response in this case. Your answer would see being increasing your inherent risk. Inherent risk is something that's absent, what the auditor can control, so that shouldn't even have been on your list of considerations and D increasing your materiality levels. Materiality is something that you assess for the financial statements as a whole.

It also is not tied into your actual audit risk assessment in and of itself. So therefore your most appropriate response is B.

Let's now talk about materiality within the general accepted auditing standards. Materiality is the magnitude of emission or misstatement that would cause somebody to make a different economic choice. So it changes the judgment of an informed user of the financial statements. This judgment that the auditor makes about materiality is going to be based on two different dimensions.

One of them is quantitatively. How far off could these numbers be? But also qualitatively. There may be certain elements of the financial statements where it's not big dollars, but qualitatively. It could cause somebody to make a different economic choice, perhaps it's because it relates to a compliance, something that relates to.

A law or regulation that the organization has to comply with. Whether it's a direct material effect on the financial statements, it could be related to a debt covenant. For example, with an organization that has debt with an outside financial institution, there could be something related to fraud.

That's a small number, dollar wise and fraud, but it's qualitatively something that's very significant and material. Ultimately what the auditor has to do in this process of determining materiality is to think about the financial statements and who are the intended user of these financial statements.

And to what degree are they relying on this financial information to make economic choices that are based on the results of the financials? It's based on the auditor's judgment and perspective. So it's solely something that is ultimately left the judgment of the auditor quantitatively. The audit process does have some methodologies available to it where I can calculate.

A dollar amount to try and have a threshold of quantitative materiality. So it may be that I apply some sort of percentage to a given chosen benchmark. It might be total revenues, or it might be total assets. The auditor says out of the different. Line items on these financial statements, which is the one that's probably most relevant to the intended users.

It might be that if I have investors that are the primary users of the financial statements, that I might focus on revenues and income statement, if it's because I have the financial statements being applied and given to a creditor, I might instead focus on the balance sheet and total assets. If I have unknown users, I'm really not quite sure who's going to be the users of these financial statements.

Then you might use the most conservative threshold which might be taking the larger of total assets and total revenues and calculating multiple thresholds, and just use your judgment to perhaps alter the calculation to what it is that you're comfortable with from the auditor's perspective. So there's no rote answer.

There's no just magic calculation. Ultimately materiality is left up to the judgment of the financial statement, auditor to decide what they believe should be a material consideration when I'm evaluating the results of my audit procedures. I mentioned that you're going to look at materiality, both quantitatively, as well as qualitatively.

As I said, you need to look to see, is there any. Misstatement that maybe is small dollars, but it actually changes my client's financial results from being operating at a profit to operating at a loss. That might be something that even though it might be a $5,000 entry, if it changes from a net profit to a net loss, I may feel like I still need to book that adjustment.

Okay. I mentioned how it could be something that qualitative leads important because it impacts compliance with debt, covenants or contracts or regulations. It could have a magnifying effect on stock prices or price earning calculations. It could be something that is related to an area where it's tied to management compensation or bonuses or raises.

So we really need to think about. Qualitatively. Is there something that's not big dollars, but still has big effect on the intended use of these financial statements and would it influences somebody's economic choices ultimately with materiality, the auditor is going to go through and do what's called planning materiality.

So during the planning phase of the engagement, they're going to assess some threshold of talking about materiality, taking into account, that, what is it that I think. Could go wrong with these financial statements. So ultimately there may be something that we calculate materiality using some sort of rote calculation, but then based on risk and based on the intended use of these financials, I may actually lower materiality down from what the calculation said it was okay.

There may be some sort of threshold Barolo, which I am not willing to accept misstatement. There is materiality there's planning, materiality. Another term that you might hear is called performance materiality and performance materiality would be what's the level of materiality that I'm actually going to use in performing all of my different audit procedures.

So when I get to performing my further audit procedures and I'm establishing scopes and acceptance thresholds and assessing risk of material misstatement at the relevant assertion level. I'm going to be basing it, perhaps on this concept of performance materiality, that typically is going to be less than my planning, materiality, because I want to lower it down to take into account that several misstatements could occur that when aggregated together might lead me to risk and material misstatement.

I want to use a lower level to be able to perform procedures at the account class of transaction and disclosure level to allow for that to happen that individually and in the aggregate, I don't have any issues.

Let's continue our discussion about materiality emphasizing that performance materiality is generally less than planning, materiality. I'm taking an M reducing my concept of materiality down to an acceptably low level, such that any aggregated, uncorrected and undetected misstatements that might occur would not then end up exceeding my materiality that I came up with when I was thinking about materiality for the financial payments as a whole.

So it's something that is generally lower. Then my planning materiality, and it's the performance materiality number that I generally use to assess risk and material misstatement and perform further audit procedures. Another related concept that we have is something called tolerable misstatement.

Tolerable misstatement is similar to performance materiality, but tolerable misstatement is a sampling term that when I'm calculating sample sizes, for example, that I'm going to put in a concept of Taba misstatement into that calculation to be the maximum monetary misstatement that I'm willing to accept in a particular account class of transaction.

So it may be the same as performance materiality, or it may be something different. Tolerable misstatement is something that I establish for each audit procedure that I'm doing when I'm doing my further audit procedures. And it influences my extent in testing because there's a maximum misstatement within a given population that I'm willing to accept tolerable.

Misstatement is a tool that allows me to design my audit. Such that the combination of all of my audit procedures does not end up having a known misstatement there that exceeds my materiality performance and materiality and tolerable misstatement, as I mentioned may be the same number, but tolerable misstatement is very specific to talking about the extent of testing.

Particularly as it relates to school, we have planning materiality that's assessed during risk assessment. Which then drives my performance materiality, which then drives my tolerable misstatement as I go through the audit process though. I may get new and better information such that I might change my concept of what's considered to be material.

Ultimately when I'm evaluating my audit procedures and my findings at the end of the audit engagement, I'm going to revisit my determination about materiality, quantitatively and qualitatively and decide. Now that I've been through the audit process, do I feel the nature time and extent of my further audit procedures were still appropriate?

So ultimately the end of the audit process, you're going to revisit your materiality determinations to make sure that you still feel that they are sufficient and appropriate given the results and the outcomes that you had during the audit process itself.

Multiple choice questions said, which of the following statements is not correct about materiality. Your first choice was the concept of materiality recognizes that some matters are important for fair presentation of your financial statements. Others are simply not important. That is a true statement.

So would not be the correct response to this multiple choice question. Option B said an auditor considers materiality for planning purposes, in terms of the largest aggregate level of misstatements that could be material to any one of the financial statements. This is an incorrect statement because I'm thinking about materiality to the financial statements as a whole, not just one not just the balance sheet, not just the income statement.

I'm looking at it in terms of the financial statements in its entirety. I may use a lesser form of materiality for performance or toggle misstatement, but when I talk about materiality, it's the overall financial results. C said an auditor's consideration of materiality is influenced by the auditor's perception of the needs of a reasonable person who will rely on the financial statements.

See is a true statement. Okay. It's a judgment call on the part of the auditor to think about who are the users of the financial statements, how were they using these financial statements to make economic decisions? And what's going to influence their judgment calls and cause them to make different economic decisions.

D says materiality judgments are made in light of surrounding circumstances and necessarily involve both quantitative and qualitative. Once again, answer D is correct because the auditor has to think about quantitative and qualitative decisions, both in making determinations about whether or not something is considered to be a material misstatement in the financial statement.

Yeah,

another discussion question said, which of the following would an auditor most likely use in determining the auditor's preliminary judgment about materiality? Would it be a, the anticipated sample size, the plan substantive tests be the entities, annualized, interim financial statements. See the results of the internal control questionnaire or D the contents of the management representation letter.

What would I determine my preliminary judgment or my planning materiality on the only option up there that makes any sense is B I need to have some sort of key component of my financial statements. That's going to be used to calculate some sense of quantitative materiality. Analyzing my client's interim financial statements to project.

What I think their total assets, total revenues, et cetera, may be would be an appropriate means of me doing a preliminary judgment amount materiality.

Let's now talk about assessing risk of material misstatement. There's some critical steps in an auditor's ability to successfully assess risk of material misstatement. First of all, we need to go to the process of identifying risks of material misstatement throughout the audit process. So yes, it's a process that starts in planning, starts in the risk assessment phase of the engagement, but it's something that needs to be continually modified and updated as we're getting additional information based on the results of any tests of controls that we might perform, or any substantive that testing that we're doing in our further audit procedures.

Hey, so we need to constantly revisit to determine whether or not we've properly assessed, audit risk, to make sure that we're getting sufficient and appropriate evidence to support our conclusions. Also, we have to do risk assessment at the relevant assertion level. So we're looking at identifying specific things that could go wrong, potentially for various accounts, classes of transactions and disclosures at the relevant assertion level.

Remember, we need to memorize those six assertions, the existence and occurrence, completeness, cutoff, valuation allocation. We need to go through each of those and make sure that we're thinking about those for every line item on the financial statements and think about the likelihood of something being wrong with each of those different assertions and evaluate them the pervasiveness of any potential risk.

Lee steps in looking at it evaluating risk and material misstatement is thinking about both the likelihood of a problem, as well as the magnitude. So we might say, you know what, it's that we're going to have ghost employees in this organization because there's only 10 employees to start with, or it might be that it's a large multinational company.

And we might say, you know what, it's probable that there's ghost employees. Once I think about the likelihood of something happening, then I'm going to go through and think about the magnitude of it. So just because it's possible for something to happen, it's possible it could happen. It might be that it's going to be really inconsequential and not material.

Even if it were to occur, something could, I'd probably be wrong and still not be significant or material to the financial statements and may not increase my risk to be something that we consider a high risk of material misstatement. So as we're thinking about evaluating risk, being low, moderate high, it's a combination of both likelihood and magnitude based on judgment.

That gives me a sense of what is it that I need to gather with my detective risk or my further audit procedures in order for me to satisfy my requirements of evaluating audit risk as a whole, the higher my risk of material misstatement. That means that I need stronger. Detective procedures to satisfy my risk, the lower, my risk of material misstatement.

That means that I can take more risk on when I'm looking at designing the nature time and extent of my audit procedures.

Let's talk a little bit more about assessing risk of material misstatement, focusing in on some of the key terms that are built into the generally accepted auditing standards. We've talked about inherent risk control, risk detection, risk. Even within the concept of inherent risk, there's some inherent risks where it's not just that my inherent risk without something would say it's high.

It's like it's super high, right? So there are certain things that are called significant risks. I can identify a risk and have it not be significant. Because the likelihood of magnitude don't mean that it's super high, right? It's not probable, there's going to be a material misstatement. It might be that it's possible.

Something could go wrong, but it would be inconsequential if it did well, it still has risk, but it's not a significant risk. Significant risk are aware. It's. Possible or probable that there's going to be material misstatement. So generally if it's probable that there's going to be material misstatement as a result of this thing that could go wrong.

That risk is going to require special audit consideration. Significant risks requiring special audit consideration are differentiated in the audit standards because it's the potential for these misstatements that were it's probable, that there's going to be material misstatement as resolved. So I want to get my most persuasive audit evidence over my significant risks requiring this special audit consideration.

Special audit consideration may require that I have to test controls. Test operating effectiveness of controls over that area. It may mean that I have to do extensive tests of details over that area, but I'm going to, when I'm designing my audit plan, I'm going to give special consideration to my significant risks, requiring special audit consideration, ultimately the auditor to document their thought process and the rationale for how it is that they assessed risk.

So I'm going to go through and look at all of my risk assessments at the relevant assertion level. And I'm going to you wait and assess risk of material misstatement for all of those assertions at each relevant. Like for every account class, that transaction disclosure, that's single, and I'm going to make that assessment and have a basis for that assessment.

If it's not obvious, if the reason why you're making something low risk or high risk wouldn't necessarily be obvious to somebody that's reviewing the financial statements. Then we need to put more detail around that risk assessment, particularly the areas where I've identified significant risks, requiring special audit consideration.

I need to talk about why it is that I think this is a super high risk. Ultimately, we're going to use this documentation to make sure that as we're linking and matching our further audit procedures, our audit program up, that it's commensurate with risk, right? That we've made a linkage between risk assessment and my audit programs in and of themselves.

That there's a relationship between the two that would be deemed sufficient and appropriate. And I want to be careful not to too overwrought it and not to under audit. Ultimately, we need to find a designed audit plan. That really makes sense. Based on my risks,

this multiple choice question stated that the acceptable level of detection risk is inversely related to what. So if my detection risk is going to go up and down it's inversely related to a, the assurance provided by my substantive testing B the anticipated sample size for planned substant testing.

See the entities, financial statements of the prior ear, or D the assertions that are embodied in the relevance in the financial statements themselves. Ultimately right. The acceptable level of detection risk. If I'm going to alter my detection risk and make it lower or higher, I'm changing the persuasiveness of my audit evidence that I'm providing.

Therefore the best answer up here is a assurance provided by my substantive tests. Hey, as my detection risk goes down. Great. I'm willing to accept less risk that I'm missing something. So I want to have greater, more persuasive audit procedures. As my detection risk goes up, I can do less persuasive procedures.

So detection risk is inversely related to the assurance provided by my substantive tests.

Let's now talk about evaluating the results of the audit as we go through and perform our audit procedures, we're going to identify misstatements. Some of these may statements are going to be known and some of them are going to be considered likely. And we're going to take both known and likely misstatements into account when we're deciding what type of audit opinion can I issue at the end of the day, do I have sufficient and appropriate evidence to give that reasonable assurance that there's not many serial misstatement due to fraud or air based on the results of my testing, known misstatements are the things that I've specifically identified as a result of the audit.

It can be that they. Miscalculated a number or they incorrectly applied an accounting principle. It can be a misstatement of facts. These are things that the client can correct. We can book a debit or a credit to fix this, and we can alter a footnote disclosure to include all the elements that need to be there in accordance with the applicable financial reporting framework.

So known misstatements are things that we do know are wrong, and we can specifically go to the client and tell them.

Likely misstatements are things that are more based on estimates. So let's say I ran a sample and based on the results of my sample, I extrapolated out what I think the projected error could be of that population. I don't know it's off by that amount, but yeah. It's possible that it's off by that amount.

And so I'm looking to see, even if this were, projected out, to say that I'm seeing the same issue over and over again within this population, I'm still okay with it not being materially misstated, likely misstatements need to be resolved. If we think the projection of these likely misstatements could be material.

So if it's material, we're going to request management to go back and do more work in that population in order for us to change this likely misstatement into known misstatements so that I could get to the point where I think the projection of my error, the likely error is something that I am willing to accept and still give reasonable assurance about whether or not the financial statements are materially misstated.

Beyond just extrapolating the results of sampling. Another area where there's sometimes likely misstatements are things where there's subjectivity involved, say we're doing an accounting estimate. And my client has an allowance for doubtful accounts established at one number. And I think it should be a different number.

If I think that their number is unreasonable, I can take the difference in our numbers. And I'm going to put that in as a likely misstatement. If it's material, then we're going to have to go and work with management to try and come up with a number that we're both happy with. But if it's not material, I can, except that there's a difference in these financial statements.

But as long as it's not material, I can allow there to be uncorrected misstatements in the financial statements and still give potentially an unqualified unmodified report. Ultimately, when we're looking at our known and likely misstatements, a critical thing for auditors to do is to look at, is this a misstatement due to fraud?

Or is this a misstatement due to air? If I find that there are misstatements where things are intentionally misrepresented, say that they're intentionally giving me bad data in order to perpetrate fraudulent financial reporting, or I find that somebody stealing or misappropriating assets. Fraud qualitatively becomes just naturally something that I would qualitatively think is more material versus an error where there's just an unintentional mistake in the amount of disclosures.

And the reason being for that is that fraud being an intentional misrepresentation is going to increase audit risk there, because if they're willing to deceive you intentionally in one way, you've got to worry. What else is out there that perhaps I didn't. Identify and deal with that could aggregate up to be something where I misleading the financial statement users.

We have to think about the cause of misstatement. And as they said, that could have a direct influence in evaluating the qualitative significance of those misstatements.

Let's talk a little bit more about evaluating our audit results. We mentioned how, when you evaluate materiality, you have to think about quantitative and qualitative materiality. When you're looking at the results of your procedures at the end of the day, and you're looking at your known and likely misstatements.

I have to compare that to what my planning materiality was, make sure that my final materiality determinations my judgment call about what would be materials still holds true. Given now that I've gotten all of the audit procedures completed, when we're, connotatively looking at something we can't assume naturally that something is automatically an isolated occurrence.

We do have to look and say individually and in the aggregate, is there other misstatement that's potentially out there that I haven't identified? That's why we extrapolate errors when we're looking at things as a result of a sample. So we have to look at the misstatements and think about, really, is there more work that needs to be done to flush this out?

Do you think about things that I may be Hatton uncovered or encountered yet? That still is a risk that it could be wrong. And then when I do have, where I believe I've got a good handle around the things that do need to consider as far as correction of known and likely misstatements, I go to the client and they make a determination of what to fix or not fix.

And there may be misstatements that both known and likely that the client decides not to. Correct. And we, as the auditor would look at the things that my client decides not to correct and determine whether or not we think. That's appropriate. Do we believe that individually and in the aggregate, these uncorrected known and likely misstatements do not have a material effect on our financial statements.

And that we think that people can still make good economic decisions to fight the fact that we know that there's no one in likely problems that still exist in these audited financial statements. Remember it's that we're giving reasonable assurance, not absolute assurance that there's not material misstatement, quantitatively qualitatively.

We're going to evaluate our known and likely misstatements to see, even though something might be a small dollar because of. It changing something related to compliance or impacts management's bonus or because we think it's related to fraud, or we think it's an component of that financial statements that my financial statement users really pay attention to.

There may be qualitative reasons that we ask the client to correct a known misstatement or to delve into investigating a likely misstatement because we're still uncomfortable lingering in out there for qualitative reasons.

This multiple choice question States, which of the following statements properly reflects an auditor's evaluation of results of audit procedures. Your choices were a, the effect of prior period. Misstatements need not be considered. We know that's not true, right? So that's a, not a true statement that we do need to think about the impact of prior period misstatements that maybe were uncorrected.

And how does it influence the current period? B says reasonable difference between management and auditors judgments concerning accounting estimates is a known misstatement. We discuss differences in estimates being a likely misstatement, not a known misstatement. So answer B would not be the correct response.

C says errors are intentional. Mistakes of amounts are disclosures. Errors are unintentional. Mistakes fraud would be an intentional mistake. So answers C would not be correct. That leaves us with D the auditor should evaluate both the quantitative and qualitative impact of misstatements, both known and likely answer D is the correct response in this case.

Let's now talk about fraud management is responsible for designing, implementing, and maintaining a system of internal controls to prevent. Deter detect fraud. It's the auditor's responsibility to plan and perform our audit procedures to provide reasonable assurance that the financial statements are free from material misstatement, whether that misstatement is the result of fraud or error.

Okay. So the auditor's testing to make sure that there's nothing wrong in the financial statements, that's material because of this fraud situation. We're not accountable for preventing deterring and detecting fraud. We're looking at whether or not there's any risk of fraud and building that into our audit plan to get sufficient and appropriate evidence that there's nothing material.

As a result of fraud management is responsible for managing their own fraud. There are different types of fraud. You have your fraudulent financial reporting and you have your misappropriation of assets. Fraudulent financial reporting is going to be either in an intuition, intentional misstatement or omission can be an amount, or it could be a disclosure in the financial statements that is being manipulated or falsified or altered or misrepresented in order to deceive the financial statement users themselves.

So it's something about the presentation and disclosure of the financial statement. Misappropriation is also fraud, but it's more specifically related to theft or stealing. So if somebody is stealing cash or stealing inventory or stealing fixed assets, that would be considered a misappropriation of assets.

Now they may be covering up that misappropriation through manipulating the financial statements. And so it could have a financial statement impact, but most directly we're talking about. With misappropriation that we're talking about stealing assets, whereas fraudulent financial reporting could just be overstating sales and putting them in the wrong period.

When you're evaluating fraud. It's important to remember. There are three elements that are conditions that relate to fraud. First of all, there has to be an incentive or pressure for management or governance or others to actually perpetrate fraud. There has to be an incentive and pressure to cook the books.

Perpetrate fraudulent financial reporting or misappropriate assets to steal. There has to be the incentive pressure. And there also has to be an opportunity for them to do they have to have access to the assets that are being stolen. They have to have access to the accounting system to manipulate it instead of and pressure opportunity.

And then the third element is attitude and rationalization. They have to be able to rationalize their actions. Either everybody else is doing it. So why not me? Or I'm not really hurting anybody, whatever their rationalization is about the fraud. We have to assume that when we have two or more of these conditions related to fraud, that we probably have a fraud risk that needs to be addressed in our detailed audit plan.

So if somebody has a pressure to manipulate the financial statements and also has access to the system and the opportunity to do so well, that's going to increase. My risk that there could be fraud that's occurring, and I need to plan some audit procedures around that area to make sure that I'm comfortable, that is not happening.

Let's continue our discussion about fraud. Specifically focusing in on professional skepticism. Professional skepticism means that when we're looking at my client's situation, that I am going through and regardless of how much I trust the client, regardless of my perception about management's integrity, I am always going to go through and consider it a possibility that there could be material misstatement due to fraud.

So I have to go in assuming that this could be the case the auditing standards presume for example, that management override is a fraud risk condition. That's always going to be present. And that is an auditor and a financial audit should always perform, should perform PR procedures to test for management override because we have to presume.

That there's incentive and pressure from management to do that. And it might be that they generally have a high sense of integrity, but there was something specific going on where there was this pressure for them to maybe do something that they wouldn't normally do. Thinking that they're going to pay the money back or I'm going to correct it next time, or I'm not hurting anybody.

So there are situations where we've got to have a brainstorming session and to say, if management were to override controls, How would they go about doing it? Why would they do it? Let's do some procedures to test to see if there are any indications that they may be doing it. We also need to think about other areas that management might perpetrate fraud like misappropriation or revenue recognition.

The auditing standards require that the engagement team in the risk assessment process. Have a discussion about the susceptibility of the financial statements to material misstatement due to fraud, the audit partner engagement partner has to be involved in this process of discussing this. And there has to be a true brainstorming around how would it happen if somebody were to do it?

And what audit procedure are we doing that is responsive to that identified risk to have us look, to see whether or not we think that. Possibility may or may not be true. The required risk evaluations is that I should address the possibility of management override to be a specific identified risk that requires special audit consideration.

And then I should presume improper revenue recognition as a fraud risk. Although I can overcome that presumption on the auditing standards. If my clients in a situation where revenues is just not a critical component of their financial statements, the users don't really pay attention to revenues. Then I can overcome that presumption, but generally overstating your revenues is a significant fraud risk.

Further our discussion about fraud by talking about the procedures that an auditor has to do, not in just assessing the fraud risk, but actually. Documenting as far as audit procedures that they're performing within your detailed audit plan, one of the required procedures is to directly ask management if they know of any fraud or are they, do they, are there any areas of potential fraud?

Is there anything that you might've suspect is happening? Have there been any allegations about fraudulent financial reporting or misappropriation of assets? That we should be aware of. And if there were these allegations, what did you do about it? Like how you handle preventing deterring and detecting fraud to make sure that there are within the design of internal controls over financial reporting, that they do have preventive and detective controls around not just the things that could go wrong with error, unintentional mistakes, but also things that could happen with fraudulent franchise, port a and misappropriation of assets.

The larger and more complex the organization and the more controls they should have over preventing deterring and detecting and correcting fraud. We need to understand how the entity communicates it's concerns about fraud and how it is that they establish a tone in the organization, such that they are requiring people to operate within a context of ethics.

That our business practices and our ethical behavior is supposed to support a culture where doing anything that might be considered fraudulent is considered unacceptable. We're not just going to talk to management about these things, but we're also going to talk to other people within the organization.

If there's a governance structure, like a board or an audit committee, If there's an internal audit department, we're going to talk to people that are outside of the financial reporting process to get their analysis about the culture, as it relates to identifying and managing and preventing and deterring and detecting and correcting fraud.

We're going to use the results of our analytic procedures that we perform in the risk assessment phase to be alert for where there might be manipulation of the numbers. We're going to look at all the information that we gathered including previous years and having discussions with predecessor auditors.

If that's the case to try and design an audit program that doesn't ignore the fact that management. Governance and others could be intentionally deceiving us as it relates to the proper treatment of certain transactions and events that are reflected within the financial statements.

Let's delve a little bit further into the different types of fraud. Fraudulent financial reporting and misappropriation of assets, your fraudulent financial reporting. You have to look at those components that we discussed the instead of, or pressure to perpetrate fraudulent financial reporting, the opportunity to do as well as the ability to rationalize it.

Things that typically increase your incentive or pressure as it relates to financial reporting is because of the fact. That there's something that hits my bottom line myself. So it could be that it's something that creates an incentive or pressure because impacts my bonus. It impacts my res it also could be that it's something that I'm held accountable for.

So maybe. It's something that we know that an outside third party pays attention to a particular trend or ratio. It might be that I'm having struggling, economically. And so therefore I'm trying to smooth things out to not make our year look as bad as they did thinking that things are going to turn around.

So a high degree of competition, declining margins. Rapid changes in the operating environment threats of bankruptcy, negative cash flows, expectations. All of those things could create an incentive or pressure for fraudulent financial reporting. And then just because I have the incentive of pressure doesn't mean I can do anything about it.

So now I also have to have the opportunity to manipulate or cook the books. These are often things that are done either through management override or they're done through. Out of the ordinary course of business complex non-routine transactions. So manipulating significant estimates or related party transactions are often used as a means of cooking the books.

And then lastly, They have to have the ability to rationalize that what they're doing is not so bad, so they could have inappropriate values to start with. We could have a known history of violations of fraudulent financial reporting, but it also could be that They're just somebody that tends to be ultra aggressive.

You could have a CEO of a company that really pushes the concept of what's considered material and where there's gray lines. They always, they might always end up over on the aggressive side of the gray line. So we have to think about, where they could be skewing things to their best interest and that they're purposely.

Deceiving us or withholding information or, not really being fully responsive to our questions that might be signals around. There might be fraudulent financial reporting that's occurring within this organization. Stealing asset misappropriation is generally going to be because somebody is worried about their own personal obligations or their compensation.

The opportunities are going to exist when there are large amounts of assets like cash or inventory or PPD on hand. And there's not a lot of oversight or management of those assets. Often the rationalization is going to be employee dissatisfaction or the tone at the top of the organization that culturally it's acceptable for somebody to take something home and use it for personal use.

When you're doing your audit procedures, we are required for being alert for where there could be red flags or signals around fraudulent financial reporting and misappropriation of assets to evaluate those signals and say, do I think there's greater risk of material misstatement due to the fact that this could be occurring?

If I have multiple discrepancies in my accounting records, if I have conflicting or missing evidence, if I'm finding unusual relationships between accounts, if the client seems to. Really not be open and honest with me. Those are some of the signals that would lead me to perhaps decide that I need to increase my risk associated with those areas.

And therefore get more persuasive audit evidence with my detective procedures in gathering that sufficient and appropriate evidence in order to conclude on my audit.

Specific procedures that we're going to do as it relates to fraud, it's really going to depend on the degree of the fraud risk assessment. So even though I think that it's possible, there will be fraud. I'm going to handle that differently than if I think it's probable that there's material fraud.

You're still looking at the likelihood and the magnitude of your risk to make sure that you're making your fraud risk procedures commensurate with that risk. If there may be cases that my fraud risk is so high that increasing my audit evidence and pulling large samples and doing lots of work may not compensate for that fraud.

So completing the audit may end up not being possible. And it might be that I have to withdraw from that engagement, unless I'm not allowed to, by law regulation. Generally my clients that have the higher fraud risks, I'm willing to put my more experienced people on these engagements. I'm going to increase the level of supervision.

I'm going to make sure that with the review of the work papers, that we're really focusing on the areas where there's subjectivity and complexity and the transactions and events. I also, if I'm concerned about fraud and going and do things like. Building in an increased level of unpredictability from year to increase my corroboration of management representations, to make a closer scrutiny of the internal controls that exist that the client has designed and implemented to prevent deter detect and correct where there could be fraud occurring, things that could be unpredictable as far as my audit plan would be to.

Confirm something in writing, as opposed to just getting an oral representation, to do surprise test counts of inventory, to come in and do things on an interim basis when they're not expecting it to more closely scrutinized related party transactions or interview people that are operating within areas where I'm suspecting that there might be a fraud occurrence.

I might duplicate testing at multiple locations to see if I'm getting the same answer or use a specialist to help me evaluate the results of transactions or events. Each of those things, are things that I need to think about, whether it's with revenues or whether it's with inventory that I'm going to try and build in some.

Procedures with the nature, the timing, the extent of what I'm doing to allow for the fact that management could be intentionally trying to mislead me. And I'm going to try and counter that by building in unpredictability or redundancy in my testing, or trying to get the most persuasive evidence I can get like sending confirmations or directly observing things.

Another area that you will find. Is focused on, as it relates to fraud, particularly with management override is to really look, to see if there's a bias that management might have with their accounting estimates, to look at journal entries and other adjustments, to see if they're using the journal entry process to override the day-to-day recordkeeping and trying to manipulate the financial statements.

So a lot of times with the management override, the journal entry process is used to. Alter your financial information to put yourself, to be presenting that information in the light and the context that you're hoping to do. So even if it's intentionally deceiving,

Fraud documentation is important because it is such a matter of emphasis. With the auditing standards to really make sure that we are taking into account that even though we might have a client, that's been our client for 10 years, doesn't mean that there might not be a situation where there's an incentive or pressure for them to perpetrate fraud that year.

We have to document this brainstorming session we had about where we think the financial statements are most susceptible to fraud. And if we feel as if we need to design a specific audit program step to address that risk, what was that procedure and what were the results and the outcomes of it, and how did it influence our ability to to give our opinion, whatever that opinion is.

We have to identify specific risks of material misstatement due to fraud. And what's our response to them. And particularly if we're not going to identify revenue recognition as a fraud risk, then why is it that we don't think that we needed to do that? If we decide, as we're looking at performing our audit procedures, if we find there's missing documentation, for example, We should automatically evaluate why is it that they can't find that documentation is this potentially a fraudulent transaction and how am I going to validate, that it truly is a proper transaction in the right period and so forth. So whether it's Tessa details or whether it's analytic relationships, trends, and variances, that maybe are inconsistent with what we expected, our further audit procedures and where we're finding issues. We really should make sure that not just that we are comfortable, that it's not an error, but that we're also comfortable that it's not a fraud.

Ultimately we have some required communications, not just what it is that we're documenting in our files, but what is it that we're telling management and governance when it relates to fraud type issues? We're required to communicate to an appropriate level of management. Anything that we have that we think is a fraud finding, even if it's in material.

Okay. So we want to communicate what's appropriate. It's one level above the person that's involved. If it involves senior management, then obviously we're going to go to governance. If it's appropriate, if we believe that it's something that's a much larger issue than we would want to work with the client to talk with them and their legal counsel to figure out what an appropriate response might be.

Ultimately, when we're looking at internal controls, we want to make sure that as we're looking at the design of our client's system of internal controls, that they have sufficient controls to prevent or detect and correct things that could go wrong, whether fraud or error. When we're communicating deficiencies and internal controls, significant deficiencies and material weaknesses.

We may have something that's considered a material weakness in the design of my client system, because I think that they don't have strong enough procedures to deal with fraudulent, financial reporting or misappropriation that they're so focused on oopsies, unintentional misstatements with the errors that they're not really focused on, where somebody may be.

Stealing for them. And there tends to be a natural inclination, particularly with smaller entities that nobody would steal from me. They get, we're like a family. And what you find is that fraud situations happen both in small companies, as well as large companies. The communications with management is critical management and governance.

When we believe that it starts adding into consequences and we believe that there's an internal control deficiency that's related to this fraud issue. And then potentially in some cases, our communication may go all the way up to third parties, particularly if I'm in a regulated environment sec.

Government auditing standards that to fulfill my legal and regulatory requirements, I might need to communicate with outside third parties about this situation whenever I'm in that situation. Usually I'm precluded from talking to outside parties, but when it relates to fraud and we're talking about laws and regulations, there might be exceptions to the rule for us to have those outside communications, but in all cases, the.

Auditor is going to consult their own legal counsel before taking that step.

One of your multiple choice questions said, which of the following statements reflects an auditor's responsibility for detecting errors and fraud. Choice one said an auditor is a choice. A says the auditor is responsible for detecting employee errors and simple fraud, but not for discovering fraud involving employee collusion or managers when override well, when we're looking at risk and we're brainstorming risk, we're going to think about fraud and error and it is going to include.

Collusion and management override as being part of what we're looking at. So really we're not excluding things just because there's management override option B said is the auditor's responsibility to plan the audit, to detect errors and fraud that are caused by departures from gap. The key word that's missing from B, which makes it not the appropriate response is it's missing the word material.

Okay. So be careful about that. We're only responsible for looking at risk of material misstatement due to fraud or error option C an auditor is not responsible for detecting errors and fraud, unless the application of generally accepted auditing standards would result in such detection. We're you know, we are responsible for planning to give reasonable assurance about Material fraud and material error.

So this one would not be the appropriate response. The most appropriate response up here is D an auditor should design the audit to provide reasonable assurance of detecting errors and fraud that are material to the financial statements. So option D is the only one that addresses both the reasonable assurance, addresses both fraud and error and addresses the concept of materiality.

Another one of the questions said, which of the following is an example of fraudulent financial reporting. Is it a that they falsify inventory count tags, therefore overstating their inbound inventory and understating Callista sales. That's fraudulent financial reporting. I'm overstating a number, right?

I'm misrepresenting the numbers that are on my income statement. Answers B, C and D are all related to misappropriation of assets. B was an employee diverts customer payments to his personal use, concealing it by Devin and expensive pounds and over an overstating expenses. So they're stealing the cash.

See, as an employee steals inventory, now they're covering up by charging it to cost of sales. D is an employee borrows small tools from the company and the cost is reported as a miscellaneous expense. What B, C and D all have in common is that an asset is actually being misappropriated by the employee and it, and they are being, it's getting covered up in the financial statements, but in S in a it's that nobody's been necessarily stealing the inventory.

They're just overstating their inventory.

The question said, which of the following statements best describes the auditor's responsibility to detect fraud, risk factors related to financial stress of employees or adverse relationships between the entity and its employees. Is it a, the auditors required to plan the audit to detect these risk factors?

Is it B. These factors relate to fraudulent financial reporting and an auditor's required to detect them when the client is vulnerable. Is it, see the auditor is required to plan the audit to detect these factors when new employees are hired or is it D the auditor is not required to plan the audit to discover these items, but should consider them and identifying the risks of material misstatement arising from misappropriation of assets.

If we become, if we come across them during the course of the audit, If you look at all four of those responses, what best describes the auditor's responsibility is D I don't have to plan my audit to detect financial stress of employees or adverse relationships. What I am though is as I'm looking at anything that I happen to identify or happen to think is a potential risk.

I'm going to include that in my. Risk of material misstatement assessment. And I'm going to make sure that I perform appropriate procedures accordingly. If I believe the risk to be there and it to be material. Another multiple choice questions has which of the following inquiries is required under generally accepted auditing standards related to fraud a is it required to inquire about whether management has ever intentionally violated securities laws?

B, whether management has any knowledge of fraud within the entity C management's attitude towards regulatory authorities or D management's attitude toward internal control. The required communication is that we ask management. If they had any knowledge of fraud that occurred within the organization.

Or are they aware of any suspected fraud? B is the required communication a may or may not be in there depending on whether or not they even have securities and see the same thing. They may not have regulatory authorities.  The best response, if you look at it in this case, as far as what is the required communication is only B is the only one that's required.

Another question says generally accepted auditing standards related to fraud requires which of the following to be documented. Which do we have to document? Is it a evidence of risk assessment for material misstatement due to fraud, be a description of assessment, for example, maximum or minimum. See an explanation of how assessment of fraud risk was determined or D all of the above.

The requirement when we say required, that means that it's unconditional. The unconditional requirement is that we have to document evidence that we did do a risk assessment associated with fraud. How we do it, whether it's quantitatively or qualitatively, there's, doesn't have to be a precise measurement, but how we describe the fraud explaining how we came up with a fraud, like those things are optional for me to include in.

If I don't think that it's readily apparent in the file, but the only thing that was the unconditional requirement was a

let's now talk about illegal acts, which are slightly different than fraud. Illegal acts is a violation of a law or regulation. It could be perpetrated by management or employees that are acting on behalf of the entity that excludes any type of personal misconduct unrelated to business activities.

The concept around illegal acts is it's a legal determination that should be left to qualified experts. So an auditor's responsibility as it relates to illegal acts on the financial statements is that we. It's less likely that an auditor will detect an illegal act because they're further removed from the transactions and events that are ordinarily reflected in the financial statements.

There may be an illegal act that does have a direct material effect on the financials. And there may be those that, that aren't ultimately what the auditor needs to do from a compliance standpoint is to think about the laws and regulations that have a direct immaterial effect. On determining financial statement amounts, and to think about, is there some sort of risk there that something could be misleading or miss or misrepresented often it's these things that have a direct and material effect on the financial statements that would normally result in some sort of contingent liability, or do you know that might be recorded or disclosed if there is any type of allegations of illegality?

Typical. Audits do not include procedures that are specifically designed to detect illegal acts. However, if I have information that comes to my attention, indicating that there's a possibility glass that could mirror clearly affect the financial statements, then I am required to follow up on it. So if there's a direct and material effect, then I do need to follow up on.

Investigating it to see what that impact is, which might be a footnote. It might be something where I'm setting up some sort of a cruel for some sort of contingency that might arise because of this possible non-compliance with law regulation or something of that nature. If I don't really. Become aware of anything that causes me to be concerned about illegal acts.

I still am going to talk to the client about, what are the things that you have to be in compliance with? And the management representation letter that management provides to us at the end of the engagement is going to specifically assert that they are not aware of any violations. Or if they are aware of violations that they're describing the possible violations that should be considered for a footnote or for a loss contingency type of cruel.

Certain communications about illegal acts that we have to have with the client. If we believe that these illegal acts are going to be direct and material to the financial statements. Then we need to inform management and those charged with governance about that situation. If we find that there's a potential illegal act and we don't believe it to have a direct and material effect on the financial statements, then we won and to perhaps communicate with management about that, but we only have to communicate to governance about that.

If it's More than clearly and consequential, right? So there's the sense of materiality with the illegal acts. But what we need to do is to understand from the client's perspective, what really would be something that would be considered clearly sick and consequential. Like we need to have a sense of what would be clear to you in consequential to management and governance and making that determination of whether or not I need to have it's required communication.

If it's something that's more than clearly on consequential, we want to at least tell people about it. If we believe that it's direct and material, then we need to have an audit response to it and to make sure that it's properly presented and disclosed in the financial statements, we're going to document any communications we had, even if we verbally tell management and governance about an issue, we still need to document in the audit file to show that we did have that communication.

Normally we're precluded by confidentiality laws and ethics to communicate things outside of the client's situation. However, if there is an illegal act, there may be situations where the client is responsible, where the auditor does discuss these illegal acts with outside third parties. Particularly if we're in a.

Regulated environment like SCC. If there is a governmental funding agency, that's required that where I've a government audit standards engagement, if a successor auditor makes inquiries to us about why it is, we terminated our relationship, it might be because of that illegal act or if we're responding to a subpoena ultimately, there, there are exceptions to the rules about communicating with outside parties.

When we talk about illegal acts, when we talk about fraud, when we talk about non-compliance. The effect on the auditor's report is if it has a material effect on the financial statements, I don't believe that it's been properly accounted for and disclosed. Then either going to qualify our opinion or give an adverse opinion.

Okay. If the client refuses to accept that we're modifying our audit report, then we may withdraw from this engagement and make sure that we inform those charged with governance. Why it is that we're withdrawing from this engagement? If we can't obtain sufficient and appropriate evidence to evaluate an illegal ad, they don't give us access to the people that we need.

Then we need to disclaim an opinion. If I'm unable to determine if an illegal act if I'm unable to evaluate it fully because of the fact that there is. Limitations that are imposed by the circumstances, not imposed by the client, but imposed by the circumstances. Or if the interpretation of laws are really uncertain, that there's a gray area, then I still need to consider the effect on the report.

But that's where I might give a qualified opinion as opposed to a disclaimer of opinion. If I'm not able to fully determine the effect because of things that the client's doing, client imposed limitations, it's more likely I'm going to actually disclaim an opinion.

One of your multiple choice. Questions said an auditor who discovers that client employees have committed an illegal act that has a material effect on the client's financial statements. Most likely will withdraw from the engagement. If so, in what situation would we withdraw? A, the illegal act is a violation of gap B the client fails to take remedial action.

The auditor considers necessary. See the legal act was committed during a prior year. That was not audited or D the auditor has already assessed control risk at the maximum level. So the question here is when would I actually withdraw from the engagement I want to withdraw if the client fails to take remedial action.

So if I feel they're not being responsive to an issue that I've identified as being an illegal act, that has a direct and material effect on the financial statements, right? So there's client use. Those are going to be the situations where I'm most likely going to withdraw. I could ultimately have an illegal act that's properly presented or disclosed in the financial statements and still.

Give an unqualified opinion, or I may qualify my opinion. Another multiple choice question said the term material misstatement in the audit report includes which of the following was it a fraud involving senior management and material fraud, B fraud and direct effect, illegal acts. See material fraud, material error, and certain illegal acts.

Or D material, air and material fraud in each of these cases, what you have to look at is which is the most comprehensive answer that includes all of the elements that I should be looking at when I'm thinking about risk of material misstatement. I am thinking about material errors, material fraud, and certain illegal acts, all three of them.

So that's why answer C would be your best response in this given situation.

Now talk about the communications that the auditor has to have with those charged with governance, who you have to communicate to is going to depend on. The structure of the organization. Some organizations just have an owner, some have an executive management team, some have a board, some have an audit committee.

So each in each situation, the auditor is required to go in and evaluate who is governance really in this given situation. And it may be that governance is management. That they're the same individuals. Ultimately governance are the. The people, or perhaps just the person with responsibility for overseeing the strategic direction of the organization, including the reliability of the financial statements, right?

Management are the people that are responsible for achieving the objectives of the entity. And they're the ones that have the authority to establish policies and make decisions about those objectives. Including the financial reporting objectives. Governance really is accountable for overseeing management.

Before the engagement, the auditor needs to identify who governance is during the engagement. We're going to communicate to governance. If we do have any disagreements with management, we have differences in estimates. And then after the engagement, we're going to communicate with those charge of governance.

They're both going to receive a copy of the audit report. But they also are going to get communications about in writing. If we have internal control, significant deficiencies and material weaknesses within the auditing standards, those things are directly reported to management and governance. And then there may be other things that we communicate to governance depending on the conditions and the circumstances.

So let's go ahead and talk about that things that we would communicate potentially to governance. The things that need to be in writing would be the audit report and significant deficiencies and material weaknesses and internal controls. There's other things that we need to communicate to governance, which may be in writing, or it may be orally, but even if we communicate it orally, we're going to, into document in our files that we had that communication, the things that we want to make sure that governance understands is what is the difference between management's responsibility and the auditor's responsibility.

So management is responsible for the preparation and fair presentation of the financial statements for designing, implementing, and maintaining internal controls. They are responsible for projecting and deterring and detecting and correcting fraud and illegal acts. Those are all things that are management's responsibilities, the auditor's responsibilities to come in and give reasonable assurance that there's not material misstatement in the financial statements as a result of all those things.

We may have things that we, you want to communicate that are significant to the financial statements like management selection of a significant accounting policy, or if they've implemented a change in accounting policies, or we might communicate the areas where we think that there is a high level of subjectivity, like with estimates.

If we had audit adjustments that we came up with at the auditor identified both corrected and uncorrected, we tell management governance about those. Disagreements with management, even if they've been resolved, maybe appropriate to communicate to governance so that they just know the context of what is management's tone and attitude about embracing responsibilities for the financial statements.

If we know that management went and consulted with people besides us about how to treat an issue, they may be opinion shopping. For example, we're going to let governance know about that. Ultimately, we need to make sure that governance understands the scope of the engagement, the types of required communications, the timing of our services.

And we also need to let them know about the results of our work, internal control, significant deficiencies and material weaknesses. Maybe key representations that we asked management to represent in that management representation letter any type of communications we might've had with specialists might be yeah, appropriate.

It's a lot of judgment involved in what the auditor thinks is appropriate, but ultimately we have to think about, are there things that we need to put in writing where we feel as if they are so significant that oral communication in and of itself, wouldn't be adequate. If it's given in writing, the communication is going to indicate that this communication is meant to be for the sole use of those chart of governance.

If it's communicated orally, as I mentioned, we still need to document it in our work papers to show that we did have that oral communication. The goal of the auditing standards is to make sure that we're evaluating the sufficiency of having a robust and open dialogue between the auditor and those charged with governance.

To make sure that there's no miscommunications, no misperceptions about what the auditor's responsibilities are and to make sure that they have all the tools that they need and all the information that they need in order to oversee and govern the organization.

Your multiple choice questions said that an auditor would least likely discuss which of the following with an audit committee. Would it be a, the method used to account for significant unusual transactions? B. The maximum dollar amount of misstatement that could exist without causing material misstatement in the auditor's estimation, see indicators of fraud and illegal acts committed by management or D disagreements with management about application of the applicable financial reporting framework, gap, or gas.

The best answer that we would least likely we discuss would be B. We're not going to. Tell them, what's the maximum amount of quantitative misstatement that I'm going to accept. If there's a sense of materiality, we can talk materiality theory with the client, but we really don't want to give them any hardened, thresholds with which that they might be able to use to manipulate the financial audit in, in future years.

So we need to build some unpredictability in there. The other items, a C and D are all things that we would likely discuss with the audit committee, unusual transactions, fraud, or illegal acts disagreements with management. Those are all inbounds for that communication.

Another multiple choice question said which of the following best describes the auditor's responsibility for communicating adjustments to an audit committee. A. We're only required to communicate material adjustments B we're required to communicate material adjustments as well as individual and aggregated uncorrected immaterial adjustments.

See adjustments should not be communicated to the audit committee or D materiality should not be discussed with the audit committee. When we're talking about communicating with governance and communicating about adjustments, it's important for them to have the information they need to govern the organization.

So the best answer in this response is B we are required to communicate material adjustments, and then if we have uncorrected adjustments, Individually in the aggregate, we need to let them know that there's misstatement out there. That management has decided not to correct, because we need to give governance and opportunity to oversee management, and to concur with their conclusion. So therefore what's not that we want to limit our communications only to those things that are material. We want to communicate to them. Everything that we've encountered, at least in a summary level.

Let's revisit what we've accomplished. We've gone through a lot of materials in this hotspot, as a reminder, the things that you want to memorize, you want to go back and memorize the elements of the quality control system. You also want to memorize the audit risk formula. They inherent risk control, risk detection, risk, and the interrelationships of those components.

And finally, you want to memorize the six assertions as it relates to what management is representing about their financial statements. You do want to go back and revisit all of the chapters that we've covered and this material. Being very clear that you can differentiate between what's management's responsibility versus the auditor's responsibilities and a financial statement audit, knowing how the generally accepted auditing standards define professional responsibilities with the unconditional requirements and the presumptive requirements, as well as the explanatory information, be sure that you're familiar with the preconditions for an audit, including when there is a predecessor auditor that you have to have communications with.

No. What happens as far as the initial part of the financial statement, audit process, what's your preliminary planning activities. What's the risk assessment procedures. How do I gain an understanding of the entity and its environment? What types of risks evidence do I have around assessing risk and materiality and putting that all together into a detailed audit plan.

And then at the end, after I performed my audit procedures, I need to have an appropriate way of evaluating my audit results, including those known and likely missed statements, being alert to where there's fraud or illegal blacks. That could be something that I need to communicate and take into consideration with my financial statement audit report and what are the required communications that I need to have with management and governance, particularly around my audit results, fraud, illegal acts, significant deficiencies and material weaknesses, and internal controls.

Yeah.

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And welcome to the bisque CPA review course and our coverage of the auditing and attestation section of the CPA exam. My name is Bob Monette. I'll be your instructor for this AUD cpa review course and in this AUD cpa exam review course, we're going to be discussing. A very heavily tested topic in the auditing exam. And that is the topic of internal control.

Before we begin the class. Let me just say a word about the best way to use this AUD cpa review course. The most important thing is to avoid just sitting back passively, just watching the class, be an active participant. Take good notes later in the class. When we do problems from past exams, it's important that you shut the class down.

You do the problem. You get your answers before you come back to the class and we discuss the problems together. You find, if you do those very simple things, you'll get much more out of this auditing cpa exam prep course. And that's what we both want. Now, as I say, in this AUD cpa exam study course, we're going to be discussing a very important topic, the topic of internal control, but to get us started just to get us in the mood, get us warmed up.

Let's go over the basic steps. In the audit process. So they're in our mind ready for this AUD cpa study course. The first step of the audit process is to establish an understanding with the client. We have to establish an understanding with the client regarding the objective of the engagement, the services we're going to perform any limitations on the engagement.

We're going to lay out as clear as we can. The auditor's responsibility. The client's responsibility. And of course we document the understanding with the client in the engagement letter, that in step two, we enter the planning phase of the audit. In the planning phase, we have to obtain an understanding of the entity, the client, and its environment, including internal control.

In the planning phase, we perform our risk assessment procedures, observation inquiry. We look, we ask inspection and don't forget analytical procedures must be done in the planning phase. So in the planning phase, we begin our risk assessment. We perform our risk assessment procedures, observation inquiry, inspection, analytical procedures.

And of course the risk assessment procedures that we use depend on the size of the company. It's complexity. Our previous experience with the client. Are we there every year? And in the planning phase, we discuss with the audit team, how susceptible the financial statements are to errors and fraud, how susceptible the financial statements are to material misstatement in step three, in the audit process, we evaluate the risk of material misstatement related to particular assertions.

Always remember. That set of financial statements is nothing more than a set of assertions on a balance sheet. Management is asserting. This is our cash balance. Management is asserting. This is our inventory balance management is asserting. These are our liabilities management is asserting. This is our capital management is asserting.

These are our disclosures. That's all a set of financial statements amounts to is a set of assertions. And in step three, we evaluate the risk of material misstatement. The risk of errors and fraud related to particular assertions the words in step three, in the audit process, we're going to use our understanding of the entity and its environment, including internal control to evaluate the probability of errors and fraud in particular assertions and our evaluation of the risk of material misstatement.

In particular assertions will determine the nature and the extent and the timing of our audit procedures. Remember an E T the nature, the extent and the timing, all of our audit procedures will be affected by our evaluation of the risk of material misstatement related to particular assertions.  Let's think about this.

Why would our evaluation of the risk of material misstatement related to a particular surgeon like Ash, why would it affect the nature of the evidence that we gather on the audit? Because if we evaluate the risk of material misstatement to be low, there's a low probability of errors and fraud, then we'll likely use, take more advantage of the client's record.

We'll gather our evidence from the client's records because we think they're reliable. But if our evaluation of the risk of material, misstatement errors and fraud is high, we're going to need more outside corroboration. So notice our evaluation of the risk of material misstatement related to a particular assertion does affect the nature of the evidence that we gather on the audit.

Also the extent, right? If our evaluation of the risk of material misstatement in a particular assertion is low, then we're not going to have to gather that much evidence. In order to form an opinion, but if our evaluation of the risk of material misstatement is high, we're going to need a lot of evidence.

So it does affect the extent of the evidence that we gather as well. And then finally timing is affected because if our evaluation of the risk of material misstatement is low, we'll do more interim testing. But if our evaluation of the risk of material misstatement is high, we'll do our testing after year end.

So ultimately our evaluation of the risk of material misstatement in particular assertions affects the nature, the extent and the timing of all our audit procedures. I always tell our, I always tell my students that it's auditors. Just imagine we're on a sea of transactions and we're going to throw out our net N E T nature extent, timing of audit procedures.

Now in step four, we design and we perform our audit procedures. We use tests of controls, substantive testing, but in step four, we perform our audit procedures to address the risk of material misstatement in particular assertions. In step five, we evaluate all the audit evidence that we've gathered. And in step six, the final step of the audit process, we form an opinion and we issue our audit report.

So when you really think about this. When you consider the six steps in the audit process, this auditing cpa exam prep course is really about steps two, three, and four, because an auditor is required to obtain an understanding of internal control in step two. So they can do their initial risk assessment. They need an understanding of the client's internal control for step three, to evaluate the risk of material misstatement in a particular session.

And then finally in step four, they need an understanding of internal control to design all the further audit procedures. It's a very critical part of the audit process to have an understanding of the client its environment. And of course the internal control.

What are the objectives of internal control? There are three main objectives of internal control. Number one, the first objective of internal control is to provide reasonable assurance of the reliability of financial reporting. That's number one, provide reasonable assurance, not absolute, but reasonable assurance on the reliability of financial reporting.

Reasonable assurance that material misstatements errors and fraud are being prevented, detected corrected on a timely basis. Number two, now the objective of internal control is to provide reasonable assurance of compliance with laws and regulations. And then finally, number three, the final objective of internal control is to provide reasonable assurance of the effectiveness and the efficiency of operations.

Now, the auditor is not overly concerned with efficiency, but that is another objective of internal control. The final objective to provide reasonable assurance of the effectiveness and the efficiency of operations in the final analysis. When you lay out what's management's responsibility. What's the auditor's responsibility.

When you think about that management's responsibility is to establish and maintain the internal control structure, right? That's management's responsibility to establish and maintain the internal control structure. The auditor's responsibility is to see if the controls are working to see if the internal control structure is preventing, detecting, correcting errors and fraud on a timely basis.

In other words, The audit responsibility is to determine the effect that the internal control structure has on the financial statements. And as always, auditors are concerned with substance, not form. We don't care about the client showing us a little pretty flowchart. Here's the, Oh, here's all the controls we have.

That's the form, here's a narrative or the controls we have. We don't care about the form. We care about the substance. Are they really working now? It's also important to remember that in any internal control structure, no matter how well designed there are inherent limitations, inherent unavoidable, baked in the cake.

For example, human fallibility. That's an inherent limitation in any system. However well, Devon, how well, however well devised people are fallible. They make mistakes. You just have to accept that it's unavoidable, it's baked in the cake of any system. Another inherent limitation is collusion.

No matter how well you design a system, employees could collude to circumvent the system. And then finally, another inherent limitation that we have to accept is management. Override management always has the ability to override the system. So no matter how many controls you put in place management can just circumvent them.

They could do that.

So with all that in mind, let's get right down to the components of internal control. There are five components of internal control and the way you can remember the five. Is C R I M E crime. Just remember strong internal control should help to prevent crime. C R I M E. And if you remember crime, you've got the five components.

Let's go over the five components of internal control. The first opponents see the C in crime is control activities, refer to the specific. Policies and procedures that are in place to assure that all transactions are properly initiated, authorized, approved, recall ex executed and recorded.

That's so important. What specific policies, what specific procedures are in place to assure all transactions are properly initiated, authorized, approved, executed, and recorded. Control activities includes a proper segregation of duties. Remember, it is essential that there be a proper separation of duties.

We never want an employee to be in a position in the system where they can perpetrate something and cover it up in the records. That would be what is called an incompatible function. If an employee is able to perpetrate something and cover it up in the record. That employee is performing an incompatible function and the way you prevent incompatible function in compatible functions is by separating authorization, recordkeeping, and custody of assets.

Remember that a R C you must segregate authorization, recordkeeping and custody of assets arc. That is the arc that will prevent you. Protect you from a sea of troubles. If you always separate authorization, recordkeeping and custody of assets. So proper segregation of duties is included in control activities.

The Arwin crime is risk assessment. Now this risk assessment refers to how your client manages risk the risk of errors and fraud, not the auditor. This is risk assessment refers to how the client manages the risk of material misstatement. There are internal risks. There are external risks. There are internal risks, new employees, a high turnover, rapid expansion, new technology.

You're offering new products. There's a basic, there's a basic formula should always have in your mind change equals risk. That's true. Change equals risk. Anytime there's a change. There's some kind of risk. If you change your job, there's a risk. You just won't, you won't be happy there that you'll wish you stayed with your old job.

There's always a risk when you make a change. And it's true in business and an internal control structure change equals risk. So if there are new employees, if there's a high turnover, Rapid expansion, new products, new technology change equals risk. Those are internal risks, but there are external risks, a bad economy, a downturn in the industry, would management be tempted to cut corners?

How does the client manage the risk of material misstatement? How do they handle it on a daily basis? That's what we mean by. Risk assessment. The, I stands for information and communication information refers to the quality of the accounting records. Communication refers to many things proper communication between management and those in charge of governance.

The board of directors, the audit committee, particularly the audit committee communication between management and regulatory agency.

And also communication to individuals, employees on their individual responsibilities.

The admin crime is monitoring. It refers to management's ability to evaluate internal control over an extended period of time. How does management handle breakdowns? There will be inevitable breakdowns. Does management have the ability to take corrective action? And of course, a huge part of monitoring is does the client have an internal audit function?

And then finally the Ian cry is the control environment. The control environment refers to the overall actions of management, the overall actions of management. And the board of directors, the overall attitude, do they set a tone that emphasizes internal control? Is there a written code of conduct, does management and those in charge of governance, do they communicate ethical values?

Is there an active board of directors, an active audit committee? Is there an internal audit function? No what's management's philosophy, is it hands-on or more absentee? And it should be said that if there's any weakness in the control environment, any weakness in this component will tend to have a pervasive effect

on the whole system. Now, the auditor remember is required. The auditor is required to document in the Workpapers their understanding of each component of crime. The auditor must document the Workpapers, their understanding of internal control. Whether it's through flowcharts narratives, there's no particular form of documentation that's required, but the auditor is required to document their understanding of each element.

Each component of crime that's documented in the work papers and that's required.

As you can see, ultimately we as auditors, we're using our understanding of the client's internal control to assess risk because as we know, risk is unavoidable in auditing it's unavoidable. Why because ultimately, aren't we going to issue an opinion on financial statements and we will not have examined a hundred percent of the documentary evidence that supports the statements.

Isn't that the situation we're in, we have to take a risk because ultimately we're going to issue an opinion on financial statements. And we will not have examined a hundred percent of the documentary evidence that supports the financial statements. And even if we did, the client wouldn't pay for it.

The audit fees would be astronomical if you say, Oh, no, we have to examine a hundred percent of the documentary evidence. Of course not. It's not practical, but even if we did, they'd still be a risk because we could misinterpret what we're looking at. We could make mistakes as auditors risk is unavoidable in auditing it's inherent in auditing.

We're stuck with it. And there were several categories of risks that you have to be very comfortable with in the exam. The most important risk is audit risk. What's audit risk. These risks have names and you've got to know them for the exam. They're tested, what's audit risk is the ultimate risk that you take an auditing.

It's the risk that the financial statements are materially misstated, the financial statements. Ha have material errors and fraud. They contain material errors and fraud, but we as auditors, we miss it and we issue a clean opinion. We issue an unmodified opinion. That's the ultimate risk is taken auditing.

It's called audit risk. The financial statements are materially misstated, but our audit misses it. And we issue a clean opinion. We issue an unmodified opinion. Then there is control risk is the risk that the internal control structure is not preventing detecting, correcting material misstatements on a timely basis.

In other words, control risk is the risk that internal controls are not functioning well.

And every internal control structure has controlled risk. Whether we were doing an audit or not, it exists. The auditor has to come in and evaluate it in any client, the auditor in any audit, the auditor has to come in and say, what's their evaluation of the control risk? Is it high? Is it at its maximum?

Is it low? The auditor evaluates control risks, but control risk exists. Whether or not there's an audit there's control risk in every system. Another risk you have to be aware of is inherent risks. Inherent risk is the risk that a given account by its very nature could be materially misstated. I'll say it again.

Inherent risk is the risk that a given account by its very nature could be materially misstated cash has a lot of inherent risk cash. Liquid assets, securities have more inherent risk, then furniture and fixtures. Why? Because it's easier to. Fold up some cash and stick it in your pocket and leave than it is to try to bring your desk home, to try to steal lighting, fixtures, cash, and a lot of inherent risk.

So again, inherent risk is the risk that a given account, a given assertion by its very nature could be materially misstated. And it's important to remember that the combination of control risk and inherent risk. Equals your risk of material misstatement. That's a very important little formula that the combination of control risk and inherent risk combined gives you your risk of material misstatement.

And then finally, there's detection risk. Now this is the one risk maybe I should back up inherent risk that exists apart from the audit that exists. Whether there's an audit or not. There's a certain amount of inherent risk in cash. As I say, the auditor comes in on an audit and evaluates the inherent risk for that particular assertion, that particular client, but control risk inherent risk exists in every system.

The last risk detection risk is only related to the audit. It's only related to the auditor themselves because detection risk is the risk. That an auditor will fail to detect errors and fraud, fail to detect material misstatements that do in fact exist. They just miss it. Now, this is the one risk that only relates to the auditor.

We have detection risk because there's an audit detection risk doesn't exist in the system. Again, detection risk is the risk. That the auditor will fail to detect errors and fraud that do in fact exist. The audit will fail to detect material misstatements that do in fact exist. That's called detection risk

once, All these risks and you're comfortable with the names of all these risks and what they represent. Now, it's important in the CPA Examto know how these risks interrelate. And if you look in your viewers guide, you'll see a little table. It's very important. How the risks interrelate notice the first column we have the risk of material misstatement.

Now, remember that's made up of control, risk and inherent risk control risk. Plus inherent risk gives you your risk of material misstatement. So the first column, we have risk of material misstatement, second column, we have detection risk and the third column, we have further audit procedures. So you see how these all interrelate, if the auditor evaluates the risk of material misstatement to be high.

In other words, the auditor thinks there's a high probability of material misstatements. Then notice the auditor shoots that their detection risk to be low. There's an inverse relationship because if the auditor assesses. That there's a lot of material misstatements. The auditor wants to set the detection risk low.

They want to, they want that to be a low probability that the audit would fail to detect the errors and fraud because they think there's a lot of them, they think is a lot of it. Let's go over that again. There's an inverse relationship between the risk of material misstatement and detection risk. So if the auditor sets the risk of material misstatement to be high.

They think there's a lot of errors and fraud. Then the auto should set their detection risk to be low. The audit will want there to be a low probability that they'll fail to detect material misstatements because they think there's a lot of it. So what's the effect on further audit procedures?

Of course they would do extensive, further audit procedures. If you look at that little table, notice there's an inverse relationship between the risk of material misstatement and detection risk. There's an inverse relationship between detection risk and for the RADA procedures. Now, on the other hand, if the auditor assesses the risk of material misstatement to be low, the auditor thinks there's a low probability of material misstatements.

Then the auditor can set the detection risk could be high. They can take a higher probability, a higher risk of failing to detect errors and fraud because they don't think there's a lot. They don't think there's a lot in the records. They think the internal control structure is catching the material.

Misstatements preventing, detecting, correcting the material misstatements on a timely basis. They don't think there's a lot to bind there. So the audit can set their detection risk to be high. They can take a higher risk that they'll fail to detect. Material misstatements. They don't think there's a lot of them.

And what's the effect on further audit procedures. They do much less for the Rotter procedures. Now, if you cut, if you cover up the middle column, if you do, that's what, that's, what kind of complicates it. If you just gotta mentally cover up detection, risks, cover up that middle column.

It makes perfect sense. If we assess the risk of material misstatement to be high, we do a lot of testing. It has a direct relationship. There's a direct relationship between the risk of material misstatement. And further audit procedures. Makes perfect common sense. We think the risk of material misstatement is high.

We do a lot of testing. If we think the risk of material misstatement is low, we do much less testing. Just direct relationship again. What complicates it for exam questions is that middle column detection risk. You have that inverse relationship. Now, another way to look at this, you can look at it in mathematical terms.

This can be expressed mathematically, for example, If you, if the auditor assesses the risk of material misstatement, to be 10% and the auditor thinks the auditor sets detection risk at 10%, it's really up to the audit reset, the detection risk they're willing to take. So the auditor assesses the risk of material misstatement to be 10%, the auditor sets the detection risk, what they could tolerate to be 10%.

If you take. 10% times, 10%. That means your audit risk is 1% because the risk of material misstatement times detection risk will give you your audit risk. 10%, times, 10%. When the auditor is willing to take an audit risk of about 1%. So now when you express it in mathematical terms, you can see what happens.

If the risk of material misstatement goes up. If the risk of material misstatement is 20% and the audit does not want to take any more than a 1% audit risk. And they would have to set their detection risk to be 5%, 20% times 5% is 1% notice how it's an inverse relationship. The higher the risk of material misstatement goes the lower, the auditor will set their detection risk.

So they end up with the same audit risk, which is the real concern, audit risk. The ultimate risk that the auditor is taking in an audit. Now I've thrown a lot at you here to start off. Now let's do some questions. I'd like you to shut the class down, do the first 12 questions, one through 12, get all your answers.

And you'll notice there are no answers in the viewer's guide. There's no answers. You have to come up with the answers. We have to come up with the answers. That's something that I really think is important. Not to have answers in the viewer's guide because at the answers were there. I know what will happen.

You'll look, you look up the answer for the first one. Notice the next three. Don't lie to me. You'll do that. You'll just, you'll notice now a bunch of other answers. No, I don't want that. I want this to be more like being in an exam. So do the first 12 questions. Get your 12 answers and then come back and we'll go through them together.

Welcome back. Let's go through these questions together. Number one says which of the following most likely would not be considered an inherent limitation of the potential effectiveness. Of an entities, internal control. Answer B management override. You are stuck with that. That is an inherent limitation management.

You will usually have the ability to override controls in certain situations. If they insist on doing it, their management, it's hard to prevent that they shouldn't be, but it's inherent in just about every system. Answers see mistakes in judgment. How do you prevent that? You're stuck with it. People aren't perfect.

They're fallible, mistakes and judgment happen, no matter how perfect the system is. And finally collusion, you can design a perfect system with proper separation of duties, but employees might collude. They might. You're stuck with that. It's a, it's an inherent possibility in any system, but incompatible duties.

That's not inherent. You can prevent that. You can prevent incompatible functions, answer a by having a proper segregation of duties. Remember you don't want an employee to be in a position in the system where they can both perpetrate something and cover it up in the records. That's an incompatible function.

That's not inherent. That's not an inherent limitation in any system, cause that can be prevented by proper separation of duties. Separating authorization, recordkeeping. And custody of assets. Number two, in the consideration of an entity's internal control, the auditor is basically concerned that the controls provide reasonable assurance, that what pre's reasonable assurance that a operational efficiency has been achieved.

That's one of the objectives of internal control, but that's not the auditor's primary concern. How about C is the auditor basically concerned that management cannot override the controls? That's not that's not the auditor's primary concern or basic concern. Usually you're stuck with that possibility.

It's an inherent limitation.

Same thing with answer. D is the auditor basically concerned? The controls have not been circumvented by collusion. That's important. We want to. Test to see if controls have been circumvented, but that's not what they're basically concerned with. What an auditor is basically concerned with bottom line.

His answer be that errors and fraud material misstatements are being prevented, detected corrected on a timely basis. That's the basic concern. Number three. Proper segregation of function, functional responsibilities in an effective internal control structure calls for the separation of the functions of, it's answer B arc authorization, recordkeeping, and custody of assets.

That's the arc that protects us from a sea of troubles. That number four proper segregation of duties reduces the opportunities to allow persons to be in a position to both. I know you went right to it, answer date, perpetrate something, and conceal it in the records. If they can perpetrate and conceal errors and fraud, that is an incompatible function and proper separation of duties reduces the opportunity for an employee to do that answer.

D as I say, number five, the overall attitude. And awareness of an entities board of directors concerning the importance of internal control usually is reflected in the control environment answers. See that's the control environment, the overall attitude, the philosophy of management, do they have a written code of conduct?

Do they

project ethical values? That's the control environment. Number six, which of the following is not a component of an entities, internal control structure. I'm sure you noticed that answer B control activities. That's the C in crime answer C information and communication is the I and crime answer.

D the environment is the E in crime. So answers B, C, and D are all components of crime. But answer a control risk. That's not a component of the, of an entity's internal control. Not, that's not one of the components control, risk exists in every system of internal control. That's true, but it's not one of the components of internal control.

Number seven, the primary objective of procedures performed to obtain an understanding of the entity and its environment, including internal control. It's Revit an auditor with now, this is a great example of when you're in the CPA Examand you see a question like this, be very careful where you are in the steps in the audit process.

Remember there were six steps in the audit process. We went through them in this AUD cpa exam review course and every now and then in the CPA Examto get to the right answer, you've got to be clear. About what step in the audit process. This question is referring to. So when it says in this question, the primary objective of procedures performed to obtain an understanding of the entity and its environment, including internal control.

What step is, what step are we in, where we obtain an understanding of the entity and its environment, including internal control that's step two. So they're asking what's the primary objective of step two. And the audit process, is it. Answer a to provide the auditor with knowledge necessary to assess the risk of material, misstatement and design, further audit procedures.

Now that's step four steps, three and four, where we evaluate the risk of material misstatement related to particular assertions and use that knowledge to design our further audit procedures. That's steps three and four. So it's not a, is it to provide the auditor with B. An evaluation of the consistency of application of management's policies.

It's not about consistency. No. Is it to provide the auditor with answers, see a basis for modifying tests of controls? That may grow out of it. We may modify or tests of controls based on our understanding of the environment. And.

The internal control as well. That's true. No, it's answer D it's to provide the auditor with audit evidence in assessing inherent risk. That's why in step two, you are obtaining understanding of the client and its environment, including the internal control. Ultimately it's D it's providing the auditor with evidence.

So they can assess inherent risk. Where are the problem areas? What assertions are susceptible to errors and fraud. That's what you're doing in step two. Just want to understand the client. And again, what assertions, could be susceptible to errors and fraud. It's evidence that you can use in assessing inherent risk.

That is the primary objective. Most important thing in that question is in the exam. When you read that question to stop and think, wait a minute, what step am I in? As long as you knew, what step in the audit process you were in, you could avoid answer a, which was the tricky one. And hopefully get down to answer D number eight, which of the following factors would most likely be considered an inherent limitation?

In an auntie's and internal control. What would be an inherent limitation when you're stuck with baked in the cake? A, the complexity of the information processing system, no complexity. You're not necessarily stuck with. You can do things to reduce complexity. You can simplify. That's not inherent in any system.

How about answer? See the ineffectiveness of the board of directors. We're going to stuck with that. Get a different board of directors, get an effective one. Answer D the lack of management incentives to improve the control environment. Give them incentives. You got stuck with that. That's not inherent in the system.

That can be changed, but answer be human judgment. In the decision making process, I'm afraid you're stuck with that. Every system involves the use of human judgment and human judgment is fallible. It's an inherent limitation. It's baked in the cake number nine, which of the following is an inherent limitation of internal control.

Judgmental sampling, answer a that's an audit procedure. Answers C and D segregation of duties, employee peer review. Those are controls. No. An inherent limitation is collusion. The possibility of collusion. You're stuck with that possibility, no matter how carefully you separate authorization, recordkeeping, and custody of assets, you design a beautiful system, proper separation of duties inherently.

You're stuck with the possibility that employees could collude and circumvent that separation of duties.

Number 10, the objective of tests of details of transactions performed. As tests of controls. Remember you can do as an audit or you can do tests of controls and tests of details concurrently on, on the same transaction, testing for different purposes.  The test would be done as a test of controls to see if the controls are effective.

The using the test as a test of details can be to determine if there's a problem and the materiality of the problem. So when they say the objective of tests of details of transactions performed, as tests of controls is to a monitor the design and use of. Entity documents. No, that's not. That's not why you're doing it.

B is it to determine whether internal controls have been implemented now because they could be implemented but not effective. That's not why you're doing it. I'll control. It could be implemented, but it's just not having the effect that should have. Is it C to detect material misstatements in the account balances?

Yes.  If that was a test of details done as a substantive test, that would be the purpose.

To detect material misstatements. But when it's done as a test of controls, it's answer D to evaluate whether the internal control procedure is operating effectively. That's what we care about. Again, it's substance over form. Don't give me a flowchart showing me all the, the beautiful controls that are built in the system.

I want to know if they're effective. And that would be the purpose of a test of controls and a test of details done simultaneously to see how effective the control is

11 when obtaining an understanding of the entities internal control and auditor should concentrate on the implementation of the procedure, because answer D management may establish appropriate procedures, but then not enforce compliance with them. That's why come to bisque CPA review comprehensive CPA review materials for the CPA exam to let you customize your own review programs to meet your individual learning style and ensure your success.

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Hello, and welcome come to the bisque CPA review course and our coverage of the auditing and attestation section of the CPA exam. My name is Bob Monette. I'll be your instructor in this AUD cpa exam study course. And in this AUD cpa exam review course, we're going to be discussing reporting issues, specifically reporting on special purpose financial statements.

And also we're going to discuss reviews and compilations. Now, before we begin, I want to say a word about. The way to get the most out of this AUD cpa review course, the most important thing it is to be, yeah, an active participant in this auditing cpa exam prep course. Don't just sit back passively and watch the class take good notes later in the class.

When we do problems, shut the class down, do all the problems, get your answers before you come back and discuss the problems with me. You'll find if you do those simple things, you get much more out of the class.

Now as you probably know, you really begin your study of reporting issues by studying and memorizing the standard unmodified opinion. And hopefully. You've already had our class on the unmodified opinion, but just to start us off to get us in the mood, to get us in the right frame of mind, I want to go over the standard unmodified opinion.

And in fact, I want to start with this question. How does a client earn an unmodified opinion? How does a client deserve an unmodified opinion? Basically there are six requirements. If your client meets six requirements, Your client gets an unmodified opinion, a clean opinion. Number one, there can't be any significant departures from us gap or whatever the appropriate, whatever the applicable financial reporting framework is that you're testing.

whatever it might be. But that's number one. There can't be any significant departures from us gap in this AUD cpa review course. We'll assume that the framework is us gap. Number two us gap where the framework must have been consistently applied between accounting periods. Number three, there must be adequate and complete disclosures.

Number four, there can't be any significant uncertainties. No significant uncertainties. Number five, no significant scope, limitations and number six. No significant going concern problems. If your client meets those six requirements, the client gets a clean opinion, an unmodified opinion. Now, when you break those down, you look at those six requirements.

If you look at the first three, no significant departures from us gap or whatever the framework is. Number two, us gap with a framework must have been consistently applied. Number three, adequate and complete disclosures. Aren't we really saying in the first three, that there can't be any problem with the financial statements.

It's really that simple. There can't be any problem with the financial statements. And if you look at the last three, no significant uncertainties, no significant scope, limitations, no significant going concern problems. Aren't we saying in the last three, no problems with the audit. That's really what it boils down to.

If there are no problems with the financial statements, no problems with the audit, the client gets a clean opinion. An unmodified opinion. So let's take a quick look at a standard unmodified opinion in the viewer guide. You'll see an example of the standard unmodified opinion. Notice the heading independent auditor's report.

This, if an auditor, if a CPA is going to provide any kind of assurance on financial information of any kind, the CPA has to be independent. Independent, in fact, independent in appearance. So right in the title, independent auditor's report. And remember our goal in an audit is to provide reasonably positive assurance that the financial statements are free of material misstatement, reasonably positive assurance, that the financial statements are free of errors and fraud.

That's what it comes down to. And as I say, if the CPA is going to provide any type of assurance on financial information, the CPA has to be independent. So there it is right in the title, independent auditor's report. It's addressed to the company it's addressed to the board of directors, the shareholders, but never management.

Of course, we start with the introductory paragraph. We have audited. We make it very clear. What we've done. This is not a review. This is not a compilation. We have audited the accompanying financial statements of XYZ company, which comprise the balance sheet as of December 31 year one. And the related statements of income changes in stockholders' equity and cash flows for the years that ended and the related notes to the financial statements.

That's the introductory paragraph. Then there's the management responsibility paragraph. We're going to make it very clear. What management is responsible for, what the CPA, what the auditor is responsible for. So the next paragraph is the management responsibility. Paragraph management is responsible for the preparation and fair presentation of these financial statements in accordance with accounting principles generally accepted in the United States of America.

This includes the design implementation and maintenance of internal control, relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error, then next of course, Is the auditor's responsibility. Paragraph. 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 from material misstatement, an audit involves.

Performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor's judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error in making those risk assessments, the auditor considers internal control relevant to the entities, preparation and fair presentation of the financial statements in order to design, audit procedures.

That are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entities. Internal control accordingly, we express no such opinion on audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements.

We believe that the audit evidence we have obtained is sufficient and appropriate. To provide a basis for our audit opinion. And then finally, the opinion paragraph itself, in our opinion, the financial statements referred to above present fairly. Remember this is a clean opinion. This is an unmodified opinion present fairly in all material respects the financial position of XYZ company as of December 31 year one, and the results of its operations and its cash flows for the year, then ended in accordance with accounting principles, generally accepted.

In the United States of America, the report is dated no earlier than the date on which the auditor has obtained sufficient appropriate evidence on which to base the audit opinion. Now, after the opinion, paragraph, the auditor may add an emphasis of matter paragraph to emphasize information. That's fundamental to the user's understanding of the financial statements.

That's what the auditor is doing. When the auditor adds an emphasis of matter paragraph, this is information that's properly presented and disclosed in the financial statements, but the auditor wants to emphasize the information to aid the user's understanding of the financial statements. Now, after the opinion paragraph and any emphasis of matter paragraph, the auditor may add an other matter.

Paragraph an other matter paragraph is the aid, the user's understanding of the audit report. Or the auditor's responsibility.

Now, as we said, if the client meets six requirements, the client gets a clean opinion. The client gets an unmodified opinion, and as we broke it down, the first three requirements. We're saying there's no problem with the financial statements. The last three requirements were saying, there's no problem with the audit.

That's what it comes down to when there's no problem with the financial statements, when there's no problem with the audit, client gets clean opinion. Client gets an unmodified opinion, but what if there is a problem with the financial statements? I think, if there is a significant departure from us gap, if us gap has not been consistently applied, if disclosures are not adequate.

And complete. If there is a gap disclosure problem, you know what to do. If there's a material gap or disclosure problem, the client gets an except for qualified opinion. If it's very material, if there's a very material gap or disclosure problem, it's PR it's pervasive. Client gets an adverse opinion, really very simple.

There's a material gap or disclosure problem. Client gets an except for qualified opinion, very material pervasive. Adverse now, what if there's a problem with the audit? What, if there is a scope problem, what if there is a going concern problem? What if the, what if there is a problem with the audit?

Let's start with a scope problem. The auditor is not able to gather evidence is on availability of data. If there's a material scope problem, the client gets an except for qualified opinion. If it's very material, a very material scope problem, pervasive, the auditor has to disclaim an opinion. How about a going concern problem?

If there's a material going concern problem, the client does get an unmodified opinion. Again, a material going concern problem means that the client would get an unmodified opinion, but there would be a required emphasis of matter paragraph. Would that language we know so well, raising substantial doubt about the entities ability to continue as a going concern.

Now let's talk about uncertainties. If there's an uncertainty that causes the financial statements to be materially misstated, that's possible. If there's an uncertainty that would cause the financial statements to be materially misstated. Then that's a gap disclosure problem. So if it's material and except for qualified opinion, if it's very material, if it's pervasive, adverse opinion, but what if there's an uncertainty because the auditor is not able to gather enough evidence if there's an uncertainty, because the auditor is not able to gather enough evidence.

Then that's a scope problem. Isn't it? You're right back to basically a scope problem. So if it's material except for qualified opinion, If it's very material, if it's pervasive, the auditor would have to disclaim an opinion. Now, once you're comfortable with the unmodified opinion, you have the unmodified opinion firmly in your mind, you're ready to move on to other reporting issues and we'll get into other reporting issues in our next segment.

We'll see you then.

Welcome back in this section, we're going to begin our discussion about engagements other than an audit of a complete set of financial statements under us gap, or I firs, or another general purpose. Framework. We're going to begin our discussion on reports on special purpose financial statements. Now, when you're talking about special purpose financial statements, there are four main areas.

Number one, there would be an audit of financial statements prepared in accordance with a special purpose framework. That's number one, an audit of financial statements prepared in accordance with a special purpose framework. Number two. There would be audits of a single financial statement and specified elements, accounts, or items of a financial statement.

Number three would be reports on compliance with aspects of contractual agreements or regulatory requirements in connection with audited financial statements. And then number four would be reports on summary financial statements. Now we're going to begin with number one, because it is the most heavily tested of those four areas.

Remember number one would be audits of financial statements prepared in accordance with a special purpose framework. There are five special purpose frameworks. Number one would be the cash basis of accounting. Number two would be the tax basis. Number three would be regulatory base. Number four would be any other basis of accounting with a definite set of logical criteria applicable to all material items in the financial statements like price level.

Now those first four cash basis tax basis, regulatory basis, and any other basis like price level with a definite set of criteria, we normally refer to those first four as Bowen. Oh, C B O a other comprehensive basis of accounting, other than us gap. Think of those first bore as our boas, other comprehensive basis of accounting, other than U S gap.

And number five would be contractual basis. Now, if you look in your viewers guide, you'll see an example of a report. On financial statements prepared in accordance with the cash basis of accounting now, because you have studied and memorized the standard unmodified opinion, you're in a very good place now, because once you have that down now, when you study an area like this, you can just focus in on the differences.

And if you look in the viewer guide, you'll see an example of this report and the differences are underlined. Notice in the introductory paragraph, you can't use gap terms because this is not us gap. This is a special purpose framework. This is the cash basis. So you don't say balance sheet. Notice we say a statement of assets and liabilities arising from cash transactions.

Can't say balance sheet. That's a gap term. You can't say statement of income changes in stockholders' equity statement of cash flows. No. It's the related statement of revenues collected and expenses paid. Notice the management responsibility, paragraph management is responsible for the preparation and fair presentation of these financial statements in accordance with the cash basis of accounting described the note X, this involves determining that the cash basis of accounting is an acceptable basis.

For the preparation of the financial statements in the circumstances, management is also responsible for the design implementation and maintenance. Then it's the same. After that point, notice the auditor's responsibility, paragraph unchanged, and then finally the opinion paragraph, in our opinion, the financial statements referred to above present fairly.

This is a clean opinion, an unmodified opinion in all material respects. The assets and liabilities arising from cash transactions and its revenues collected and expenses paid in accordance with the cash basis of accounting described. In note X notice, once again, there can't be any gap terms. Now, after the opinion paragraph, now there would be a required emphasis of matter paragraph stating that the financial statements have been prepared in accordance with a special purpose framework.

It would refer to the note in the financial statements that describes the framework and States that the special purpose framework, the cash basis is a basis of accounting other than U S gap. It's an boa.

Now there would be a required other matter paragraph, listen carefully. Now they would be required. Other matter paragraph that restricts use. If the special purpose framework is regulatory basis, not intended for general use. Let me say that again. You would have a required other matter paragraph that restricts use of the report.

If the special purpose framework is regulatory basis, not intended for general use because. And in that case, it's restricted to the parties within the entity and the regulatory agency. If it's not intended for general use and its regulatory basis, this report is going to be restricted to parties within the client, within the entity and also regulatory agencies.

Also, if it's contractual basis, if the special purpose framework is contractual basis, the report's going to be limited to the parties in the contract.

Now, keep in mind that even though a special purpose framework is being used here, we've done an audit. What, if there's a problem with the financial statement? What if instead of a gap problem, what if there's an Aqua problem? You know what to do if there's a problem with the financial statements, if it's material a qualified opinion, if it's very material, if it's pervasive, adverse opinion, what if there's a problem with the audit?

All these issues arise again. What if there's a scope problem? You know what to do a material scope problem, a qualified opinion. If it's very material, if it's pervasive, Disclaim. What if there's a going concern problem. If it's a material going concern, problem, the client gets an unmodified opinion with a required emphasis of matter paragraph.

If it's very material, if it's pervasive disclaim. And then one more time. How about uncertainties? If there's an uncertainty that's causing the financial statements to be materially misstated that's an acapella problem. So if it's material qualified opinion, very material adverse, but if there's an uncertainty caused by the fact that the auditor is not able to obtain sufficient evidence, it's a scope problem.

So if it's material qualified opinion, if it's very material disclaim, my only point is not to forget that we've done an audit here, even though these are special purpose financial statements, they're using a special purpose framework. We have done an audit. Now, if you look in your viewers guide, you'll see an example of an audit report done for financial statements that were prepared in accordance with the tax basis of accounting, the basis of accounting they using for tax purposes.

And once again, the differences from the standard unmodified opinion are underlined. So you can focus right in on the differences. Once again, notice in the introductory paragraph, you can't use Gapter in the management responsibility paragraph. We say that management is responsible for the preparation and fair presentation of these financial statements in accordance with the basis of accounting used for income tax purposes, the auditor's responsibility, paragraph unchanged.

So you know that anyway. And then in the opinion, paragraph, you can't use gap terms, and we're going to say that. The statements are presented fairly in accordance with the basis of accounting used for income tax purposes described in note X and notice the required emphasis of matter paragraph stating that the financial statements have been prepared in accordance with a special purpose framework, refers to the note in the financial statements that describes the framework and States that the special purpose framework is a basis of accounting, other than us gap.

And then finally, you'll notice in your viewers guide, an example of an audit report done for financial statements that were prepared using a regulatory basis. And again the differences are underlined, no introductory paragraph notice you can't use gap terms that make sense in the management responsibility paragraph.

Management is responsible for the preparation and fair presentation of these financial statements in accordance with the basis of accounting

to comply with the requirements of the regulatory agency, the auditor's responsibility paragraph again, is unchanged. And in the opinion paragraph, we're going to say the financial statements are presented fairly. This is a clean opinion and unmodified opinion presented fairly in accordance with. The financial reporting provisions of section Y of regulatory Z, whatever it is, notice the required emphasis of matter paragraph, because this is regulatory basis, not intended for general use the required emphasis, the required other matter paragraph that restricts use, because again, it's regulatory basis not intended for general use and then filing you viewers guide.

You'll see an example of an audit report done on financial statements that will prepared under contractual basis. And you'll notice again, the required other matter paragraph that restricts use, because this is going to be restricted to parties within the entity and parties to the contract.

Now, before you do the next section, There are four multiple choice that I want you to get done. Please get your answers to those four multiple choice before you come back to the next section and I'll see you then

welcome back. Let's look at these questions together in the first question. It says an auditor's report on financial statements prepared on the cash receipts and disbursements basis of accounting would include all of the following, except so they want to know what's not in this report. A says a reference to the note in the financial statements that describes the cash receipts and disbursements basis.

No, that is in the report. That's not the answer. C says an opinion as to whether the financial statements. Are presented fairly in conformity with the cash receipts and disbursements basis. No, that of course is in the report. We've done an audit. We're expressing an opinion. D says a statement that the audit was conducted in accordance with generally accepted auditing standards.

We know the auditor's responsibility. Paragraph is unchanged. That would be there. But answer B is not there. A statement that the cash receipts and disbursements basis of accounting is not a comprehensive basis of accounting. No, there's a statement that it is right. There's a required emphasis of matter paragraph that is required to say that it is an other comprehensive basis of accounting other than us gap.

So answer B would not be in the report. Next question. When an auditor reports on financial statements prepared in an. On an entities income tax basis, the auditor's report should a says disclaim an opinion on whether the statements were examined in accordance with generally accepted auditing standards.

That's not true. We've done an audit. The auditor's responsibility paragraph is unchanged. B says not express an opinion on whether the statements are presented in conformity with the comprehensive basis of accounting. No, of course we. We'll express an opinion. We've done an audit. Our objective is to express an opinion.

C says include an explanation of how the results of operations differ from the cash receipts and disbursements basis of accounting. There's nothing like that in the report explaining how the results of operations would differ, but answer D would be in the report state that the basis. Of presentation is a comprehensive basis of accounting, other than gap.

Remember that is the answer is day what's going to be in that report is a required emphasis of matter paragraph that States that the financial statements were prepared in accordance with a special purpose framework and referring to the note in the financial statements that describes the framework and state specifically answer date.

That this special purpose framework is a comprehensive basis of accounting other than U S gap. Now that's their answer D next, which of the following titles would be considered suitable for financial statements that are presented or prepared on the cash basis? If you prepare the financial statements on the cash basis, you can't use gap terms.

So that knocks out a income statement, B statement of operations, D statement of cash flows. Now the answer is going to be C we're going to refer to a statement of revenues collected and expenses paid, get use any kind of gap terms. And then finally, an accountant who is not independent of a client is precluded from issuing a, says a report and consulting services.

You don't need independence for that. Because you're not providing any assurance on financial information, BNC, compilations, which we'll be talking about later in this glass, you're just compiling. You're not giving any kind of assurance on information, just compiling numbers. That management gives you in a financial statements, but you are precluded from answer D issuing a special report on compliance with contractual agreements because you are providing assurance on financial information.

So you are required to be independent.

Let's continue on our discussion of special purpose financial statements and the. Second special area in this topic would be an audit of a single financial statement or a specified elements, accounts, or items within a financial statement. Now, of course, if you're auditing a single financial statement, that could be that you're auditing a balance sheet, you're auditing an income statement.

You're auditing a statement of cash flows. If you're auditing a specified element, you could be auditing a schedule, a pension expenses, a schedule of royalty income, profit sharing. Now these engagements can be done as a separate engagement or in conjunction with an audit. Now, if you're doing one of these reports on a far reaching element, if you're doing a report on net income, if that's the specified element, that's a far reaching element

because it has such far reaching implications to the entire financial statements. So anytime you're doing a report on a far reaching element, like net income, then it has to be done in conjunction with an audit. Has to be also, if you're auditing a specified element, you must also audit any interrelated items.

So if you're auditing sales, you must also audit receivables. If you're auditing inventory, you must also audit payables. If you're auditing fixed assets, you must also audit depreciation. So anytime you're auditing a specified element, You must also audit any interrelated items. Interestingly, in international standards and international auditing standards, you are not required to audit the interrelated items, but in generally accepted auditing standards, U S generally accepted auditing standards, you are required to audit any interrelated items.

Now, this is important, whether you are, whether you're auditing a single financial statement or a specified element. The auditor is required to obtain an understanding of the purpose for which the report is being prepared. The auditor is required to obtain an understanding of the intended users and required to understand the steps that were taken by management to determine the appropriate financial reporting framework in the circumstances.

Also, materiality is an issue. If you're auditing a single financial statement, you determine materiality in relation to that single financial statement, not in relation to the complete set of financial statements. Let's say that again, in terms of materiality, if you're auditing a single financial statement, you're going to determine materiality in relation to that single financial statement, not in relation to the entire set of financial statements.

If you're auditing a specified element. You determine materiality separately for each element. And of course, usually an audit of a specified element is much more extensive than the audit would be for that element as part of an audit of a complete set of financial statements.

When you're auditing a complete set of financial statements and also auditing a single financial statement, and you're also auditing a specified element to understand the circumstances we're auditing the complete set of financial statements. We're also. Auditing a single financial statement. We're also auditing perhaps a specified element.

You are required. You are required to issue a separate report. You have, you are required to issue a separate audit report with a separate opinion for each engagement that's required that you are required to issue a separate audit report with a separate opinion for each engagement. Now, can they be published together?

They can be published together. If you're issuing an unmodified opinion on the complete set of financial statements and the reports are differentiated. Again, the reports can be published together. If you're issuing an unmodified opinion on the complete set of financial statements and the reports are differentiated.

Now, the report on a specified element in that report on a specified element, you are required to have an other matter paragraph. I'm talking about the report on a specified element. You are required to have an other matter paragraph with the date of the audit opinion on the complete set of financial statements, the date of the auditor's report and the type of the opinion.

If you modify the opinion on the complete set of financial statements and it's relevant to the specified element, again, if you're modifying the opinion on the complete set of financial statements and it's. Related relevant to the specified element. Then the auditor has to express an adverse opinion on the specified element.

Assuming the helmet would have a material effect on the financial statement. Let me say that again. If the auditor is going to express a modified opinion on the complete set of financial statements and it's relevant to the specified element, then the auditor has to express an adverse opinion on the specified element.

Assuming it would have a material effect on the financial statement. If the auditor expresses a disclaimer of appeal on I'm sorry, the auditor must express a disclaimer of opinion on the specified element. When the auditor modifies the opinion on the complete set of financial statements, due to a scope limitation.

Again, the auditor is required to express a disclaimer of opinion on the specified element. If the auditor is modifying the opinion on the complete set of financial statements. Due to a sculpt limitation. Now let's talk about a piecemeal opinion. This is very important. If the auditor expresses an adverse opinion or a disclaimer of opinion on the complete set of financial statements, understand the situation out the auditor has expressed an adverse opinion or a disclaimer of opinion on the complete set of financial statements that precludes an unmodified opinion.

On a single financial statement, because that would contradict the adverse opinion that would contradict the disclaimer. That's a piecemeal opinion that's not allowed. So again, remember if the auditor expresses an adverse opinion or a disclaimer of opinion on the complete set of financial statements, then that precludes the auditor expressing an unmodified opinion on a single financial statement.

That would be a piecemeal opinion. Because that unmodified opinion on the single financial statement would contradict the adverse opinion or a disclaimer, stay with me. If the auditor expresses an adverse opinion or a disclaimer of opinion on the complete set of financial statements. And the specified element is a far reaching element.

The auditor cannot express an unmodified opinion. On the specified element, if it's a far reaching element like net income, cause that would contradict the adverse opinion, the disclaimer of opinion on the complete set of financial statements. Again, that would be a piecemeal opinion would not be allowed.

Now if the specified element is not far reaching, if it's not far reaching and the auditor considered considers it appropriate to express an unmodified opinion on the specified element, it's not far reaching that's okay. If the opinion on the specified element is not published with the opinion on the complete set of financial statements does not accompany the opinion on the complete set of financial statements.

They'll let you do that. So again, if the specified element is not far reaching, not far region, and the auditor wants to express an unmodified opinion on the specified elements, not far reaching that's okay. But that report can not be published with the report on the complete set of financial statements and cannot accompany the report on the complete set of financial statements.

But it is allowed one more point, if there's an emphasis of matter paragraph or an other matter paragraph in the audit report on the complete set of financial statements and it's relevant to the single financial statement or. The specified element, then you must also include the emphasis of matter paragraph or other matter paragraph in the report on the single financial statement or the specified element.

One more time, if there's an emphasis of matter paragraph or an other matter paragraph in the audit report on the complete set of financial statements and it's relevant to the single financial statement or the specified element, then you will report on the single financial statement or the specified element must also include that emphasis of matter or.

Other matter paragraph, if you look in your viewers guide, you'll see a report on a single financial statement, and it's an unmodified opinion. And notice look at the, again, once again the standard unmodified opinion, like the back of your hand. So you want to focus in on the differences, which are underlined.

If you notice in the introductory paragraph, we have audited the schedule of accounts receivable. In the management responsibility, paragraph management is responsible for the preparation and fair presentation of the schedule. So you don't have to make little changes here in the auditor's responsibility.

Paragraph, our responsibility is to express an opinion on the schedule. And of course, in the opinion, paragraph, the schedule referred to above presents fairly it's an unmodified opinion and notice the required. Other matter paragraph disclosing that we audited the complete set of financial statements, the date of the auditor's report and the type of opinion that was expressed,

the third special area. And reports on special purpose financial statements would be a report on compliance with aspects of a contractual agreement or regulatory requirements in connection with audited financial statements. Now, the auditor's goal in this area is to express what is called negative assurance, which means nothing came to the auditor's attention.

That would cause the auditor to believe that. The entity failed to comply with the specific aspects of a contract of a contractual agreement or a regulatory requirement. So that's the goal of this engagement to express negative assurance. Negative assurance is okay. If the auditor has not identified any instances of non-compliance of course.

So during the audit, the auditor can't have noted any instances of non-compliance. The auditor must've expressed either an unmodified or a qualified opinion on the financial statements notice not adverse or a disclaimer. So the auditor must've expressed either an unmodified or a qualified opinion on the financial statements.

And the other requirement is that the covenants and the contract or the regulatory requirements have been subjected. To audit procedures as part of the financial statement audit. So you do have to apply procedures to the aspects of the con of the contractual agreement or to the regulatory requirements as part of the audit.

Now, what if the auditor expresses an adverse opinion or a disclaimer of opinion on the financial statements? If the auditor expresses an adverse opinion, Or a disclaimer of opinion on the financial statements I'll report on compliance can only be issued if they buy if the auditor has identified, instances of non-compliance notice that.

So if the auditor expresses an adverse opinion or a disclaimer of opinion on the complete set of financial statements, now there'll only be a report on compliance when the auditor is identified. Instances of non-compliance. Now if the auditor does identify instances of non-compliance, the report has to identify and describe those instances of non-compliance.

Now this report on compliance with contractual agreements or regulatory requirements can either be done as a separate report. If it's done as a separate report. There'll be an other matter paragraph that restricts use, why you're restricting use while you're restricting use to, if it's regulatory requirements you're restricting use too, the entity and, regulatory agencies, if it's contractual requirements, then you're restricting use to the entity and parties to the contract.

So this report on compliance. Can either be a separate report or it can just be included in the auditor's report on the complete set of financial statements with a re with a required other matter paragraph. The other matter paragraph would, give the negative assurance and restrict use, and then the final area in special purpose financial statements.

Would be a report on summary financial statements. Now a report on summary financial statements must be done in conjunction with an audit it's required to have been done in conjunction with an audit. And the auditor in this case is either going to issue an unmodified opinion or an adverse opinion.

Those are the only two choices it's either going to be unmodified or adverse unmodified means that the summary is. Consistent in all material respects with the audited financial statements. That's what an unmodified opinion would mean in this context that the summary is consistent in all material respects with the audited financial statements.

So that's, that would be unmodified. The other choice would be adverse saying that the summary's not consistent. The summary's not consistent

with the audited financial statements. And management has refused to make any necessary changes basically is what that means. Now, one more point, if the auditor is going to express an adverse opinion or a disclaimer of opinion on the financial statements, the complete set of financial statements, then they will, they withdraw from this engagement.

You don't express an opinion on the summary. One more time. If the auditor is going to express. An adverse opinion or a disclaimer of opinion on the complete set of financial statements, while then you withdraw from this engagement, you do not do a report on the summary of the financial state.

Welcome back in this glass. I want to discuss compilations. And I think, you know that when a CPA does a compilation, they're not doing very much. All a CPA is doing is putting numbers. That management gives them into the form of financial statements. They're simply compiling putting numbers that management gives the CPA into the form of financial statements.

You are simply compiling. This is the lowest. Level of service that a CPA provides when a CPA does a compilation, the CPA follows SARS S a R S statements on standards for accounting and review services issued by the AICPA. And of course the CPA only does a compilation for a non issuer because an issuer needs audited financial statements and with a compilation.

Since the CPA is just compiling, the CPA is not giving any assurance of any kind on the financial information, just compiling. So independence is not required. Now, if the CPA is not independent, it has to be stated no. In the final paragraph of the compilation report, I am not independent with respect to X company.

It's gotta be stated. Now the CPA may also. Disclose the reasons for their lack of independence, but if they do disclose the reasons for their lack of independence, they have to disclose all the reasons. All right. So let's get right down to it. When a CPA does a compilation, what is required? First thing that's required is that the CPA establish an understanding with the client and document that understanding in an engagement letter.

Notice an engagement letter is required for a compilation and the CPA is not required to do much else. The CPA is required. Read over the financial statements, make sure that they are free of obvious errors, does the balance sheet balance, things like that. And it's a pretty low level of service.

This compilation requires the lowest level of knowledge about the industry, the client. The lowest level of expertise. And of course, a review, which we'll talk about in future sessions, a review requires a higher level of expertise, and of course an audit requires the highest level of expertise that we provide.

So let's flip it around. What's not required when you do a compilation, what is not required? You're not required to get a management representation letter. Because you're not gathering evidence. Remember a management representation letter is evidence and in a compilation you're not gathering evidence.

So you're not required to get a management representation letter. You're not required to obtain an understanding of the client's internal control. You're not required to do a risk assessment procedures, any kind of fraud evaluation. You're not required to do any inquiries or any analytical procedures.

Now, if the financial statements that you have compiled as a CPA are expected to be looked at by third parties, then the auditor is required to issue a compilation report. I'll say that again. If the financial statements that have been compiled are expected to be looked at by third parties. Then the CPA is required to issue a compilation report because the CPA is associated with these financial statements and has to avoid any misunderstanding about the degree of responsibility that the CPA is assuming in regard to those financial statements.

If you look in your viewers guide, you'll see an example of a compilation report. Notice. The heading accountant's compilation report. It can say independent account. If it if that's true, but accountant's compilation report. Notice the introductory paragraph. We have compiled, we make it very clear what we have done.

And later it says we have not audited or reviewed the accompanying financial statements and accordingly do not express an opinion or provide any assurance. About whether the financial statements are in accordance with accounting principles generally accepted in the United States of America. Notice the disclaimer is very clear and there's a management responsibility paragraph.

And then the accountant's responsibility paragraph, our responsibility is to conduct the compilation in accordance with statements on standards for accounting and review services issued by the AICPA. The eject, the objective of a compilation is to assist management in presenting financial information in the form of financial statements.

Notice without undertaking to obtain or provide any assurance that there are no material modifications that should be made to the financial statements. We make it again, very clear. So that's all the compilation report is introductory paragraph management responsibility, paragraph accountant's responsibility, paragraph no opinion paragraph because we're not expressing an opinion.

As a CPA, what are you required to document when you do a compilation? You're required to document in sufficient detail, the work that you've done to comply with SARS. Basically you are required to document as a CPA, the work that you've done to comply with SARS. Document any significant findings, any fraud or illegal acts, non-compliance with laws and regulations that came to the CPA's attention and document that you've communicated those findings to the client and how they were resolved.

Now, when you do a compilation, what if there are disclosure problems? What if disclosures are not adequate and complete? That's okay. If there's no intent to deceive, if there's as long as there's no intent to deceive, the CPA adds to the compilation report, what is called a buyer beware paragraph and in your viewers guide, you'll see an example of the buyer beware paragraph.

It says management has elected to omit substantially. All of the disclosures required by accounting principles, generally accepted the United States of America. And then at the bottom says, accordingly, the financial statements are not designed for those who are not informed about such matters. It's at your own risk it's buyer beware again, as long as there's no intended to see, okay, the disclosures have been omitted, but be aware that, these statements are not designed for people who are not informed about those matters.

Let's say the CPA becomes aware of, significant departures from us gap or Ivers, whatever framework is being tested, whatever framework is being used. And the client refuses to revise the statements. If the client refuses to revise the statements and. The departure from us gap is very material it's pervasive.

CPA has to withdraw you. Can't be associated with financial statements and provide any further services with respect to those financial statements. You can't be associated with them at all. So if it's if the departure is very material pervasive, the CPA withdraws. If they're just material, not pervasive, then the CPA would add a paragraph to the compilation report.

After the accountant's responsibility paragraph, there'll be another paragraph that describes the departure and the effects if they were available or state that to determining the effects. Is not possible.

And also in the accountant's responsibility paragraph, there would be a reference saying during our compilation, we became aware of a departure that would be added to the accountant's responsibility paragraph as well. One more point, anytime, a CPA issues, a compilation report, each page of the financial statement.

Would be stamped. See accountant's compilation report. And again, anytime a CPA issues, a compilation report that each page of the financial statements must be stamped. See accountant's compilation report. If no compilation report is issued, each page of the financial statements is stamped restricted for management use only because remember we were told the CPA was told that the financial statements would not be used by third parties.

So if accomplished report is issued, each page of the financial statements is stamped. See accountant's compilation report. If there's no compilation report issued, then each page of the financial statements is stamped restricted from management use only because again, the CPA was told the statements would not be used by third parties.

Okay. Now there's a group of questions I'd like you to have done before you come to the next section. And I'll look to see you in the next section.

Welcome back. Let's look at these questions together. In the first question, it says an account may compile. So we're compiling here a non-issue as financial statements. That omit all of the disclosures required by gap only if the omission is first clearly indicated in the accountant's report. That's true.

There would be a buyer beware paragraph. That's true. And number two, not undertaken with the intention of misleading, the financial statement users. They can't be any intent to mislead. Both those statements are true and the answer is C.

Next, which of the following representations does an accountant make implicitly when issuing a standard report for a compilation of a non issuers financial statements? How about a, the accountant is independent with respect to the entity. Yes. That is implicit because if the accountant is not independent, then.

In the last paragraph in the accountant's responsibility paragraph, there's going to be a statement. I am not independent with respect to X company. So if that statement is not there, if nothing is said about independence, then it's implied. It's implicit that the accountant is independent. So that is implicit.

The answer is a, B says, is it implicit that the financial statements have not been audited? No. Said very clearly C says a compilation consists principally of inquiries and analytical procedures. No, those are procedures that would never be done in a compilation because all we're doing is compiling D says the accountant does not express any assurance on financial statements.

That's not implicit. That's very explicit that said in the introductory paragraph. And it's also said. And the accountant's responsibility paragraph, it said over and over again, not implicit, very explicit. Anyway, the answer is a next, the standard report on compiled financial statements includes which of the following statements or phrases.

So you see why it's important that you read over that standard compilation report a few times. So did you have a good understanding of it and a good memory of exactly what's in it. It's not lengthy. So they want to know what's going to be in that report. How about a compilation includes assessing the accounting principles used and significant management estimates, as well as evaluating the overall financial statement presentation.

That's from an audit report. That's not a compilation report. Statement C says a compilation is substantially less in scope than an audit. The objective of which is the expression of an opinion. Nothing like that is said in a compilation report, D says the accountant is not aware of any material modifications that should be made to the accompanying financial statements.

Know that's limited assurance. We're not providing any assurance whatsoever in a compilation, but answer B. The accountant compiled the financial statements in accordance with statements on standards for accounting and review services issued by the ICPA. That is that statement is in a standard compilation report.

Answer B next, when compiling the financial statements of a non issuer and accountants should notice a says review agreements. That's an audit procedure. So he says inquire of keeper. We don't make any inquiries. In a compilation D is a ratio analysis. We don't do anything like that in a compilation.

We're just compiling. All we do is answer B a basic understanding of the accounting principles and practices of the industry, lowest level of service that we provide lowest level of expertise that is required of what we do next, which of the following procedures is ordinarily performed by an accountant.

In a compilation engagement. How about a, would you read over the financial statements to consider whether they appear to be appropriate inform and free of obvious material errors? Yes, we would do that. Answer a that's about all we do. We don't do much, but we would do we'd look, we would look over the statements, make sure that they're appropriate.

See if there's any obvious mistakes. We certainly answer B. We don't obtain a management representation letter. We don't see make any kind of inquiries or D do any kind of analytical procedures. All we do is a

next, when an accountant is engaged to compile a non-issue or financial statements that omit substantially all disclosures required by the applicable financial reporting framework, the accountant should indicate the comp in the compilation report. That the financial statements are answer a, not designed for those who are not informed about such matters.

Don't forget the buyer beware paragraph. Exactly what happens as long as they're not trying to mislead anybody, not trying to mislead the users. Then we just add the buyer, beware paragraph saying exactly that because all these disclosures have been omitted. These statements are not designed for those, not informed about those matters next.

Which of the following procedures is ordinarily performed by an accountant during an engagement to compile financial statements. Again, a, we don't make inquiries B we're not, we don't do any kind of analysis of whether the entity will continue as a going concern answer. See, we don't evaluate subsequent events.

Do any of that. We don't do much with, but we do answer date. We consider whether the financial statements are free from obvious mistakes and application of accounting principle, application of accounting principles. Very basic next, which of the following actions should an accountant take when engaged to compile a company's financial statements in accordance with statements on standards for accounting and review services, a performing analytical procedures, of course not be expressed negative assurance.

Not expressing any assurance whatsoever. See, make management inquiries. We don't do any of that. No, the answer is day. We perform the engagement, even though independence is compromised because we don't have to be independent to do a compilation because we're not providing any assurance on the financial statements.

Finally, when an accountant is not independent with respect to an entity, which of the following types of compilation reports. Maybe issue. You're not just issuing the standard compilation report. A certainly not be accomplished in a report with negative Sharon's we're not providing any insurance at all.

D says a compilation report may be issued if the engagement's upgraded to a review. No, of course the answer is C a compilation report with special wording that notes, the accountant's lack of independence may be issued in the. Welcome to Bisk CPA review comprehensive CPA review materials for the CPA exam.

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This program is a bisque hotspot professional responsibilities, and I'm Jack Lemmon in this program. We're going to be discussing ethics. We're going to be discussing them in the context generally of the AICP code of professional conduct. Remember, however that each of you has your own ethical code. And although we will be talking about requirements of the profession, your own ethical hallmarks, your own ethical views will also play a part in how you address many of the issues that we will discuss in this program.

The AICPA recognizes that a distinguishing Mark of the profession is its acceptance of a high degree of responsibility. You are part of that profession. Now the code of professional conduct applies to all members of the AICPA, but once you've passed the exam, you will also be subject to the respective state rules of your state of licensing.

Now the ASC code of professional conduct consist of six articles. These six articles contain the principles of conduct and compliance, the norms of behavior, which are expected of every CPA. Backing up these six articles are various rules and interpretations, and we'll be discussing both the articles and the rules and a great deal of detail throughout the program.

These rules break into five different sections and they are supplemented by interpretations of the specific rules. Now your written material will set forth each of the articles in its full text. What I have in the screen before you are simply keywords and phrases from each of the articles, you need to read the articles in full, but let's focus first on article number one, responsibilities members should exercise sensitive and professional, moral judgments.

Now notice that while the code is going to be setting out a number of standards, it requires you to exercise sensitive, professional and moral judgment. And as I said, many of these are drawn from your inherent ethos that you've been taught and growing up with in here, we talk about the essential rule of the CPA in society.

The certified public accountant performs many essential services, and we need to be viewed by our public as a highly qualified, moral, and ethically upright member of society in rendering those services. We have a responsibility to cooperate with fellow professionals to assure integrity of the profession.

So this is a cooperative venture. It is a profession we all belong and all have obligations. We must always remember to evaluate our actions in light of moral and ethical standards and imperatives. That was article number one. Article number two focuses on our service to the public interest. We must honor the public trust and demonstrate commitment to professionalism.

This is the hallmark of being a CPA. You are a professional. And as the Supreme court said in the famous Arthur Young case, many years ago, the obligation of the CPA is to be the public watchdog. Yes, we're advocates for our clients in many things we do, but we also have that independent standard of watching out for the public in our work.

We must address any potential conflicts of interest with integrity and are there conflicts of interest inherent in this profession? You'll see them every day. This doesn't mean that they can't be resolved. Every conflict must, however, be addressed with integrity and full disclosure. We have an obligation to serve our client because remember that's what they are.

Our clients. Nevertheless, our highest obligation is not to the client, but to the collective wellbeing of the community of people and institutions that we stand to serve. Article number three is entitled integrity. We're to perform all professional responsibilities with the highest sense of integrity.

Now here's a question for you. What is integrity? And I believe it's the quality of being complete or undivided. It's a firm adherence to a code of especially moral or aesthetic values. It comes from the Greek, meaning undivided. If you are a person with integrity, you are complete. There are no pieces sticking out from you.

You're an integrated whole, and it's measured in terms of what is right. And just. Integrity requires adherence in both form and spirit of technical and ethical standards. So it is the form and the spirit just as we will see, when we talk about independence, it is the perception as well as the reality and using that as my segue, we move over to article four, objectivity and independence.

The CPA must obtain, maintain objectivity and be independent in both fact and appearance objectivity requires impartiality, intellectual honesty, and to be free from conflict of interest, you must avoid even the appearance of a conflict of interest. And you must demonstrate objectivity in a myriad of circumstances.

Article five is the one you have been training for due care. You must observe standards, improve competence and discharge, professional responsibility to the best of your ability, your career in learning. Accounting and learning, auditing and learning. Taxation has been to bring you to a level of technical competence that you can exercise with due care and carrying out every assignment that you're given.

You must achieve the level of facility and acumen, but at the same time, you must know the limits on your competence. There are areas that you may not have had experience with yet. These are opportunities for learning, but move into each new area, understanding your limitations and striving to increase your level of expertise in that field.

You must exercise diligence, promptness, and care. And perhaps if there's one complaint that will occasionally come back to the CPA is that they did not get back to me on a prompt basis. Always be diligent. Prompt and communicate clearly with your client. I like to believe that proper planning, proper prior planning is the key to do care.

Think it through before you get involved and article six ties in some ways into article five, it deals with the scope and nature of services. Observes the code of professional conduct in determining the scope and nature of services to be provided this. If you think about it is the summary article in the code that ties all the others together.

You should always be practicing in a firm, or if you're a sole practitioner yourself, you must have a quality control procedure and adhere to it. This is the hallmark of professionalism. Quality assess in light of all of the articles, whether every activity you engage in is consistent with your membership in a valued profession.

Now, those were the six fundamental articles that comprise the code of professional conduct.

Let's turn to some of the rules that implement these various articles. Rule number one, a member shall be independent in the performance of professional services. This probably is the single most important key to your professional conduct is a CPA. Independence in both appearance and action. Not only do you need to look to the AICP code, but you also have to focus on your state society rules and other requirements.

For instance, by issued by the sec, the department of labor, the public accounting oversight board, and remember one very fundamental principle of ethical practice. While you may be subject to a number of different rules. And some of them may not seem quite in a chord or have slightly different interpretations than another set of rules.

You always must take and follow the strictest standard. Even that strict standard may not comport with your ethical guideline. Remember, these codes are only a bottom line and there is certainly nothing that says you can't be even more strict than these various codes and formulations. No rule number one Oh one does not set forth a positive definition of what is independence.

Rather. It provides a negative definitions of when independence may be impaired. Let's begin to look at some of the implications of this rule. One Oh one, independence is impaired, and we're going to go through a series of things. The first one being transactions and interest. And I want you to focus on this one very carefully any directly or material indirect financial interest in a client.

So it's any direct interest, whether material or even immaterial or a material indirect financial interest in a client, impairs your independence, business investment with a client or a principal that is material. Is an impairment of independence loans to clients or principles of clients is an impairment of independence.

And there are certain relationships that you cannot undertake. For instance, being a trustee or a director of one of your clients that too will impair independence. Interpretation one Oh one day, two talks about employment or association with ad test clients. Now, remember we're not talking about all engagements with clients.

We're talking about attest clients. Independence is impaired. If a former partner or professional is employed by or associated with that client. Start with that as your general rule, independence is impaired. Now there isn't on less clause in interpretation, one Oh one dash two. Independence will not be impaired.

If that engagement is for a payment for prior services that former partner or professional has no influence in the firm's operations. That your firm, no participation with the former firm. In other words, your current firm, there is an engagement procedure and notification of the relationship. And there is also a procedure in place for notification.

If a partner or professional is considering employment with that attest client. So there are a number of things that must be done here to assure that you have independence, be careful and watch your checklist. Interpretation one Oh one day three talks about performance  services. We've talked about ad tests.

You know what? That is an audit, a review, certain compilations, but let's talk about non-attest services. And here there's some interesting little quirks. A member may provide such non-attest services, but must evaluate the impact on independence. And that makes sense. The general activities start with the principle that independence is going to be impaired, but now let's talk about some specifics.

Can you provide bookkeeping services to a client? The answer is yes and no. And I know that's not what you wanted to hear, but think about it this way. If you're doing ministerial acts for the client, that's acceptable. If you're in a decision-making role that is not acceptable and will impair independence.

So for example, you cannot prepare the monthly journal entries, record accounts receivable, and so forth for a client. Once they've made the journal entries, can you take the posted material and help prepare financial statements for a client answer? Yes. The same. Yes. And no analysis must be done in the case of plan administration.

For instance, can you help the client in administering their retirement plan? You could do some work, perhaps helping them with a 5,500. You can do some works on census of employees for purposes of actuarial calculations, but you can not administer grant loans approved checks and so forth for the plan.

That same dichotomy applies of ministerial acts versus decision-making. When we look to financial and investment consulting or systems implementation, one non-attest service, which will generally impair your independence is to do any internal audit work for a client. Now we've gone through some Ryther.

Significant standards, dealing with independence, as well as the six basic principles of the code of professional practice. I'd like you to now stop the tape, go and answer the following set of questions. And I will be back in a moment to discuss with you the answers to these questions, which highlight the material.

We just went over.

Just begin with question number one, which of the following statements best explains why the CPA profession has found it essential to promulgate ethical standards and to establish means for ensuring. Their observance, a distinguishing Mark of the profession is an acceptance of its responsibility to the public.

Be it requirement for a profession is to establish ethical standards, distress, primary responsibility to clients and colleagues see ethical standards that emphasize excellence in performing over material rewards. Establish a reputation for competence and character. Or D vigorous enforcement of an established code of ethics is the best way to prevent unscrupulous acts.

This may be the easiest question that you're given in this program, and the answer clearly should be a, the AICPA in its preamble to the code says that this is one of the distinguishing marks of the profession. Clearly you should have eliminated. Number B because our primary responsibility is not to clients and colleagues.

It's to the public, see ethical standards that emphasize excellence over material rewards, establish a reputation for competence that may happen, but that's certainly not a reason for Cote. And of course, D we'd love to prevent any unscrupulous acts in the profession, but that's not a reason for establishing the code.

Clearly a. Now question number two must a CPA in public practice. Be independent. In fact, and appearance in providing the following services, you have three columns, compilation of personal financial statement, preparation of a tax return, compilation of a financial forecast. The question is, are any of these  services, which is where we are looking for the independence rule.

And the answer is no, we do not have to be independent under, in compiling a personal financial statement. It preparing a tax return for a client or uncle piling of financial forecast. The answer here is D question number three. The auditor with final responsibility for an engagement. And one of the assistants have a difference of opinion about the results of an auditing procedure.

If the assistant believes it is necessary to be disassociated from the matters resolution. The CPA firms procedures should enable the insistent to a. Refer the disagreement to the AICP is quality review committee B document the details of the disagreement with the conclusions reached see, discuss the disagreement with the entities management or the audit committee D report the disagreement to any impartial peer review monitoring team.

Now, remember this is a dispute within the firm. Over an audit engagement and here, the answer should be to resolve the issue within the firm itself. If this is not possible, and the partner makes the decision with which the associate disagrees, then the answer should be B there's documentation in the Workpapers of the dispute, the arguments on the sides and the conclusion reached.

This issue does not go outside to the AACP AICP quality review team nor to the client nor to the peer review monitoring team. Now that also raises the question though, as to whether the assistant wants to continue to work on the client with that particular partner or remain in the firm, that's a personal decision, but the dispute resolution needs to remain within the firm.

Answer B is appropriate. Question number four, according to the standards of the profession, which of the following activities may be required in exercising, a duty of care consulting with the experts obtaining specialty accreditation, this would, should be fairly simple for you to analyze clearly consulting with the experts outside of your own knowledge.

It would be an item of due care. So we would expect to find it a or B yes. For column one. And do we need to have specialty accreditation? The answer is no. So combining a yes for column a no for specialty accreditation leaves you with answer B, which is the correct answer to number before. Question number five.

Burrow and co CPAs have provided annual audit and tax compliance services to mayor Corp. For several years, mayor has been unable to pay borough its full cost for services. The borough rendered 19 months ago, burrow is ready to begin field work for the current year's audit under the ethical standards of the profession, which of the following arrangements will permit borough to begin the fieldwork on mayor's audit.

Your answers were a mirror sets up a two-year payment plan with burrowed to subtly unpaid fee balance B mayor commits to pay the past due fee in full before the audit report is issued. See mayor Guisborough and 18 month note payable for the full amount of the past due fees before borough begins the audit.

Or D Mary engages another firm to perform the field work and burrow is limited to reviewing the work papers and issuing the audit report. The basic rule on independence is that the client may not have fees that are more than a year due. So even an accounts receivable or payment plan does not satisfy that independence requirement that knocks out answers a and C.

Mayor cannot engage in another form, another firm to do the field work and then go back after reviewing those work papers is an issue. The audit report D is clearly out. The only option is for mayor's commitment to pay the past two fee in full before the audit report is issued. Now, remember, this does allow the.

Auditor to begin the fieldwork, but the report cannot be issued until full payment for prior services is received. Answer B question number six under the code of professional conduct, which of the following is required to be independent. In fact, And appearance when discharging professional responsibilities, a CPA in public practice, providing advisory services, a CPA in public practice, providing oddity and other attestation services, a CPA, not in public practice or all CPAs.

The independence rule goes to the CPAs in public practice providing atta services. This is an easy answer. B. Many of the ethics rules do apply to all CPAs, but not this independence requirement, a CPA, not in public practice. This is going to be doing the work for their employees, lawyer. So C is out and providing advisory services, not an attest function.

You still have a number of ethical obligations, but you are not barred under this test. Answer B to question number six.

Question number seven, a violation of the profession's ethical standards most likely would have occurred when a CPA. Hey issued an unqualified opinion on the year two financial statements. When fees for year zero were unpaid recommended a controller's position description with Kennedy's specifications to an audit client C purchased a CPA firms practice of monthly write-up work for your percentage of fees to be received over a three-year period.

Dee made arrangements with a financial institution to collect notes issued by a client in payment of fees due for the current year's audit. Remember in focusing on many of these questions in the professional responsibility arena, to note whether the question asked most likely to Provide a violation or which items are not violations.

This is one that goes to the question of what would cause a violation. And here the answer is a. As we've previously discussed, you must have prior fees paid up before issuing reports. On subsequent years, a is a violation B non-active service, a ministerial act, providing a position description is not a problem.

No impairment purchasing a practice for write-up work. For percentage of the fees. Again, non-attest work. This is an area that is acceptable. Does not pose a problem under the code or made arrangements with a financial institution to collect notes. Yes. Again, you're not getting into the managerial acts of the business and this will be an acceptable action for the CPA to take answer a.

Now question number eight, car CPA is a staff auditor participated in the audit engagement of forte, Inc, which of the following circumstances in pairs cars, independence. So now notice the question is saying, which are impairments a during the period of the engagement Fort gives car tickets to a football game with $25 B.

Car on stock and incorporation that Fort's 401k plan also vest in C cars, friend, and employee of another local accounting firm prepares for its tax returns and D cars. Sibley is an internal auditor employed part-time by Fort to have these answers should have given you no trouble. Too may have troubled you a little bit.

First of all, B just because a car on stock in a corporation that Fort's 401k plan, it has no relevance to the independence of car. Nor does the fact that car's friend prepares for its tax returns. There's confidentiality rules there. His friend is also bound by various ethical requirements. So neither bean or C pose a problem.

D should have been an obvious one to you. If your sibling is eternal auditor employed part-time by fourth, that probably impairs independence. And that's the correct answer, but let's look at a. During the period in question Fort gives car tickets to a football game where it's $25 is not a material amount.

It happens all the time. It is not considered an impairment under the code. My personal ethical rule would suggest that during the period of the engagement, this is not something the car should do, but the correct answer, according to the AICP, his only D question number nine. On June one year one, a CPA obtained, a hundred thousand dollars personal loan from a financial institution.

Client for homeless CPA provided compilation services. Notice that's not an audit or review. It's a compilation. Excuse me. The loan was fully secured and considered material to the CPA's net worth the CPA repaid the loan in full December 31 year one. On April three year two, the client asked the CPA to audit the client's financial statements for the year ended December 31 year two is the CPA considered independent with respect to the audit of year two.

The answer to that is yes, the CPA is independence because he was not required to be independent at the time of the loan. Remember he was doing compilation work, not audit work. So the answer is actually be here. Matter of whether the loan was fully secured or not is irrelevant. Answer a is out.

And he, and in this particular case, the CP a was independent. The answer is C and D on not being independent are both incorrect. The answer is B because there was no independence requirement at the time of the outstanding loan question. Number 10. Watch how this question is worded. It's a little tricky.

The concept of materiality would be least, least important to the auditor when considering the adequacy of a disclosure of a client illegal act B discovery of a weakness in a client's internal console structure. See the effects of a direct financial interest in the client on the CPA's independence. D decision, whether it is positive or negative confirmations of accounts receivable.

The answer is really C because remember when you have a direct financial interest in the client, it does not make any difference whether it's material or immaterial any direct financial interest is impairment of independence. So that is the correct answer. Materially absolutely needs to be considered when you were discussing positive or negative confirmations of accounts receivable and the question of weaknesses in the internal control system.

So in both those cases, materiality is important. Now a gets to an interesting question. Disclosure of a client's illegal act is materiality important there. The answer is I, the. Code would say that it is as an item to be taken into consideration disclosure in the financial statements. Of course, it's going to be amended to be thought about, I get into a personal ethical issue where we talk about clients, illegal acts, and I have to assess my involvement with the client when we discover something like that question, number 11, according to the standards of the profession.

Which of the following activities would most likely not impair a CPA's independence again, watch the wording here. We're looking for something that will not impair independence, a providing extensive advisory services for a client. That's the correct answer. Advisory services are acceptable and did not impair independence, but again, Personal view here.

I put a caveat on this. If the advisory services get too extensive and you are providing attest services, also, there may be an issue and you need to look to some of the various interpretations clearly be contracted with the client to supervise office personnel does not impair independence, signing a client's checks in an emergency situation.

C. Does not impair independence, although I don't like doing this this is something, again, I'd have to think very long and hard about and D accepted the luxurious gift from a client. Something I would not do. But the answer here would not likely impair independence only a, B, C, and D probably would impair.

And I think even extensive a might. Question number 12 under the ethical standards of the profession, which of the following business relations would not generally impair independence, not impair would promote your client's securities. Absolutely. Would being a member of the board of directors that would impair independence being the client's general counsel.

Absolutely impairs independence, only being an advisor to a client's board of trustees would generally not impair an auditor's independence, but be careful as to what that advisory role involves. There has been the potential for it. If that advisory role gets too extensive.

Question number 13 under the ethical standards of the profession, which of the following positions would be considered a position of significant influence and an audit client. You ought to be able to knock this one out easily marketing. No. Policymaking and finance. Yes. Staff positioned in R and D no human resources, no answer B correct answer.

That is a significant influence for an audit client, a position in the finance division, a policy making decision. Now we come down to question number 14, in which of the following situations would a CPA's independence be considered to be impaired. Number one, the CPA maintains a checking account that is fully insured by a government deposit insurance agency at an audit client, financial institution to the CPA has a direct financial interest in an audit client.

But the interest is maintained in a blind trust as a trust where there's an independent trustee who does not know. So that the trustee manages the trust and supposedly the beneficiary of the trust does not know what goes on there. Three, the CPA owns a commercial building and leases it to them. Audit client, the lease qualifies as a capital lease.

Now we're looking at one, two or three, which one would be considered to be in it. Paramount one and two is answer a B. Two and three C one and three or D one, two and three. The answer is B two and three. Maintaining the checking account. That's fully insured by the federal deposit. Insurance agency does not impair independence, but the blind trust and the commercial capital lease, both impair independence.

Question number 15, according to the profession's ethical standards. On auditor would be considered independent. This time we asked to be considered independent. In which of the situations a, the auditor is officially appointed stock transfer agent be the auditor's checking account is fully insured by a federal agency that tell that an audit client.

See the client owes the auditor fees for more than two years. D the client is the only tenant in a commercial building owned by the auditor. As we've just been through several of these questions, this one should immediately pop out at you. You can't do a as a transfer agent, you can't do C with unpaid fees.

You can't do D with a commercial lease. B is the only situation here just as we've previously mentioned, where you will not impair. Independence question 16 under the ethical standards as a profession, which of the following investments in a client is not considered to be a direct financial investment, direct financial interest.

Hey, an investment held through a non-regulated mutual fund, an investment held through a non-client investment club, an investment held in a blind trust or an investment held by the trustee of a bank. Position taken by the AICPA is that only a, is an acceptable situation, which is not considered a direct financial interest investment through a non-regulated mutual fund.

But be careful if you have significant decision-making authority there, even that. Could impair independence, but generally be a non-client investment club, C a blind trust or D as trustee of another trust. All of those will impair independence. Only a is the correct answer. Now we're up on question number 17, an auditor's independence is considered impaired.

If the auditor has. An immaterial, indirect financial interest of the client. Answer a B an automobile loan from a client bank collateralized by the automobile C a joint. Closely held business investment with a client that has material to the auditor's net worth or D a mortgage loan executed with a financial institution that is in March of 1990.

This is material to the auditor's net worth. An immaterial direct indirect financial interest, not impairing an automobile loan, fully collateralized, not impairing a mortgage loan in 1990, even though it's material, it is a grandfathered loan. Does not impair independence, see a joint closely held business investment.

That is material clearly. Impairs independence is unacceptable and you should've selected answer C as you can see, there are a lot of independence questions adhere. It's the heart and soul of the CPA's ethical obligations. Question number 18, according to the standards of the profession. Which of the following circumstances will prevent a CPA for performing engagements, audit engagements for being independent, obtaining a collateralized loan, answer a B litigation with a client relating to billing for consulting services, for which the amount is immaterial C employment of the CPA spouses, a client and D acting as an honorary trustee for non-preferred.

If you miss this one. You need to do a little bit more boning up on your ethics and independence. See if the CPA spouse is the client's internal auditor, you've got a major independence issue. The collateralized auto loan, as we pointed out is not a problem. The honorary trustee is not a problem. And even the consulting service is litigation is done an issue when the amount is immaterial.

But in all of these circumstances, you need to look and dig a little bit deep into the issue. If somebody would just bring you answer B, if I'm engaged a litigation with a client on our consulting services, is that a problem? And your instinct might be no, that's not a problem. It's not an audit. It's not an unpaid audit fees, but if that amount is material, you may have him paired independence.

Make sure you get all of the facts before you answer an ethical question.

A little earlier in the program, independence is the heart and soul of the AICP code of professional conduct. And we've discussed a number of scenarios as we've gone through these. Discussion questions. Let's take a look at a couple more interpretations and all of these interpretations are set forth in the materials that you've been able to review interpretation one Oh one dash four.

It talks about honorary director trusteeships in nonprofit entities. Generally this does not impair independence. Permitted loans from financial institutions is the subject of interpretation, one Oh one dash five fully collateralized loans and certain needs. Certain grandfathered loans are permitted and do not compromise independence.

There are however certain situations with loans from financial institutions that may compromise your independence. So this needs to be looked at. The question of actual or threatened litigation again, interpretation one Oh one day six is an issue which may or may not depending on the nature of the litigation and the materiality of the amounts at issue affect your independence.

Government financial statements are the subject of interpretation. One Oh one dash 10.

Now let's turn to rule number two and remember the way the code is set up. You have the articles and. We're talking article one, then rule one Oh one rule one Oh two and so forth and under each rule or interpretations. So we've just been through rule one Oh one and some of the interpretations under it.

One of the two now says we're dealing with integrity and objectivity. The CPA shall not knowingly misrepresent facts or suburb ordinate his or her judgment to others. You haven't obligation to maintain complete integrity and objectivity in the work you do. This means you must be free from conflicts of it.

never knowingly misrepresent facts and never substitute your personal judgment for. The professional standards that we have now remember on this professional judgment issue, all situations are prized only on their merits. Now, if a client asks you, what could you do? What would you do? You certainly are allowed to do that.

You can express your own views, but you can not substitute your personal judgment for the professional requirements. A couple of interpretations under that this rule interpretation one Oh two dash one, knowing misrepresentation in the preparation of statements. Of course, if this is done, you have jeopardized everything you've worked so hard to get your certificate, your education, absolutely knowing misrepresentation in preparation of documents.

Forget it. One Oh, two dash two deals with conflicts of interest interpretation, one Oh two dash four talks about subordination of judgment. And in this interpretation, the AICPA talks about whistleblowing and documentation. As I mentioned a little earlier in the program, there are actual situations where staff.

Managers partners and seniors may disagree on the approach or something involving engagement, reasonable men and women will differ on things. This is the place where you work it out within the firm, document your disagreements, reach a consensus, the issue. Of whether you, as the person who has been placed in this situation where you disagree with the judge would have others are prepared to stay there then becomes personal judgment, but you have the obligation to try and resolve this within the firm.

And if it's an issue with the client that is for the partner to resolve vis-a-vis the client, it may ultimately come that there may need to be some whistleblowing or reporting, but that is not the job of the staff or the senior. The continuing integrity and objective objectivity interpretations continue with one of the two dash five educational services.

You have to provide this integrity and objectivity in all of your teaching research and CPE presentations. Now as a. First or second year staff person, you may not have this opportunity in a formal setting, but you're always going to be teaching working with researching issues with your coworkers.

You must bring this integrity and objectivity to that function. And then as you rise through the firm and are sent out to train up into becoming a new staff, people that same obligation carries over to all of your work. Interpretation one on two day six deals with client advocacy. Can we be a client advocate?

Absolutely. After all the word is client and we do advocate on their behalf. Remember however that in the  function, we are primarily obligated to the public, but in other engagements, we are the client's advocate. You can press very hard as an advocate. Be aware of the ethical and legal limits that you can not step over.

Now let's move over to rule two Oh one general standards. You must comply with the following rules and interpretations. In other words, As a CPA, there are rules, regulations, interpretations that are set out and you are obligated to follow all of those items, including professional competence in technical and console and consulting engagements.

You must always use due professional care and people will ask me, what do you mean do care? That means the care that is appropriate to the circumstances in which you are operating some types of engagements or consultations require one level of diligence and care, others raise it up. So there's that care, which is appropriate to the circumstances in which you are operating.

You must always comply with the planning and supervision. Initially you will be supervised. Although, even as a, perhaps six months on the job, you may be supervising some type of intern or another person, always prior planning will prevent problems. So the planning and supervision standards must be complied with and most important, as you've learned in auditing every type of decision, every conclusion you reach must be backed by sufficient relevant.

Data that is constitutes the reasonable basis for your conclusions or representations. This rule is focusing on the standards, promulgated by bodies, such as the AICPA counsel, but it's not limited to that. You have, I have to deal with the financial accounting standards board, all of those FAS, as that you've learned about.

If you're involved with government accounting, then it's the government accounting standards board at the state and local level, or at the federal level, the federal accounting standards advisory board. We also have a number of rules, regulations, standards, even ethics requirements promulgated by the general accounting office of the federal government, the securities and exchange commission, the office of management and budget, the public accounting oversight board.

And that's just at the federal level. There are certain state agencies. If you're involved with tax exempt organizations where you may have their standards to deal with moving from rule two Oh two to rule two Oh three, the CPA may not express an opinion if there's a deviation from gap and that deviation has a material effect, unless there are unusual circumstances.

Now, what do we mean by unusual circumstances? You must show that the, there is a reason to justify that departure and. We could talk about a couple of things. There might be for instance, new legislation or a new form of doing a business transaction. This is set forth in interpretation, two or three dash one departure from gap.

Now some might say how about a new transaction? The did the limited liability companies. Was that something that would involve a departure from gap answer, even though it was a new type of legal entity, it was treated for many purposes, just as a partnership or a An unincorporated enterprise.

So I don't think that's what they were talking about, but you could have a new development in a derivative type transaction or an EFT, and that might justify a departure from gap. It must be documented and must be well thought through. We continue. There are interpretation two Oh three days too, on the status of FASBY and Gasby interpretations.

And two, three days, three employees responsible is for gap conformity, which requires an affirmative confirmation from a client. Many of these rules are set forth in great detail in the supplemental material, and you need to review them as you're preparing for the exam.

Silver right now to rule three Oh one confidential client information. The CPA may not disclose confidential information without the consent of the client. That's the general start with the principal, no disclosure of confidential information. There are a few exceptions to that rule. However, you may disclose without consent to comply with a subpoena with applicable laws and regulations, a professional quality review or actual or threatened litigation or alternative dispute resolutions that are related.

To your client. Now, I want you to make sure of one thing here, and this is so frequently missed by young. Staff people particularly, you can talk about things, which you may not have been advised, were confidential. For instance, you're working out at a client's office, you overhear something about a potential acquisition.

Nobody disclosed it to you. You simply heard it in the hall. Be aware, be sensitive to the fact that is confidential information. You may not disclose it. So be careful when talking to your peers, even on the elevator, going to lunch or something else, assume that most of what you hear in a client's office may be confidential and do not discuss close it.

As we turn over to right rules three Oh two, which talks about contingent fees. A CPA may not offer or render services whereby the fee is contingent on findings or results. This prohibition applies to audits reviews and some compilations of prospective financial information where there will be reliance on it.

Continued fees are also prohibited for original or amended tax returns or claims for refunds. Certain other activities, however, may allow contingent fees.

I want to move from that rule three Oh two over to rule five Oh one. Now this is a catch all that sounds like nobody would ever violate it. But be very careful rule five Oh one C says the CPA may commit. No act did it just discreditable to the profession. What does that mean? This really goes to your ethical framework and the code has a few things in it.

I personally have a much broader definition of acts discreditable for instance It was going out after work on Friday night, having a drink discreditable some people may not agree with drinking, but I don't think that brings in that discreditable act. However, overindulging committing harassment in a bar in that gets to the point that it could be perceived as credible to the profession.

I could tell you that the IRS takes the position, did failure to file your tax returns is a discreditable act to the profession. So watch very carefully. And in my opinion, in my conduct, take a broad definition of discreditable act. Under this particular rule, the ACPA is issued interpretation five Oh one.

Dash one retention of client records. You may not hold back. Client records. Can you hold back materials that you had prepared that the client may need? And the answer there is possibly for unpaid fees, but you have to be very careful about holding back, even material prepared by the CPA that is essential for the client to comply.

For instance, suppose you have prepared all of the depreciation records that they need, and you have them in your files. They have no depreciation records. You may be walking a very narrow line here. I'm also going to tell you that from a practical perspective, refusing to return records of the clients is probably one of the areas that brings most Centure and penalties against CPAs.

I wouldn't even hold back any materials that I had prepared for unpaid fees. I don't think it's worth it. The hassle with clients, that's my ethical standard, but be very careful in talking about retaining records, interpretation five Oh one days, two deals with discrimination and harassment and employee practices.

Such a thing is a discreditable act interpretation, five Oh one day three failure to file standards and or procedures that government audits. Interpretation five Oh one dash Ford negligence. The preparation of financial statements or records five Oh one day five failure to follow requirements of government bodies interpretation, five Oh one day six solicitation or disillusion of CPA or district solicitation or disclosure of CPA, exam questions and answers and five a one day seven failure to file tax returns or.

Pay tax liability. These are all discreditable acts under the AIC PA code of professional conduct. If we move rule five Oh one to rule five Oh two, the CPA may not solicit in a manner that is false misleading or deceptive. And inter there are two interpretations here, five Oh two days too. Deceptive acts include creating unjustified expectations of favorable results representations regarding unrealistic fee's influence on tribute channels or agencies and interpretation.

Five Oh two days, three talks about engagements through third parties who advertise being an acceptable approach. If the member assures the advertising is consistent with the code of professional conduct. Five. Oh one day three talks about two different issues and it gets into a very interesting discussion rule five Oh three says the CPA is prohibited from receiving a commission when ATIs services are provided to the client.

That's part of the rule. There's also a discussion about referral fees. If you have an ad test, Engagement audit and review certain compilations. You may not receive a commission now. They may become accepted in other situations, the commissions for refer here. If the client is advised of it. Now, if you are paying or receiving a referral fee that is acceptable.

If there is disclosure to the client. So be very careful indeed to make full disclosure to the client. There is an issue with commissions when at test server are provided, that is not the case with referral fees, rule five Oh five, the CPA may practice in any form or organization permitted by law. As long as the name of one of the more current owners is included in that name.

Now I'd like you to stop the program, go review the next set of questions and we'll be back in a couple of moments to go through those additional questions and answers.

As we continue our review of professional responsibilities. Let's look at the answers to a few more questions. A CPA purchased stock in a client corporation and placed it in a trust as an educational trust for the CPA's minor child. The trust securities were not material to the CPA, but we're material to the child's personal net worth with the independence of the CPA.

Be considered to be impaired with respect to the client, answer a yes, because the stock would be considered a direct financial interest and consequences. Consequently materiality is not a factor. Yes because the stock would be considered an indirect financial interest that is material to the CPA's child.

No, because the CPA would not be considered to have a direct financial interest of the client or D no, because CPA would not be considered to have a material indirect financial interest in the client. The answers here need a little sorting through, but the answer ultimately is a, the stock is considered a direct financial interest because it's the child of the CPA.

And if it's a direct financial interest, materiality is not a factor. So we are not looking at an indirect financial interest, but one that is direct B is incorrect. Now. C is incorrect because as I said, the CPA is considered to have those same interest as the child, the minor child and see as an incorrect answer.

And D is also an incorrect answer because that assumes that this CPA does not have a material indirect interest only answer a is correct to this question. The next question begins, which of the following reports may be issued only by an accountant who is independent of a client. Remember, think at test services, how about a standard report on an engagement of a financial forecast?

That's an ancestor engagement, and that is a correct answer. A consulting services do not require independence. So be as a wrong answer. Compilation reports on historic financial statements. Again, do not require independence. C is incorrect and D compilation report on a projection. Again, not requiring independence D is incorrect.

That test standard a is the answer to here in the next question, we are confronted with this question, according to the profession's ethical standards. Which of the following events may justify a departure from a statement of financial accounting standards, new legislation, or evolution of a do form of business.

Now both of these may justify a departure, so we should be looking for a yes. Answer the answer. C is the only one that meets that definition and it is the correct answer. Yes. To legislation. Yes. Evolution of a new form of business transaction. Which of the following best describes what is meant by the term, generally accepted auditing standards.

Going back to the beginning of your auditing class, is it a rules acknowledged by the accounting profession because of the universal application? Is it pronouncements issued by the auditing standards board or C? Is it measures of the audit quality and the objectives to be achieved in the audit? Or is it D procedures to be used to gather evidence to support financial statements?

It's clearly not be the auditing standards board may once upon a time have issued some of these auditing standards, but no longer, of course it is The generally accepted standards are much broader than just auditing standards. Board B as incorrect rules acknowledged to be by the professional because of universal application.

None necessarily not worldwide. Knock a out. Okay. Measures of audit quality and the objectives to be achieved in an audit. Yes, that's correct. At D procedures to be used together. Evidence that sort of a little portion of doing the audit work, but that is not G a, a S the auditing standards. So settle just on C for the answer to this question.

Generally accepted auditing standards. The next question reads, according to the ethical standards of the profession, which of the following acts is generally prohibited, accepting a contingent fee for representing a client in connection with obtaining a private letter ruling from the house. I R S B retaining client records ethical after the client has demanded their return.

See. Revealing client tax returns to a prospective purchaser of the CPA's practice D issuing a modified report, explaining the CPA's failure to follow a government regulatory agency standard. We conducted an attest service to a client. The general prohibition is the one about returning client records after they'd been demanded.

And I told you, that's an area of frequent controversy between the CPA and the client. B is the correct answer here. Now, the IRS does allow contingent fees in a few situations and a private letter ruling would be acceptable. Can a client tax return be revealed to a prospective purchaser? The answer is yes.

But be careful. I would have some confidentially agreements in place before showing any of this work out, even to a prospective client, you need to have some type of arrangement with the prospective purchaser and issue the modified report appropriately documented. Yes, that would be an acceptable act.

Would not run a foul of these prohibitions. Only B is a major issue. Our next question asks a CPA is permitted to disclose confidential client information without the consent of the client to one another CPA firm. If the information concerns suspect the tax return irregularities or to a state CPA society, voluntary quality control review is the answer only in one only into.

Can we disclose as both one and two allow or neither one or two? Can you disclose to another CPA, a firm with tax irregularities answer? No. So clearly one does not work. That's going to take out a C and D. How about, can we do it, but to a state societies, voluntary quality control. Yes, we may too, as acceptable.

So B is the correct answer. You cannot do it under one. And so that's going to dihydro other options.

The profession's ethical standards, most likely would be considered to have been violated when a CPA represents that specific consulting services will be performed for a stated fee. And it's apparent at the time of the representation that the. Hey, actual fee will be substantially higher. Be the actual fee would be substantially lower than the fees charged by other CPAs for comparable services.

See the CPA would not be independent or D the fee was a competitive bid. I don't remember what the question is asking here that. Most likely the rules would be violated. They are not going to be violated. If the Thea's substantially lower than comparable fees, you may want to do that engagement and bid low.

As long as you are performing with professionalism with due diligence, completely and accurately, that's an acceptable approach. You do not have to be independent with respect to a consulting engagement. Whether the fee was competitively bid or not is irrelevant to your standard issue here. The answer is a, if you knew in advance at the time you made the representation that the actual fee is going to be substantially higher, that is a violation of the professional rules.

Answer a is the correct choice. And the next question we were asked. May a CPA hire for the CPAs public accounting firm, a non CPA systems analysis or systems analyst who specializes in developing computer systems. A yes. Provided the CPA is qualified to perform such service B. Yes. Provided the CPA is able to supervise the specialist and evaluate the work C no, because of non CPA.

Professionals are not permitted to be associated with CPA firms or no, because developing computer systems is not a recognized service. Performed by public accountants. You should have recognized immediately that C and D are incorrect answers. Of course, non CPA professionals are permitted to be associated with CPA firms.

There's some limitations on what they can and do and how they're held out, but they can be associated. And of course, developing computer systems is a service performed by public accountants, C and D incorrect. The answer a is obviously wrong because if the CPA was qualified, why hire the specialist? The only requirement here is that the CPA is able to supervise and appropriately evaluate the specialist and product answer B.

Now, which of the following theory monuments generally would not be permitted under the ethical standards of the profession. A referral fee, paid to a CPA to paint a client. That's answer a answer B, a commission for compiling a client's internal use financial statements. See he could teach a fee for preparing a client's income tax return or a contingent fee for representing a client in tax court.

In this particular case, a referral fee is acceptable. You need to make disclosure to the client. The commission issue. If we are doing internal use financial statements, not a problem for the commissions areas, dotted at test engagement, it contingency fee for preparing a client's original or amended income tax return is a major problem.

That's an ethical violation answer. C looks like the great answer and a contingency fee for representing a client in tax court. The answer. You could do that. So that's not a violation. The answer C is the only correct answer for this particular question. Now we turn to this question under which of the following circumstances may a CPA charge fees that are contingent upon finding a specific result.

So the contingency fee for a result, a, for an examination of prospective financial statements. B for an audit or review, if agreed upon by the CPA and the client C for a compilation of a third party will use the financial statement and disclosure is not made in the report. Or D if fixed by courts, other public authorities are in tax matters.

If based on the results of judicial proceedings, only one answer is correct here. The only place that you could charge it continued fee is an answer D. D is the correct answer now B just because the CPA and the client agree upon it makes no difference. It's still a violation of the ethical rules for an examination of prospective financial statements.

No, you're predicating the results of a prospective financial statement or a contingent fee. And that is not acceptable. Neither is one where there's a compilation that will be re. Will be used in the future and disclosure is not available a, B and C out of the box, select only D which following statements best describes the ethical standard of the profession pertaining to advertising and solicitation.

All forms of advertising and solicitation are prohibited. B, there are no prohibitions regarding the banner in which CPA is based. Elicit new clients. See a CPA may advertise in any manner that is not false misleading or deceptive or D a CPA may only solicit new clients through mass mailings. I have to chuckle at this one because clearly you can advertise and solicit.

That's not prohibited. Answer a is wrong. There are some restrictions regarding how you can solicit answer B is wrong. A CPA would be very remiss. If the only way they could get new clients was by sending out mass mailings, knock D off the list only see, and there's your standard. Any manner could be television.

Advertising could be signs, could be mailings, could be newsletters, word of mouth. As long as that advertising is not false. Misleading or deceptive select C.

In this part of the program, we're going to turn away from the AICPA code of professional conduct and focus on two other topics. All related are consulting services and international ethical standards. Now, let me just begin by saying that when I began in the profession more than 40 years ago at the services with the bulk of the practice of public accounting firms, and then there was a tax adjunct portion of the practice.

There was very little consulting services in those days, but those services have grown exponentially over the years. Consulting services are not limited to advice on accounting and related matters. They include a wide variety of technical skills, industry knowledge and consulting skills today. The AICPA management consulting services, executive committee issue statements on standards for consulting services.

Those general standards include professional competence due professional care. Planning and supervision and sufficient data. The rules of the AI PA code of professional conduct in many respects, do apply to the consulting services and tie in with the statements on consulting services. Let's look at some additional consulting service guidance provided under rule two Oh two in this particular case consulting services.

Or a little bit different from attest services. The member rendering consulting services serves the client's interest. Independence is not required. There must be an understanding between the CPA and the client on the scope and limitations of the engagement. And this should be documented in writing with the client.

There must be clear communications between the CPA and the client and a consulting engagement, which tends to be a little bit more amorphous. And you're working with the client's expectations. Clear communications are absolutely essential. Remember that generally consultant with attest clients does not impair independence.

But I have to tell you, be careful. There can be situations where consulting engagement may come very close or even potentially impair independence. If that is also an ad test client, just watch exactly what you're doing.

Moving from the consulting practice now to the international Federation of accountants and their code of ethics for professional accountants in as international arena. These standards are issued by the international ethics standard board for accountants. It's called . And it's part of the international Federation of accountants.

It establishes ethical requirements for professional accountants. Now you may have to be a little careful here again, because there is a possibility of conflict with national codes and members use their judgment to comply just as in the United States with the ISP rules, the rules of their state their national requirements.

And. Just as we have in this country to comply with our federal rules, our AICP rules and our state requirements, the international code is divided into three parts. Part a is of general application, part B professional accountants in public practice and part C professional accountants in business. For purposes of this program, I want to focus on part a, the general application rules.

The introduction and fundamental principles are integrity, objectivity professional competence and due care confidentiality and professional behavior. Although slightly. Worded differently. Those five objectives, those six objectives. I'm sorry. Five, five objectives. Excuse me, integrity. Objectivity due care, confidentiality and professional behavior mirror.

Very much the original premises in the AICPA's code of professional responsibility. Under these fundamental principles, the CPA, the professional accountant must exercise professional judgment and consider what a reasonably informed person would conclude in the same circumstances. Both qualitative and quantitative factors must be considered when evaluating the significance of a threat.

And this is a threat to the professionalism and the work being done by that accountant. If safeguards or protections are not available, the accountant must discontinue those professional services. So we are focusing on threats and potential remedies or protections against those threats. This is a little bit.

Different way of focusing the standards. Then under the AICPA's code, the threat categories, self-interest self-review advocacy, familiarity, and intimidation. And. These sound a little bit strange, but I think as you, as we flesh them out, you're going to see what they mean by threat categories and how they could impair the professionalism of the professional accountant.

Self-interest this is when financial or other influence or other interests influences. Judge would have behavior. You get so caught up. In other words, you may have a financial interest. Does that sound like independence under the AIC PA's rule financial or other interests? Influencing judge would behavior.

We talked in one of our problems about the spouse being an internal auditor for an attest client engagement. That sounds very much like an interest might influence judge wood or behavior. So as you look through these threat categories, try and correlate them back with some of our American standards.

The second, third category is self review. The failure to appropriate review. Prior judgments we've talked about in the American standards, prior planning, adequate supervision here, the international standard Eva goes to the point of, do you go back and second guess yourself? And I'm a firm believer that I need to move on after I make a decision.

But when you're going back and reviewing the prior your work in preparation for this year's work, do you self review those decisions you made the previous year? If you don't, there's a threat category, number three, advocacy, improper promotion of a client's interest. Your objectivity is compromised again, nothing new and different from the American standards.

So the Arity. Too close or long-term relationship. Now this is one we've danced away from a bit in the United States. We have had an awful lot of discussion about the question. Should there be auditor rotation? And we do that with audit partners, but what about from the equity of the firm being too close to term with a client and intimidation?

That's another threat, perceived pressures, undue influence by a client. Now here's one. Remember those unpaid fees? Is that a pressure or an undue influence? If the client says, yes, I'd love to pay you. I have an, I know I owe you money for last year obligation. We're under. A lot of pressure right now to get this audit out so that we can renew our letter of credit.

Is that intimidation, undue pressure influenced by a client. Certainly sounds like a threat to me, not stated as a threat, but these are threat categories that you need to assess.

Now some factors that are taken into account in perhaps resolving or preventing these threats from endangering your professionalism, you have to understand and really dig down to get all of the specific facts. Get everything on the table. So you can analyze every single detail of the problems that are being presented to you, then identify the ethical issues involved.

Do we have a conflict of interest? Do we have some intimidation? Do we have a familiarity issue? What ethical issues, underlay and are tied into the specific facts. Once you've identified those ethical issues. See what fundamental. Principals are involved in it. How do we get to the heart and soul of the principles being brought to bear on that ethical issue in the specific fact pattern more than anything else, we need to work within established internal procedures of our firm, and I cannot stress enough the incredible importance of a quality control system tailored to your practice.

To your specific client base and to the professionals in your firm there, of course, overarching code of professional responsibility, rules, guidelines, but each and every internal procedure must be tailored to the uniqueness of your circumstances in assessing threats and specific. Matters of resolution, lay out alternative courses of action.

There's usually not one particular course. That's the best. The only approach, it may be the best approach, but lay out two or three different ways that this issue could be resolved. Now, things that you need to bear in mind. I don't know, American word, a British word, a South African word. A Japanese word as translated, integrity, objectivity, professional care and competence.

These words transcend any nationality, any language they provide the groundwork for professional accounting, worldwide integrity, straightforwardness honesty, fair dealing, and truthfulness. Objectivity. There is no compromise of judge wood due to bias. Conflict of interest or undue influence professional competence and due care, maintain your professional skills, a diligence in providing services, confidentiality and professional behavior.

The remaining two standards again, worldwide commonality. You must framed from disclosing outside the firm, confidential information without specific and proper authority, unless I do illegal or professional, to do so using any such information for personal gain. And I'm going to caveat this one with something I believe very strongly.

It says refrain from disclosing outside the firm, confidential information. I believe you have to be very careful about disclosing confident, essential information, even within the firm. If you have it and it's necessary for the work you're doing, keep it confined to only those individuals who have a need to know professional behavior comply with all relevant law and regulations.

Avoid any action that may discredit the profession. And that behavior is not just in the office. It's outside the office. What you do 24 hours a day, seven days a week has an impact because you are a CPA. You are viewed as a representative of the profession. With those words. Let's pause again and review a few more questions.

I'll be back in a couple of moments to go through those answers, to the final questions in this particular program.

This question asks which of the following is not. One of the five fundamental principles of the international Federation of accountants, code of ethics for professional accountants, a integrity B objectivity C professional behavior D independence. The answer is D independence. If you remember, I gave you the five standards of integrity, objectivity.

Professional behavior confidentiality and do care and competence in this particular case, independence is still very important in the whole question of attest engagement but it's not one of the five fundamental problems right now. This question also highlights one of the things I want you to be very careful of in taking the CPR yeah.

Exam and the questions on professional responsibility. Some of the questions say which of the following. Is not, or does not impair something like that. Others, which one will look very carefully at the wording of the question, whether it's a positive or negative question, our next question says. As a member of the international Federation of accountants may practice in a jurisdiction or belong to another professional organization that has less stringent requirements than the I E S B a code of ethics, which set of requirements should the member follow under these circumstances a member of IFAC, shall Donna apply less stringent standards from those data to the code under any circumstances?

Be a member of IFAC shall not apply less stringent standards than those stated in the code. Unless prohibited from complying by law or regulation. C a member of IFAC is allowed to comply with a less stringent requirements. If these are imposed by an organization recognized by AIPAC or D a member of

Shall request a ruling. I asked regarding a conflict between its standards and those of another organization. This may be the toughest question that we've had in the program. And the answer is be a member of IFAC shall not apply less stringent standards than those stated in the code, unless prohibited from complying by law or regulation.

Now this leads to that real interesting question. When you have multiple restrictions, which do you apply? My rule is you always apply the strictest. Whichever provides the toughest ethical regulatory rules on less as I faxed as prohibited by law or regulation. So take the ethical standard. Take all of them together.

Follow the most stringent ethical rule unless you have a law or regulation, which prohibit you from doing so it's an unusual circumstance. And the, about the only situation I can think of which might lead. Under B would be in some jurisdictions where there are payments made to government people for certain policies.

It's an interesting, tough question. And you have to wrestle with that one ethically on your own here. If you see question 41 or something like it, select answer B, follow the IFAC code on less prohibited.

This question States, which of the following acts by a CPA is a violation of professional standards regarding the confidentiality of client information, a releasing financial information to a local bank with the approval of the client's mail clerk. B allowing a review of professional practice without the client authorization, C responding to an enforceable subpoena, or D faxing, a tax return to a loan officer at the request of the client.

This one should have been obvious to you. If you release financial information to a bank with the approval of the client's mail clerk, I think you have a problem. Answer is the right answer, but I have some comments on the other ones, clearly allowing a review of professional practice a professional practice review without the plan authorization is acceptable and is certainly set forth in the code.

Responding to enforceable subpoena. Yes, that does not constitute a breach of confidentiality. I always, if I received a subpoena for client information, call the client and see. Whether they wish to contest the subpoena since it's some of their records before you automatically respond and faxing a tax return to a loan officer at the request of a client that doesn't breach the confidentiality, but it does breach some department of the treasury circular, two 30 rules.

Don't do it. If a client asks you to fax the tax return to the loan officer say very simply. I'll send a copy of the return to you if you don't have it readily available and you've accepted, it provided to the loan officer. So you can do it under the professional standards. You're going to run into a problem with department of treasury regulations.

The next question says a CPA in public practice may not disclose confidential client information regarding auditing services without the client's consent in response to which of the following. A review of the professional practice by a state society, a letter to the client from the IRS, an inquiry from the professional ethics division of the AICPA, or a court ordered subpoena or summons.

Now remember what this question said, a CPA may not disclose. So we're looking for something where they may not disclose in response to a summons. You may disclose D is wrong. Professional ethics division. You may disclose C is wrong. Perfect professional review by the state society. You may answer is also great.

Simply a letter to the client from the IRS. You may not disclose was confidential information of auditing services in each of these cases. However, I personally would still get the consent of the client. I'm a firm believer. It's easier to ask them scent than to try and explain why you didn't. Our next question says, which of the following areas of professional responsibility should be observed by a CPA, not in public practice, not in Boulder practice.

You have two choices, objectivity and independence. Let's take the easy one. First does the CPA not in public practice have to be independence. Answer. No. They had their obligations to their employer. So we know that answer D as I'm sorry, C and a are both incorrect. Does the CPA not in public practice have to be objective.

Absolutely. Yes. So we need a yes and objectivity. I know in independence, the only qualifying answer is B.

Which of the following actions by a CPA, most likely violate the profession's ethical standards, a using a records retention agency to store confidential. Client records. B retaining client records after the client has demanded their return. See arranging of the financial institution to collect notes issued by a client and payment of fees.

Do D compiling the financial statements of a client that employed the CPA spouse as a bookkeeper. After the hour plus we've been together, you should clearly know that item B is a major problem with ethics. And frequently gets CPAs in trouble. You may not retain client records after the client has demanded their return.

So that is the correct answer here. B a D rather employing the CPA's spouse as a bookkeeper. I in compiling the financial statements does not create a problem and. How about a record retentions agency? They store confidential files all the time. That's not a problem. You may have had some questions about arranging with a finance Angela institution to collect notes issued by a client and payment of the fees.

Do you can make arrangements with the institution. The fees are duty you again, consult with the client, tell them what you're doing. Have the financial institution work this out, but that isn't acceptable arrangement. So your correct answer here, you should have selected B a CPA is permitted. So now we're going with the permitted route to accept a separate engagement.

Not in conjunction with an audit of financial statements to audit an entities schedule of accounts receivable, schedule of royalties. The answer is they can do an audit of either one or both. So the answer should be yes. For receivables. Yes. For royalties you're providing separate at test independent engagements for this client answer.

Yes. Answer a.

Next question States, a pervasive characteristic of a CPA role in consulting services engagement. Is that of being a, an objective advisor? Be an independent practitioner, see a computer specialist or D a confidential advisor. Let's knock out computer specialists first off because we know consulting can consist of many things.

Do you have to be independent in the consulting practice? No answer. Be knocked out confidential. No, you are going to have a confidential relationship in all probability with your client as you were working through this engagement, but that's not a requirement you must tell ever be an objective advisor.

You should select answer a, if this question appears in the future, according to the standards of the profession, which of the following would be considered a part of the consulting services engagement, one. Expressing a conclusion about the reliability of a client's financial statements to reviewing and commenting on a client prepared business plan.

Is it only one, is it only two? Is it both one and two or is it neither one and two? What is one. One is expressing a conclusion about the reliability of a client's financial statements. That's basically an attest engagement. Be it an audit or review. That's not a consulting services engagement, but reviewing and commenting on a prepared business plan.

The client has put together and wishes your comment upon that certainly is a consulting engagement. No, should be the answer to one. Yes. The answer to two. So your answer here. Is B only two is considered part of a consulting services engagement.

Under the statement on standards for consulting services, which of the following statements best reflects a CPA's responsibility when undertaking a consulting services engagement, the CPA must a. Not seek to modify any agreement made with the client B not perform any at their services for the client C inform the client of significant reservations because they'll see the benefit of the engagements or D obtain a written understanding with the client concerning the time for completion of the engagement.

If you notice the question to the CPA must this. And answer a is wrong. The CPA may, botified the agreement. You worked out an arrangement. You may find circumstance. The scope has changed. The timing has changed, whatever it is, certainly you can modify it D you don't need a written understanding about the completion date.

Frequently the client would say, I need to have this in X. You can attend, but it's not necessary. It's not a must. Are you prevented from providing  services for the client? No, we said it previously, independence is not required here. However, C is the correct answer. The CPA must inform the client of significant reservations concerning the benefits of the engagement.

That is a factor under the standards for consulting services, select answer C. Now which of the following services may a CPA perform and carrying out a consulting services, engagement for a client. Can you review a client prepared business plan? Can you prepare information for obtaining financing? Is it one, two, both or not either.

And in a previous question, we said, you certainly could review a client prepared business plan. So one is acceptable. Can you prepare information for obtaining financing answer. This is perfectly acceptable as part of a consulting engagement. They're both acceptable. And again, you should have selected answers.

See both one and two. Our next question asks according to the profession standards, which of the following would be considered a consulting service advisory services, implementation services. Or product services, all you need is a yes or a no. And the answer is advisory services or consulting, implementation services, or consulting and product services.

Providing a product to a client are all consulting services. You could have it services. For example, that made a, that meet the advisory services, the implementation services and the product services three. Yes. Answers, select a.

You're reviewing for the CPA exam. You're on the verge of getting your certificate and becoming an esteemed member of an old and most honorable profession. There are many keys to your successful career as a CPA. But none greater than your professional responsibilities in this program, we've talked about the AICP, a code of professional responsibilities, the various articles, rules, and interpretations, which you must know for the exam, but more than that, you must live them in the oncoming years.

The most important single factor. And your understanding of professional responsibility is the word independence that will guide so much of what you do. And as the heart and soul of the CPA exam, that's why in this program, I spent so much time talking about interpretations and independence requirements.

But in addition, we have talked about the consulting engagements and the uniqueness of them, as well as the international standards, which are so becoming a part and parcel of our globalized world economy, whether it's talking about the American code of professional responsibilities or the international code, I want you to bear in mind those five attributes, which are so well set forth in the international standard integrity.

Objectivity competence and due care, confidentiality and professional behavior. Those hallmarks are the keys to your successful career. And to you feeling good about yourself, always remember the codes of conduct, statutory rules, penalties laws are only the floor on ethical behavior. Your responsibility is to understand those floors.

To draw your interpretations, consistent with them and then live to the highest standards of your own self image. Good luck. And I welcome you to the profession.