Transcript Chapter 1

Chapter 1
The Set Up- Revisited
• Who issues your transcript?
• Who issues the “transcript” for businesses?
• You are going to hire someone. You know they
were able to issue their own transcript. How
much do you trust it?
• Stock market crash -> SEC and auditors ->
Enron -> SOX -> Subprime meltdown -> Dodd
Frank
Types of Risk
• Business Risk: The risk that an entity will fail to
meet its objectives.
• Information Risk: The probability that
information circulated by the company will be
false or misleading.
• See page 2 for four environmental conditions
that increase the demand for relevant, reliable
information.
Definitions
• Assurance: Lending of credibility to information
• Attestation: Assurance provided over specific
assertions made by management
• Auditing: Attestation over assertions embodied in
the financial statements
• The product auditors deliver is an opinion (aka
audit report) about the fair presentation of the
financial statements and related footnotes.
Auditing and Assertions
• Auditing def. on page 4.
• Auditing is a logical, systematic process to
obtain and evaluate evidence.
• There are implicit management assertions
behind every line item you see on a Balance
Sheet, P&L, etc.
• Assertions are often tied to risks.
Auditing and Assertions (cont.)
• Auditors have to logically think about the
applicable assertions and risks with every item in
the financial statements to be able to determine
1) the relevant population to obtain a sample
from and 2) the most appropriate audit
procedure based on the risk and assertion.
• This is often very difficult at first, but becomes
second nature with some practice.
• Ask yourself WCGW?
Auditing and Assertions (cont.)
• Inventory- Does it actually exist? Or has this
balance been inflated by management?
• Revenue- Did the sales actually occur? Or is
management improperly
recognizing/recording revenue?
• Liabilities- Is this list complete? Or are there
more liabilities that are not recorded on the
Balance Sheet?
Auditing and Assertions (cont.)
• Obtaining evidence enables the auditor to
determine the degree of correspondence
between the information provided (e.g.,
financial statements) and the established
criteria (e.g., GAAP).
• See Exhibit 1.1 page 5 and AICPA Auditing def.
at bottom of page 5.
Assurance vs. Attestation vs. Audits
• Assurance Service: An independent
professional service that improves the quality
of information for decision makers.
• May involve non-financial information.
• Ex: Secret shoppers, CPA’s counting votes at
the Oscars, CPA’s overseeing the
determination of lottery winners.
Assurance vs. Attestation vs. Audits
(cont.)
• Attestation Service: A practitioner issues a report
on subject matter, or an assertion about subject
matter that is the responsibility of another party.
• Ex: Audits of financial statements, Reviews of
financial statements, Compliance Attestations
(e.g., for debt covenant compliance).
• Reviews consist primarily of inquiry and analytical
procedures. Auditors express limited (negative)
assurance on the financial statements.
Assurance vs. Attestation vs. Audits
(cont.)
• Exhibit 1.2 pg. 7.
• Remember “STU” for Exhibit 1.4 diagram pg.
10.
• Consulting services are not assurance services.
AB’s, SCOT’s, and Presentation and
Disclosure
• Management’s assertions in the financial
statements are related to
1. Account Balances: Cash, Inventory, Accounts
Receivable. Think BS.
2. Significant Classes of Transactions: Sales,
Depreciation Expense. Think P&L.
3. Presentation and Disclosure: Footnotes have
been prepared in accordance with GAAP (e.g.,
Roll-forward for Level 3 Instruments per ASC
820).
AB’s, SCOT’s, and Presentation and
Disclosure (cont.)
• Pg 12. Second paragraph, first sentence.
• The PCAOB and ASB assertions are fairly close,
but the ASB assertions are more detailed.
• Note that in practice, slight variation exists
across firms in what they call assertions or
exactly which assertions are used.
AB’s, SCOT’s, and Presentation and
Disclosure (cont.)
• But all assertions/risks are tested regardless of
this slight variation in name/approach.
• Similarly, some items in the financial
statements may be called AB’s by one firm and
SCOTs by another firm.
• Think about cash. Is this an account balance or
class of transactions?
AB’s, SCOT’s, and Presentation and
Disclosure (cont.)
• AB or SCOT depends on whether account
tested throughout period or mainly at YE with
substantive tests of details.
• Q: What are the different assertions you see
for AB’s and SCOTS on page 13?
AB’s, SCOT’s, and Presentation and
Disclosure (cont.)
• A: Rights and Obligations for AB’s; Cutoff for
SCOTs; and Classification for SCOTs.
• Read def’s on pg. 13 for each assertion.
• PCAOB assertions vs. ASB assertions like right
hand vs. straight right or overhand right.
• Transcript example for completeness and
existence. Draw on board.
AB’s, SCOT’s, and Presentation and
Disclosure (cont.)
• The Big 4 firm I worked at had the same
assertions for both SCOTs and ABs so the
distinction didn’t matter much as long as audit
procedures were performed for all relevant
risks.
• Show Planning Doc_CLASS_EXAMPLE. Pg 73.
AB’s, SCOT’s, and Presentation and
Disclosure (cont.)
• Draw cutoff line on board.
• Another Big 4 firm doesn’t have the cutoff
assertion.
• Q: Why? Do they just not test for it? Or can
you argue that cutoff is a specific case of
something else?
AB’s, SCOT’s, and Presentation and
Disclosure (cont.)
• A:
• Note that some these tests must be done near
the end of the period and beginning of the
next period to ensure that the cutoff assertion
is tested.
• The real world is messier than textbooks.
Understanding what you’re doing and why
you’re doing it is more important than naming
conventions.
AB’s, SCOT’s, and Presentation and
Disclosure (cont.)
AB
SCOT
Big 4 A:
AB
SCOT
P&D
Big 4 B:
Completeness
X
X
X
X
Existence
X
X
X
X
Accuracy
X
X
Measurement
x
Valuation
X
X
X
Obligations
and Rights
X
X
x
Presentation
and Disclosure
x
X
Separate
Just because neither firm has classification or cutoff does not mean half of
the Big 4 doesn’t know to test for these!
Assertions
• Existence/Occurrence: Do the assets on the
Balance Sheet exist? Is the revenue line item
on the P&L the sum of individual sales that
actually happened?
• Risk for these accounts is overstatement.
• For the Existence assertion related to AB’s,
auditors will typically confirm the balances
(Cash, AR) or will physically observe the item
(Inventory).
Assertions (cont.)
• On page 14, the book says auditors also,
“complete procedures to ensure that the
reported sales transactions really did occur…”
• Q: What do you think auditors should do to
test the existence/occurrence assertion for
revenue?
Assertions (cont.)
• A:
• Rights and Obligations: Does the company
actually own the assets? Are reported
liabilities really the responsibility of the
company to settle in the future?
Assertions (cont.)
• Completeness: Has everything that should
have been recorded in the financial
statements been recorded?
• Common assertion for liabilities due to
management’s incentives. Risk for these
accounts is understatement.
• But we also check Revenue for Completeness
to guard against errors.
Assertions (cont.)
• Book extends this to note disclosures on pg.
14, but the separate “Presentation and
Disclosure” assertion actually takes care of
that.
• Cutoff: Have transactions been recorded in
the proper period?
• This is similar to completeness, but the
emphasis is on the timing of the transactions.
Assertions (cont.)
• Concern is that transactions have been
booked in the wrong period.
• Note that the third and fifth examples on page
14 are actually completeness and not cutoff.
Assertions (cont.)
• Valuation, Allocation, Accuracy: Has a
valuation method in accordance with GAAP
been used? Is the math behind the balance
accurate?
• Note that just about any error discovered by
an auditor may be thought of as a violation of
the accuracy assertion.
Assertions (cont.)
• Presentation and Disclosure: Have all
required disclosures been made in the notes
(e.g., commitments and contingencies, fair
value roll-forwards, etc). Are items presented
at gross or net when required?
Assertions (cont.)
• This is also related to “classification” where, for
example, repairs and maintenance expenses are
not capitalized.
• Q: If you were concerned about this, but your
audit firm methodology didn’t have a separate
“classification” assertion, what other assertions
would be violated if R&M were capitalized for:
1. The R&M account?
2. The applicable capitalized expenditure account?
Assertions (cont.)
• A:
• The Big 4 firm I worked for had six assertions.
These were Completeness, Existence,
Accuracy, Valuation, Obligations/Rights, and
Presentation/Disclosure
• The acronym we used was CEAVOP.
Assertions (cont.)
• Another Big 4 firm has an assertion they refer
to as “measurement” which their
methodology says includes valuation.
• For our class, I would like you to focus on
CEAVOP-CC.
• This is CEAVOP augmented with the cutoff and
classification assertions.
Assertions (cont.)
• Determining the appropriate assertions for
each AB or SCOT drives the type of testing
done and evidence gathered.
• If you decide that the primary risk for an
account is understatement and then fail to
conduct audit tests for completeness, then
you have failed to appropriately audit the
account.
Example
• Q: From a risk-based approach, what assertion
would auditors be most concerned about for
AP?
Example (cont.)
• A:
• Q: Given that, from a risk standpoint, one
would assume management would want to
understate AP, what relevant population
should you sample from? What do you ask for
(i.e., where do you start the completeness test
from)?
Example (cont.)
• A:
• Q: What are all the possible outcomes from
this test? How many do you think there are?
Example (cont.)
• A:
• Draw examples of Cash and AP tests from old
notes.
Professional Skepticism
• Defined as, “including a questioning mind and
a critical assessment of evidence.”
• Book says that auditors ask management to
prove assertions with “documentary
evidence.”
• Note that evidence may consist of verbal
inquiries where management’s responses are
included in the workpapers.
Professional Skepticism (cont.)
• There is a “sweet spot” with how your level of
skepticism comes across to the people
employed at your client.
• Be professional- not adversarial or
confrontational.
• Ignore the rest of the chapter.
• Work 1.40, 1.45, 1.47, 1.48, 1.49