ACCT 320 Auditing Prepared by Lei Gao List of Review Questions for EXAM I You are expected to be able

to answer following questions: (The essay question in the exam will be selected from the BOLD questions) Chapter 1: 1. What is an auditing? --accumulation and evaluation of evidence about information to determine and report on the degree of correspondence between the info and established criteria; done by a competent, independent person --information must be in a verifiable form and there must be criteria which the auditor can evaluate the information (electronic data about transactions, written and electronic communication with outsiders, observations by the auditor, oral testimony of the auditee) 2. What is the difference between accounting and auditing? --many individuals that perform audits are CPAs thus contributing to the confusion --accounting is the recording, classifying and summarizing of economic events in a logical manner for the purpose of providing financial information for decision making; accountants must have a thorough understanding of the principles and rules that provide the basis for preparing the accounting information --in auditing accounting data, auditors focus on determining whether recorded information reflects the economic events that occurred during the acct period 3. Why do we need auditing? --information riskreflects the possibility that the information upon which the business risk decision was made was inaccurate; possibility of inaccurate financial statements; reduction of information risk can have a significant effect on a borrowers ability to obtain capital --remoteness of information, biases and motives of the provider, voluminous data, complex exchange transactions Ways to reduce information risk: user verifies information (user goes to get info about the reliability of the statements), user shares information risk with management (mgmt. needs to provide information to users), audited financial statements are provided (have an independent audit) 4. What is an assurance service? What is a nonassurance service? What is the difference between the two? Can you give examples of each? --independent professional service that improves the quality of information for decision makers; valued b/c the assurance provider is independent and perceived as being unbiased with respect to the information examined --nonassurance services: accounting & bookkeeping, tax services, management consulting services --primary purpose of an assurance service is to improve the quality of information while the purpose of a management consulting engagement is to generate a

ACCT 320 Auditing Prepared by Lei Gao List of Review Questions for EXAM I recommendation to mgmt.; quality of information is important, yet its not the primary purpose in a nonassurance service 5. What is an attestation service? What are some regular types of attestation services? Can you give examples of attestation services on information technology? --attestation service is a type of assurance service in which the CPA firm issues a report about the reliability of an assertion that is made by another party --audit of historical financial statements (statements in accordance with US/international standards), audit of internal control over financial reporting (assert that internal controls have been developed/implemented following criteria), review of historical financial statements (asserts that statements are fairly stated in accordance with standards), attestation services on information tech (assertions about reliability and security of electronic information WebTrust, SysTrust) --WebTrust: assures the user that the Website owner has met established criteria related to business practices, integrity, and information processes --SysTrust: to evaluate and test system reliability in areas such as security and data integrity & may be done by CPAs to provide assurance to management, board of directors, or 3rd parties about reliability of information systems 6. Can you differentiate the three main types of audits: financial statement audit, operational audit and compliance audit? Can you determine the type of audits under a specific situation? Operational audit: evaluate the efficiency and effectiveness of any part of an organizations operating procedures and methods; expect recommendations for improving operations, reviews not limited to accounting and can deal with organizational structure, computer operations, production, etc.; example: error reports, payroll records, payroll processing costs Compliance audit: determine whether the auditee is following specific procedures, rules, or regulations set by some higher authority; examples: accounting personnel are following the procedures prescribed by the company controller, review wage rates for compliance with minimum wage laws, examine contractual agreements; reported to management rather than outside users because this has to do with prescribed procedures and regulations Financial statements audit: whether financial statements are in accordance with specified criteria; US or international accounting standards 7. Can you list the three types of auditors? Can you explain what types of audit do they perform? CPA: responsible for auditing the published historical financial statements of all publicly traded companies; common to use auditor and CPA firm with one another yet other people may perform the audit

ACCT 320 Auditing Prepared by Lei Gao List of Review Questions for EXAM I GAO: government accountability officer; working for US govt; reports to Congress; evaluate efficiency/effectiveness of federal programs (many GAOs are CPAs) Internal Revenue Agents: enforce tax laws; audit taxpayers returns to determine whether they have complied with tax laws; compliance audits Internal Auditors: employed by all organizations to audit for management; report directly to the president of a company Chapter 2: 1. What are the roles of Public Company Accounting Oversight Board (PCAOB), SEC, and AICPA? PCAOB: appointed and overseen by the SEC; oversight for auditors of public companies, establishes auditing and quality control standards for public company audits, and perform inspections of the quality control standards for public company audits; conducts inspections of registered accounting firms to assess their compliance with the rules of the PCAOB and SEC, professional standards and each firms own quality control policies SEC: agency of the govt which assists in providing investors with reliable information upon which to make investment decisions; planning to issue new securitiesmust submit a registration statement to the SEC for approval examine completeness and adequacy before permitting the company to sell securities (Form S-1); Form 8-K (report significant events of interest to investors); Form 10-K (close of fiscal year); Form 10-Q (quarterly for all public companies) AICPA: set standards and rules that all members and other CPAs must follow: auditing standards (ASB) issue pronouncements on auditing matters for all entities other than publicly traded companies; compilation & review standards statements on standards for accounting and review services to provide guidance for performing compilation and review services; other attestation standards; code of professional conduct; perform many education and other functions for CPAs; meet continuing education requirements 2. What are some different types of standards issued by AICPA? --International standards on auditing: work to improve uniformity; US standards are consistent with international standards --auditing standards for private companies are established by ASB and they are similar to international standards; PCAOB now has responsibility for auditing standards for public companies while ASB deals with private companies 3. Can you describe the 10 Generally Accepted Auditing Standards (GAAS)? Can you give examples of violations of those rules?

ACCT 320 Auditing Prepared by Lei Gao List of Review Questions for EXAM I --General qualifications & conduct: adequate training & proficiency (auditor needs formal education) ; independence in mental attitude (follow practices to increase likelihood of independence of all personnel), due professional care (auditors must fulfill duties diligently & carefully) --Field Work: proper planning & supervision, sufficient understand of the entity, its environment & internal control (understanding of the business), sufficient appropriate evidence (what information should be collected to prepare a report) --Reporting results: whether statements were prepared in accordance with GAAP, circumstances when GAAP isnt consistently followed, adequacy of informative disclosures, expression of opinion on financial statements 4. Can you distinguish between GAAS and GAAP? --10 GAAS too general to provide meaningful guidance; look to the SASs for more specific guidance; GAAS & SASs provide less direction than might be assumedbeing too specific would eliminate difficult audit decisions and provide a line of defense for a CPA firm charged with conducting an inadequate audit, yet too specific would turn auditing into a mechanistic evidence gathering devoid of professional judgment 5. What is the relationship between GAAS and Statements on Auditing Standards (SASs)? --both authoritative auditing guidelines, yet GAAS is very general (developed by the AICPA) while SASs are more specific and the SASs come from the ASB and deal with primarily privately traded companies --look on as minimum standards rather than ideals; more specific guidelines look at materials published by the AICPA such as the Journal of Accountancy and industry audit guides, furnish assistance on specific questions 6. What are some major requirements in SOX that have been affecting the audit profession? 7. What are Quality Control and Peer Review? --quality controlcomprises the methods used to ensure that the firm meets its professional responsibilities to clients & others; auditing standards require each CPA firm to establish quality control policies and procedures; related to but distinct from GAAS; quality controls are established for the ENTIRE firm where GAAS are applicable to individual engagements --peer review--- review by CPAs of a CPA firms compliance with its quality control system; determine and report whether the CPA firm being reviewed has developed adequate quality control policies and procedures and follows them in practice; Center of Audit Quality (CAQ)public policy organization that is

ACCT 320 Auditing Prepared by Lei Gao List of Review Questions for EXAM I affiliated with the AICPA serving investors, public company auditors, and capital markets Chapter 3: 1. Can you describe the seven parts of a standard unqualified audit report? What are the purposes of the introductory, scope, and opinion paragraphs? What are some major elements in an audit report? Report title: report should be titled, title includes the word independent; example: independent auditors report Audit report address: addressed to the company, stockholders or the board of directors; report to board of directors/stockholders to prove independence Intro paragraph: makes the simple statement that the CPA firm has done the audit, intended to distinguish the report from a compilation or review report, lists financial statements that were audited, including the balance sheet dates and accounting periods for the income statement and statement of cash flows; wording should be exactly like those used by management on reporting the financial statements; states that the responsibility is to express an opinion on the statements based on the audit Scope paragraphfactual statement about what the auditor did in the audit; states that the auditor followed GAAS, designed to obtain reasonable assurance about whether the statements are of material misstatement; material conveys that auditors are responsible only to search for significant misstatements; reasonable assurance is intended to say that an audit cannot be expected to completely eliminate the possibility that a material misstatement will occur; discusses audit evidence accumulated and states that the auditor believes that the evidence accumulated was appropriate for the circumstances to express the opinion presented; while the intro says that mgmt. is responsible for the prep of the financial statements, the scope says that the auditor evaluates the appropriateness of those acct standards, principles, estimates, etc. Opinion paragraphreports auditors conclusions based on the audit; entire audit report is usually referred to as the auditors report; in our opinion is used to say there may be some information risk associated with the reportrelated to the 1st and 4th GAAS; required to state an opinion about the financial statements as a whole and whether or not they followed GAAP; present fairlyauditors are responsible for looking beyond GAAP to determine whether users might be misled Name of CPA firmidentifies CPA firm or practitioner who performed the audit Audit report dateone on which the auditor completed the auditing procedures in the field; indicates the last day of auditors responsibility for the review of significant events 2. Can you identify major deficiencies of an audit report? 3. Can you explain the concept of materiality? 4. Under what situations should an auditor issue: an unqualified report with an explanatory paragraph/modified wording, a qualified report, a disclaimer

ACCT 320 Auditing Prepared by Lei Gao List of Review Questions for EXAM I report, and an adverse report? Can you determine the type of reports under a specific situation? 5. How should the audit report (format and content) differ between different types of reports? Chapter 4: 1. What is an ethical dilemma? Can you give an example of ethical dilemmas in auditing? --situation a person faces in which a decision must be made about the appropriate behavior; finding a diamond ringtake it to the owner or keep it? --rationalizing unethical behavior---everybody does it, if its legal, its ethical, likelihood of discovery/consequences --resolving ethical dilemmas: obtain relevant facts, identify ethical issues from the facts, determine who is affected by the outcome of the dilemma and how each person/group is affected, identify alternatives available to each person, identify consequences of each action, decide the appropriate action to take 2. Can you explain the concept of independence? --independence of mind: reflects auditors state of mind that permits the audit to be performed with an unbiased attitude; reflects a long-standing requirement that auditors should be independent in fact; independence of appearanceresult of others interpretations of this independence --SEC adopting rules of independence that are consistent with SOX; restrict the provision of non-audit services to audit clients and restrict employment of former audit firm employees by the client 3. What are the nine types of nonaudit services that have been prohibited by SOX? --bookkeeping & other accounting services, financial information systems design & implementation, appraisal or valuation services, actuarial services, internal audit outsourcing, management or human resource functions, broker/dealer/investment banker services, legal & expert services unrelated to the audit, any other service the PCAOB determines by regulation is impermissible --CPA firms are not prohibited from performing these services for private companies and for public companies that are not audit clients; for example the SEC and PCAOB allow CPAs to provide tax services for audit clients --also must disclose in their proxy statement or annual filings with the SEC the total amount of audit and nonaudit fees paid to the CPA firm for the two most recent years: audit fees, audit related fees, tax fees, all other fees 4. What are the requirements regarding audit committee, employment with client, and partner rotations in SECs independence rules? Can you explain

ACCT 320 Auditing Prepared by Lei Gao List of Review Questions for EXAM I why these new changes are proposed in SOX? What are the requirements of SEC regarding ownership interests that relate to auditors independence? --audit committee is a selected number of members of a companys board of directors whose responsibilities include helping auditors remain independent of management; not a part of company managementin response to the SOX requirement that all members of the audit committee be independent, stock exchanges amended their listing rules to reflect the provision; companies must disclose whether or not the audit committee includes at least one member who is a financial expert; SOX requires the audit committee be responsible of the appointment, compensation & oversight of the work of the auditor; must preapprove all audit and nonaudit services and responsible for the oversight of the work of the auditor including resolution of disagreements between mgmt. and the auditor; PCAOB requires CPA firm before its selection as the companys auditor, to describe in writing and document its discussions with the audit committee about all relationships between the firm and the company including executives in the reporting positions and determine whether there is any impairment of the CPAs independence --conflicts arising from employment relationships: former audit team members with an audit client raises concerns; consistent with SOXcooling off one year periodbefore a member of the audit engagement team can work for the client in certain mgmt. positions; example for an auditor working for a CPA firm who receives an offer from a publicly held client for a position as a CEO, controller, CFO, CAO, etc.; under SEC rules prior to SOX, a CPA firm is not independent with respect to an audit client if a former partner, principal, shareholder, or professional employee of the firm accepts employment with a client if he/she has a continuing financial interest in the CPA firm or is in a position to influence the CPA firms operations or financial policies --Partner Rotation: SEC/SOX requires that the lead and concurring audit partners rotate off the audit engagement after 5 years (concurring partner isnt involved with the actual audit); 5 year time out for the lead and concurring partners after rotation before they can return to the audit client; additional audit partners with significant involvement on the audit must rotate after 7 years and are subject to a 2 year time out --Ownership Interests: SEC rulesprohibit ownership in audit clients by those persons who can influence the audit; ownership by covered person and their immediate family including members of the audit engagement team, those in a position to influence the audit engagement in the firm chain of command, partners & managers who provide more than 10 hours of nonaudit services to the client; partners in the office of the partner primarily responsible for the audit engagement 5. What are the requirements in AICPA Code of Professional Conduct regarding auditor independence? Rule 101Independence: a member in public practice shall be independent in the performance of professional services as required by standards promulgated by

ACCT 320 Auditing Prepared by Lei Gao List of Review Questions for EXAM I bodies designated by Council; ASB requires that auditors of historical financial statements be independent --prohibits covered members from owning any stock or other direct investment in audit clientsdamages independence of mind & affect users perceptions of auditors independence; covered members include: individuals on the attest engagement team, individual in a position to influence the attest engagement, partner who provides nonattest services to the client, partner in the office of the partner responsible for the attest engagement, firm and employee benefit plans, entity that can be controlled by any of the covered members listed above or by two or more of the covered individuals working together --ownership of stock/equity is direct financial interest, indirect financial interest is when there is a close, but not a direct financial interest; materiality affects ownership in violation of rule 101 only for indirect ownership --former practionerspermit former partners/shareholders who have left the firm due to such things as retirement or the sale of their ownerships with clients of the firm; normal lending proceduresloans between a CPA firm or covered members and an audit client are prohibited b/c its a financial relationship; with intermediate/close family membersdont usually impair independence unless the ownership interest is material to the close relative; joint investor/investee relationship with client---client investor: if clients investment in the nonclient is material, any direct or material indirect investment by the CPA in the nonclient investee impairs independence; client investee: investment in a client is material to a nonclient investor, any direct or material indirect investment by the CPA in the nonclient impairs independence --director, officer, mgmt., or employee of a companyif a CPA is a member of the board of directors or an officer of a client company, his or her ability to make independent evaluations of the fair presentation of financial statements is affected; interpretations prohibit covered members, partners, and professional staff in the office of the partner responsible for the attest engagement from being a director or officer of an audit client company; can be impaired when a former partner of the audit firm leaves the firm and is employed by the client in a key position unless certain conditions are met --litigation between firm & clientability of the CPA firm and client to remain objective is questionable; litigation in itself doesnt affect independence, yet it will be affected if cross claims between the auditor and client are filed that have a significant risk of a material loss to the CPA firm/client --bookkeeping: can the CPA be independent in the audit role if they perform the bookkeeping and the audit? A CPA firm may do the bookkeeping and auditing for a private company audit client; based on a comparison of the effect on independence of having both bookkeeping and auditing services performed by the same CPA firm with the additional cost of having a different CPA firm do the audit; client must accept full responsibility for the financial statements, CPA must not assume the role of employee or of mgmt. conducting the operations of an enterprise, CPA in making an audit of financial statements prepared from books

ACCT 320 Auditing Prepared by Lei Gao List of Review Questions for EXAM I and records that the CPA has maintained completely or in part must conform to auditing standards --unpaid feesimpaired if billed or unbilled fees remain unpaid for professional services provided more than a year before the date of the report --network of firmsjoin larger groups to enhance their capabilities to provide prof. services --independence conceptual frameworkidentify and evaluate circumstances that might threaten independence, determine whether safeguards can be implemented that might mitigate the threat, conclude that independence is impaired if no safeguards are available to eliminate an unacceptable threat or reduce it to an acceptable level 6. Can you determine whether an auditors independence has been impaired under a specific situation? 7. Can you describe the requirements in the rules under the AICPA Code that relate to confidentiality and contingent fees? --Rule 301: confidential client information: member in public practice shall not disclose any client information without the specific consent of the client; exceptions: obligations related to technical standardseven though he agrees that the financial statements are misstated, confidentiality prevents the CPA from telling anyone yet in this case a correct audit report must be issued; subpoena or summons and compliance with the laweven information which is called privileged information if legal proceedings cannot require a person to provide the information even if there is a subpoena, only privileged information can be communicated in this case; peer reviewif authorized by the AICPA then there client permission to examine the audit documentation is not needed, access to files for PCAOB inspections is allowed to comply with SOX; response to ethics division---charged with inadequate technical performance by the AICPA Ethics Division trial board, likely to want documentation so this prevents a CPA firm from denying the inquirers access to audit documentation by saying that is confidential information --contingent fees: perform for a contingent fee any professional services for or receive such a fee from a client for whom the member or members firm performs: an audit or review of financial statements, compilation of a financial statement when the member expects or reasonably might expect that a third party will use the financial statement and the members compilation report doesnt disclose a lack of independence or an exam of prospective financial information --example: $50,000 for an unqualified opinion rather than a $25,000 if the opinion was qualified opiniontempt a practitioner to issue the wrong opinion --permitted to charge contingent fees for nonattestation services unless the CPA firm is also performing attestation services for the same client Chapter 6: 1. What is the objective of an audit of financial statements?

ACCT 320 Auditing Prepared by Lei Gao List of Review Questions for EXAM I --purpose of an audit is to provide financial statement users with an opinion by the auditor on whether the financial statements are presented fairly, in all material respects, in accordance with the applicable financial accounting framework; issuing an opinion on financial statements; --issues report on internal control over financial reporting as required in section 404 of SOX; reach conclusions about whether the financial statements are fairly stated and to determine the effectiveness of internal control after which they issue the appropriate audit report --if auditor believes that the statements are not fairly presented or are unable to reach a conclusion about insufficient evidence, the auditor must notify users through the auditors report 2. What are the managements and auditors responsibilities in a financial statement audit? --responsibility for adopting sound accounting policies, maintaining adequate internal control and making fair representations in the financial statements rests with management rather than with the auditor; companys management knows more about the companys transactions and related assets, liabilities, and equity than the auditor --auditors knowledge of these matters and internal control is limited to that acquired during the respective audit --annual reports of many public companies include a statement about mgmt. responsibilities and relationship with the CPA firm; mgmt. responsibilities for the integrity and fairness of the representations in the financial statements carries with it the privilege of determining which presentations and disclosures it considers necessary; auditor can issue an adverse or qualified opinion or withdraw from the engagement if they find the mgmts disclosure unfair/unacceptable --SOX requires the CEO and CFO to certify the quarterly and annual financial statements submitted to the SEC 3. What is the difference between a misstatement caused by error and by fraud? --error is an unintentional misstatement of the financial statements whereas fraud is intentional; an error is a mistake in extending price times quantity on a sales invoice and overlooking older raw materials in determining the lower of cost or market for inventory --misappropriation of assets: defalcation or employee fraud vs. fraudulent financial reporting which is often called management fraud; misappropriation of assets is a cashier taking cash at a time the sale is made and not entering it into the cash register --professional skepticismprovide reasonable assurance of detecting material errors and fraud in the financial statements

ACCT 320 Auditing Prepared by Lei Gao List of Review Questions for EXAM I --fraudulent financial reporting harms users by providing them incorrect financial statement information for their decision making; when assets are misappropriated, stockholders are harmed b/c assets are no longer available to their rightful owners 4. Can you describe the cycle approach to segment an audit? What are the advantages of using cycle approach to segment an audit? --divide financial statements into smaller segments or components; divide an audit is to keep closely related types or classes of transactions in the same segment; for example: sales, sales returns, cash receipts, and charge-offs of uncollectibles would be all part of the sales and collection cycle --sales and collection cycle, acquisition and payment cycle payroll and personnel cycle, inventory and warehousing cycle, capital acquisition and repayment cycle --ties the way transactions are recorded in journals and summarized in the general ledger and financial statements --important way to organize audits; auditors treat each cycle separately during the audit; auditors need to consider the interrelationships between cycles, they typically treat cycles independently to the extent practical to manage complex audits effectively --most efficient and effective way to conduct audits is to obtain some combination of assurance for each class of transactions and for the ending balance in the related accounts --transaction-related audit objectives (conclude the transactions are properly recorded), balance-related audit objectives (must be met for each account balances) --presentation and disclosure related audit objectives 5. Can you describe management assertions? 6. Can you describe balance-related, transaction-related, and presentationrelated audit objectives? What are the relationships between management assertions and audit objectives? 7. Can you identify the audit objective and related management assertion for an audit procedure? Can you give examples of audit procedures that provide evidence for an audit objective?