CPA Exam — AUD flashcards

The threat that a CPA will promote a client's interests or position to the point that their objectivity or independence is compromised.

• Often arises in litigation support or tax advocacy.
• Can occur when representing a client in negotiations.
• Requires safeguards or declining the service if unmitigable.

Memory trick: SAM FInancial Interest Management Advocacy

A review engagement provides limited assurance that there are no material modifications that should be made to the financial statements for them to be in conformity with the applicable financial reporting framework.

• Primarily involves inquiry and analytical procedures.
• Less extensive than an audit.
• Requires the accountant to be independent.

Memory trick: When 'reviewed' facts are not quite clear, address them with management, my dear.

Transactions between parties that have a relationship that permits one party to influence the other, or both parties to be influenced by a third party.

• Often involve economic substance over legal form.
• Require special attention due to potential for manipulation.
• Auditor's role is to ensure proper identification, authorization, and accounting.

Memory trick: Related parties need careful eyes, to ensure no hidden lies.

The requirement or policy for audit partners to rotate off an engagement after a specified number of years to enhance independence and objectivity.

• Mandatory for lead and concurring partners on public company audits (5 years).
• Aims to prevent over-familiarity threat.
• Supports professional skepticism and independence.

Memory trick: Quality audits need fresh pairs of eyes, to catch all the financial lies.

A written agreement between the auditor and the client outlining the terms of the engagement.

• Mandatory for all audit engagements.
• Minimizes misunderstandings between the auditor and client.
• Specifies responsibilities of both parties.

Memory trick: The letter's terms must be clear and precise, to avoid any audit device.

Fundamental principles of professional ethics requiring CPAs to be straightforward and honest in all professional and business relationships, and to not compromise professional or business judgment because of bias, conflict of interest, or undue influence.

• Applies to all professional activities.
• Requires freedom from bias and conflicts of interest.
• Essential for maintaining public trust in the profession.

Memory trick: PICDO, a CPA's guiding light, through every ethical fight.

Acts of omission or commission by the entity, either intentional or unintentional, which are contrary to the prevailing laws or regulations.

• Auditor's responsibility is to obtain reasonable assurance that financial statements are free from material misstatement due to NOCLAR.
• Auditor performs procedures to identify noncompliance that may affect financial statements.
• Communication with management and those charged with governance is key.

Memory trick: When laws are broken, the auditor must speak, to management and governance, a clear critique.

Engagement planning for a group audit involves coordinating the audit work across multiple components (subsidiaries, divisions) often performed by different auditors (component auditors).

• Requires clear communication and coordination.
• Group engagement team retains overall responsibility.
• Focuses on identifying significant components and risks.

Memory trick: Plan with PERC: Personnel, Estimates, Risks, Communication.

When an auditor becomes aware of potential noncompliance with laws and regulations (NOCLAR), they must take appropriate action, starting with communication with management and those charged with governance.

• Focus is on financial statement impact.
• Initial step is communication with management/governance.
• External reporting is generally not the auditor's role unless legally required.

Memory trick: Investigate, Discuss, Evaluate, Report.

A threat to independence that occurs when a CPA promotes a client's interests or position in such a way that the CPA's objectivity may be compromised.

• Prohibited for public audit clients in material matters (e.g., litigation, tax court).
• Cannot be mitigated by safeguards for certain services.
• Impairs both independence in fact and in appearance.

Memory trick: An auditor's scales must always be fair, no client's case should you bear.

A system of policies and procedures designed to provide reasonable assurance that the firm and its personnel comply with professional standards and regulatory requirements, and that reports issued are appropriate.

• Required for all CPA firms performing attest engagements.
• Consists of six interrelated elements.
• Aims to ensure high-quality audit and attest services.

Memory trick: HELP ME: Human resources, Engagement performance, Leadership, Monitoring, Ethical requirements, Acceptance and continuance.

The application of relevant training, knowledge, and experience in making informed decisions about the courses of action that are appropriate in the circumstances of the audit engagement.

• Involves critical thinking and experience.
• Used throughout the audit process.
• Aids in interpreting accounting and auditing standards.

Memory trick: Skeptical minds judge with care.

The Human Resources element of a quality control system focuses on policies and procedures to ensure the firm has sufficient personnel with the competence and capabilities to perform engagements.

• Covers recruitment, development, and assignment.
• Aims to match staff skills with engagement requirements.
• Includes performance evaluation and professional development.

Memory trick: HELM ACE: HR, Ethics, Leadership, Monitoring, Acceptance, Engagement.

Independence is impaired if a covered member (which includes partners in the same office as the engagement partner) has a material indirect financial interest in an audit client.

• Materiality is key for indirect interests.
• Indirect interests are often held through intermediaries (e.g., mutual funds).
• A partner in the same office as the engagement partner is considered a covered member for independence purposes.

Memory trick: Always be independent, or your audit is incomplete.

For independence purposes, a spouse (or spousal equivalent) of a covered member is generally subject to the same independence restrictions as the covered member.

• Direct financial interests in an attest client by a covered member or their spouse are generally prohibited.
• Material indirect financial interests are also prohibited.
• Applies to those in a position to influence the attest engagement.

Memory trick: Money in client, a spouse's stake, independence you will break.

The employment of a covered member's spouse by an audit client may impair independence, depending on the spouse's position, responsibilities, and the materiality of their compensation.

• Key position always impairs independence.
• Non-key position may not impair if no influence on financial reporting.
• Materiality of compensation is a factor for non-key positions.

Memory trick: Family ties can bind, but some are fine.

The risk that a material misstatement that could occur in an assertion will not be prevented or detected on a timely basis by the entity's internal control.

• Assessed by the auditor.
• Relates to the effectiveness of internal controls.
• Higher when internal controls are weak.

Memory trick: AR = IR x CR x DR

A CPA firm must assess its competence and capabilities to perform an engagement before accepting it, ensuring it has the necessary skills, knowledge, and resources.

• Includes industry-specific knowledge.
• Considers technical expertise for complex accounting.
• Involves assessing available staff and specialists.

Memory trick: PIC: Professional, Integrity, Competence.

The risk that management, despite the existence of effective internal controls, can circumvent or override those controls, leading to material misstatements in the financial statements.

• Considered a pervasive fraud risk factor in all audits.
• Requires specific audit responses, even if controls are otherwise effective.
• Often involves sophisticated methods to conceal misstatements.

Memory trick: When management's hand tries to stray, more detailed tests will light the way.

Auditors are required to communicate identified significant deficiencies and material weaknesses in internal control to management and those charged with governance.

• Must be in writing.
• Timing requirements vary slightly for issuers vs. non-issuers.
• Significant deficiencies are less severe than material weaknesses but still important.

Memory trick: Communicate control issues timely.

External auditors may use the work of an effective internal audit function to obtain audit evidence or to provide direct assistance in performing audit procedures.

• External auditor must evaluate the competence and objectivity of internal audit.
• External auditor remains solely responsible for the audit opinion.
• Cannot rely completely on internal audit work; must perform some independent procedures.

Memory trick: Internal audit, a helpful hand, but external judgment must still stand.

Before accepting a new audit engagement, a prospective auditor must communicate with the predecessor auditor to inquire about matters that may bear on the integrity of management, disagreements with management, and reasons for the change of auditors.

• Required by professional standards.
• Requires client permission.
• Provides crucial information for engagement acceptance decisions.

Memory trick: New clients need a thorough check, before you sign on the dotted speck.

Engagement documentation must include identified misstatements and the auditor's evaluation of whether they were corrected by management.

• Includes both uncorrected and corrected misstatements.
• Documents management's decision regarding correction.
• Provides evidence of the audit work performed.

Memory trick: Documentation: Who, What, When, Why, How, and Done.

The degree to which audit evidence provides conviction regarding the truth or falsity of an assertion, determined by its appropriateness (relevance and reliability) and sufficiency (quantity).

• Higher quality evidence is more persuasive.
• Relevance means it addresses the assertion.
• Reliability means it's trustworthy and objective.
• Sufficiency refers to the quantity of evidence.

Memory trick: Relevant and Reliable, that's the evidence you can believe.

Audit procedures performed to evaluate the operating effectiveness of controls in preventing, or detecting and correcting, material misstatements at the assertion level.

• Involve inquiry, observation, inspection of documents, and reperformance.
• Are performed when the auditor plans to rely on controls to reduce substantive testing.
• Focus on how controls were applied, consistency, and by whom.

Memory trick: Audit Procedures: Tests of Controls vs. Substantive Tests.

Auditing related party disclosures involves procedures to ensure that all material related party transactions and relationships are properly identified, accounted for, and presented in the financial statements in accordance with the applicable financial reporting framework.

• Related party transactions pose a higher risk of material misstatement due to potential for management override or lack of arm's-length terms.
• Auditors need to identify related parties and transactions, understand their business purpose, and evaluate their accounting and disclosure.
• Sources of information include management inquiries, prior year audit files, SEC filings, and minutes of board meetings.

Memory trick: BOARD minutes REVEAL related party SECRETS for proper DISCLOSURE.

A measure of the quality of audit evidence, including its relevance to the assertion being tested and its reliability (trustworthiness) in supporting or detecting misstatements.

• Relevance: Does it relate to the assertion?
• Reliability: Is it trustworthy (e.g., from independent sources, directly obtained)?
• Higher quality evidence is more appropriate.

Memory trick: QR: Quality is R&R (Relevance & Reliability).

A scope limitation occurs when the auditor is unable to obtain sufficient appropriate audit evidence. The impact on the audit opinion depends on the pervasiveness of the limitation.

• If alternative procedures reduce the limitation to an immaterial level, an unmodified opinion may be issued.
• If the limitation is material but not pervasive, a qualified opinion is appropriate.
• If the limitation is material and pervasive, a disclaimer of opinion is appropriate.

Memory trick: Limit Scope, Audit Hope: Assess impact, then opine with care.

Events occurring after the balance sheet date but before the financial statements are issued that provide additional evidence about conditions that existed at the balance sheet date, requiring adjustment to the financial statements.

• Relate to conditions existing at year-end.
• Require adjustment to financial statement amounts.
• Examples: uncollectible receivables, settlement of litigation.

Memory trick: Balance sheet date condition? Adjust the numbers, it's a Type 1 decision.

Procedures performed to evaluate the feasibility and effectiveness of management's strategies to alleviate substantial doubt about an entity's ability to continue as a going concern.

• Focus on management's future-oriented plans (e.g., financing, asset sales, cost cuts).
• Requires scrutinizing underlying assumptions for realism.
• Often involves reviewing cash flow forecasts and comparing to external data.

Memory trick: PLAN: Plans, Liquidity, Assumptions, Need for disclosure.

When an auditor identifies a control deficiency that leads to an unacceptable deviation rate, the control cannot be relied upon. This necessitates an increase in the scope of substantive procedures to gather sufficient appropriate evidence.

• Unacceptable deviation rate means the control is ineffective.
• Increased control risk requires more substantive testing.
• Adjusting audit strategy is the immediate priority.

Memory trick: If the control is BROKEN, you can't trust it; you must look harder.

Drawing a conclusion about a population based on a non-random sample, requiring significant professional judgment and a conservative approach, especially when the sample deviation rate approaches or exceeds the tolerable rate.

• Does not quantify sampling risk.
• Requires professional judgment.
• If sample deviation rate is close to or exceeds tolerable rate, control is likely ineffective.

Memory trick: RISK: Rate, Ineffective, Sample, Know your limits.

Using Audit Data Analytics techniques to identify potential undisclosed related party relationships or transactions by analyzing patterns and connections within various data sets (e.g., master files, transaction logs).

• Focuses on identifying unusual relationships or transactions.
• Often involves comparing data across different master files.
• Helps overcome the challenge of related parties being intentionally concealed.

Memory trick: DATA: Detect Anomalies, Target Areas, Analyze Transactions, Uncover Relationships.

External auditors may rely on System and Organization Controls (SOC) reports, specifically SOC 1 Type 2 reports, to obtain assurance about the operating effectiveness of controls at a service organization that processes transactions for the client.

• SOC 1 reports cover controls relevant to financial reporting.
• Type 1 reports describe controls at a point in time.
• Type 2 reports describe controls and test their operating effectiveness over a period.
• External auditors rely on Type 2 reports for control effectiveness.

Memory trick: To RELY on controls, you need proof they actually WORKED.

External auditors assess internal auditors' objectivity by evaluating their independence from the activities they audit and their freedom from bias.

• Key factors include organizational reporting lines (e.g., to the audit committee).
• Policies on conflicts of interest and restrictions on auditing areas where they have personal involvement are important.
• Compensation schemes should not create pressure to bias results.

Memory trick: Internal Audit: Competence, Objectivity, and Systematic Approach.

An audit procedure where the auditor selects a sample of source documents (e.g., shipping documents, timecards) and traces them forward to the corresponding entry in the accounting records (e.g., sales journal, payroll register) to ensure that all valid transactions have been recorded.

• Tests the completeness assertion.
• Starts with source documents and moves to ledgers.
• Aims to detect unrecorded items.

Memory trick: Completeness is about catching EVERYTHING that should be there.

In Monetary Unit Sampling (MUS), the tainting factor (or misstatement ratio) for an individual sampled item is the ratio of the misstatement amount to the book value of that sampled item. It is used to project misstatements to the population.

• Tainting factor = Misstatement Amount / Book Value of Item.
• It is applied to the sampling interval to calculate the projected misstatement for that interval.
• Items with book value greater than the sampling interval are always selected and their actual misstatement is used directly, not a tainting factor.

Memory trick: TAINTING factor is about how much a single item's MISSTATEMENT TAINTED its OWN value.

Non-statistical sampling, while relying on auditor judgment, does not allow for the quantification of sampling risk or the objective projection of sample results to the population.

• Auditor judgment is used for sample size and selection.
• Sampling risk cannot be quantified.
• Results are extrapolated judgmentally, not statistically.

Memory trick: Non-Stat means you can't Measure the Margin.

Inventory valuation under FIFO requires ensuring that inventory is recorded at the lower of its cost or net realizable value, considering factors like obsolescence.

• Valuation assertion includes LCNRV.
• FIFO cost flow assumption affects cost determination.
• Obsolescence assessment is crucial for net realizable value.

Memory trick: Cost vs. Sale Price: Is the inventory still Worth it?

An unexpected decrease in a recurring operating expense, when other related accounts are stable, often indicates potential misstatement through improper capitalization of expenses.

• Analytical procedures highlight unusual fluctuations.
• Capitalization of expenses overstates assets and understates expenses.
• Requires further investigation to determine the cause and impact.

Memory trick: Hidden costs in assets, a profit's disguise.

A Service Organization Control (SOC) 1 Type 2 report provides a user auditor with evidence about the design and operating effectiveness of controls at a service organization relevant to the user entity's financial reporting. When the report is favorable and covers the audit period, the user auditor can often reduce the extent of their own testing of controls and substantive procedures related to the outsourced function.

• SOC 1 reports focus on controls relevant to financial reporting.
• Type 2 reports cover both design suitability and operating effectiveness over a period of time.
• User auditors must evaluate the report's adequacy, coverage, and the service auditor's competence.
• Reliance on a favorable SOC 1 Type 2 report can reduce, but not eliminate, the need for user entity-level control testing or substantive procedures.

Memory trick: A GOOD SOC 1 Type 2 means LESS work for YOU.

In Monetary Unit Sampling, the projected misstatement for an item is calculated by applying the tainting factor (percentage of misstatement in the item) to the sampling interval.

• Tainting Factor = (Recorded Value - Audit Value) / Recorded Value.
• Projected Misstatement = Tainting Factor * Sampling Interval.
• Used for items where the misstatement is less than 100%.

Memory trick: Tainting Factor times Interval, that's the projection for sampling.

When external auditors use internal auditors to perform audit procedures under the external auditor's direction, supervision, and review, subject to strict limitations on judgmental tasks.

• External auditor must supervise and review the work.
• Internal auditors cannot make significant judgments.
• Appropriate for routine, objective tasks (e.g., confirmations, inventory observation).

Memory trick: SCOPE: Supervision, Competence, Objectivity, Professional Judgment, External responsibility.

The existence assertion for property, plant, and equipment (PP&E) states that recorded assets actually exist at the balance sheet date. This is typically tested by vouching from the accounting records to supporting documentation or by physically inspecting assets.

• Tests for existence typically involve vouching from the accounting records back to source documents.
• Physical inspection of assets is also a strong test of existence.
• A common risk for existence is fictitious assets or assets that have been disposed of but not removed from records.

Memory trick: EXISTENCE means the RECORDED things are REALLY THERE.

Methods auditors use to obtain sufficient appropriate evidence regarding the reasonableness of management's accounting estimates.

• Three main approaches: test management's process, develop independent estimate, review subsequent events.
• Independent estimate generally provides highest assurance.
• All approaches may be used in combination.

Memory trick: Independent estimate gives the best audit fate.

A letter from management to the auditor confirming certain matters and supporting other audit evidence. It is required for all financial statement audits.

• Acknowledges management's responsibility for the financial statements and internal controls.
• Confirms that management has provided all relevant information.
• Addresses specific assertions or matters relevant to the audit.

Memory trick: Written Reps: Management's Promise, Auditor's Assurance.

The reliability of audit evidence refers to its trustworthiness and ability to provide assurance. For legal contingencies, evidence is most reliable when obtained from independent, knowledgeable, and objective sources, such as external legal counsel.

• Independence of the source significantly impacts reliability.
• Evidence obtained directly by the auditor is more reliable than indirect evidence.
• Documentary evidence is generally more reliable than oral representations.
• Reliability is crucial for complex and subjective areas like legal contingencies.

Memory trick: For LAW, INDEPENDENT EXTERNAL EXPERTS give the BEST evidence.

Testing the operating effectiveness of an authorization control involves examining documentation for evidence that the authorization was properly applied.

• Focuses on how a control was applied to transactions.
• Often involves inspection of documents or electronic logs.
• Aims to determine if the control prevents or detects misstatements.

Memory trick: Look at the Paper Trail to See if they Signed.

When auditing clients in seasonal industries, analytical procedures must account for predictable cyclical variations in financial data. Comparing current period data to prior period data for the same specific time frame (e.g., quarter-to-quarter, month-to-month) is more effective than annual comparisons or general industry averages.

• Seasonality can distort overall annual comparisons, making unusual fluctuations harder to detect.
• Disaggregated data (e.g., monthly, quarterly) is often more informative for seasonal businesses.
• Trend analysis over several periods for specific seasonal segments is particularly useful.

Memory trick: SEASONAL data needs QUARTERLY COMPARISONS to find the REAL story.

Auditing the process by which revenue is recognized over time for contracts where control of goods or services transfers continuously to the customer, often using methods like percentage of completion.

• Requires careful estimation of costs and progress.
• Auditor must test the underlying inputs and calculations.
• Focuses on accuracy, valuation, and cutoff assertions.

Memory trick: CONTRACT: Costs, Revenue, Accuracy, New estimates, Timely recognition.

A subsequent event that provides additional evidence about conditions that existed at the balance sheet date and affects the estimates inherent in the financial statements. These events require adjustment to the financial statements.

• Conditions existed at the balance sheet date.
• Requires adjustment to financial statements.
• Examples: bankruptcy of a customer with a receivable, settlement of litigation at an amount different from the recorded liability.

Memory trick: DATE: Does it Affect The Existing conditions?

An audit procedure involving the examination of cash received by the client after the reporting period to determine if accounts receivable balances were collected, providing evidence of their collectibility.

• Directly tests the valuation assertion for accounts receivable.
• Highly persuasive evidence of collectibility.
• Performed for a sample of accounts outstanding at year-end.

Memory trick: For collectibility, cash in hand beats promises.

Analytical procedures tailored to account for predictable fluctuations in financial data that occur due to seasonal business cycles, often involving period-over-period comparisons of specific intervals.

• Focus on comparing same periods across different years.
• Helps identify deviations from expected seasonal patterns.
• More effective than annual or broad comparisons for seasonal businesses.

Memory trick: Same season, same reason, compare the year's rhyme.

Procedures aimed at detecting related party transactions or relationships that management has not explicitly identified or disclosed to the auditor.

• Focus on governance communications and unusual transactions.
• Requires professional skepticism.
• Often involves reviewing legal and financial documents.

Memory trick: Look for the hidden connections in the official records.

Events that provide additional evidence about conditions that existed at the balance sheet date and affect the estimates inherent in the financial statements. They require adjustment to the financial statements.

• Examples include resolution of litigation for an amount different from the estimate, or a customer bankruptcy indicating uncollectibility of specific receivables existing at year-end.
• The financial statements are adjusted to reflect the new information.
• Occur between the balance sheet date and the date of the auditor's report.

Memory trick: Subsequent Events: Type I Adjusts, Type II Discloses.

Under the percentage-of-completion method, revenue and profit are recognized as work progresses based on the proportion of costs incurred to total estimated costs. Auditors must carefully assess management's cost estimates due to the risk of revenue overstatement.

• Revenue recognized based on progress towards completion.
• Progress is often measured by costs incurred / total estimated costs.
• Risk of overstatement if total estimated costs are understated.
• Auditors test the reasonableness of cost estimates.

Memory trick: Overstatement in construction revenue often hides in the 'ESTIMATES'.

Audit Data Analytics (ADA) can identify journal entries with characteristics indicative of management override, such as unusual accounts, non-standard users, or entries near year-end.

• Override bypasses internal controls.
• Journal entries are a common vehicle for override.
• ADA helps identify patterns and anomalies quickly.

Memory trick: Unusual Accounts + Year-End = Override Suspect.

A deficiency in internal control exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to prevent or detect misstatements on a timely basis.

• The least severe type of internal control deficiency.
• Indicates a control is not operating as designed.
• May or may not lead to a significant deficiency or material weakness.

Memory trick: CDM: Control, Deficiency, Material weakness.

The completeness assertion for accounts payable means that all liabilities that should have been recorded have been recorded.

• Focuses on understatement risk (unrecorded liabilities).
• Key procedure: Search for unrecorded liabilities.
• Often involves examining subsequent cash disbursements.

Memory trick: Look FORWARD in time to find the HIDDEN debts.

A Type I subsequent event provides evidence about conditions that existed at the balance sheet date, requiring adjustment to the financial statements.

• Examples: resolution of litigation, customer bankruptcy, discovery of errors/fraud.
• Impacts balances and disclosures as of the balance sheet date.
• Requires financial statement adjustment.

Memory trick: Did it EXIST at the Date? Adjust! If NOT, just Note it.