Role of The Professional Accountant in The Economy?
Role of The Professional Accountant in The Economy?
Role of The Professional Accountant in The Economy?
Answer:
Answer:
Generally, to be a CPA one must meet certain education requirements,
and pass the CPA exam.
Answer:
The “Philippine Accountancy Act of 2004” (RA 9298) Article II, Section 13 to 18
provides for the requirements for the Examination, (Registration and Licensure)
for the Practice of Accountancy as follows:
Any person applying for examination shall establish the following pre-requisites
to the satisfaction of the Board that he/she:
a) Is a Filipino citizen;
b) Is of good moral character;
c) Is a holder of the degree of BSA conferred by a school, college,
academy or institute duly recognized and/or accredited by the CHED
or other authorized government offices; and
d) Has not been convicted of any criminal offense involving moral
turpitude.
4. What are the requirements that a CPA in public practice must comply with
before he is issued a certificate of accreditation by the Board of Accountancy?
Answer: Refer to page 110 (Section 28 of the Philippine Accountancy Act of 2004)
of the textbook.
Answer:
1. Communication Skills
2. Leadership Skills
3. Critical-/Thinking and Problem-Solving Skill
4. Anticipating and Serving Evolving Needs
5. Synthesizing Intelligence to Insight
6. Integration and Collaboration
Answer:
10. How may a professional accountant develop and sustain the required
capabilities and competence after admission to the profession?
Answer:
This is brought about by the nature of accounting standards and the demand
for accounting-related information which have changed in several
significant ways. These changes include:
Global Harmonization of Accounting Standards
Expanded Accountability
More Detailed Reporting
Increased Risk Reporting
Global Audit Standards
Answer:
Additional Questions:
15. What are the 5 different areas that a professional accountant’s mindset
needs to embrace? Page 17 of the Text.
Answer:
18. What are the 10 Insights and Directions that the research project
conducted by AICPA in 2011 entitled “CPA Horizons 2025”, cited?
CHAPTER 2
2. Describe the role of the various organizations that affect the practice of the
accounting professionals in the Philippines?
5. Give and explain briefly the most sought-after assurance services among
professional accountants.
Answer: Page 36 of the textbook
The following are the most sought - after services among professional
accountants.
A. Assurance Services. Examples are:
1. Independent financial statement audit
2. Reviews
3. Other assurance services (e.g., CPA Web Trust, Business Performance
Measurement Service)
B. Non-Assurance Services. Examples are:
1. Agreed-upon procedures
2. Compilation
3. Tax
4. Management consultancy/advisory services
5. Accounting and data processing
6. Other non-assurance services (e.g., Information Technology System
Services)
Answer:
Answers:
14.Give and explain briefly at least five (5) initiatives to address the credibility
crisis in the accountancy profession?
15. What are the 2 types of assurance engagements under the Philippine
Framework for assurance engagements? Explain Each?
Cases
(b) Suitable criteria are those that are objective and permit reasonably
consistent measurements. In addition, the criteria must be sufficiently
complete such that no relevant factors are omitted that would affect a
conclusion about the subject matter. Finally, the criteria must measure
some characteristic of the subject matter that is relevant to a user’s
decision.
OVERVIEW OF AUDITING
Answer: 65/67
Answer:
The rules of accounting are the criteria used by the auditor for evaluating
the presentation of economic events for financial statements and he or she
must therefore have an understanding of Philippine Financial Reporting
Standards (PFRS), as well as Philippine Standards on Auditing (PSA).
The accountant need not, and frequently does not, understand what
auditors do, unless he or she is involved in doing audits, or has been trained
as an auditor.
4. What are major differences in the scope of audit responsibilities for CPAs,
COA auditors, BIR agents, and internal auditors?
Answer:
The major differences in the scope of audit responsibilities are:
1. CPAs perform audits in accordance with Philippine Standards on
Auditing of published financial statements prepared in accordance
with identified and applicable Statements of Financial Accounting
Standards.
2. COA auditors perform compliance, financial or operational audits in
order to assure the Congress of the expenditure of public funds in
accordance with its directives and the law.
3. BIR agents perform compliance audits to enforce the tax laws as
defined by Congress, interpreted by the courts, and regulated by the
BIR law.
4. Internal auditors perform compliance, management or operational
audits in order to assure management or the board of directors that
controls and policies are properly and consistently developed,
applied and evaluated.
5. Discuss the major factors in today’s society that have made the need for
independent audits much greater than it was fifty years ago?
Answer:
6. Identify the major causes of information risk and identify the three main
ways information risk can be reduced. What are the advantages and
disadvantages of each?
Answer:
The four primary causes of information risk are remoteness of information,
bias in motives of the provider, voluminous data, and existence of complex
exchange transactions.
Advantages Disadvantages
User verifies 1. User obtains 1. High cost of
information information obtaining
desired. information.
2. User can be 2. Inconvenience
more confident to the person
of the providing the
qualifications information
and activities of because large
the person number of users
getting the would be on
information. premises.
Users share 1. No audit costs 1. Users may not be
information incurred. able to collect
risk with on losses.
manage-
ment
Audited 1. Multiple users 1. May not meet
financial obtain the needs of certain
statements information. users.
are prepared 2. Information risk 2. Cost may be
can usually be higher than the
reduced benefits in some
sufficiently to situations, such
satisfy users at as for a small
reasonable company.
cost.
3. Minimal
inconve-nience
to
management
by having only
one auditor.
7. Explain what is meant by information risk and discuss the four causes of this
risk?
Answer:
Information risk is the possibility that information upon which a business
decision is made is inaccurate. Four causes of information risk are:
remoteness of information,
biases and motives of the provider,
voluminous data, and
complex exchange transactions.
8. Discuss the three primary ways users of information can reduce risk? Same
as question number 6.
Answer:
Three primary ways users of information can reduce information risk are:
users can verify the information themselves,
users can share information risk with management, and
users can obtain audited financial statements.
9. Discuss four factors that are likely to significantly reduce information risk in
the next five to ten years?
Answer:
Four factors that are likely to significantly reduce information risk in the next
five to ten years are:
technological advances,
more companies will go on–line, reducing the risk of investors
obtaining outdated information,
new accounting and auditing standards, and
auditors will find more efficient and effective audit techniques.
Answer:
11. Describe several business situations that would create a need for a report
by an independent public accountant concerning the fairness of a
company’s financial statements
Answer
A report by an independent public accountant concerning the fairness of
a company’s financial statements is commonly required in the following
situations:
(1) Application for a bank loan.
(2) Establishing credit for purchase of merchandise, equipment, or other
assets.
(3) Reporting operating results, financial position, and cash flows
to absentee owners (stockholders or partners).
(4) Issuance of securities by a corporation.
(5) Annual financial statements by a corporation with securities listed on
a stock exchange or traded over the counter.
(6) Sale of an ongoing business.
(7) Termination of a partnership.
Answer:
13. The overall risk of the investment in a business includes both business risk
and information risk. Contrast these two types of risk. Which one is most
directly affected by the auditors?
Answer:
Business risk is the risk that the investment will be impaired because a
company invested in and is unable to meet its financial obligations due to
economic conditions or poor management decisions. Information risk is the
risk that the information used to assess business risk is not accurate. Auditors
can directly reduce information risk, but have only limited effect on business
risk.
14. What does an operational audit attempt to measure? Does an operational
audit involve more or fewer subjective judgments than a compliance audit
or an audit of financial statements? Explain. To whom is the report usually
directed after completion of an operational audit?
Answer:
An operational audit attempts to measure the effectiveness and efficiency
of a specific unit of an organization. It involves more subjective judgments
than a compliance audit or an audit of financial statements because the
criteria of effectiveness and efficiency of departmental performance are
not as clearly established as are many laws and regulations or financial
reporting standards.
15. Evaluate the following quotation: “Every business, large or small, should
have an annual audit of a CPA firm. To forgo an audit because of its cost
is false economy:
Answer:
The first quoted sentence overstates the case. Although annual audits by
CPA firms are universal practice for large corporations, they are not
essential to many small businesses. The financial statements of large
corporations go to many stockholders (often hundreds of thousands) who
demand the assurance of reliability supplied through independent audits
by CPA firms. Moreover the SEC and the stock exchanges require that listed
companies have annual audits.
For a small business concern, the primary need for annual financial
statements is to support an application for a bank loan. If a small business
does not need to borrow, or can obtain borrowed funds without providing
audited statements, the cost of an audit may not be justified.
Often a small business can obtain from a CPA firm specialized services other
than an audit, which are more useful and may cost less. Examples are the
review or compilation of financial statements, installation of a computer
based accounting system, or a study of internal control. Thus, the second
quoted sentence, as well as the first, is too sweeping to be correct. A
decision not to have an audit is not always “false economy.”
Required:
Answer:
(b) A bank loan officer may insist that a prospective borrower provide
audited financial statements. This provides assurance that the data in
the financial statements have been examined by independent
competent persons.
18. Discuss the similarities and differences between the roles of independent
COA auditors, BIR agents and internal auditors?
Answer:
Answer:
Answer:
Answer:
1) Compliance Audit
Compliance audit is the evaluation of the degree of compliance with laws,
regulations and managerial policies and operating procedures in the
agency, including compliance with accountability measures, ethical
standards and contractual obligations. This type of audit is a necessary first
step to, and part of, management and operations audits.
2) Management audit:
Management Audit is a separate evaluation of the effectiveness of
internal controls adapted in the operating and support services
units/systems to determine whether they achieve the control objectives
over a period of time or as of a specific date. It includes the
determination of the degree of compliance with laws, regulations,
managerial policies, accountability measures, ethical standards and
contractual obligations covering specific timeframes.
Management Reviews are conducted any time prior to, during or after
the implementation of the processes.
3.Operations Audit:
CHAPTER 4
1.
2.
3.
Answer:
4.
Answer:
Examples of typical lawsuits against CPAs are
a) Alleged misstatements that the auditor did not detect in the financial
statements involving
1) improper or inadequate disclosure
2) inappropriate valuations
b) Alleged failure to detect defalcation as a result of negligence in the
conduct of the audit
c) Alleged failure to complete the audit on the agreed-on date
d) Alleged inappropriate withdrawal from an audit
5.
Answer:
6.
7.
Answer:
PSA 260 (Clarified), “Communication with Those Charged with
Governance” deals with the auditor’s responsibility to communicate with
those charged with governance in relation to an audit of financial
statements. Although this PSA applies irrespective of an entity’s
governance structure or size, particular considerations apply where all of
those charged with governance are involved in managing an entity, and
for listed entities. This PSA does not establish requirements regarding the
auditor’s communication with an entity’s management or owners unless
they are also charged with a governance role.
8.
Answer:
9.
Answer:
Due (professional) care is the standard by which the courts and the
profession expect a CPA to practice. A CPA who is found to have
exercised due professional care in an engagement should not have any
liability to others.
10.
Answer:
11.
12.
Answer: Refer to page 126 of the textbook.
13.
Answer: Most courts have held that an auditor has a higher responsibility to
communicate information beyond that required by PFRSs and PSAs. Courts
have held that compliance with PFRSs is persuasive but not conclusive
evidence.
14.
Answer:
An auditor should (a) follow the Philippine Standards on Auditing, the Code
of Ethics for Professional Accountants in the Philippines, and where
appropriate, PFRSs; (b) establish and follow appropriate quality control
procedures; (c) evaluate whether a client has the necessary integrity and
appropriate reputation in the community; (d) evaluate carefully why a
client wants an audit; (e) conduct the audit with appropriate professional
skepticism; (f) provide for appropriate levels of consultation for issues; and
(g) provide for appropriate review of the audit.
15.
Answer: The prudent man concept states that a man is responsible for
conducting a job in good faith and with integrity, but is not infallible.
Therefore, the auditor is expected to conduct an audit using due care, but
does not claim to be a guarantor or insurer of financial statements.
Answers
CHAPTER 5
CODE OF ETHICS FOR PROFESSIONAL ACCOUNTANTS
IN THE PHILIPPINES
1. Why is there a need for ethical behavior for professionals? Why do the
ethical requirements of the CPA differ from other professionals?
Answer:
Answer:
Activities which may not affect independence in fact, but which are likely
to affect independence in appearance are: (Notice that the first two are
violations of the Code of Ethics.)
1. Ownership of a financial interest in the audited client.
2. Directorship or officer of an audit client.
3. Performance of management advisory or bookkeeping or
accounting services and audits for the same company.
4. Dependence upon a client for a large percentage of audit fees.
5. Engagement of the CPA and payment of audit fees by
management.
3. What do the principles of the Code imply about a CPA’s obligation toward
the public interest?
Answer:
In return for the faith placed in CPAs by the public, CPAs should continually
seek to demonstrate their dedication to professional excellence. The
public interest is defined as the community’s collective well-being. CPAs
handle ethical conflicts best by acting with integrity, objectivity, and due
professional care and by having a genuine interest in serving the public.
Answer:
5. Why might the rule “Let conscience be your guide” not be sufficient basis
for your personal ethics decision?
Answer:
7. What ethical responsibilities do CPAs have for acts of non-CPAs who are
under their supervision (e.g. recent college graduates who are not yet
CPAs)?
Answer:
Answer:
10. Three months ago, a national CPA firm hired Gary Angeles to work as a
staff auditor in its Cebu office. Yesterday Angeles’ father was hired to be
the chief financial officer of one of the CPA firm’s Cebu clients. Has the
independence of the CPA firm with respect to this client been impaired?
Answer:
11. Alex Ybanez is a CPA who often serves as an expert witness in court cases.
Is it proper for Ybanez to receive compensation in a damage suit based on
the amount awarded to the plaintiff? Discuss
Answer:
12. Lea Sanchez, wife of Juan Sanchez, CPA, is a life insurance agent. May
Juan Sanchez refer audit clients needing officer life insurance to Lea
Sanchez or to another life insurance agent who will share a commission with
Lea Sanchez? Explain.
Answer: Sanchez may only refer certain clients to his wife or to another life
insurance agent who will share such a commission with his wife provided
that he does not perform assurance as well as nonassurance services.
*7.A fee for audit clients which is dependent upon the results achieved by the
CPA’s efforts is a contingent fee and is prohibited for audit clients.
Cases
Answers:
2. Impress Mike Hernan (and the board of directors) that they must be
able and willing to accept primary responsibility for the financial
statements as their own, and
3. Not take managerial responsibility for conducting operations of the
Hernan Corporation (although Benitez’s supervision of the
bookkeeper seems to have this characteristics), and
4. Conduct the audit in conformity with PSA and not fail to audit records
simply because they were processed under Benitez’s supervision.
e. Interpretation
Still not enough. The grandfather (either Jack’s father or his father-in-
law) is considered a nondependent close relative, but the appearance
of independence is impaired. The grandfather’s investment is material
(50 percent) in relation to his net financial resources.
Answers:
2. a. Pee and Co. / United Furniture, Inc.: This is a judgment call. In this case,
the services can be considered temporary, mechanical in nature and
performed on a one-time emergency basis. For these reasons, the SEC
would probably not consider independence impaired.
b. Renson & Co. / Spectrum Corporation Laser Division: The SEC would
consider independence impaired because of the extent of the
bookkeeping services and the relative size of the Division. The only
solution that might work is to have another accounting firm audit the
Laser Division financials so that Renson & Co. can write a report “in
reliance on the work of other independent auditors.”
c. Reyes & Co. / Valley Bank: The SEC would consider independence
impaired because of the family relation of Annabelle, her connection
with Valley’s financial statements and the fact that Kris is a “member”
(partner) in the audit firm. (The PICPA would probably also consider
independence impaired because of the apparent closeness of the two
sisters and the “audit sensitivity” of Annabelle’s job).
d. Cruz & Reyes / Jonas Tomas / Starex Money Market Fund: Jonas is a
“member” since he is a manager and will provide audit services to
SMMF. Cruz & Reyes’ independence is impaired since Jonas holds a
direct financial interest.
Answer:
Since Bella had an employment relationship with the client during part of
the period covered by the financial statements, her independence is
impaired.
Answer:
Answer:
5. Although her decision will not be popular with the audit staff, Tracy Ong
should thank the client but decline the offer, both for her and for the staff.
She should explain that an outsider who had knowledge of all of the
relevant facts might view the free use of a condominium as a sizable “gift”
to the auditors, which might influence their independent mental attitude.
Thus, we believe that to maintain an appearance of independence, the
auditors should not accept this offer.
Answer
6. No. CPAs may refuse client access to their working papers for any valid
business purpose. Therefore, a CPA may require that fees be paid before
working papers including such adjusting entries and supporting analysis are
provided to the client.
Answers:
7. The answers provided in this section are based on the assumption that the
traditional legal relationship exists between the CPA firm and the third party
user. That is, there is no privity of contract, the known versus unknown third
party user is not a significant issue, and high levels of negligence are
required before there is liability.
a. False. There was no privity of contract between Tan and Cañada,
therefore, ordinary negligence will usually not be sufficient for a
recovery.
b. True. If gross negligence is proven, the CPA firm can and probably
will be held liable for losses to third parties.
c. True. See a.
d. False. Gross negligence (constructive fraud) is treated as actual
fraud in determining who may recover from the CPA.
e. False. JC is an unknown third party and will probably be able to
recover damages only in the case of gross negligence or fraud.
Answer
8. Yes. Normally a CPA firm will not be liable to third parties with whom it has
neither dealt nor for whose benefit its work was performed. One notable
exception to this rule is fraud. When the financial statements were
fraudulently prepared, liability runs to all third parties who relied upon the
false information contained in them. Fraud can be either actual or
constructive. Here, there was no actual fraud on the part of Dantes or the
firm in that there was no deliberate falsehood made with the requisite intent
to deceive. However, it would appear that constructive fraud may be
present. Constructive fraud is found where the auditor’s performance is
found to be grossly negligent. That is, the auditor really had either no basis
or so flimsy a basis for his or her opinion that he or she has manifested a
reckless disregard for the truth. Dantes’ disregard for standard auditing
procedures would seem to indicate such gross negligence and, therefore,
the firm is liable to third parties who relied on the financial statements and
suffered a loss as a result.
Answers:
9. a. Yes. Carlos was a party to the issuance of false financial statements and
as such is a joint tortfeasor. The elements necessary to establish an
action for common law fraud are present. There was a material
misstatement of fact, knowledge of falsity (scienter), intent that the
plaintiff bank rely on the false statement, actual reliance, and damage
to the bank as a result thereof. If the action is based upon fraud there is
no requirement that the bank establish privity of contract with the CPA.
Moreover, if the action by the bank is based upon ordinary negligence,
which does not require a showing of scienter, the bank may recover as
a third-party beneficiary (an exception to the strict privity requirement).
Thus, the bank will be able to recover its loss from Carlos under either
theory.
b. No. The lessor was a party to the secret agreement. As such, the lessor
cannot claim reliance on the financial statements and cannot recover
uncollected rents. Even if he or she was damaged indirectly, his or her
own fraudulent actions led to his or her loss, and the equitable principle
of “unclean hands” precludes him or her from obtaining relief.
c. Yes. Carlos had knowledge that the financial statements did not follow
financial reporting standards and willingly prepared an unqualified
opinion. The financial statements were not in accordance with financial
reporting standards. That is a criminal act because there was an intent
to deceive.
Answers:
10. a. Base, Umapas & Cañada is potentially liable to its client because of the
possible negligence of its agent, the in-charge accountant on audit, in
carrying out duties that were within the scope of his or her employment.
Should there be a finding of negligence, liability would be limited to
those losses that would have been avoided had reasonable care been
exercised.
standard; that is, that the accountant perform his or her duties with the
actions by the in-charge accountant would have disclosed the fraud. If both
lack of due care and causation are established, recovery for negligence will
Answer:
It appears that the three deficiencies in the audit by Gonzales & Esteban
might be sufficient to satisfy either approach. Failure to check the
existence of certain receivables, collectibility of other receivables, and
existence of security investments, taken collectively if not individually,
appear to show a reckless disregard for the truth by the auditor. In fact, the
audit probably lacks sufficient competent evidential matter as a
reasonable basis for an opinion regarding the financial statements under
examination.
Answer:
12.Corpuz has stated that the CPA firm has “reviewed the books and records
of Flores Ventures,” when in fact no such “review” has occurred. A “review”
of financial statements consists of limited investigatory procedures
designed to provide statement users with a limited degree of assurance
that the financial statements are in conformity with financial reporting
standards. Corpuz’s actions are similar to issuing an auditors’ report without
first performing an audit. Such an action may well be considered an act of
criminal fraud, intended to mislead users of the financial statements. If the
financial statements of Flores Ventures turn out to be misleading, there is
little doubt that any court would find the CPA firm guilty of at least
constructive fraud and liable to any third party who sustains a loss as a result
of reliance upon the statements.
The fact that Corpuz violated Vasquez’s policy of submitting all reports for
Vasquez’s review would not lessen the CPA firm’s liability. The concept of
mutual agency allows Corpuz, as a partner, to commit the firm to contracts,
including auditors’ reports and accountants’ reports. The fact that this
report was not submitted for Vasquez’s review might be introduced as
evidence against Corpuz in the event he is accused of criminal fraud.
Answers
(2) The prospects for Manila’s recovery of its P30,000 loss are substantially
less than those of Beta. Manila was not a third-party beneficiary to the
contract. Thus, in many jurisdictions following Ultramares, Manila cannot
recover losses attributable to the CPAs’ ordinary negligence. Similarly, it
is doubtful that Manila would qualify as a foreseen third party as
necessary under the Restatement approach. Even in a jurisdiction
accepting the Rosenblum precedent, which allows third parties to
recover losses caused by the auditors’ ordinary negligence, Manila
would have to prove that it was a “foreseeable third party relying upon
the financial statements for routine business purposes.” It is questionable
whether the loan by Manila was either “reasonably foreseeable” or
“routine,” as Manila was a customer of Mega, not a lender.
CHAPTER 6
MANAGEMENT OF A
PUBLIC ACCOUNTANCY PRACTICE
Questions and Answers:
1. What is the “special function” that auditors perform? Whom does the
public accounting profession serve in performing this special function?
Answer:
2. How does complexity affect (a) the demand for auditing services and (b)
the performance of auditing services?
Answer:
Complexity affects the demand for auditing services in that both users and
management need the expertise of professionals who understand the
underlying economic substance of transactions and financial instruments
and, thus, who have the ability to determine the appropriate accounting
best to "fairly" portray the economic substance of an organization's
activities and financial condition.
3. Are small, local CPA firms that serve only small business and other local
clients subject to the same auditing and accounting standards as the large
international CPA firms?
Answer:
For the most part, local CPA firms are subject to the same auditing and
accounting standards as the large international CPA firms. The differences
relate to whether the audit firms have (a) public clients, or (b) international
clients. If a firm has public clients, then the firm is subject to the standards
of the The Public Company Accounting Oversight Board PCAOB. If a firm
has clients that are domiciled in other countries, then they should utilize
international auditing standards. If the audit firm only has non-pubic clients,
then they are subject to auditing standards promulgated by the PICPA.
Answer:
In some cases, the network can be a network of firms that are not otherwise
affiliated. In other cases, the network firms all operate under one common
name, e.g. Grant Thornton International.
Answers:
a. Professional skepticism represents a state of mind that is
characterized by appropriate questioning and a critical assessment of
audit evidence. When employing professional skepticism, auditors will not
simply accept all evidence provided and assume that clients are
unquestionably honest. However, the statement that “you really have to
question everything the client tells you” is a bit exaggerative and goes
beyond the concept of professional skepticism.
Cases
Answers:
1. (1) Auditing does not involve the creation of goods. However, it does serve
a worthwhile purpose in our society because it enhances the flow of
reliable financial information needed to conduct commerce in our
economy. It also assists in the conduct of government by providing
reliable information for tax purposes and regulatory purposes. Audits
have been legally mandated to ensure objective information. However,
research has indicated that audits would be required even if not
mandated. The initial audits performed in conjunction with the
settlement of the new world arose because of owners' need to have an
independent assessment of the returns earned by their managers.
(2) The accounting profession did provide early warning signals of the
potential problems within many industries. However, it clearly failed in other
areas. Some of the problems were related to the impreciseness of
accounting principles (e.g. Enron) while others were more closely related
to regulatory failures (e.g. Savings & Loan Industry). However, many of the
failures were due to systematic problems in the accounting profession that
has been addressed by Sarbanes-Oxley (often shortened to SOX) is
legislation passed by the U.S. Congress to protect shareholders and the
general public from accounting errors and fraudulent practices in the
enterprise, as well as improve the accuracy of corporate disclosures.
(3) Finding fraud may be important. However, many misstatements that are
made in conjunction with an organization's financial statements are not
intentional but are simply the result of errors. The audit function is designed
to detect material misstatements -- whether they are due to errors or fraud.
Thus, the audit function is actually broader than the colleague had desired.
Ensuring that a financial statement contains no material misstatements also
ensures that the auditor addresses the likelihood that material fraud may
also have occurred.
(5) PFRS represents rules and conventions that are acceptable at one point
in time. Much of the diversity in accounting principles is necessary to
reflect real economic differences between organizations and the types
of transactions in which the organization is engaged. Beyond this
argument, differences such as Weighted Average / FIFO accounting
have evolved over the years. The profession attempts to mitigate the
potential problems associated with the diversity by providing disclosure
of the differences and by developing other procedures to make it
difficult for firms to change accounting principles. Thus, the financial
statements of a company should be comparable over a period of time.
(6) It seems that this individual really wants to have a career in auditing.
External auditing has changed; in today's environment, the auditor must
thoroughly understand a company's business in order to audit it. A key
function of internal auditors is to add value through their
recommendations.
Answers:
CHAPTER 7
Cases
a)
1. Supervision;
2. To ensure that work performed meets the firm’s standard of quality;
3. Staff personnel are to follow firm guidelines for working paper
development.
b)
1. Inspection / Review;
2. To verify that quality control procedures are being followed;
3. Inspect that audit programs for all engagements are being complied
with.
c)
1. Acceptance and retention of clients;
2. To minimize the risk associated with clients;
3. New clients must be investigated by a private investigative agency.
d)
e)
f)
1. Skills and Competence;
2. To ensure that in-charge accountant must have passed the CPA
examination;
c. Has a certificate of registration and professional identification card from
PRC.
g)
1. Skills and Competence;
2. To ensure that personnel continue to be updated on changes in
accounting or auditing standards;
3. Personnel will participate in forty hours of continuing education per year.
h)
1. Assigning personnel to engagements
2. To ensure that personnel posses the degree of technical training and
proficiency required for an engagement.
3. Personnel have participated in forty hours of continuing education per
year.
i)
1. Independence;
2.To ensure that personnel meet PICPA guidelines for independence;
3. Firm personnel must list their investments. Personnel must report any stock
acquisitions.
If Kristoffer dela Cruz will not agree to such explanation, and insist on his
demand that only persons who graduated from his alma mater will be
assigned in the proposed audit engagement, Gwen Salcedo after thorough
discussion with his Audit Partners will have to decline the proposed audit
engagement because of the reasons cited above.
CHAPTER 8
Answer:
Foreign public accounting firms have found that to retain their multinational
clients, they have had to develop the capacity to provide services
worldwide. Although the roots of at least two of the big firms in the United
States are traceable to European ancestry, public accounting firm
involvement in international activities has paralleled the gradual
involvement of businesses in international activities. In the early 1900s, some
public accounting firms established representative offices in foreign
countries. As business activity expanded, the firms opened offices in foreign
cities. During the 1970s, some countries forced these firms to close their
offices. To be able to serve their clients, the firms established correspondent
relationships with locally owned accounting firms; in these relationships,
local partners remain separate, local, autonomous organizations. Because
domestic and foreign partners in a correspondent relationship agree to
follow a common code of ethics and practice guidelines, each is able to
rely on the work the other performs. A big firm auditing a U.S. business with
significant activities in France, for example, would rely on its Paris office to
audit the activities of the business in France.
Answer:
Answer:
Answer:
Answer:
Answer:
Cases
1. The PICPA currently develops independence and ethical standards, quality
control standards, and auditing and attestation standards that apply to its
members. However, PICPA standards are applicable to the audits and
auditors of nonpublic clients based on general acceptance by the courts,
and adoption by state boards of accountancy and other regulatory
bodies. The AICPA also has a voluntary peer review program, and enforces
its standards on its members.
The PCAOB (Public Company Accounting Oversight Board) was given the
legal authority to develop independence and ethical standards, quality
control standards, and auditing and attestation standards that apply to
public company auditors and integrated audits. The PCAOB also is
charged with performing inspections of registered audit firms, and may
sanction the firms for noncompliance with its standards and the provisions
of Sarbanes-Oxley Act.
The state boards of accountancy regulate CPA firms and CPAs in the
various states and jurisdictions. They have the authority to establish their
own standards, but have generally adopted the standards of other bodies
such as the PICPA and the PCAOB. A state board enforces its standards in
its state or jurisdiction and has the authority to revoke a CPA firm or
individual CPA’s right to practice in the state.
3. (a) When the auditors discover illegal acts by a public client, they should
consider three major factors. First, the auditors should consider the
effect of the acts on the client's financial statements, including the
possibility of fines and loss of business. To comply with the applicable
reporting framework, the financial statements must reflect the material
effects of illegal acts.
Second, the illegal acts may affect the auditors' assessment of the
integrity of management. In deciding whether to continue to serve the
client, the auditors should consider the nature of the illegal acts and
management's response to the acts after they are uncovered.
Third, the auditors should consider whether the occurrence of the illegal
act indicates that there is a material weakness in the company’s internal
control over financial reporting.
(c) We believe that the auditors should consider withdrawing from the
engagement. Generic's top management seems far too complacent
regarding these activities. Their refusal to take any action to prevent the
acts in the future provides a signal to lower level management that top
management approves of illegal acts. The auditors clearly should
question the integrity of management in this situation.
Dear Jenny:
As much as I support your strenuous efforts to minimize air and water
pollution from the manufacturing operations of your company, there are
specific reasons which make it impossible for me as a CPA to attest to the
extent of your accomplishments in this area along the lines you have
suggested. When we perform the attest function with respect to your
financial statements each year, we are expressing our professional opinion
that your financial statements are prepared in conformity with certain
standards, or applicable reporting framework.
In order for us to attest to the effectiveness of your pollution control
program, recognized standards would have to be established in this field.
No such standards presently exist for a factory to the best of my knowledge.
Of course the national government has set standards for exhaust emissions
on automobile engines and we could, by retaining independent consulting
engineers, obtain a basis for attesting to the compliance of a given
automobile engine to those standards.
We are quite willing to extend the attest function in various directions
if we can find a basis for objective comparison of a given operation with a
clearly defined standard. Perhaps your engineering department can
develop some specific quantitative data on the industrial waste from your
operations. We might then be able to perform the necessary examination
of such data to enable us to attest to the validity of your representations as
to your operations. Of course, this would not be the same thing as providing
your relative position in the industry. After reviewing this possibility with your
engineering staff, if you would like to discuss the matter further with us, we
will be glad to meet with you.
Sincerely,
Alice Borromeo
CHAPTER 9
OVERVIEW OF RISK-BASED
AUDIT PROCESS
Answer:
Answer:
An engagement letter is sent to the client by the auditors to make clear the
nature of the engagement, any limitations on the scope of the audit, work
to be performed by the client's staff, and the basis for computing the
auditors' fee. The engagement letter represents the written contract for the
engagement, and its primary objective is to prevent possible
misunderstandings between the client and the auditors. It constitutes an
executory contract between the auditors and the client.
Answer:
4. Criticize the following statement. Throughout this audit, for all purposes we
will define a “material amount” as “P500,000”.
Answer:
Answer:
The two types of misstatements due to fraud are (1) misstatements arising
from fraudulent financial reporting, and (2) misstatements arising from
misappropriation of assets (sometimes referred to as defalcation).
Fraudulent financial reporting is of more concern to the auditors because it
typically results in effects that are much more material to the financial
statements. Defalcations often are not material to the financial statements.
6. Many CPA firms are taking a business risk approach to audits. Define what
is meant by business risk? Provide an example of a business risk that could
result in a risk of material misstatement of the financial statement?
Answer:
Answer:
8. “An audit program is desirable when new staff members are assigned to
an engagement, but an experienced auditor should be able to conduct
an audit without reference to an audit program.” Do you agree? Discuss.
Answer:
Answer:
10.Certain audit risks are significant in that they require special audit
consideration. Describe the typical characteristics of this risk?
Answer:
Answer:
12.What problems are created for a CPA firm when audit staff members
underreport the amount of time spent in performing the specific audit
procedures?
Answer:
Underreporting of time results in the CPA firm not billing the client for all of
the time actually involved in rendering the professional services. 1) Thus,
the firm's revenue is being restricted. 2) In addition, the underreporting will
cause the firm to underestimate the amount of time required for future
engagements. 3) Thus, auditors on future engagements will be expected
to perform audit procedures in an unrealistically short period of time. 4) This
interferes with the performance of an effective audit as well as the realistic
evaluation of firm personnel.
Cases
1. a. Prior to acceptance of the engagement, Argante & Tan should have
communicated with the predecessor auditor regarding:
Facts that might bear on the integrity of management.
Disagreements with management concerning accounting
principles, auditing procedures, or other significant matters.
The predecessor’s understanding about the reason for the
change.
Any other information that may be of assistance in determining
whether to accept the engagement.
b. The form and content of engagement letters may vary, but they would
generally contain information regarding:
The objective of the audit.
The estimated completion date.
Management’s responsibility for the financial statements.
The scope of the audit.
Other communication of the results of the engagement.
The fact that because of the test nature and other inherent
limitations of any system of internal control, there is an
unavoidable risk that even some material misstatement may
remain undiscovered.
Access to whatever records, documentation, and other
information may be requested in connection with the audit.
Arrangements with respect to client assistance in the
performance of the audit engagement.
Expectation of receiving from management written confirmation
concerning representations made in connection with the audit.
Notification of any changes in the original arrangements that
might be necessitated by unknown or unforeseen factors.
Request for the client to confirm the terms of the engagement by
acknowledging receipt of the engagement letter.
The basis on which fees are computed and any billing
arrangements.
Analysis:
Special or unusual risk related to the prospect
Need for special skills (e.g., computer or industry expertise)
b. Students can decide this acceptance question either way, although the
brief facts prejudice the conclusion toward non-acceptance. The
CPA’s own firm decided to resign only 10 years ago, presumably over
matters of owner-manager integrity. Yet, Mr. Sello appears to be a
respected member of his new community. Maybe his “fast and loose”
accounting past is behind him. Maybe not.
5.
Answer:
1) The main objective of an independent audit is to express an
opinion whether the financial statements are prepared in all
material respects, in accordance with an identified financial
reporting framework.
Answer:
CHAPTER 10
1. Many CPA firms are taking a business risk approach to audits. Define what
is meant by business risk. Provide an example of a business risk that could
result in a risk of material misstatement of the financial statements.
Answer:
Answer:
Answer:
The purpose of the team meeting on fraud risk is designed to allow the more
experienced team members to share insights and exchange ideas about
how and where the entity’s financial statements might be susceptible to
material misstatement due to fraud, to discuss how to design appropriate
tests to detect the misstatements, and to emphasize the importance of
maintaining the proper degree of professional skepticism regarding the
possibility of fraud.
4. When planning an audit, the auditors must assess the levels of risk and
materiality for the engagement. Explain how the auditors’ judgments
about these two factors affect the auditors’ planned audit procedures.
Answers:
5.
Answers:
(a) Auditors must obtain an understanding of the client and its environment
in order to determine whether the client should be accepted and to
plan the audit. This understanding encompasses the following:
(c) Knowledge of the client and its environment helps the auditors in:
6.
Answer:
During the tour of the client's plant facilities, Sison inspects all inventory
areas and makes note of the location, types, security, "housekeeping," and
general condition of the inventories. He also visits the receiving and
shipping departments and reviews the types of documents maintained. His
observations in these areas enable him to form a preliminary impression of
the adequacy of internal controls for inventories, and possible problems
with respect to obsolete or slow-moving inventories. He also can begin
formulating plans for staffing and carrying out the physical inventory
observation.
Sison’s observation of the productive processes will acquaint him with the
client's physical plant facilities and layout, the nature of the products and
computer applications employed in the production process. He may also
obtain information on the client's documentation such as for production
orders, raw materials requisitioned to production, direct and indirect labor,
and inspection and testing of finished products. He meets the supervisory
personnel, engineers, and other key personnel responsible for production,
and through inquiries and conversations learns of any unique production
problems, including excessive spoilage and scrap. As a result, he will be in
a position to evaluate the client's cost accounting system during the course
of the audit. He will also inquire about the details of the client’s business
processes.
Throughout the tour, Sison will add to his impression of the client's business
processes, control procedures and accounting records. He will notice, for
example, what personnel have access to computer terminals and
accounting records, whether plant assets have identification tags, and
whether documents such as production orders and receiving reports are
serially numbered or controlled by the computer.
7.
Answers:
(b) The three conditions necessary for the commission of fraud include: (1)
some type of incentive or pressure, (2) an opportunity to commit the
fraud, and (3) an attitude that allows the individual to rationalize the act.
In a case of fraudulent financial reporting, members of top
management may have an incentive to commit the act relating to
maintaining the value of their stock options. They may have an
opportunity based on weaknesses in the corporate governance of the
organization. Finally, they may be able to rationalize the act by
assuming that the company will make enough income next period to
allow them to correct the misstatement.
(c) The auditors may respond to fraud risks by (1) a modification in the
approach having an overall effect on how the audit is conducted, (2)
an alteration in the nature, timing, and extent of the procedures
performed, and (3) performance of procedures to further address the
risk of management override of internal control.
8.
Amswer:
(a) Shin may respond to fraud risks in the following three ways:
(1) A modification in the overall approach to the audit which might
involve:
(a) Applying increased professional skepticism and designing
procedures that provide more reliable evidence.
(b) Assigning additional staff with specialized skill and knowledge or
by assigning more experienced staff to the engagement. Also the
extent of the supervision of the staff should be adjusted to reflect
the fraud risks.
(c) Giving further consideration to the appropriateness of the
accounting principles used by the client.
(d) Incorporating an added element of unpredictability in the
selection of auditing procedures.
(2) An alteration in the nature, timing and extent of the procedures
performed. For example, Shin might apply procedures that provide
more reliable evidence, shift more audit tests to year-end, or increase
sample sizes for certain substantive tests.
(3) Perform procedures to further address the possibility of management
override of internal control, including (1) examining journal entries
and other adjustments for evidence of fraud, (2) reviewing
accounting estimates for biases, and (3) evaluating the business
rationale for significant unusual transactions.
(b) Whenever the auditors believe that there is evidence that fraud may
exist, the matter should be brought to the attention of an appropriate
level of management. Fraud involving senior management and fraud
that causes a material misstatement of the financial statements should
be reported directly to the audit committee. In very serious situations
the auditors should consider resigning the engagement.
1. d 6. d
2. a 7. d
3. d 8. d
4. d 9. d
5. d 10. d
Answer:
1)
A)
(a)There is an increased risk of fraudulent financial reporting by subsidiary
management. More specifically, subsidiary management would likely
attempt to increase revenue or decrease expenses.
(b)The auditors would probably respond by performing more
procedures
at the subsidiary location. Additional tests of revenue would be performed
and the auditors would likely decide to observe inventory at year-end.
In addition, some of the procedures may be performed on
an
unannounced basis.
B)
(a) There is an increased risk of fraudulent financial reporting by
management related to revenue.
(b)The auditors would likely respond by utilizing more experienced audit
Team members. Specifically, audit staff that had experience with complex
Revenue contracts in the telecommunications industry. They would also
likely increase the extent of the substantive tests of revenue.
C)
(a) There is an increased risk that the futures traders will fraudulent
Overstate the value of the contracts to increase their compensation.
(b)The auditors would likely respond to this situation by bringing in a
specialist to assist in valuing the contracts. In addition, they would do
extensive testing of the valuation of the contracts.
D)
(a) There is an increased risk that management may be fraudulently
overstating income at one or more of the stores.
(b)The auditors would likely respond by doing increased testing of revenue
And inventory at the stores. The auditors could use the results of the
Analytical procedures to identify stores that are more likely to have
Fraudulent reported results (e.g., those with unusually high profit margins).
The auditors also may not disclose the locations that they intend to visit
for inventory observation.
2. Mr. Gian Lee
President
Palace Corporation
Our recent tour of Palace's plant was a most pleasant and interesting
experience. The information obtained on this tour and during the discussion
of your financial statements and accounting records has enabled us to
plan the scope of an audit especially suited to your needs.
Our fees are based on the time spent on the engagement by various
members of our audit staff, and will be billed at our established rates. The
total time required for an initial engagement is usually somewhat greater
than in repeat examinations, since the latter do not require analysis of past
years' transactions. Considerable savings in the cost of the audit may be
made by utilizing the services of your accounting staff to help us in certain
phases of the work. We can arrange for your employees to prepare for us
a number of working papers. If you approve, we shall indicate to your chief
accountant the exact nature of the working papers to be prepared.
We would like an opportunity during the next few days to discuss with you
and your chief accountant the nature of the preliminary work to be done by
your staff. We shall also be pleased to answer any further questions which
you may have concerning the determination of audit fees.
CHAPTER 11
Answer:
2. What are the primary and secondary reasons for conducting an evaluation
of an audit client’s internal control?
Answer:
Answer:
Answer:
Answer:
Answer:
Answer:
10.How does testing of internal controls help in the design of substantive audit
procedures?
Answer:
Answer:
The following factors may cause the auditor to decide not to test the
client’s internal financial controls beyond obtaining an initial
understanding:
a. Controls may already have been evaluated as ineffective;
b. Further testing is not cost effective (i.e., the cost of further testing is
greater than the cost savings resulting from reduced substantive
testing)
Answer
Answer:
substance alteration.
14.Give an example showing how a control weakness may lead to an
expansion of substantive audit procedures?
Answer:
committee?
Answer:
result of his/her study and evaluation of the client’s internal financial controls,
process, summarize, and report financial data consistent with the assertions
conditions letter is to inform the audit committee, or similar body within the
Answer:
Cases
1.
Answers:
a. Given identified financial control weaknesses, the auditor may elect to
expand the extent of substantive testing, or search for and test
compensating controls. In the present case, the following errors and
irregularities may occur, given the control weaknesses in the payroll
subset of the expenditure cycle:
1. Hours may be in error, inasmuch as the time cards are prepared
by employees and not reviewed. This could lead to
overstatement or understatement of wages expense in the
income statement. This could also affect the carrying value of
finished goods inventories if Quicky is a manufacturing company.
2. The payroll could be “padded” inasmuch as signed checks are
returned to the department supervisors for distribution. This could
result in overstatements of salaries and wages expense on the
income statement. It could also cause a finished goods inventory
overstatement.
b. If, based on the initial understanding, controls are thought to be
adequate, the auditor should consider the following alternatives:
1. Document the understanding, assess control risk below maximum,
as considered appropriate, and document the basis for
conclusions; or
2. Document the understanding and test controls as a means for
further reduction in the assessed level of control risk. This
alternative would be chosen if the following conditions exist:
a. Controls are thought to be effective; and
b. Cost reductions through reduced substantive testing
exceed cost of further testing of controls.
Answer:
ISLANDER DRUG STORE, INC.
Processing Cash Collections
Internal Control Questionnaire
Yes No
-Question
Are customers who pay by check
identified via store I.D. card or other
means?
Does company policy prohibit accepting
checks for anything except
merchandise sales plus a nominal cash
amount?
Is a receipt produced by the cash register
given to each customer?
Is the reading of each cash register taken
periodically by an employee who is
independent of the handling of cash
receipts?
Are cash counts made on a surprise basis
by an individual who is independent of
the handling of cash receipts?
Is the reading of each cash register
compared regularly to the cash
received?
Is a summary listing of cash register
readings prepared by an employee
who is independent of physically
handling cash receipts?
Are receipts forwarded to an
independent employee who makes
the bank deposits?
Are each day’s receipts deposited intact
daily?
Is the summary listing of cash register
receipts reconciled to the duplicate
deposit slips authenticated by the
bank?
Are entries to the cash receipts journal
prepared from duplicate deposit slips
or the summary listing of cash register
readings?
Are the entries to the cash receipts journal
compared to the deposits per bank
statement?
Are areas involving the physical handling
of cash reasonably safeguarded?
Are employees who handle receipts
bonded?
Are charged back items (NSF checks,
etc.) directed to an employee who
does not physically handle receipts or
have access to the books?
CHAPTER 12
FRAUD AND ERROR
Answer:
Answer:
Errors and irregularities: Auditors are required to plan the audit to detect
errors and irregularities that would have a material effect on the financial
statements.
Clients’ illegal acts: Auditors are not required to search for illegal acts, but
they are warned to be alert to any that might be detected in the ordinary
course of an audit.
3. List and briefly explain the seven major assertions that can be made in
financial statements and auditors’ objectives related to each.
Answers:
a. Existence assertion:
The practical objective is to establish with evidence that assets,
liabilities and equities actually exist and that sales and expense transactions
actually occurred. Cut-off can be considered an aspect of the existence
assertion.
b. Occurrence assertion:
The practical objective is to establish with evidence that recorded
transactions or events that occurred during a given accounting period
pertained to the entity.
c. Completeness assertion:
The practical objective is to establish with evidence that all transactions
of the period are in the financial statements and all transactions that
properly belong in the preceding or following accounting periods are
excluded. Another term for these aspects of completeness is cut-off.
e. Measurement assertion:
The practical objective is to establish with evidence that a transaction
or event is recorded at the proper amount and revenue or expense is
allocated to the proper period.
f. Valuation assertion:
The practical objective is to establish with evidence that proper
values have been assigned to things (assets, liabilities, equities and related
disclosures) and events (revenues, expenses and related disclosures).
Auditing Standards refer to the practical objective of obtaining evidence
about “valuations” achieved by cost allocations such as depreciation and
inventory costing methods.
Answer:
number.
Relative size.
No. If P500,000 is less than 5% of a relevant base.
Maybe. If P500,000 is between 5% and 10% of a
relevant base.
Answer:
Answer:
In assessing inherent risk and control risk, the auditor must consider the
types of errors or irregularities that might occur and their impact on the
financial statements (materiality.) In evaluating materiality, the auditor
should consider the impact of errors and irregularities both individually and
in the aggregate. Auditing Standards require that the auditor design the
audit to provide reasonable assurance of detecting errors and
irregularities that are material to the financial statements. Auditing
Standards require that audit risk and materiality be considered both in
planning the audit and in evaluating audit results.
Control risk and inherent risk are also directly related to the setting of
materiality thresholds. If, for example, application of analytical procedures
(inherent risk analysis) leads the auditor to suspect earnings inflation,
individual item materiality thresholds should be reduced accordingly (i.e.,
either the materiality percentage or the amount of unaudited income
should be decreased.) Similarly, if control risk analysis leads the auditor to
suspect numerous errors, aggregate materiality thresholds need to be
lowered accordingly.
Answer:
10. PSA 320 states that the auditor should consider materiality and its
relationship with audit risk when conducting an audit. Explain briefly the
relationship between materiality and audit risk.
Answer:
PSA 320 states… that materiality and audit risk are considered throughout
the audit, in particular, when:
(a) Identifying and assessing the risks of material misstatement;
(b) Determining the nature, timing and extent of further audit procedures;
and
(c) Evaluating the effect of uncorrected misstatements, if any, on the
financial statements and in forming the opinion in the auditor’s report.
Answer:
The factors that should be considered are the peso amount of the account,
the likelihood of error, and the cost of auditing the account.
12. At what point in the audit process does the auditor deal with inherent risk?
With control risk?
Answer:
The auditor deals with both inherent risk and control risk during the planning
phase of the audit. Inquiry of client personnel, study of the business and
industry, application of analytical procedures, and documentation of the
auditor’s initial understanding of internal control are all performed during
the planning phase of the audit. Further study of internal control
procedures may occur after the planning phase if the auditor wishes to
further reduce the assessed level of control risk, and considers it
economically feasible to do so.
Cases
1.
Answers:
b. The problem does not describe the kind of related party transactions
discussed in PSA 550.
d. The problem description indicates that this element of the audit was
conducted in a negligent manner. There’s nothing wrong about
auditing a sample of the transactions, but Campos’ follow-up and
explanation of the missing receiving reports leaves much to be desired.
At the very least he could have reviewed the reports produced by
Antonio at a later date, and he could have traced the purchases to the
inventory records and perhaps noticed an over-stocking condition. The
auditors had some evidence that an irregularity might exist, but they
failed to apply extended audit procedures properly.
2.
Answer:
a. Yes. Nicolas was a party to the issuance of false financial statements
and as such is a joint tortfeasor. The elements necessary to establish an
action for common law fraud are present. There was a material
misstatement of fact, knowledge of falsity (scienter), intent that the
plaintiff bank rely on the false statement, actual reliance and damage
to the bank as a result thereof. If action is based upon fraud there is no
requirement that the bank establish privity of contract with the CPA.
Moreover, if the action by the bank is based upon ordinary negligence,
which does not require a showing of scienter, the bank may recover as
a third-party beneficiary (an exception to the strict privity requirement).
Thus, the bank will be able to recover its loss from Nicolas under either
theory.
b. No. The lessor was a party to the secret agreement. As such, the lessor
cannot claim reliance on the financial statements and cannot recover
uncollected rents. Even if he was damaged indirectly, his own
fraudulent actions led to his loss, and the equitable principle of “unclean
hands” precludes him from obtaining relief.
CHAPTER 13
Answer:
In the past decade, all parties failed to a certain extent. For detailed
analysis, see exhibit in the chapter and repeated here:
Overview of Corporate
Party Overview of Responsibilities Governance Failures
Stockholders Broad Role: Provide effective Focused on short-term
oversight through election of prices; failed to perform
Board process, approve major long-term growth analysis;
initiatives, buy or sell stock. abdicated all responsibilities
to management as long as
stock price increased.
Answer:
The board of directors is often at the top of the list when it comes to
responsibility for corporate governance failures. Some of the problems
with the board of directors included:
Answer:
Answer:
Answer:
7. What is an audit committee? What critical role does the audit committee
play in corporate governance?
Answer:
Answer:
5) All adjustments that were not made during the course of the audit;
6) Difficulties in conducting the audit;
7) The auditor’s assessment of the accounting principles used and overall
fairness of the financial presentation;
8) The client’s consultation with other auditors;
9) Any consultation with management before accepting the audit
engagement;
10)Significant deficiencies in internal control.
Answer:
The auditor might utilize the following procedures in determining the actual
level of governance in an organization:
Cases
1.
Answer:
2.
Answer:
Overview of Corporate
Party Overview of Responsibilities Governance Failures
Stockholders Broad Role: Provide effective Focused on short-term
oversight through election of prices; failed to perform
Board process, approve major long-term growth analysis;
initiatives, buy or sell stock. abdicated all responsibilities
to management as long as
stock price increased.
3.
Answer:
Audit Activity to
Element of Poor Determine if Risk Implication of Poor
Corporate Governance Governance is actually Governance
Poor
The company is in the This is not necessarily The lack of good risk
financial services sector poor governance. management by the
and has a large number However, the auditor organization increases
of consumer loans, needs to determine the the risk that the financial
including mortgages, amount of risk that is statements will be
outstanding. inherent in the current misstated because of
loan portfolio and the difficulty of
whether the risk could estimating the
have been managed allowance for loan
through better risk losses. The auditor will
management by the have to focus increased
organization. efforts on estimating loan
losses, including a
comparison of how the
company is doing in
relation to the other
companies in the
financial sector.
The CEO and CFO’s This is a rather common In combination with
compensation is based compensation package other things, the use of
on three components: and, by itself, is not ‘significant stock options’
(a) base salary, (b) necessarily poor may create an incentive
bonus based on growth corporate governance. for management to
in assets and profits, and However, in combination potentially manage
(c) significant stock with other things, the use reported earnings in
options. of ‘significant stock order to boost the price
options’ may create an of the company’s stock.
incentive for
management to
Audit Activity to
Element of Poor Determine if Risk Implication of Poor
Corporate Governance Governance is actually Governance
Poor
potentially manage The auditor should
reported earnings in carefully examine if the
order to boost the price company’s reported
of the company’s stock. earnings and stock price
The auditor can differs broadly from
determine if it is poor companies in the same
corporate governance sector. If that is the case,
by determining the there is a possibility of
extent that other earnings manipulation
safeguards are in place and the auditor should
to protect the company. investigate to see if such
manipulation is
occurring.
The audit committee There is a strong indicator This is an example of poor
meets semi-annually. It is of poor corporate governance because (1)
chaired by a retired CFO governance. If the audit it signals that the
who knows the company committee meets only organization has not
well because she had twice a year, it is unlikely made a commitment to
served as the CFO of a that it is devoting independent oversight
division of the firm before appropriate amounts of by the audit committee,
retirement. The other time to its oversight (2) the lack of financial
two members are local function, including expertise means that the
community members – reports from both internal auditor does not have
one is the President of and external audit. someone independent
the Chamber of that they can discuss
Commerce and the There is another problem controversial accounting
other is a retired in that the chair of the or audit issues that arise
executive from a audit committee was during the course of the
successful local previously employed by audit. If there is a
manufacturing firm. the company and would disagreement with
not meet the definition of management, the audit
an independent committee does not
director. have the expertise to
make independent
Finally, the problems with judgments on whether
the other two members is the auditor or
that there is no indication management has the
that either of them have appropriate view of the
sufficient financial accounting or audit
expertise. issues.
The company has an The good news is that the The bad news is that a
internal auditor who organization has an staff of one isn’t
reports directly to the internal audit activity. necessarily as large or as
CFO, and makes an diverse as it needs to be
annual report to the to cover the major risks of
audit committee. the organization. The
Audit Activity to
Element of Poor Determine if Risk Implication of Poor
Corporate Governance Governance is actually Governance
Poor
external auditor will be
more limited in
determining the extent
that his or her work can
rely on the internal
auditor.
The CEO is a dominating A dominant CEO is not The centralization of
personality – not unusual especially unusual, but power in the CEO is a risk
in this environment. He the centralization of that many aspects of
has been on the job for 6 power in the CEO is a risk governance, as well as
months and has that many aspects of internal control could be
decreed that he is governance, as well as overridden. This
streamlining the internal control could be increases the amount of
organization to reduce overridden. The auditor audit risk.
costs and centralize should look at policy
authority (most of it in manuals, as well as
him). interview other members
of management and the
board – especially the
audit committee.
The Company has a loan The auditor should There are a couple of
committee. It meets observe the minutes of elements in this
quarterly to approve, on the loan committee to statement that carries
an ex-post basis all loans verify its meetings. The great risk to the audit
that are over $300 million auditor should also and to the organization.
(top 5% for this interview the chairman First, the loan committee
institution). of the loan committee to only meets quarterly.
understand both its Economic conditions
policies and its attitude change more rapidly
towards controls and risk. than once a quarter,
and thus the review is not
timely. Second, the only
loans reviewed are (a)
large loans that (b) have
already been made.
Thus, the loan committee
does not act as a control
or a check on
management or the
organization. The risk is
that many more loans
than would be expected
could be delinquent,
and need to be written
down.
Audit Activity to
Element of Poor Determine if Risk Implication of Poor
Corporate Governance Governance is actually Governance
Poor
The previous auditor has The auditor should This is a very high risk
resigned because of a contact the previous indicator. The auditor
dispute regarding the auditor to obtain an would look extremely
accounting treatment understanding as to the bad if the previous
and fair value factors that led the auditor resigned over a
assessment of some of previous auditor to either valuation issue and the
the loans. resign or be fired. The new auditor failed to
auditor is also concerned adequately address the
with who led the charge same issue.
to get rid of the auditor.
Second, this is a risk
factor because the
organization shows that it
is willing to get rid of
auditors with whom they
do not agree. This is a
problem of auditor
independence and
coincides with the
above identification of
the weakness of the
audit committee. This
action confirms a
generally poor quality of
corporate governance.
4.
Answer:
a&b. Cookie jar reserves are essentially funds that companies have
“stashed away” to use when times get tough. The rationale is that
the reserves are then used to “smooth” earnings in the years when
earnings needs a boost. “Smooth” earnings typically are looked
upon more favorably by the stock market. An example of a cookie
jar reserve would be over-estimating an allowance account, such
as allowance for doubtful accounts. The allowance account is
then written down (and into the income statement) in a bad year.
Auditors may have allowed cookie jar reserves because they are
known to smooth earnings, and smooth earnings are rewarded by
the market. On the flip side, fluctuating earnings are penalized, and
present more risk to the company of bankruptcy or other problems.
The Sarbanes-Oxley Act addressed the issue by creating an oversight
body, the PCAOB, but also addressed the issue in other ways. For
example, Congress felt that creating more effective Boards would
decrease the use of earnings management.
Allowing improper revenue recognition is one thing that auditors may
have done in their unwillingness to say “no” to clients. For example,
companies shipped out goods to customers at the end of the year
for deep discounts and allowed returns at the beginning of the next
year. This practice is known as channel stuffing. Since the goods had
a great chance of being returned, it would be improper to recognize
all as revenue.
deep discount-a large or greater than usual reduction in price or
substantially more than the normal discount.
Greed, the same reasons as the revenue recognition issue, was most
likely the motivation for this creative accounting.
Discussion between an educated audit committee and auditor plus
certification of financial statements required by Sarbanes-Oxley will
certainly address this issue.
Assisting management to meet earnings. Too often, auditors
confused ‘financial engineering’ with value-adding. In other words,
auditors often sought to add value to their clients by finding ways to
push accounting to achieve earnings objectives sought by
management. These earnings objectives then played a major role in
escalating stock prices – all desired because of the heavy emphasis
of management compensation on stock options.
Incentives were misaligned. Most of management compensation
came in the form of stock options.
5.
Answer:
b. The main way that the audit committee can influence the
independence of the internal audit department is by choosing who
is in charge of the department. The “tone at the top” in the internal
audit department will go a long way. Further, the audit committee
ought to approve the scope of the internal audit charter, approve
annual audit plans, as well as annual budgets.
CHAPTER 14
DESIGNING AN EFFECTIVE
Answer:
2. Explain how vouching differs from tracing, and identify the financial
statement assertions each can be used to test.
Answer:
Answer:
Answer:
Confirmations are usually considered more reliable because they are from
outside parties, while inquiries are made of client personnel.
Answer:
Cases
1.
Answer:
2.
Answer: