CH-14-17 Auditing The Financing/Investing Process: Prepaid Expenses, Intangible Assets, And Property, Plant, And Equipment – Auditing and Assurance Services: A Systematic Approach : Chapter Notes

This Document Contains Chapters 14 to 17 Chapter 14 Auditing the Financing/Investing Process: Prepaid Expenses, Intangible Assets, and Property, Plant, and Equipment Learning Objectives Review Questions Multiple- Choice Questions Problem s Discussion Cases Internet Assignments LO 14-1: Know the various types of prepaid expenses and deferred charges. 1,2 23 LO 14-2: Understand the auditor’s approach to auditing prepaid insurance. 1,3,4, 5 12 23 LO 14-3: Know the various types of intangible assets. 2,6,7 18 24 LO 14-4: Understand the auditor’s approach to auditing intangible assets. 24 LO 14-5: Develop an understanding of the property management process. 13,14,15 , 16,17,19 30,31 LO 14-6: Know the types of transactions in the property management process. 6 26 30,31 LO 14-7: Be familiar with the inherent risks for property, plant, and equipment. 7 LO 14-8: Assess control risk for property, plant, and equipment. 8 13,14, 15,16, 17,19,20 25,26 LO 14-9: Know the appropriate segregation of duties for property, plant, and equipment. 9 16,17 25 LO 14-10: Know the substantive analytical procedures used to audit property, plant, and equipment. 10 20 27,28 This Document Contains Chapters 14 to 17 LO 14-11: Know the tests of details of account balances and disclosures used to audit property, plant, and equipment. 11 19,20, 21,22 26,27, 28 29 30 LO 14-12: Understand how to evaluate the audit findings and reach a final conclusion on property, plant, and equipment. 26 29 31 NOTE: References to auditing standards in the instructor manual follow a similar convention to that followed in the text: AICPA standards will be referenced by clarified AU section and PCAOB standards will be referenced by Auditing Standard (AS) number. END OF CHAPTER MATERIALS COMPARISON CHART Number in 10th edition Comparison Number in 11th edition 14-1 Unchanged 14-1 14-2 Unchanged 14-2 14-3 Unchanged 14-3 14-4 Unchanged 14-4 14-5 Unchanged 14-5 14-6 Unchanged 14-6 14-7 Unchanged 14-7 14-8 Unchanged 14-8 14-9 Unchanged 14-9 14-10 Unchanged 14-10 14-11 Unchanged 14-11 14-12 Unchanged 14-12 14-13 Unchanged 14-13 14-14 Unchanged 14-14 14-15 Unchanged 14-15 14-16 Unchanged 14-16 14-17 Unchanged 14-17 14-18 Unchanged 14-18 14-19 Unchanged 14-19 14-20 Unchanged 14-20 14-21 Unchanged 14-21 14-22 Unchanged 14-22 14-23 Unchanged 14-23 14-24 Unchanged 14-24 14-25 Unchanged 14-25 14-26 Unchanged 14-26 14-27 Unchanged 14-27 14-28 Unchanged 14-28 14-29 Revised 14-29 14-30 Unchanged 14-30 14-31 Unchanged 14-31 Chapter 14 covers the audit of selected asset accounts associated in the financing/investing cycle: prepaid expenses, intangible assets, and property, plant, and equipment. [LO 14-1] Auditing Prepaid Expenses We normally point out that prepaid expenses are common “other assets” that have an economic life of less than a year. Assets providing economic benefit for more than one year are referred to as “deferred charges” or “intangible assets.” It is helpful to provide examples of items that fall into each category. We note that for many companies these asset accounts are not material and that analytical procedures can be used to verify the account balances. The text uses prepaid insurance as an example since most students have a good understanding of this account from their financial accounting class. Inherent Risk Assessment—Prepaid Expenses We tell the students that prepaid expenses do not involve any significant inherent risk and that it can usually be assessed as being low. Deferred charges and intangible assets, on the other hand, may represent serious inherent risk considerations because of valuation issues. Control Risk Assessment—Prepaid Expenses The students should note that prepaid expenses, deferred charges, and intangible asset transactions are typically processed through the purchasing process. For example, the control procedures in the purchasing process should ensure that new insurance policies are properly authorized and recorded. We mention that larger entities should have an insurance register to keep track of insurance policies and that an independent person should verify the adequacy of the entity's coverage. Lastly, there should be controls over the systematic allocation of prepaid insurance to insurance expense. [LO 14-2] Substantive Procedures—Prepaid Insurance We point out to the students that, on many engagements, analytical procedures can be used to verify prepaid insurance and insurance expense. Such analytical procedures include: • Comparing the current-year balance in prepaid insurance and insurance expense with the prior year's balances after considering any changes in operations. • Computing the ratio of insurance expense to assets or sales and comparing it with the prior year's ratio. • Computing an estimate of the ending prepaid account balance(s) using the current premium and the amount of time remaining on the policy at the end of the period. Tests of the prepaid insurance and insurance expense may be necessary when the auditor suspects misstatements based on prior audits or when analytical procedures indicate that the account balance may be misstated. We use Exhibit 14-1 to demonstrate to the students the steps that would be followed to audit prepaid insurance and insurance expense. Use Exhibit 14-1 [LO 14-3] Auditing Intangible Assets Intangible assets are assets that provide economic benefit for longer than a year, but lack physical substance. The following list includes examples of six general categories of intangible assets: 1. Marketing–trademark, brand name, and Internet domain names. 2. Customer–customer lists, order backlogs, and customer relationships. 3. Artistic–items protected by copyright. 4. Contract–licenses, franchises, and broadcast rights. 5. Technology–patented and unpatented technology. 6. Goodwill—the difference between the acquisition price for a company and the fair values of the identified assets. [LO 14-4] Substantive Procedures—Intangible Assets The principal substantive evidence regarding intangible evidence is obtained via tests of details. Tests of details associated with valuation and impairment of intangible assets are often necessary because the complexity and degree of judgment increase the risk of material misstatement. [LO 14-5] Auditing the Property Management Process For most entities, property, plant, and equipment represent a material balance on the financial statements. However, the students should note that with an ongoing engagement, the auditor is often able to focus on current-year activity only, making the audit of this account straightforward. [LO 14-6] Types of Transaction—Property Management Process We briefly discuss the four types of property, plant, and equipment transactions: • Acquisition of capital assets for cash or nonmonetary considerations. • Disposition of capital assets through sale, exchange, retirement, or abandonment. • Depreciation of capital assets over their useful economic life. • Leasing of assets. The students should be told that for most small entities, there might not be any formal control system over property, plant, and equipment. Larger entities, on the other hand, may have an accounting system similar to the computerized system shown in Figure 14-1. We walk the students through the system shown in Figure 14-1. When discussing leases, consider highlighting the revised leasing standards and how those changes affect the audit. Use Figure 14-1 [LO 14-7] Inherent Risk Assessment—Property Management Process There are three inherent risk factors that should be discussed: • Complex accounting issues. • Difficult-to-audit transactions. • Misstatements detected in prior audits. We use lease accounting, self-constructed assets, and capitalized interest as examples of property, plant, and equipment transactions that can be complex and difficult to audit. [LO 14-8] Control Risk Assessment—Property Management Process Most control procedures for property, plant, and equipment are contained in the purchasing process. We limit our comments to controls over occurrence, authorization, and completeness. [LO 14-9] Segregation of Duties—Property Management Process We discuss the key segregation of duties for the property management process and examples of possible errors or fraud that can result from conflicts in duties. Problem 14-25 can be used here. Use Table 14-1 Substantive Procedures—Property, Plant, and Equipment Our presentation on substantive procedures for property, plant, and equipment covers substantive analytical procedures and tests of details of transactions and account balances and disclosures. [LO 14-10] Substantive Analytical Procedures—Property, Plant, and Equipment The following analytical procedures should be discussed: • Compare prior-period balances in property, plant, and equipment and depreciation expense with current-year balances, taking into account any changes in conditions or asset composition. • Compute the ratio of depreciation expense to the related property, plant, and equipment accounts and compare to prior years' ratios. • Compute the ratio of repairs and maintenance expense to the related property, plant, and equipment accounts and compare to prior years' ratios. • Compute the ratio of insurance expense to the related property, plant, and equipment account and compare to prior years' ratios. • Review capital budgets and compare the amounts spent with amounts budgeted. [LO 14-11] Tests of Details of Transactions and Account Balances and Disclosures— Property, Plant, and Equipment We usually review the substantive tests for the property, plant, and equipment accounts for each assertion relating to transactions and balances as shown in Table 14-2 (Note: in the 11th edition, the assertions have been updated to be consistent with international and AICPA auditing standards). We then focus our discussions on Exhibit 14-3 and show how the auditor verifies the various amounts on the lead schedule. We mention two other items. First, we point out that the auditor should obtain a list of major additions (all items over some dollar limit) and vouch the purchases to vendor invoices. Second, we note that the auditor may vouch items in the repairs and maintenance expense account, looking for items that should be capitalized. Use Table 14-2 Use Exhibit 14-3 We also discuss some of the disclosure items that are required for property, plant, and equipment (see Table 14-3 and Exhibit 14-4). Problem 14-27 can be used here. Use Table 14-3 Use Exhibit 14-4 [LO 14-12] Evaluating the Audit Findings – Property, Plant, and Equipment We review how the auditor completes the third step in applying materiality—comparing the aggregated misstatements to the tolerable misstatement assigned to the account. Discussion Case The Discussion case 14-29 is complex and is best used in a second or graduate auditing course. Internet Assignments Internet assignment 14-30 can be used as part of the EarthWear case relating different depreciation methods to substantive analytical procedures. Internet assignment 14-31 requests the students to research the SEC website for companies that have been cited for problems related to property, plant, and equipment or lease accounting. Practice Insight Practice Insights provide real-world integration. Practice Insight scenarios are included in each chapter to highlight important and interesting real-world trends and practices. These self-contained insights or scenarios focus on current events, student decision-making, and professional problem solving. The 11th edition includes a new practice insight regarding how audit data analytics and IT help audit leases and contracts. IDEA and TABLEAU The Chapter 14 IDEA and TABLEAU problems are an excellent hands-on supplement to the textbook material. Please go to Connect for chapter assignments. Chapter 15 Auditing the Financing/Investing Process: Long-Term Liabilities, Stockholders' Equity, and Income Statement Accounts Learning Objectives Review Questio ns Multipl e- Choice Questio ns Problem s Discussi on Cases Internet Assignmen ts LO 15-1: Understand the types and features of long- term debt. 1 26 LO 15-2: Be familiar with assessing control risk for long-term debt. 2 LO 15-3: Be familiar with key control activities for long-term debt. 2 11 LO 15-4: Know how to conduct substantive audit procedures for long-term debt. 1,3,4 12,13,14 21,22,23 25 26 LO 15-5: Understand the types of stockholders’ equity transactions. 1,5 LO 15-6: Be familiar with assessing control risk for stockholders’ equity. 16 LO 15-7: Be familiar with key control activities for stockholders’ equity. 15,16 LO 15-8: Know the appropriate segregation of duties for stockholders’ equity. 6 15,16 24 LO 15-9: Know how to conduct substantive audit procedures for capital stock. 1,7 15,17,18 24 LO 15-10: Know how to conduct substantive audit procedures for dividends. 8 LO 15-11: Know how to conduct substantive audit procedures for retained earnings. 8 LO 15-12: Know how to 9,10 19,20 assess control risk and conduct substantive audit procedures for income statement accounts. NOTE: References to auditing standards in the instructor manual follow a similar convention to that followed in the text: AICPA standards will be referenced by clarified AU section and PCAOB standards will be referenced by Auditing Standard (AS) number. END OF CHAPTER MATERIALS COMPARISON CHART Number in 10th edition Comparison Number in 11th edition 15-1 Unchanged 15-1 15-2 Unchanged 15-2 15-3 Unchanged 15-3 15-4 Unchanged 15-4 15-5 Unchanged 15-5 15-6 Unchanged 15-6 15-7 Unchanged 15-7 15-8 Unchanged 15-8 15-9 Unchanged 15-9 15-10 Unchanged 15-10 15-11 Unchanged 15-11 15-12 Unchanged 15-12 15-13 Unchanged 15-13 15-14 Unchanged 15-14 15-15 Unchanged 15-15 15-16 Unchanged 15-16 15-17 Unchanged 15-17 15-18 Unchanged 15-18 15-19 Unchanged 15-19 15-20 Unchanged 15-20 15-21 Revised 15-21 15-22 Unchanged 15-22 15-23 Revised 15-23 15-24 Unchanged 15-24 15-25 Unchanged 15-25 15-26 Replaced 15-26 Chapter 15 presents the audit of long-term liabilities, stockholders' equity, and the income statement. A substantive strategy is normally followed when these accounts are audited because, although the number of transactions is few, each transaction is usually material. [LO 15-1] Auditing Long-Term Debt We point out to the students that long-term debt is no longer just composed of notes and bonds but includes sophisticated types of debt financing, such as collateralized mortgage obligations and derivatives (see Exhibit 15-1). These sophisticated instruments are beyond the scope of the text. Use Exhibit 15-1 We have found it worthwhile to discuss some of the features of long-term debt and some terminology related to long-term debt such as (1) convertible, (2) callable, (3) secured, and (4) sinking fund. [LO 15-2] Control Risk Assessment—Long-Term Debt For most entities, the auditor follows a substantive strategy. However, the auditor must have a sufficient understanding of the entity's internal control system to be able to anticipate the types of misstatements that may occur in order to plan the substantive tests. Thus, we focus our comments to the students on the general types of control procedures that should be present to minimize material misstatements. [LO 15-3] Assertions and Related Control Activities—Long-Term Debt Our discussions focus on five assertions: occurrence, authorization, completeness, valuation, and classification (Note: In the 11th edition, the assertions have been revised to be consistent with international auditing standards and the standards of the AICPA). For example, we point out that authorized individuals should properly initiate any long-term borrowings. We mention that there should be adequate documentation to verify that a note or bond was properly authorized. For major debt financing, it is usually the board of directors who authorize the transaction and the board of directors' minutes are the source of evidence to verify the authorization. [LO 15-4] Substantive Procedures—Long-Term Debt Under substantive tests, we first discuss how analytical procedures are useful in auditing interest expense and show the students a simple calculation for such a test. The auditor can multiply the twelve monthly balances for long-term debt by the average interest rate to arrive at an estimate for interest expense. This amount can be compared to the interest expense recorded on the general ledger. We use Table 15-1 and Exhibit 15-2 to explain to the students how long-term debt and accrued interest payable are audited. For example, we mention how the debt is normally confirmed with debt holders and that payments may be traced to the cash disbursements journal. It is also important to mention that the auditor must ensure that the entity is in compliance with any restrictive covenants included in the debt agreement. If material, such restrictions must be disclosed (see Exhibit 15-3). Problems 21 or 23 could be used here. Use Table 15-1 Use Exhibits 15-2 and 15-3 [LO 15-5] Auditing Stockholders' Equity We point out that for most entities, stockholders' equity is composed of common stock, preferred stock, paid-in capital, and retained earnings. We usually mention to the students that, in recent years, companies have issued financial instruments that have characteristics of both debt and equity. The three types of transactions that can occur in stockholders' equity are: • Issuance of stock. • Repurchase of stock. • Payment of dividends. [LO 15-6] Control Risk Assessment—Stockholders' Equity Again, we note that a substantive strategy is followed when auditing stockholders' equity. However, the auditor must have an understanding of the types of control procedures that are in place to prevent misstatements. We tell the students that most large entities use an independent registrar, transfer agent, and dividend-disbursing agent. The students should know what activities each of these agents perform. When the company uses such agents, the auditor may be able to obtain sufficient evidence by confirming the relevant information with those parties. When an entity has its own employees perform the stock transfer and dividend disbursement functions, the auditor will need to perform more detailed testing of stock- related records. We then cover the (1) assertions and related control procedures and (2) segregation of duties. [LO 15-7] Assertions and Related Control Activities—Stockholders' Equity Following are the major assertions for stockholders’ equity: • Occurrence—verify that stock and dividend transactions are valid and comply with the corporate charter. • Accuracy—verify that all stock and dividend transactions have been properly posted and summarized in the accounting records. • Authorization—verify that stock and dividend transactions have been properly approved. • Valuation—verify that stock and dividend transactions have been properly valued. [LO 15-8] Segregation of Duties—Stockholders’ Equity If the entity has enough personnel, the following segregation of duties should be maintained; • The individuals responsible for issuing, transferring, and canceling stock certificates should not have any accounting responsibilities. • The individual responsible for maintaining the detailed stockholders’ records should be independent of the maintenance of the general ledger control accounts. • The individual responsible for maintaining the detailed stockholders’ records should not also process cash receipts or disbursements. • Appropriate segregation of duties should be established among the preparation, recording, signing, and mailing of dividend checks. [LO 15-9] Auditing Capital—Stock Accounts The auditor begins the audit of the stockholders' equity accounts by obtaining a schedule of all activity in the accounts for the current period. We tell the students that the auditor is concerned with four assertions: occurrence, completeness, valuation, and completeness of disclosure. We usually explain to them the various audit steps the auditor performs to verify the current-year activity in the stockholders' equity accounts. Table 15- 2 provides sample disclosures for stockholders' equity. Problem 24 can be used here. Use Table 15-2 [LO 15-10] Auditing Dividends When the company uses a dividend-disbursing agent, the amount of dividends can be confirmed. This amount should also be agreed to the amount authorized by the board of directors. If a dividend-disbursing agent is not used, the auditor can compute the amount authorized by the board of directors and agree it to the general ledger. [LO 15-11] Auditing Retained Earnings We point out to the students the items that can affect retained earnings: • Net income or loss. • Dividends. • Prior-period adjustments, correction or errors, stock retirements, and changes in appropriations of retained earnings. The first few items are easy to verify. The auditor must be certain that prior-period adjustments and correction of errors satisfy the requirements of relevant accounting standards. Changes in appropriations can usually be traced to the board of directors' minutes. [LO 15-12] Auditing Income Statement Accounts For many companies, revenue is one of the largest accounts in the financial statements and is typically deemed to be a significant account that must be specifically considered. We point out to the students that auditing the income statement accounts is affected by the level of work conducted on the entity's business processes and balance sheet accounts. For example, if the auditor obtains good results from testing the purchasing process, he or she has evidence that the expense accounts are not likely to contain material misstatement. The students should know that the auditor normally performs the following substantive procedures on selected income statement accounts: • The results of testing controls for the various business processes. • The results of the detailed tests of balance sheet accounts and the related income statement accounts. • Performance of substantive analytical procedures on income statement accounts. • Detailed tests on selected income statement accounts. We generally discuss each of the audit steps. We start by showing the students Table 15-3 for examples of income statement accounts that are verified when the relevant balance sheet accounts are audited. We talk about the types of analytical procedures that can be applied to the revenue and expense accounts. We discuss how recent regulatory changes have decreased the extent to which auditors use analytical procedures to audit revenue, instead using more detail testing of transactions. However, audit data analytics are also being used to provide high-level assurance over revenue and identify risky areas. We mention the use of examination of absolute changes in the accounts and changes in their ratios as a percentage of revenue. Lastly, we discuss some specific accounts where the auditor obtains an account analysis and vouches the transactions. The account analysis of legal expense in Exhibit 15-4 can be used as an example. Use Table 15-3 Use Exhibit 15-4 Discussion Case Discussion case 15-25 provides a good example for discussing audit procedures that an auditor uses when there is a possibility that the entity was in violation of its debt covenants. Internet Assignment Internet assignment 15-26 requests the students to consider the implications of the changes in the lease accounting standards and the decision to move operating leases to the balance sheet and how the new liabilities are being treated for purposes of computing debt covenants. Practice Insight Practice Insights provide real-world integration. Practice Insight scenarios are included in each chapter to highlight important and interesting real-world trends and practices. These self-contained insights or scenarios focus on current events, student decision-making, and professional problem solving. IDEA and TABLEAU The Chapter 15 IDEA and TABLEAU problem is an excellent hands-on supplement to the textbook material. Please go to Connect for chapter assignments. Chapter 16 Auditing the Financing/Investing Process: Cash and Investments Learning Objectives Review Questio ns Multipl e- Choice Questio ns Problem s Discussi on Cases Internet Assignmen ts/ EarthWea r Mini- Cases (EWMC) LO 16-1: Understand the relationship of the various business processes to cash. 1 LO 16-2: Know the different types of bank accounts. 2 LO 16-3: Know tests of details of transactions used to audit cash. 3 EWMC LO 16-4: Be able to explain tests of details of account balances used to audit cash. 4,5 12,13 25 LO 16-5: Know how to audit a bank reconciliation. 4,5 14,15,16 26 EWMC LO 16-6: Understand fraud-related audit procedures for cash. 6,7 12,13,17 25 LO 16-7: Understand why entities invest in securities of other entities. 24,27 31 LO 16-8: Be able to explain key controls for investments. 8 18 24,27 LO 16-9: Know the appropriate segregation of duties for investments. 8 18 24 LO 16-10: Know tests of details of account balances used to audit investments. 9,10 19,20, 21,22 27,28,29 31 LO 16-11: Understand how to audit fair value measurements. 11 23 30 NOTE: References to auditing standards in the instructor manual follow a similar convention to that followed in the text: AICPA standards will be referenced by clarified AU section and PCAOB standards will be referenced by Auditing Standard (AS) number. END OF CHAPTER MATERIALS COMPARISION CHART Number in 10th edition Comparison Number in 11th edition 16-1 Unchanged 16-1 16-2 Unchanged 16-2 16-3 Unchanged 16-3 16-4 Unchanged 16-4 16-5 Unchanged 16-5 16-6 Unchanged 16-6 16-7 Unchanged 16-7 16-8 Unchanged 16-8 16-9 Unchanged 16-9 16-10 Revised 16-10 16-11 Unchanged 16-11 16-12 Unchanged 16-12 16-13 Unchanged 16-13 16-14 Unchanged 16-14 16-15 Unchanged 16-15 16-16 Unchanged 16-16 16-17 Unchanged 16-17 16-18 Unchanged 16-18 16-19 Unchanged 16-19 16-20 Unchanged 16-20 16-21 Unchanged 16-21 16-22 Unchanged 16-22 16-23 Unchanged 16-23 16-24 Unchanged 16-24 16-25 Unchanged 16-25 16-26 Revised 16-26 16-27 Unchanged 16-27 16-28 Revised 16-28 16-29 Unchanged 16-29 16-30 Revised 16-30 16-31 Unchanged 16-31 The focus of Chapter 16 is cash and investments. We usually cover these topics after the business processes because cash interacts with each of the other business processes. [LO 16-1] Auditing Cash We use Figure 16-1 to show how each business process affects the cash account. In particular, we point out that the control procedures for cash receipts and cash disbursements significantly affect the controls over cash and were discussed in Chapters 10 and 11, respectively. You may want to refer the students back to Tables 10-7 and 11-7, which summarize assertions, possible misstatements, internal control procedures, and tests of control for cash receipts and cash disbursements transactions. Use Figure 16-1 [LO 16-2] Types of Bank Accounts We briefly describe each of the following types of bank accounts: • General cash account. • Imprest cash accounts. • Branch accounts. [LO 16-3, 16-4] Substantive Procedures—Cash Because of its residual nature, cash does not have a predictable relationship with other financial statement accounts. Thus, the use of substantive analytical procedures is limited to comparisons with prior years’ cash balances and to budgeted amounts. Substantive Tests of Details of Transactions and Balances We use Table 16-1 to provide examples of tests of transactions. We point out that most of these tests were included in Chapters 10 and 11 and that they serve as dual-purpose tests that are normally conducted as part of the audit of the revenue and purchasing cycles. Use Table 16-1 We use Table 16-2 to summarize for students the assertions and tests of details of account balances for cash accounts (Note: in the 11th edition, the assertions have been updated to be consistent with international and AICPA auditing standards). We then cover two major topics: • Auditing the general cash account. [LO 16-5] • Fraud-related audit procedures. [LO 16-6] Use Table 16-2 [LO 16-5] Auditing the General Cash Account We first mention to the students that the auditor needs the following documents to audit the general cash account: • A copy of the bank reconciliation. • A standard bank confirmation. • A cutoff bank statement. We then use Exhibit 16-1 to demonstrate how the bank reconciliation is audited. We focus on the information contained in the bank confirmation and the cutoff bank statement. Problem 16-26 can be used here. Use Exhibit 16-1 [LO 16-6] Fraud-Related Procedures We point out to the students that these procedures are normally only used when the entity does not have adequate control procedures or the auditor suspects some type of fraud or defalcation involving cash. We discuss three audit procedures: • Extended bank reconciliation procedures. • Proof of cash. • Tests for kiting. We use Exhibit 16-5 to demonstrate to the students how a proof of cash is performed and Exhibit 16-6 to show how an interbank transfer schedule can be used to identify transactions used to cover cash shortages. A new practice insight also discusses how audit data analytics can be used to perform a quasi-proof of cash. Use Exhibits 16-5 and 16-6 We do not cover auditing a payroll or branch account, or petty cash. The students should be able to read and understand this material on their own. [LO 16-7] Auditing Investments We briefly mention that FASB ASC Topics 320, “Investments – Debt Securities” and 321 “Investments – Equity Securities” provide detailed guidance on the accounting for investments in certain debt and equity securities. Again, the auditor's approach to the audit of investments depends on the size of the investment account and the amount of activity in the account. [LO 16-8] Control Risk Assessment—Investments We focus on the main assertions for investments (occurrence and authorization, completeness, and accuracy and classification) and the related internal control procedures. [LO 16-9] Segregation of Duties—Investments Only entities that engage in a significant number of investment activities are likely to have adequate segregation of duties. We use Table 16-4 to present the key segregation of duties for investments. Use Table 16-4 [LO 16-10] Substantive Procedures—Investments The following analytical procedures can be used to test the overall reasonableness of investments: • Comparison of the balances in the current year's investment accounts with prior years' balances after consideration of the effects of current-year operating and financing activities on cash and investments. • Comparison of current-year interest and dividend income with reported income for prior years and with the expected return on investments. • Recompute current-year interest income using the face amount of securities held, interest rate, and time period held. We reference the students to Table 16-5 for a summary of the tests of the investment account for balance and presentation related disclosure assertions. We then cover existence, valuation and allocation, and classification and understandability. We particularly comment on the classification of securities among equity carried at fair value, and debt classified as held-to-maturity, trading, or available-for-sale. Problem 16-27 is good for covering the audit issues related to the classification of investments. Problems 16-28 and/or 16-29 could be used for covering assertions and audit procedures. Use Table 16-5 [LO 16-11] Auditing Fair Value Measurements In this Advanced Module, we discuss how auditors approach the audit of fair value measurements. We briefly review the FASB ASC Topic 820 levels used to classify the inputs for valuation and then help the students understand how to obtain sufficient appropriate evidence that assets and liabilities are stated at their fair value. Problem 30 could be used to help students understand the big picture of auditing fair value. Internet Assignment Internet assignment 16-31 provides the students an opportunity to evaluate two companies, Intel and Microsoft, who have large amounts of investments on their financial statements. Practice Insight Practice Insights provide real-world integration. Practice Insight scenarios are included in each chapter to highlight important and interesting real-world trends and practices. These self-contained insights or scenarios focus on current events, student decision-making, and professional problem solving. EarthWear Mini-Cases The Chapter 16 mini-case can be assigned as a stand-alone case and provides students with a hands-on experience of many of the aspects involved in auditing a cash account and includes documents such as bank confirmation, bank reconciliation, bank cutoff statement, proof of cash, and cash receipts and disbursements journals. Please go to Connect for the mini-case assignments. IDEA and TABLEAU The Chapter 16 IDEA and TABLEAU problems are an excellent hands-on supplement to the textbook material. Please go to Connect for chapter assignments. Chapter 17 Completing the Audit Engagement Learning Objectives Review Questio ns Multipl e- Choice Questio ns Problem s Discussi on Cases Internet Assignmen ts/ ACL Problems LO 17-1: Be able to explain the audit issues related to contingent liabilities. 1 13 22 29 32 LO 17-2: Know the audit procedures used to identify contingent liabilities. 13 22,28 29 LO 17-3: Understand the audit issues related to a legal letter. 2 14 22,23,28 29 ACL LO 17-4: Be able to explain why the auditor must be concerned with entity commitments. 3 LO 17-5: Know the types of subsequent events. 4,5 24,25 33 LO 17-6: Understand the effect of subsequent events on the dating of the audit report. 5 15 25 LO 17-7: Know the audit procedures used to identify subsequent events. 16 24,25,28 LO 17-8: Know the audit steps included in the auditor’s final evaluation of audit evidence. 6,7,8 17 26,27,28 30, 31 LO 17-9: Be able to explain how auditors identify and assess going concern issues. 9,10 18 LO 17-10: Understand the auditor’s communication with management and those charged with governance and the matters that should be 11 19, 20 28 addressed. LO 17-11: Know the auditor’s responsibilities when relevant facts that existed at the date of the auditor’s report are discovered after the audit report has been issued. 12 21 NOTE: References to auditing standards in the instructor manual follow a similar convention to that followed in the text: AICPA standards will be referenced by clarified AU section and PCAOB standards will be referenced by Auditing Standard (AS) number. END OF CHAPTER MATERIALS COMPARISON CHART Number in 10th edition Comparison Number in 11th edition 17-1 Unchanged 17-1 17-2 Unchanged 17-2 17-3 Unchanged 17-3 17-4 Unchanged 17-4 17-5 Unchanged 17-5 17-6 Unchanged 17-6 17-7 Unchanged 17-7 17-8 Unchanged 17-8 17-9 Revised 17-9 17-10 Unchanged 17-10 17-11 Unchanged 17-11 17-12 Unchanged 17-12 17-13 Unchanged 17-13 17-14 Unchanged 17-14 17-15 Unchanged 17-15 17-16 Unchanged 17-16 17-17 Unchanged 17-17 17-18 Unchanged 17-18 17-19 Revised 17-19 17-20 Unchanged 17-20 17-21 Unchanged 17-21 17-22 Unchanged 17-22 17-23 Updated 17-23 17-24 Updated 17-24 17-25 Updated 17-25 17-26 Unchanged 17-26 17-27 Updated 17-27 17-28 Updated 17-28 17-29 Updated 17-29 17-30 Updated 17-30 17-31 Unchanged 17-31 17-32 Unchanged 17-32 17-33 Unchanged 17-33 Chapter 17 contains a number of important topics that are related to the completion of the engagement. These include: • Review for contingent liabilities. • Review for commitments. • Review for subsequent events. • Final evidential evaluation processes. • Communications with the audit committee and management. • Subsequent discovery of facts existing at the date of the auditor's report. We cover each of these topics in detail. [LO 17-1] Review for Contingent Liabilities When discussing contingent liabilities, we cover the following items: • FASB ASC Topic 450, “Contingencies,” categories for accounting for contingencies (probable, reasonably possible, and remote). • Examples of contingent liabilities and disclosure include: o Pending or threatened litigation. o Actual or possible claims and assessments. o Income tax disputes. o Product warranties or defects. o Guarantees of obligations to others. o Agreements to repurchase receivables that have been sold. [LO 17-2] Audit Procedures for Identifying Contingent Liabilities We cover examples of procedures that may help the auditor identify contingent liabilities including: 1. Reading the minutes of meetings of the board of directors, committees of the board, and stockholders. 2. Reviewing contracts, loan agreements, leases, and correspondence from government agencies. 3. Reviewing tax returns, IRS reports, and schedules supporting the entity’s income tax liability. 4. Confirming or otherwise documenting guarantees and letters of credit obtained from financial institutions or other lending agencies. 5. Inspecting other documents for possible guarantees or other similar arrangements. Exhibit 17-1 includes an example disclosure for a contingency. Use Exhibit 17-1 [LO 17-3] Legal Letters The students should know and understand the importance of a legal letter and which attorneys should receive one. We use Table 17-1 to discuss the types of litigation that an auditor might encounter and show the students the example legal letter shown in Exhibit 17-2. In going over the legal letter in Exhibit 17-2, we focus on (1) the materiality limits established in the first paragraph and (2) the discussion of unasserted claims in the third paragraph. Use Table 17-1 and Exhibit 17-2 [LO 17-4] Commitments The students should be aware that some types of commitments (sales or purchases) entered into by the entity must be disclosed in a footnote. Under some circumstances, the entity may have to recognize a loss even though the contract has not been executed. [LO 17-5] Review for Subsequent Events for Audit of Financial Statements We start this topic by informing the students that transactions that occur after the balance sheet date but prior to the issuance of the financial statements and auditor's report may have a material effect on the financial statements. We discuss the two types of subsequent events that require consideration by management and evaluation by the auditor and present examples of each type of event. [LO 17-6] Dual Dating We present the requirements for dual dating by showing the timeline shown in Figure 17-1 and discuss the example of EarthWear as discussed in the text. Problem 17-25 could be used here. Use Figure 17-1 [LO 17-7] Audit Procedures for Subsequent Events Some audit procedures for business processes and their related financial statement accounts are conducted before year-end, while others may be conducted during the subsequent-events period. We review the examples of audit procedures outlined in the text. We take a few minutes to make sure the students understand the requirements for auditors of public companies in regards to reporting any changes in internal control that might affect the financial reporting between the end of the reporting period and the date of the auditor’s report. Auditors of public companies are required to inquire of management whether there were any changes in internal control that might affect financial reporting between the end of the reporting period and the date of the auditor’s report, and should obtain written representation regarding such changes. The auditor should also inquire about and examine, for this subsequent period, the following: • Relevant internal audit reports issued during this subsequent period. • Independent auditor reports of significant deficiencies or material weaknesses. • Regulatory agency reports on the company’s internal control over financial reporting. • Information about the effectiveness of the company’s internal control over financial reporting obtained through other engagements. [LO 17-8] Final Evidential Evaluation We point out that the auditor conducts a number of important audit steps prior to deciding on the appropriate audit report for the entity. We then cover each of the following steps: • Performance of final analytical procedures. • Obtaining a management representation letter. • Review of working papers. • Final evaluation of audit results. • Evaluation of financial statement presentation and disclosure. • Obtaining an independent review of the engagement. • Evaluation of the entity’s ability to continue as a going concern. In covering the representation letter, we show Exhibit 17-3 to the students. Two points are important: (1) at a minimum, the chief executive officer and chief financial officer should sign the letter and (2) failure to receive a representation letter is a scope limitation. When we discuss the final evaluation of audit results, we refer the students to Exhibit 17-4. Covering this working paper again at this point in the course reinforces the students' understanding of the third step in applying materiality. Use Exhibits 17-3 and 17-4 In covering archiving and retention, we point out to the students that this comes directly from the Sarbanes-Oxley Act and PCAOB’s documentation standard. We make sure the students understand the requirements of the standard. [LO 17-9] Going Concern Considerations In discussing the evaluation of going concern, we suggest the following approach: • Point out the recent change in accounting standards under ASU 2014-15 which requires an entity’s management to first evaluate the entity’s ability to continue as a going concern, and auditors then make an independent assessment in order to evaluate the adequacy of management’s going concern disclosures. Highlight the terms “substantial doubt,” “probable,” and “reasonable period of time.” • Describe the auditor's responsibility to evaluate management’s assertions about the entity’s ability to continue as a going concern. • Present the four steps in the going concern evaluation. • Cover the conditions and events that are indicative of going concern problems and audit procedures that may identify those conditions and events (refer the students to Tables 17-3 and 17-4). • Review the plans management can undertake to overcome the adverse effects of the conditions or events and explore the idea that management may use alternative accounting practices or creative means to secure financing. Use Tables 17-3 and 17-4 [LO 17-10] Communications with Those Charged with Governance and Management Auditing standards require that the auditor communicate to the audit committee or similar body certain matters related to the conduct of the audit. We usually go over the matters that should be covered in the communication using Table 17-5. We also cover all of the communication responsibilities with respect to the audit of internal control over financial reporting. We also point out that it is normal practice for auditors to prepare a management letter for the entity. The general intent of the management letter is to make recommendations based on observations made during the audit. Many times the letter deals with organizational structure and efficiency issues. Problem 17-28 could be used here to cover many of the chapter topics. Use Table 17-5 [LO 17-11] Subsequent Discovery of Facts Existing at the Date of the Auditor's Report When we cover this topic, we refer the students back to Figure 17-1 so they know what period of time is relevant. We point out that this usually involves situations where the previously issued financial statements contain material misstatements due to either intentional or unintentional actions by management. Exhibit 17-5 provides a good real-world example. Lastly, we go over the actions the auditor should take in such situations, including withdrawing the audit report. Use Exhibit 17-5 Discussion Cases Environmental liability issues are the subject of Discussion Case 17-29. This case can be very challenging but is one that students should experience at the end of an introductory course. Discussion Cases 17-30 and 17-31 deal with issues related to the auditor's final evaluation of evidence. Internet Assignments Internet Assignment 17-32 requires the students to identify and learn about companies that have reported contingent liabilities or pending lawsuits in their financial statements. We suggest that students start with the Edgar home page. Internet Assignment 17-33 follows up on the discussion of subsequent discovery of facts existing at the date of the auditor’s report. It requires the students to search for companies where the auditor has withdrawn the audit report. Practice Insight Practice Insights provide real-world integration. Practice Insight scenarios are included in each chapter to highlight important and interesting real-world trends and practices. These self-contained insights or scenarios focus on current events, student decision-making, and professional problem solving. Hands-On Cases IDEA and TABLEAU The Chapter 17 IDEA and TABLEAU problems are an excellent hands-on supplement to the textbook material. Please go to Connect for chapter assignments. Instructor Manual for Auditing and Assurance Services: A Systematic Approach William F. Messier, Steven M. Glover, Douglas F. Prawitt 9781260687637, 9780077732509, 9780077732509, 9781259162312