A4 – Further Procedures, Conclusions, and Communications: FINAL

REVIEW

Table of Contents
M1 – REVENUE CYCLE...................................................................................1
M2 – EXPENDITURE CYCLE...........................................................................4
M3 – CASH CYCLE..........................................................................................7
M4 – INVENTORY CYCLE...............................................................................8
M5 – INVESTMENT CYCLE..........................................................................10
M6 – OTHER TRANSACTON CYCLES..........................................................15
M7 – MISSTATEMENTS DISCOVERED DURING AN AUDIT.......................21
M8 – WRITTEN REPRESENTATIONS..........................................................23
M9 – COMMUNICATION OF DEFICIENCIES...............................................25

M1 – REVENUE CYCLE
 Sales Transaction = segregation of functions as follows:
o Preparation of Sales Order (Authority)
 Begins with the receipt of a customer Purchase Order
 Prenumbered Sales Order = sent to credit department for
approval
o Credit Approval (Authority)
 Approve credit, follow-up on old accounts, initiate write-
offs
 If approved, copy of sales order is sent to shipping, billing,
and accounting department
o Treasurer (Authority)
 Review and approve write-offs and send to billing and
accounting department
o Shipment (Custody)
 Bill of Lading = serially numbered document between
seller and shipper (copy sent to customer)
 Goods are shipped and a receivable is created
o Billing (Record Keeping)
 Sales Invoice = serially numbered sales invoice sent to
customer and accounts receivable department

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  Matches shipping document with sales order and sales
invoice

o Accounting (Record Keeping)

 Sale is entered into sales journal and a receivable is
recorded
 Accounts Receivable Transaction = segregation of functions as
follows:
o Sales
 Receivable is recorded in accounts receivable control
account in the general ledger and in the accounts
receivable subsidiary ledger
 Should be reconciled periodically by an independent
person
o Collection of Cash Receipts
 When payment is received from customer = eliminate
receivable
o Uncollectible Receivables
 Aging scheduled is prepared and sent to the credit
department
 Receivables deemed uncollectible should be written off
and sent to treasurer for approval
o Sales Returns
 Receiving Report = serially numbered report used as
sales return slip
 Sales return is recorded and receivable is
eliminated
 Separation of Duties: payment collection (custody) and
creating credit memo (authority)
o Sales Discounts
 Sales discounts procedures and records should be
reviewed to ensure discounts are properly given and
recorded based on the selected method (gross vs net)
 Cash Receipts Transaction = segregation of functions as follows:
o Mailroom (Custody) = incoming mail should be opened, by a
person (custody) who does not have access to the accounts
receivable ledger (record keeping), and provided to the following
parties:
 Cashier (Custody) = receives actual receipts and
prepares bank deposit slip
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  Accounts Receivable Department (Record Keeping)
= enters receipts into accounts receivable subsidiary
records
 Matches the details from the bank deposit slip with
the details from the remittance advices
 Accounting Department (Record Keeping) = enters
receipts into accounts receivable control account
o Lockbox = reduces diversion of cash receipts
 (1) Customer sends payments directly to the bank, which
the (2) bank deposits the money into client accounts, and
(3) sends copies of checks to the client
 Auditing Sales
o Completeness
 Objective = ensure all sales are recorded
 Procedure = tracing shipping documents (source) to the
corresponding sales invoices (records) to the sales journal
(records)
o Cutoff
 Objective = ensure sales for the year under audit are
included and sales for the subsequent year are excluded
 Procedure = compare invoices from just before and after
year-end with the shipment dates and the dates the sales
were recorded
o Valuation, Allocation, and Accuracy
 Objective = ensure sales were recorded at an appropriate
amount
 Procedure = compare prices and terms on a sample of
sales invoices with authorized price lists and terms of
trade
o Existence and Occurrence
 Objective = ensure all recorded sales actually exist
 Procedure = vouch sales transaction from the sales journal
(record) to the customer order (source) and shipping
documents (source)
o Understandability of Presentation and Classification
 Objective = ensure all sales are properly classified into the
appropriate revenue accounts
 Procedure = examine a sample of sales invoices for
proper classification
 Auditing Accounts Receivable
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 o Completeness
 Trace the total from AR gaining (small records) to the
general ledger (larger records)
o Valuation, Allocation, and Accuracy
 Test the adequacy of the allowance for credit losses
o Existence and Occurrence
 Confirm a sample of accounts receivable
o Rights and Obligations
 Review bank reconciliations, inspect debt agreements, and
read board minutes for evidence that accounts receivable
have no liens or have not been factored or sold
 Accounts Receivable Confirmations
o AR Confirmations are generally a GAAS required procedure
unless:
 Receivables are immaterial
 Confirmation would be ineffective
 Inherent and controls risks are very low and other
procedures are sufficient to reduce audit risk to a low level
o AR Confirmation provide evidence for Existence + Rights and
Obligations
o Types of Confirmations
 Positive Confirmation = auditor sends confirmation
letter to client to confirm AR balance, expecting a response
of whether the balance is correct or incorrect
 Blank Confirmation = client fills in AR balance in
response
 Negative Confirmation = client only respond if the
balance is incorrect, otherwise it is disregarded if correct
 Used when RMM is low and large number of small
balances

M2 – EXPENDITURE CYCLE
 Purchases Transaction = segregation of functions as follows:
o Purchase Requisition
 Purchase Requisition (Purchase Request) = must be
prenumbered and approved
 Sent by department in need of assets or services to
the purchasing department
o Purchase Orders

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 Purchase Order = indicates the quantity, description, and
related information for good or service being requested
 Purchasing department requests bids from various
suppliers (best price) and creates purchase order
(prenumbered)
 Send copies to requisitioning department, vendor,
receiving department, and accounting department
o Receipt of Goods or Services
 A copy of the purchase order with quantities omitted is
sent to the receiving department (authorization to accept
goods when arrived)
 Receiving Report = receiving department (custody)
counts goods upon arrival and records them in the
receiving report (prenumbered)
 Forwarded to the accounting department (record
keeping)
 Goods are forwarded to the requisitioning
department

 Accounts Payable Transaction = segregation of functions as follows:

o Recording the Payable
 Copy of purchase order sent to accounting department
notifies that there will a be a future cash disbursement
 Receiving report is compared with purchase order and
vendor invoice to confirm quantity
 Accounting department records the goods as inventory
and records a payable (record keeping)
o Approving Invoice for Payment and Recording Payment
 Accounts payable (accounting) department receives the
invoice and matches the following to ensure that was
requested, ordered, and received is what is billed for:
creates a voucher
 Invoice received from vendor
 Purchase order
 Receiving report
 Requisition (sometimes)
 When payment is made, the payable is eliminated

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 Cash Disbursement: TREASUER
o Treasurer received the approved voucher package from the
accounting department and pays the bill (custody)
 Prepares the check
 Signs the check
 Mails the check
 Cancel all supporting documents after payment (stamp
paid)
 Return paid vouchers to accounting department to post
payment
 Auditing Purchase Transactions
o Completeness
 Trace a sample of vouchers (source) to the purchase
journal (records)
o Cutoff
 Examine purchases before and after year-end to
determine if they were recorded in the proper period
 Compare dates on a sample of vouchers with the dates
the transactions were recorded in the purchases journal
o Valuation, Allocation, and Accuracy
 Recompute the mathematical accuracy of a sample of
vendor invoices

o Existence and Occurrence

 Test a sample of vouchers to confirm proper
authorization and the presence of the receiving report
o Understandability of Presentation and Classification
 Verify purchases are appropriately classified and read
disclosures on a sample of purchases
 Auditing Accounts Payable
o Completeness
 Agree the accounts payable listing to the general ledger
 Obtain a sample of vendor statements and agree to
vendor accounts
 Perform a search for unrecorded liabilities:
 Select cash disbursements subsequent to year-
end and examine the supporting documentation
(source to record)
 Review the cash disbursements journal, subsequent
bank statements, and voucher register
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 Examine open vouchers, receiving reports, vendor
invoices, and statement received for a period after
year-end
o Valuation, Allocation, and Accuracy
 Obtain the accounts payable listing, foot the listing, and
agree the listing to the general ledger
 Obtain a sample of vendor statements and agree the
amounts to the vendor accounts
 Review the results of accounts payable confirmations
o Existence and Occurrence
 Vouch selected accounts from accounts payable listing to
voucher package (records to source)
 Accounts payable confirmations are not required by
strong external evidence to support accounts payable is
generally available except:
 System of internal control is weak
 Disputed amounts
 Monthly vendor statements not available
o Rights and Obligations
 Review a sample of voucher packages for the presence
of the purchase requisition, purchase order, receiving
report, and vendor invoice to verify that the accounts
payable are owed by the entity

M3 – CASH CYCLE
 Fraud Risk Related to Cash Cycle
o Lapping = when an employee withholds funds received by a
customer for personal use and applies subsequent receipts
to cover prior funds
 Customer pays off a receivable but does not receive credit
 Customer’s payment is lapped to a prior customer (ponzi
scheme)
 Procedures = compare the dollar amounts and dates on
the deposit slips with accounts receivable credits
o Kiting = occurs when a check drawn on one bank is deposited in
another bank and no record of disbursement is made in the

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 balance of the the first bank until after year-end (cash exists in
both accounts at the same time)
 Low average balance compared to high levels of
deposits
 Procedures = bank transfer schedule is prepared for
any bank-to-bank transfers that occur near year-end
(receipt before year-end but disbursement after year-end)
 Auditing Cash Balance
o Bank Confirmation = confirmation sent to all banks that the
client has done business with during the year (Completeness,
Valuation & Allocation, and Existence)
 Provides additional information about year-end bank
balance including outstanding loans, pledged collateral,
guarantee agreements, and contingent liabilities
o Bank Reconciliation = year-end bank reconciliation for every
accounts should be tested by: (Valuation, Allocation, and
Accuracy)
 Footing the bank reconciliation and the list of outstanding
checks
 Agreeing the balance per the books to the general
ledger
 Agreeing the balance per the bank to the balance per
bank confirmation
 Agreeing deposits in transit and outstanding checks to the
cutoff bank statement (portion of a month after year-
end)
 Auditing Cash Receipts and Disbursement
o Completeness
 Cash Receipts = trace a sample of remittance advices to
the cash receipts journal and deposit slips (source to
record)
 Cash Disbursements = trace a sample of cancelled
checks to the cash disbursements journal (source to
record)

o Cutoff
 Verify the cutoff of cash receipts and disbursements
shortly before and after year-end for recording in the
proper period
o Valuation, Allocation, and Accuracy

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 Cash Receipts = foot the remittance advices and entries
on the deposit slips and agree to the cash receipts journal
and bank statement from a sample of daily deposits
 Cash Disbursements = agree the purchase order,
receiving report, invoice, cancelled check, and
disbursement journal from a sample of voucher packages
o Existence and Occurrence
 Cash Receipts = vouch a sample of entries in the cash
receipts journal to remittance advices, deposit slips, and
bank statement
 Cash Disbursements = vouch a sample of entries from
the cash disbursements journal to cancelled checks, the
voucher package, and the bank statement
o Understandability of Presentation and Classification
 Examine a sample of remittance advices and cancelled
checks for recording in the proper account

M4 – INVENTORY CYCLE
 Inventory Cycle Transaction = segregation of functions as follows:
o Purchasing
 Purchase Orders = serially numbered, properly
approved purchase orders are prepared and issued to the
accounting and receiving departments
o Receiving
 Responsible for the verification of quantities received,
detection of damaged goods, preparation of receiving
report, and delivery of goods received to the warehouse
department
o Warehouse
 Warehouse department acts as a custodian for the
verified quantity of goods received
o Shipping
 Responsible for shipment of goods after authorization
(approved sales order)

 Auditing Inventory Balance

o Observation of the beginning and ending inventory counts
(required)
 Internal Controls

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  Evaluating management’s instructions and
procedures for the inventory count
 Observing the performance of management’s count
procedures
 Substantive Tests
 Inspecting the inventory to ascertain its existence
and condition
 Performing test counts (watch client count)
 Other Considerations
 If an auditor is not present to observe physical
inventory = use alternative procedures to justify
opinion when:
o It is impractical or impossible to observe
physical inventory
o Inventories are immaterial
 If perpetual inventory system is used = auditor may
observe inventory before or after year-end if
necessary, but must obtain evidence about
whether changes in inventory are recorded properly
if performed before year-end
 Inventory held-off site in public warehouse or on
consignment:
o Significant = observe inventory count
o Insignificant = confirmation of inventory
o Completeness
 Trace test counts (source) to the inventory listing report
(record)
 Select a sample of prenumbered inventory tags (source)
and trace to the physical inventory report sheets (record)
o Valuation, Allocation, and Accuracy
 Test the mathematical accuracy of the inventory report
and reconcile it to the general ledger inventory accounts
 Inquire about obsolete or damaged goods, scan the
perpetual records for slow-moving items, and be alert
during the inventory observation for damaged goods or
signs of obsolescence
 Examine vendor invoices, review direct labor rates, test
the computation of standard overhead rates, and examine
standard cost variance analyses
o Existence and Occurrence
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 Vouch a sample of items from the inventory report sheet
to the corresponding prenumbered inventory tags (record
to source)
 Locate and perform test counts of items in the physical
inventory report
o Rights and Obligations
 Ascertain that consigned inventory on hand is excluded
from the physical inventory count
 Confirm consigned goods in the hands of consignees are
included in inventory balances

M5 – INVESTMENT CYCLE
 Investment Cycle Transactions = segregation of functions as
follows:
o Authorization of Purchase or Sale of Investments
 Board of Directors authorize the purchase or sale of
investments
o Custody of Investments
 Independent third-party custodian holds the actual
investment
 At a minimum, joint control by two company officials
with the investments kept in a safe-deposit box
 If held by the company = the investments should be
periodically counted and reconciled with the investment
subsidiary ledger by a party not associated with the
investments
o Record Keeping
 Separate party to keep detailed records of the
investments
 Auditing the Investment Balance
o Completeness
 Obtain evidence of completeness of the ending investment
balance of high-volume material investment
transactions:
 Performing a search of unrecorded purchases of
securities by examining transactions for a few days
after year-end

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  Confirm securities held by third-party custodian or
count securities on hand to determine that all
securities have been recorded

o Valuation and Allocation

 Obtain and foots a listing of investments by category and
agrees the totals to the general ledger
 Obtain evidence corroborating the quoted year-end fair
value by comparing assigned values to prices published
by various sources or obtained from a third party
 Recalculate ending values of investments not reported at
fair value
 Determine whether any permanent impairment in the
value of individual securities occurred
 Assess the reasonableness and appropriateness of
assumptions, market variables, and valuation models
o Existence
 Request confirmations from the custodian for securities
in the possession of third parties
 Physically examine securities in safe deposit box
 Record details of security count on a worksheet
and requests acknowledgement by client that the
securities were returned intact
 Perform analytical procedures that the interest earned
does not materially differ from the expectation
o Rights and Obligations
 Confirmation of securities and count of securities on
hand provide evidence of the entity’s ownership of
investments
 Auditing Investment Transactions
o Completeness
 Perform analytical procedures testing the
reasonableness of dividend and interest income to
determine that all investment income has been recorded
o Cutoff
 Perform cutoff to ensure that purchases, sales, and
investment income were recorded in the proper period
o Valuation, Allocation, and Accuracy

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  Make independent calculations to determine the validity
of recorded gains/losses from security sales from security
sales and of discount/premium amortization

o Existence and Occurrence

 Analytical procedures performed to test the
reasonableness of dividend and interest income provide
evidence of existence of investment income
o Understandability of Presentation and Classification
 Examine a sample of investment transactions to determine
that the transactions were recorded in the proper
accounts
 Auditing Marketable Securities
o Marketable Securities = equity (stock) and debt (bonds)
securities classified as trading or available-for-sale over which
the investor has NO significant influence (disclose
classification level)
 Trading = carried at fair value
 Reported as current assets with unrealized gains and
losses reported in net income
 Available-for-sale = carried at fair value
 Unrealized gains and losses reported in OCI
 Held-to-Maturity = carried at amortized cost (no
unrealized G/L)
o Equity Method = used to account for investments if
significant influence can be exercised by the investor (owns
20-50%)
 Investment income is recorded on income statement
 Auditor Procedures:
 Obtain and read the financial statements and audit
report of the investee
 Recalculate and compare with the equity in
investee income amount on the financial statements
o Investments in Securities: When Valuations are Based on the
Investee’s Financial Results
 Obtain and read the financial statements and audit report
of the investee

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  If the financial statements are not audited or if the audit
report is not satisfactory = request that the entity
arrange with the investee to have them audited
 If the carrying amount of the investment reflects factors
that are not recognized in the investee’s financial
statements or the fair values are materially different
from the investee’s carrying amounts = obtain sufficient
appropriate evidence regarding such amounts
 If the difference between the financial statement periods
(year-end dates) of the entity and the investee could have
a material effect:
 Determine whether management has considered the
lack of comparability
 Determine the effect on the auditor’s report
 Investments Measured at Fair Value
o Measuring Fair Value
 Level 1 = observable quoted prices in active markets for
identical assets or liabilities (stocks)
 Level 2 = observable inputs other than quoted markets
prices for similar or identical assets or liabilities (real
estate)
 Level 3 = unobservable inputs using estimates and
valuation methods, such as discounted cash flow,
determined based on management’s judgments
o Management’s Responsibility
 Responsible for making fair value measurements and
disclosures in accordance with GAAP
 Use the appropriate valuation method when using
Level 3 valuation to estimate fair value
 Incorporate reasonable assumptions that a market
participant would use
 Must be identified and supported in the fair value
disclosures
o Auditor’s Responsibility
 Understand the entity’s process for determining fair
value measurements and disclosures and the applicable
financial reporting framework
 Understand identified controls
 Separately assess the inherent risk and control risk
related to the fair value measurement

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  Evaluate whether the methods, data, and assumptions
used are reasonable and in conformity with GAAP
 Consider the need for a specialist
 Evaluate the fair value measurement for indicators of
potential management bias
 Evaluate whether fair value measurement disclosures are
in conformity with GAAP
 Evaluate the sufficiency and appropriateness of
evidence obtained
 Obtain relevant management representations
 Communicate relevant matters to those charged with
governance

o Testing Fair Value Measurements and Disclosures

 Verify quoted market prices
 Determine whether management’s significant assumption
provide a reasonable basis for fair value measurement
 Consider management’s intent and ability to carry out
courses of action that may affect fair values
 Determine whether modifications made to observable
information reflect assumptions that market participants
would use when pricing the instrument
 Evaluate whether the valuation model is appropriate
given the entity’s circumstances and the applicable
financial reporting framework
 Test the underlying data for relevance, reliability, and
susceptibility to management bias
 Develop an auditor’s point estimate or range
 Review subsequent events and transactions for evidence
regarding fair value measurement at the balance sheet
date
 Consider the use of a specialist and understand the
methods they use to determine fair value
o Using Pricing Information From Third-Parties as Evidence
 Pricing Services
 Determine whether modifications made to
observable information reflect assumptions market
participants would use when pricing the instrument
 Auditors may obtain evidence about fair value of
instruments by obtaining pricing information from

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 organizations that routinely provide uniform pricing
information to users or broker-dealers
 Reliability of pricing services is affected by the
experience and expertise of the pricing service, the
methodology used, and whether the pricing
services has a relationship with the entity
 When using information from multiple pricing
services, less information is needed about the
particular methods and inputs used by the individual
pricing services
 Broker-Dealers
 If fair value measurement is based on a quote from a
broker or dealer = the relevant and reliability are
based on whether:
o The broker or dealer is a market maker for
similar instruments
o The broker or dealer has a relationship with
the entity
o Impairment Indicators
 Impairment = loss resulting from a decline in fair value
that is other than temporary (must be recorded)
 Fair value is significantly below cost and the
decline has existed for an extended period of time
 The security has been downgraded by a rating
agency
 The financial condition of the issuer has
deteriorated
 Dividends have been reduced or eliminated, or
scheduled interest payments have not been made
 The entity recorded losses from the security
subsequent to the end of the reporting period

M6 – OTHER TRANSACTON CYCLES

 Property, Plant, and Equipment Cycle = segregation of functions
as follows:
o Acquisition = a special requisition form is generated for
acquisitions
 Includes a description, reason for acquisition, amount to be
charged, and probable cost

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  Board of directors approve acquisitions over a certain
amount
o Subsidiary Ledgers = contains detailed information
concerning each assets including description, ID, location, cost,
and depreciation
o Physical Security = fixed assets should have identification
plates with the serial number on the plates listed in the control
account
 Physical controls to safeguard assets from theft,
destruction, and unauthorized disposition should be in
place, in addition to a periodic physical inspection
o Written Policies = written depreciation policies and records
should be maintained
o Disposition = retirements of assets should be documented on
a sequentially numbered work order containing evidence of
proper authorization and reason for retirement
 Auditing PPE Balance
o Completeness
 Obtain a fixed asset schedule and agree total to the
general ledger
 Obtain a schedule of additions and dispositions of fixed
assets and agree amounts to the fixed asset schedule
 Select a sample of actual fixed assets and trace it to the
fixed asset schedule and subsidiary ledger (source to
records)
o Valuation and Allocation
 Recalculate accumulated depreciation for reasonableness
 Evaluate fixed assets for impairment by examining the
entity’s document impairment analysis
o Existence
 Vouch additions to the fixed assets accounts by:
 Examining internal documents
 Examining external documents
 Inspecting the actual asset
 Select older fixed assets from the subsidiary ledger and
then locate those assets as a means of testing for
unrecorded retirements (records to source)
 Unrecorded retirements = test of existence
o Rights and Obligations

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  Examine invoices, deeds, and title documents to confirm
ownership of fixed assets
 Auditing PPE Transactions
o Completeness
 Trace a sample of fixed asset purchase requisitions
(source) to receiving reports (source) and the fixed asset
subsidiary ledger (records)
 Review the related repair and maintenance expense
accounts to test for completeness for asset additions
 Locate items that should have been capitalized
o Cutoff (also applicable to completeness)
 Review fixed asset purchases and dispositions from
shortly before and after year-end for recording in the
proper period
o Valuation, Allocation, and Accuracy
 Recalculate depreciation expense amounts for
reasonableness and conformity with GAAP
 Gains and losses and the removal of accumulated
depreciation for fixed assets sold or retired should be
tested for reasonableness

o Existence and Occurrence

 Vouch a sample of purchases (records) to the receiving
report (source) and vendor invoice (source)
 Vouch a sample of dispositions (records) to the asset
retirement form (source) and other supporting
documentation
o Understandability of Presentation and Classification
 Review lease transactions for proper classification
 Examine a sample of significant charges to repairs and
maintenance expense for items that should have been
capitalized (also completeness)
 Payroll and Personnel Cycle = segregation of functions as follows:
o Authorization to Employ and Pay = HR department should
hire new employees and maintain personnel records
o Supervision = all pay base data should be approved by an
employee’s immediate supervisor

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 o Timekeeping and Cost Accounting = data on which pay is
based should be accumulated independent of any other function
 Hourly employees use time clocks, which should be
reviewed by the department supervisor
o Payroll Check Preparation = payroll department computes
salary based on information received
 If service organization is not used = payroll department is
responsible for issuing unsigned payroll checks that are
signed by the treasurer or CFO
 If check signature plate is used to sign payroll checks =
treasurer or CFO should supervise the process
 There should be access controls over blank checks and
check signature plates
o Check Distributions = payroll checks are typically deposited
directly into employees’ bank accounts
 If manually distributed = payroll checks should be
distributed by a person who has no other payroll function
 Evaluating System of Internal Control
o Auditor should evaluate whether the controls provide
reasonable assurance that only valid employees are being
paid, the payment is for actual hours worked, and that the
correct pay rate is used
o Observe segregation of duties between HR responsibilities
(authority) and payroll distribution (custody)
o Compare personnel records for each department with the
actual time cards and the employees actually working in each
department
o Observe payroll distribution on an unannounced basis to
ensure that all personnel being paid are actually employed
o Observe the use of time clocks and investigate time cards not
used
o Test general and application controls to ensure payroll
transactions are valid, properly authorized, and completely and
accurately recorded
 Auditing Payroll Accrual
o Effective Internal Control = focus substantive procedures on
analytical procedures and the recalculation of payroll
accruals

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 o Ineffective Internal Control = perform tests related to
completeness, existence, and rights and obligations
 Completeness = test the completeness of payroll accrual
when performing the search for unrecorded liabilities
 Valuation and Allocation = recalculate any year-end
payroll accrual and compare the calculated amount to the
reported accrual amount
 Existence = vouch amounts from the client’s calculation
of the payroll accrual to supporting documentation (record
to source)
 Rights and Obligations = examine supporting
documentation to verify that the payroll accrual is an
obligation of the entity
 Auditing Payroll Transactions
o Completeness = trace a sample of time cards to the payroll
register
o Cutoff = examine a sample of time cards from before and
after year-end and compare with the payroll report to
determine whether the transactions were recorded in the proper
period
o Valuation, Allocation, and Accuracy
 Compare total recorded payroll with total payroll checks
issued
 Test extensions and footings of payroll
 Verify pay rates and payroll deductions with employee
records from personnel
 Recalculate gross and net pay on a test basis
 Compare payroll costs with standards or budgets
 Recompute the mathematical accuracy of a sample of
paychecks
o Existence and Occurrence = vouch time on payroll
summaries by selecting a sample of payroll register entries
(record) and comparing with time cards and approved time
reports (source)
o Understandability of Presentation and Classification =
examine a sample of paychecks for classification into the
expense accounts
 Financing Cycle
o Internal Controls Over DEBT = segregation of functions as
follows:
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  Authorization of new debt financing by the board of
directors
 Adequate controls over interest and principle payments
and the recording of bond premium and discount
amortization amounts
 Adequate documentation of all financing agreements
 Detailed records of long-term debt and periodic
independent verification of amounts between the
ledger, details of debt, and the note holders’ records
o Internal Controls Over EQUITY = segregation of functions as
follows:
 All stock issuances, dividend declarations, and treasury
stock purchases must be authorized by board of
directors
 Evidence should be recorded in board meeting
minutes
 Many large entities use a stock transfer agent who
ensures that stock issuances comply with articles of
incorporation, prepares stock certificates, and maintains
records of shares authorized, issued, and outstanding
 If NO stock transfer agent = implement the following
controls:
 Periodic independent reconciliation of the stock
certificate book with the number of shares
outstanding
 An officer of the entity should ensure that stock
transactions comply with the articles of
incorporation and regulatory requirements and
should maintain the stock certificate book
o Auditing the DEBT Balance
 Completeness
 Review board minutes for evidence of new debt,
obtain new debt agreements, and trace all new
debt contracts (source) to the financial statements
(records)
 Obtain a listing of all debt and agree the total to
the general ledger
 Inquire of management regarding new debt and
any off-balance sheet financing transactions

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  Trace debt on bank confirmations to the debt
agreements and financial statements
 Notes and bonds should be confirmed directly with
creditors

 Valuation and Allocation

 Recompute any interest payable and the
amortization of premiums or discounts
 Examine new debt agreements to determine
whether they were recorded at the proper amount
 Existence
 Confirm notes or bonds directly with creditors or a
custodian
 Rights and Obligations
 Examine note and bond agreements to verify that
they are the obligation of the entity
o Auditing DEBT Transactions
 Completeness
 Examine new debt agreements (source) and board
minutes (source) for evidence of new agreements
 Review interest expense for payments to debt
holders not included in the debt listing
 Cutoff
 Review debt activity shortly before and after year-
end to ensure that transactions were reported in the
proper period
 Valuation, Allocation, and Accuracy
 Test of a sample of debt receipts and payments and
compare interest expense to the debt balance for
reasonableness
 Existence and Occurrence
 Verify the existence of new debt by reviewing the
board minutes (record) for evidence of new
agreements and then inspecting the agreements
(source)
 Understandability of Presentation and Classification
 Examine the due dates of notes and bonds to
determine whether they should be classified as short
term or long term

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 o Auditing the EQUITY Balance and Transactions
 Completeness
 Use of stock transfer agent = third-party
confirmations should be used to provide evidence
of the completeness of shares authorized, issued,
and outstanding
 If NO use of stock transfer agent = the primary
source of evidence of completeness is the stock
certificate book

 Valuation
 Recompute the value assigned to stock transactions
during the period
 Review the propriety of any direct entries to
retained earnings
 Analyze the retained earnings account from
inception
 Existence and Occurrence
 Vouch transactions recorded during the current
period to board minutes
 Completeness tests with stock transfer agent
confirmations and stock certificate book inspection
 Understandability of Presentation and Classification
 Determine whether there are restrictions on
retained earnings resulting from loans, agreements,
or state laws
 Inquire of management regarding any
appropriations of retained earnings (must be
disclosed)

M7 – MISSTATEMENTS DISCOVERED DURING AN AUDIT

 Identification of Misstatements
o Auditor accumulates misstatements identified, other than those
that are considered clearly trivial, and presents them to
management
 Management must decide whether to correct the
misstatements, but the remaining uncorrected
misstatements are placed on the Summary of
Unadjusted Misstatements

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 Evaluation of Misstatements
o Auditor must consider the effects, individually and in aggregate,
of uncorrected misstatements
 Quantitatively = if the aggregate misstatements
accumulated exceed overall materiality, result in
modified opinion
 Qualitatively = may cause an otherwise immaterial
misstatement to be deemed material
 Affects trends in profitability, make a change in
trend, or change a loss into income
 Affects compliance with loan covenants, contracts,
or regulatory requirements
 Increase management compensation, indicate
management bias, or involve fraud
 Include a misclassification between certain
account balances
 Currently immaterial, but will have material effect in
the future
 Misstatements appear too costly to correct
 Management Bias
 Selective correction of misstatements
 The identification of additional adjusting entries
by management that offset misstatements
accumulated by the auditor
 Documentation Requirements
o The amount below which misstatements are clearly trivial
o All misstatements accumulated during the audit and whether
they have been corrected or not
o Auditor’s conclusion about whether uncorrected misstatements
are material and the basis for that conclusion
o Documentation related to uncorrected misstatements:
 The aggregate effect on the financial statements
 The evaluation of whether the materiality level or levels
for particular classes of transactions, account balances, or
disclosures have been exceeded
 The effect of uncorrected misstatements on key ratios or
trends and compliance with legal, regulatory, and
contractual requirements
 Effect of Identified Misstatements on Assessment of Control
Risk

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 o Auditor must evaluate the type and cause of misstatements
discovered to determine if the assessment of control risk is
appropriate:
 The frequency of the misstatement
 The effect on other audit areas
 The financial statement implications
 Adjusting Journal Entries
o Misstatements can be corrected using adjusting journal entries,
which can impact any account that appears in the financial
statement
 Overstated accounts need the natural balance
decreased
 Understated accounts need the natural balance
increased
o Purchases/Sales
 FOB Shipping Point = recorded as soon as the item is in
the carrier’s truck (loading dock is still seller’s inventory)
 FOB Destination = recorded when item reaches its
destination
o Inventory
 Perpetual = inventory and sales are updated when a
sale occurs
 Record the sale (AR, Sales)
 Record the relief of inventory (COGS, Inventory)
 Periodic = sales are recorded when a sale occurs and
inventory is adjusted at the end of the period
 Record the sale (AR, Sales)
 Record COGS at end of the period (COGS, Inventory)
o COGS = beg inventory + purchases – end
inventory
o Consignment
 Consignee = inventory excluded from financial
statements
 Third party selling the items on behalf of the
consignor
 Consignor = inventory included in financial statements

M8 – WRITTEN REPRESENTATIONS
 Purpose of Management Representation Letter

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 o To confirm representations explicitly or implicitly given to the
auditor
o To indicate and document the continuing appropriateness of
such representations
o To reduce the possibility of misunderstanding concerning
matters that are the subject of the representations
 Elements of Representation Letter
o Addressed to the auditor
o Signed by members of management with overall responsibility
for financial and operating matters (CEO + CFO)
o Dated the same date as the audit report (last piece of audit
evidence)
o Should address all financial statements and periods covered
by the report
o State the representations are limited to material matters
 Does not apply to fraud involving management
o Assertions (statements of fact)
 Management acknowledges the responsibility for the
design, implementation, and maintenance of internal
control
 Reasonable accounting estimates
 Disclosed related party transactions, subsequent events,
litigation, fraud, noncompliance
 Any uncorrected misstatements are immaterial (list
attached)
 Provided access to all information to auditor
 Specific assertions to ERISA Plan Audit: (same as
engagement letter)
 Management provided the auditor the most current
plan instrument for the audit period
 Acknowledgment of responsibility for administering
the plan and presenting and disclosing transactions
in conformity with the plan’s provision
 Maintaining sufficient records with respect to each
of the participants
 ERISA Section 103(a)(3)(C) = acknowledgment
that management’s election does not affect its
responsibility for the financial statements and for
determining whether:

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 o The election is permissible
o Investment information is prepared and
certified by a qualified institution
o The certification meets the requirements of
DOL rules and regulations
o The certified investment information is
appropriately measured, presented, and
disclosed
 Additional assertions for Integrated Audit:
 Management acknowledges the responsibility for the
design, implementation, and maintenance of
effective internal control over financial reporting
 Management has performed an evaluation of the
effectiveness of the entity’s internal control
 Affirmation that management did not rely on the
auditor’s procedures as the basis of their assertion
 Confirmation that all significant deficiencies and
material weaknesses have been disclosed to the
audit
 Description of any fraud that resulted in a material
misstatement or fraud involving senior management
 Statement of whether there were any significant
changes to internal control over financial reporting
after the “as of” date
o The auditor must issue a disclaimer of opinion or withdraw
from the engagement if management refuses to provide
representation letter

M9 – COMMUNICATION WITH MANAGEMENT & THOSE CHARGED WITH

GOVERNANCE
 Those Charged with Governance = those who bear responsibility to
oversee the obligations and strategic direction of an entity (BOD or
Audit Committee)
o Two-way communication between BOD and auditor:
 Planned scope and timing of the audit

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  Information held by those charged with governance that
is relevant to the audit
 Timely observations arising from the audit that are
relevant to the oversight of the financial reporting
process
 Types of Deficiencies
o Deficiency in Design = occurs when a necessary control is
missing or when an existing control does not achieve the
desired objective
o Deficiency in Operation = occurs when a properly designed
control does not operate as designed or is performed by an
inappropriate person
 Deficiency Categorization
o Control Deficiency = exists when the design or operation of a
control does not allow management or employees to prevent
or detect and correct misstatements on a timely basis
o Significant Deficiency = a deficiency in internal control over
financial reporting that is less severe than a material weakness,
yet important enough to merit attention by those charged with
governance
o Material Weakness = a deficiency in internal control over
financial reporting, where there is a reasonable possibility that
a material misstatement of the entity’s financial statements
will not be prevented or detected and corrected on a timely basis
 Identification of fraud perpetrated by senior
management
 Restatement of previously issued financial statements to
correct a material misstatement
 Identification by the auditor of a material misstatement
that would not have been detected by the system of
internal control
 Ineffective oversight by those charged with governance
 Evaluation of Control Deficiencies
o Auditor must evaluate control deficiencies to determine whether
they represent significant deficiencies or material weakness
o The severity of a deficiency depends on:
 Actual Misstatement = actual misstatement amount
 Potential Misstatement

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 Likelihood = reasonable possibility that the entity’s
controls will fail to prevent or detect and correct the
misstatement
 Magnitude = consider both the dollar amount and
the volume of activity in accounts exposed to the
deficiency
 Communication of Control Deficiencies
o Control Deficiency
 Communicate to management only within 60 days of
report release
o Significant Deficiency
 Communicate the deficiency to management in writing
(60 days)
 Communicate to those charged with governance in
writing (60 days)
o Material Weakness
 Communicate the deficiency to management in writing
(60 days)
 Communicate to those charged with governance in
writing (60 days)

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