Answered Essay: Compare and Contrast Audit Procedures and Reporting

Compare and Contrast Audit Procedures and Reporting

Instructions:

In a paper, compare and contrast audit procedures and reporting within a business context. Include the following:

1- Discuss the different audit reports. Under what circumstance is each report used?

2- Outline the auditor’s code of professional conduct and independence in relation to the audit reports.?

3- What specific information would be examined during an audit that would require analytical procedures?

4- Include test examples of the cash and collection cycle?

Support your paper with minimum of seven (7) resources.

Length: 13 pages not including title and reference pages, with diagrams as needed.

Expert Answer

 

Several types of Auditor’s Reports exist. These include standard (unqualified), explanatory, qualified, disclaimer, and adverse. The Standard Auditor’s Report is unqualified. Unqualified means that in the auditor’s opinion, there are no special circumstances to report and the financial statements are presented fairly without material misstatements. Auditors may issue reports showing their opinions are something other than unqualified. These include explanatory, qualified, disclaimer, and adverse.

Explanatory reports have an explanatory paragraph added to the standard unqualified report. The explanatory paragraph follows the opinion paragraph. “Four situations require the addition of the explanatory paragraph: 1) Reference to the audit of internal control for public companies 2) Substantial doubt to the ability of the entity to continue as going concern 3) Lack of consistency due to accounting changes, and 4) A need for additional emphasis (Messier, Glover, & Prawitt, 2012, p. 616).”

Qualified reports are used for a departure from Generally Accepted Accounting Principles (GAAP). “The report describes the nature and impact of the departure. This could be because of faulty accounting. A qualified report means the financial statements are presented fairly except for this departure GAAP (Messier, Glover, & Prawitt, 2012, p. 619-620).” In qualified reports misstatements may exist but they are not material misstatements. If material misstatements exist, then an Adverse Report would be used instead.

Disclaimer reports are used when an auditor withholds his opinion on the financial statements. An auditor may withhold his opinion either because of insufficient appropriate evidence to form an opinion or because of lack of independence. The auditor must be independent, meaning they have no connection with the client personally or financially. If the auditor cannot maintain professional independence, then he/she cannot provide an unbiased opinion. “In the disclaimer, the auditor states the reason why he/she was unable to provide an opinion and explicitly states that no opinion is expressed (Messier, Glover, & Prawitt, 2012, p. 619-620).”

An Adverse Report is issued when the financial statements do not present fairly due to a departure from GAAP that causes a material effect on the financial statements overall. “In an adverse report the auditor explains the nature and size of the misstatement and states the opinion that the financial statements do not present fairly in accordance with GAAP (Messier, Glover, & Prawitt, 2012, p. 619-620).”

The Principles of Professional Conduct Responsibilities are shown below. They are also listed on the AICPA website.

In carrying out their responsibilities as professionals, members should exercise sensitive professional and moral judgments in all their activities.

The public interest: Members should accept the obligation to act in a way that will serve the public interest, honor the public trust, and demonstrate commitment to professionalism. Integrity: To maintain and broaden public confidence, members should perform all professional responsibilities with the highest sense of integrity.

Objectivity and independence: A member should maintain objectivity and be free of conflicts of interest in discharging professional responsibilities. A member in public practice should be independent in fact and appearance when providing auditing and other attestation services.

Due care: A member should observe the profession’s technical and ethical standards, strive continually to improve competence and the quality of services, and discharge professional responsibility to the best of the member’s ability.

Scope and nature of services: A member in public practice should observe the Principles of the Code of Professional Conduct in determining the scope and nature of services to be provided (Messier, Glover, & Prawitt, 2012, p. 652).

Regarding the subject of auditor ethics, independence has become a frequently discussed topic. With the complexity of the issue at hand, the AICPA has devoted multiple pages of interpretations and rulings regarding independence. Also the SEC and the now defunct ISB contain rulings about independence issues (Messier, Glover, & Prawitt, 2012, p. 654).

In the Rothenburg Construction Company case, Jay Rich, CPA, held 10 percent of the stock in Rothenburg Construction Company. Therefore, Mr. Rich could not maintain professional independence while conducting the audit. The objectivity and independence clause of the “Principles of Professional Conduct Responsibilities” would have been violated if Mr. Rich had conducted the audit. He cannot conduct an audit for a company for which he holds part of the stock.

Material misstatements discovered during audits can be more difficult to recognize in audits concerning fraud than in audits concerning errors. One solution for detecting fraud is the use of analytical procedures. Analytical procedures are “evaluations of financial information made through analysis of plausible relationships among both financial and nonfinancial data (Messier, Glover, & Prawitt, 2012, p. 121).”

Auditors must realize the possibility for financial fraud exists and act with professional skepticism. Auditors can evaluate financial statement accounts by using analytical procedures. Non-financial data can be gathered using inquiries and observation. This data can be compared to the results obtained from analytical procedures. Results of evaluations must be communicated clearly and concisely to others. These efforts should be supported during both the planning and performance stage of the audit with brainstorming meetings between the engagement team members. Results of evaluations must be communicated clearly and concisely to others. Auditors must understand the Fraud Risk Triangle and know that with enough pressure, and the opportunity, even an honest person can rationalize unethical behavior. Managers often are involved in fraud because they have the opportunity access accounting records and the incentive to make profit. Auditors can use the confirmation process to obtain evidence from third parties about financial assertions made by management.

Upon completion of an audit, the auditor should be able to ascertain whether the accumulated audit procedures may cause the financial statements to be materially misstated. Based on the understanding of the entity and its environment, the auditor should assess the risk of material misstatement at the assertion level and determine necessary auditing procedures based on the risk assessment results.

The cash and collection cycle is the process of ensuring that employees and management properly control customer billing and cash receipts. When auditing a cash a collection cycle, the auditor should be looking for fraud. However, according to Dyck (2011), it is more likely that the financial statements would be materially misstated due to unintentional bias than due to fraud (Budescu, Peecher, & Solomon, 2012, p. 26). If fraud is suspected the usual audit procedures may be extended to include the following:

  • Extended bank reconciliation procedures.
  • Proof of cash.
  • Tests for kiting (Messier, Glover, & Prawitt, 2012, p. 552).

Extended Bank Reconciliation Procedures

If the auditor suspects some type of fraud has been committed, then the auditor would examine the bank reconciliations of two consecutive months to ensure that all reconciling items were handled properly. The deposits would be traced to the bank statement to verify that they were deposited in the bank. Deposits in transit would be traced to the following month’s cash receipts journal to verify that they were recorded. Checks listed as outstanding on the bank reconciliation would be traced to the cash disbursements journal, and the canceled or substitute checks returned in the next month’s bank statement would be examined for propriety. Other reconciling items such as bank charges, NSF checks, and collections of notes by the bank similarly would be traced to the accounting records for proper treatment (Messier, Glover, & Prawitt, 2012, pp. 553-554).

Proof of Cash

The primary purposes of the proof of cash are:

( 1) to ensure that all cash receipts recorded in the entity’s cash receipts journal were deposited in the entity’s bank account

( 2) to ensure that all cash disbursements recorded in the entity’s cash disbursements journal have cleared the entity’s bank account, and

( 3) to ensure that no bank transactions have been omitted from the entity’s accounting records (Messier, Glover, & Prawitt, 2012, p. 554).

“The reader should note that a proof of cash will not detect a theft of cash when the cash was stolen before it was recorded in the entity’s books (Messier, Glover, & Prawitt, 2012, p. 554).” The auditor may suspect that cash was stolen without being recorded in the entity’s books, when during the audit test for the completeness assertion it appears that not all cash receipt transactions were recorded (Messier, Glover, & Prawitt, 2012, p. 554).

Tests for Kiting

One type of fraudulent scheme that has been around for years is called check kiting. The account holder usually has two accounts and transfers non-existent funds from one account into another one. A kiting scheme generates non-existent revenue and produces questionable account balances. Since this type of bank fraud is common, The Office of the Comptroller of the Currency (OCC) has recently issued an advisory letter to banks on how to identify and combat check kiting. Normally, when people cash checks, the funds supporting the check are actually in the account. However, clearing a check usually takes between one to five days. “During this clearing time, the bank gives the person cashing the check a short-term loan until the money is actually received from the financial institution that originally issued the check. There is a window of time during which the bank that cashed the check does not actually have the money. It is during this window when the bank that issued the check is unaware that the check was issued. The check-kiting scheme takes advantage of this transit vulnerability. Check kiting is a crime prohibited by federal law 18 USC § 1344 (Summerford & Gober, 2003).” It states that whoever knowingly executes, or attempts to execute, a scheme or artifice—

(1) to defraud a financial institution; or

(2) to obtain any of the moneys, funds, credits, assets, securities, or other property owned by, or under the custody or control of, a financial institution, by means of false or fraudulent pretenses, representations, or promises;

shall be fined not more than $1,000,000 or imprisoned not more than 30 years, or both.

Thus, individuals who perpetrate a check kite are frequently prosecuted and sent to prison. But that often does not help the banks, which are left with the loss after the check kite collapses (Summerford & Gober, 2003).”

One approach commonly used by auditors to test for kiting is the preparation of an interbank transfer schedule. To test for kiting, an auditor will check to see if the money recorded as transfers was really in the account at the time of transfer. Kiting can be detected by tracing the check to the cash disbursements and cash receipts journals and to the end-of-the-month bank reconciliation (Messier, Glover, & Prawitt, 2012, p. 554). Another method of testing for kiting is to put a hold on the account the money was transferred into for a few days while waiting to see what day the money in the other account actually becomes available.

Auditing assignments involve examining work papers and checking boxes to trace amounts on bank reconciliations, cutoff bank statements, standard bank confirmations, and proof of cash statements. However, the key issue may not be to just “check the box” but to develop more tools for evaluating and controlling audit failures. Kleinman & Palmon (2014) suggested that we do systematic research to determine how audit quality is effected by national culture, legal systems, accounting standards, auditing standards, and auditing enforcement regimes (Kleinman, Lin, & Palmon, 2014, p. 79).

PricewaterhouseCoopers (2003) and Albrecht and Sack (2000) state that future accountants must learn to solve complex, unstructured problems and communicate their solutions clearly and concisely (Green, 2013. p. 168).” Accountants must be able to perform inventory audits with accuracy and completeness at the forefront of their audit actions. Also they must be mindful of the potential for inventory losses due to fraud, theft, damages, and obsolescence. They must realize that inventory valuation methods such as LIFO, FIFO, and Standard Cost must be considered when getting the true value of inventory. Review and observation are the main ways of testing control activities within the organization. Auditors must verify that the inventory actually does exist as well as its physical location. Auditors can perform these verification procedures through the use of substantive tests.

References:

1. Division of administration and Finance, California State University. Retrieved from https://daf.csulb.edu/offices/univ_svcs/internalauditing/audits.html

2. Reports on audited financial statements. Retrieved from http://www.aicpa.org/Research/Standards/AuditAttest/DownloadableDocuments/AU-00508.pdf

3. Modifications to the opinion of independent auditor’s report. Retrieved from http://www.mia.org.my/v1/downloads/psp/standards/ISA705.pdf

4. Understanding audit reports. Retrieved from http://accounting-financial-tax.com/2009/09/understanding-audit-reports-and-auditor%E2%80%99s-opinion/

5. International standard on auditing. Retrieved from http://www.ifac.org/system/files/downloads/a039-2010-iaasb-handbook-isa-710.pdf

6. Auditor reporting. Retrieved from https://www.iaasb.org/projects/auditor-reporting

7. Auditor’s report. Retrieved from https://debitoor.com/dictionary/auditors-report

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