NINJA CPA REVIEW®

NINJA Notes 2013 AUD – Engagement Planning

   

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Updated for July 2013 Exams The NINJA Notes have been updated for the newly-tested Clarity Standards. Table of Contents The N.I.N.J.A. Framework Update: Clarity Project 8 I. Engagement Planning 13 II. Internal Control 27 III. Auditing & IT 38 IV. Evidence & Risk 44 V. Audit Reports 58 VI. Audit Sampling 69 VII. Professional Responsibilities 80 VIII. International Auditing 88

   

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The N.I.N.J.A. Framework NAIL THE VIDEOS Watch your CPA Review videos first – before working any assigned homework questions. The CPA Review industry says to watch a section of CPA Review video and then work the accompanying MCQs. This perspective stems from the old-school approach to the paper and pencil exam where you had to sit in a live classroom and learn from an instructor on weekends. Today, there is a smarter way to study. You don’t have to go to a weekend live course. You can fire up the laptop on a Tuesday morning and knock out two hours of material before you even brush your teeth. If you work MCQs in week one over your week one topic, guess what? You will work them again in week 5 or 6 when you review because you will forget what you learned. If you watch a video in week one and score an 85 on the corresponding MCQs, will you be able to score an 85 four weeks later? Not likely. You will need to work them again anyway and it’s not a smart use of study time. Instead, let the N.I.N.J.A. Framework guide you. INTENSE NOTES Repeat after me: “PUT THE HIGHLIGHTER DOWN.” Which method do you think will help you learn the material better – painting printed words in a book with pretty florescent colors or writing them down on a legal pad and thinking about the information?

   

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Grab a stack of legal pads, put the highlighter down, and start writing. Many people have said that instead of taking their own notes, they just re-write the material inside of this study guide, which is fine too. NON-STOP MCQS Now is the time to start working multiple-choice questions and do them with a focused frenzy. Do so many MCQs that you’re absolutely sick of them. As you encounter little “fact nuggets” that you didn’t know or are prone to forget, write it down and add it to your voluminous stack of notes. JUST RE-WRITE IT This is where it gets tedious. This is also where the payoff happens. You may be familiar with the fact that if you had a choice between $3 Million and 1¢ doubled daily for 31 days, the penny doubled for 31 days ends up tripling the $3 Million. The payoff, however, doesn’t happen until the 31st day. The road is long, but ends up being worth it in the end. The same goes for re-writing your study notes. The thought of grabbing that stack of legal pads and going to town re-writing what you’ve already written may sound like a ridiculous suggestion at first, but I am a firm believer in its impact. Merely writing down your notes and then reviewing them before your exam doesn’t have near the impact as taking your furious scribbles and converting them into re-packaged, easily-digestible “fact nuggets.” Not only will your notes mean more when you’ve whittled away the non-essentials, but you are actually learning the

   

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material twice. Re-processing the material by re-writing your notes is like letting the information marinade in your mind. Just like a well-prepared steak, you will taste the payoff of this extra step. Don’t like taking notes? No problem. Re-write these NINJA Notes instead. You will absorb the material better vs. reading only. Plan wisely because this will likely take a week to complete. “I have found this to be unbelievably helpful! This is now my second section that I have followed this piece of advice and, once again, I am amazed at how much the material "clicks" as I review and write the notes a second time. Sure, it's time-consuming, but for me, it is worth it. No questions asked. Not only does it help with processing and understanding the material, but it also results in a better, more organized set of study notes to use for review up until exam date.” – Sandy ALL COMES TOGETHER You have watched the videos. You’ve taken ridiculous notes and have done hundreds (thousands?) of multiple-choice questions. You’ve re-written your notes. Now, study that stack of review Gold in your hands multiple times, work MCQs over weak topics, study your notes even more, and then go in and PASS the CPA Exam.

   

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How to use NINJA Notes READING You've invested in the NINJA Notes, now let it go to battle for you. You should read the them as many times as possible. Carry it with you wherever you go. Do you have an iPhone®, iPad®, or similar device(s)? Simply load the PDF onto the device and if you have 5 minutes of downtime, you have 5 minutes of study time. It is recommended that you read the NINJA Notes at least five times leading up to your final two weeks of exam prep. If you have 6 weeks to study, then you need to complete this in 4 weeks. 5 weeks to study, then complete it in 3. 4 weeks = 2 weeks. You get the picture. The point is: plan, plan, plan and budget, budget, budget, budget because exam day is looming. 6-Week Plan: Approx. 103 pages x 5 reads /4 weeks / 7 days per week = Approx. 18 pages per day 5-Week Plan: Approx. 103 pages x 5 reads /3 weeks / 7 days per week = Approx. 24 pages per day 4-Week Plan: Approx. 103 pages x 5 reads /2 weeks / 7 days per week = Approx. 37 pages per day 3-Week Plan: Approx. 103 pages x 5 reads /1 weeks / 7 days per week = Approx. 74 pages per day

   

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RE-WRITING This step is optional, but it won over a lot of skeptics with its results. This is not mainstream advice. This is the NINJA way. The mainstream way of studying for the CPA Exam is old-fashion and outdated. Forget the old way. You are a NINJA now.

Now is the time to either 1. Re-write your own CPA Exam notes or 2. Re-Write the NINJA Notes. Plan on investing a week doing this and you should expect to get through 15 pages a day (Approx. 103 pages / 7) in order to stay on track. After this, you will still have one week left to put the finishing touches on your CPA Exam review prep – i.e. doing a ton of MCQs. (http://www.tinyurl.com/WileyTB) yI. Engagement Planning

   

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I. Engagement Planning THE AUDITOR

Ø Provides users of financial information with

o Reasonable assurance that the financial statements are not materially misstated

Ø NOT responsible for detecting theft or fraud

o Instead, provide reasonable assurance

Ø The earlier the auditor is hired prior to the Balance Sheet Date, the better for audit planning and efficiency

o Audit procedures can be carried out at interim

dates if Control Risk for the accounts/transactions is low

§ Review changes in balances at year-end

§ If the year has already been closed, an

auditor can take the engagement if they are able to overcome the limitations of the engagement

Ø An auditor uses Professional Skepticism to

o Plan the Scope of the Audit

o Plan the Objectives of the Audit

Ø When planning an audit

o Role and involvement of client’s Internal Auditors

should be decided

   

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o Analytical procedures performed

§ Compare Actual vs. Forecasted Data

o If issues relating to Predecessor Auditor’s work on previous financial statements come up during the current audit

§ Auditor must have client’s permission to discuss the issue

o Audit procedures that are carried out by assistants

§ Were they adequately performed?

• Review the working papers

§ Are the results consistent with the audit

report?

o Audit Strategy should be mapped out

§ What are the reporting objectives?

§ What is the scope of the audit? GENERALLY ACCEPTED AUDITING STANDARDS (GAAS)

Ø Materiality and Audit Risk are foundations of GAAS

o Measure Auditor’s

§ Professional Qualifications

§ Judgment

   

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General  Standards  (TIP)  

• Education  and  Audit  Experience  

Training  and  ProEiciency  

• In  Fact  and  Appearance  • Honest  • No  Direct  Financial  Interest  • No  Indirect  Material  Financial  Interest  

Independence  

• Technical  abilities  mirror  those  held  by  peers  in  the  profession  • Follow  GAAS  Standards  • Obtain  a  Reasonable  Level  of  Assurance  • Maintain  Reasonable  Level  of  Skepticism  • Supervise  Audit  Staff  • Review  judgment  at  every  level  

Professional  Care  

   

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Standards  of  Fieldwork  (PIE)  

• Audit  should  be  adequately-­‐planned  and  the  work  of  any  supporting  staff  should  be  supervised.  

Planning  and  Supervision  

• Auditor  must  understand  the  entity  and  its  internal  control  environment.  

Internal  Control  

• Auditor  must  obtain  sufEicient  &  appropriate  audit  evidence.  

Evidence  

Standards  of  Reporting  (CDOG)  

• Consistency  is  Implied.  Report  only  refers  to  consistency  if  accounting  principles  have  not  been  consistently  applied  period-­‐to-­‐period.  

Consistency  

• Adequacy  is  Implied.  Report  only  refers  to  disclosures  if  disclosures  are  NOT  adequate.  

Disclosures  

• Audit  Opinion  is  based  on  Financial  Statements  as  a  whole.  

Opinion  

• Audit  Report  MUST  state  whether  the  Einancial  statements  have  been  prepared  in  accordance  with  US  GAAP.  

GAAP  

   

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PRIOR TO ACCEPTING AUDIT ENGAGEMENT

Ø Review client’s Financial Statements

Ø Speak to 3rd Parties

Ø Contact Predecessor Auditor to evaluate whether

engagement should be accepted

o Must Have Permission from Client

§ No Permission = No Engagement

o Why the Auditor Change?

o Any Serious Discussions with Audit Committee?

o How is Management Integrity? Disagreements?

o How was Internal Control?

o Understand Industry or Be Willing to Learn

o Consider Scope Limitation

§ Limited evidence available = No Engagement

AUDIT ENGAGEMENT AGREEMENT

Ø Must be written and covers:

o Objectives of Engagement

o Limitations of Engagement

o Responsibilities of Management

   

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§ Provide written assertions o Responsibilities of Auditor

§ Limited Error/Fraud responsibility

o Expectations of Access to Records

o Financial Statements (and Disclosures) are

Management’s Responsibility

o Compliance with Laws

o Internal Control AUDIT COMMITTEE

Ø Part of the Board of Directors

Ø Corporate Officers Not Allowed

Ø Responsible for Hiring Auditor

o Oversees Internal Control

o Must Agree with Auditor on

§ Responsibility of the Parties

§ Audit Fee

§ Timing of the Audit

§ Audit Plan

   

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o Acts as Liaison Between Auditor and the Board

§ Auditor Communicates Concerns about

§ Internal Control Deficiencies § Errors § Fraud § Illegal Activities

MATERIALITY

Ø Quantitative and Qualitative Measurements

Ø Measured on the Transactional or the Financial

Statement level

o Audit plan based on smallest misstatement that could be material to Financial Statements

o If materiality thresholds differ among Financial

Statements, then use the lowest threshold amount. DON’T average them.

Ø Based on Auditor Judgment

o Auditor must consider needs of users

Ø Audit should be planned to allow “reasonable

assurance” that no material misstatements exist

Ø As acceptable Materiality level Decreases

o Auditor must find smaller misstatements

§ More individual account testing & testing closer to Balance Sheet Date

   

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AUDIT RISK

Ø Audit Risk (AR)

o Inherent Risk x Control Risk x Detection Risk

o Risk that material mistakes, errors, omissions, or

fraud will result in an inaccurate audit report

o Based on Auditor Judgment

o Measured both Qualitative and Quantitatively

Ø Control Risk (CR)

o Will Internal Control detect error or fraud?

o Auditor cannot control CR

Ø Inherent Risk (IR)

o Which transactions have a higher level of risk?

o Auditor cannot control IR

Ø Detection Risk (DR)

o Will the auditor fail detect a material misstatement?

o Auditor CAN control DR

§ Do more testing at year-end

§ Increase substantive testing

o Less Acceptable DR = Run More Substantive Tests

   

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o More Acceptable DR = Run Less Substantive Tests

o More Substantive Tests = Less Audit Risk

§ Detection Risk decreases

§ (↓AR = IR x CR x ↓DR)

o Less Substantive Tests = More Audit Risk

§ Detection Risk increases

§ (↑AR = IR x CR x ↑DR)

Ø Quantitative Measurements

o Inherent, Control, and Detection Risk can all be

measured in terms of percentages

Ø Non-Quantitative Measurements

o Inherent, Control, and Detection Risk can all be measured in terms of acceptable ranges

FRAUD AND ILLEGAL ACTS

Ø Management’s responsibility to FIND and PREVENT

Ø Auditor’s Responsibility:

o ASSESS THE RISK that such things will lead to

material misstatements.

o Design the audit to provide reasonable assurance against Material Misstatements caused by

§ Fraud

   

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§ Illegal acts that directly affect the F/S

§ If illegal (and not fraud), auditor should

seek to understand the situation and whether it affects the Financial Statements

§ Material errors

o Report all management fraud to Audit Committee

§ Minor fraud by low-level employees?

• Don’t report to Audit Committee

§ Minor fraud by management?

• Report to Audit Committee

o Required Inquiries and Procedures

§ Management inquiries

§ Analytical Procedures

§ Discussions with audit personnel about

§ Fraud leading to material misstatement

Ø Fraud is Intentional (Misappropriation)

o Born out of (RIO)

§ Rationalization

§ Incentive

   

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§ Opportunity

Ø Errors are Unintentional (Misinterpretation)

Ø Fraud Red Flags

o Current audit procedures may need to be re-considered if red flags exist.

o Examples of Audit Red Flags:

§ Management compensation tied to stock

§ Aggressive financial forecasting

§ Former auditor disagreed with Management

§ Records not available for audit

Ø A Fraud Risk Factor

o Has been observed in similar situations

§ Large sums of cash on hand

§ Earnings growth without cash flow

o Does NOT necessarily mean that there is a

material weakness in internal control

§ Internal control analysis can result in the conclusion that Internal Control is weak, but probably won’t identify illegal acts

o Leads to auditor taking action

§ Strives to make audit engagement

procedures less patterned and predictable

   

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§ Re-evaluates management’s application of accounting procedures

§ Finds and assigns audit personnel with relevant skills in this area

Ø Documentation

o Any fraud risks identified that could lead to

material misstatement

o Audit procedures performed to assess risks

o Nature of communication made to audit committee and company management

o Disclosure to third parties regarding fraud not

normally the auditor’s responsibility

§ Fraud by management should normally be reported to Audit Committee, not SEC

SARBANES-OXLEY ACT OF 2002

Ø Created the PCAOB

Ø Designates Officer responsibility for internal control

o Must disclose significant internal control

weaknesses to auditor and audit committee

o Must disclose any level of fraud discovered by employees with internal control responsibilities

AUTHORITATIVE LITERATURE HIERARCHY

Ø Statements on Auditing Standards (SAS)

↓ Ø Auditing Interpretations, AICPA Guides & SOPs

   

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↓ Ø Industry Articles (no authority)

QUALITY CONTROL FOR CPA FIRMS

Ø Firm Leadership exhibits quality and leads by example

and sets the tone for the organization

Ø Firms should Monitor and document that its policies and procedures are being followed

Ø Firms should have Relevant Ethical Requirements

Ø Acceptance and continuance of client engagements

should continue to be evaluated for

o Client Integrity

§ Does management have integrity?

o Auditor Competency

§ Is the firm competent enough to take the engagement?

o Legality

Ø Firm should have Competent and Ethical personnel

Ø Firm engagements are performed, supervised, and

reviewed in accordance with professional standards and regulations

COMPILATION SERVICES

Ø SSARS - Statements on Standards for Accounting and

Review Services to be followed

   

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o Non-Public entities only

Ø Independence NOT required for Compilations

o No Internal Control work allowed

o No Assurance given

Ø A CPA should comply with provisions of SSARS that apply to Compilation Engagements when preparing unaudited Financial Statements to a non-public company to a client or third party

Ø Must understand client industry

REVIEW SERVICES

Ø SSARS - Statements on Standards for Accounting and

Review Services to be followed

o Non-Public entities only

Ø Provides Negative Assurance

Ø Independence IS required for Reviews (AR 100)

o No Internal Control work allowed

o Performs Analytical Procedures

o No Material Indirect financial interest allowed

o No Immaterial Direct financial interest allowed

Ø Must understand client industry

   

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ATTESTATION SERVICES

Ø Independence Required

Ø CPA expresses a conclusion about an assertion

o Is the client compliant with laws? CONSULTING SERVICES

Ø Independence not required

PROSPECTIVE FINANCIAL STATEMENTS

Ø Report is restricted to specified users

Ø Agreed-upon procedures implemented

ADDITIONAL NINJA STUDY WEAPONS

Ø 10 Point Combo - http://tinyurl.com/ninja-10

Ø NINJA Audio - http://www.tinyurl.com/CPAAudio

Ø Wiley Test Bank - http://www.tinyurl.com/WileyTB