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Essential Auditing for

Individual Growth

Presented by

Edward Mendlowitz, CPA

Emeritus partner, Withum

Webinar January 7, 2021

CPA Academy

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Edward Mendlowitz, CPA

• Partner with WithumSmith+Brown, PC

• One of Accounting Today’s 100 Most Influential People

• AICPA designations: PFS, ABV, CFF, CITP, CGMA

• MBA Professor at Fairleigh Dickinson University

• Author of 29 professional books

• Developer and presenter of over 350 CPE programs

• Admitted to practice before U.S. Tax Court

• Inducted into the Estate Planning Hall of Fame

• On BottomLine/Personal panel of experts

• Practice management techniques have been reported

on by The Wall Street Journal, Journal of Accountancy

and many other publications

• Testified twice before House Ways and Means

Committee on tax equity and reform

• Has been a Team Captain and performed peer reviews

for over 60 CPA firms

• Best selling author at CPA Trendlines

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Ageless Children’s Story … Reality doesn’t change just because everyone thinks something is so

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Clarity is Meaningful

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This Program Will Discuss

How the skills employed in an audit can be used to learn how a business

operates and establishes controls,

How business communication skills are developed,

The value of doing your work the right way,

And how to see the stitches on the Emperor’s new clothes!

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Reality is What it is, Not What You Want it to Be, or Think it is, or Think it Should Be!

The auditor’s job is to see reality!

There is a purpose of auditing – know what it is, understand it and

think of it in terms of the client’s purpose in engaging your firm for

the audit

The heading is adapted from a quote by Jack Welch

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Polling Question #1

A purpose of auditing is to see reality

True

False

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Cuneiform - The first Human writing were accounting records

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Definition

Audit: From Latin “auditus” a hearing; from “audire” to hear

Audit: An official examination and verification of accounts, records or a

financial statement

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Audits Performed In the Bible

Moses hired Ithamar to perform an audit.

Exodus 38:21

St. Matthew and St. Luke refer to audits being done.

Matthew 25:19

Luke 16:2

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Canterbury TalesGeoffrey Chaucer (c. 1340 – 1400)

Whan that Aprille with his shoures soote

The droghte of March hath perced to the roote

And bathed every veyne in swich licour

Of which vertu engendred is the flour;

The beginning of The Prologue

The REEVE was a slender, choleric man.

His beard was shaved as nigh as ever he can.

His hair was by his ears full round y-shorn,

His top was dokked like a priest beforn.

Full long were his legges and full lean

Y-like a staff; there was no calf y-seen.

Well could he keep a garner and a bin;

There was no auditor could on him win.

Prologue lines 587 - 594

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Queen Isabella’s Auditor

Roderigo Sanchez accompanied Columbus on his first voyage

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Luca PacioliFather of Accounting

Fra Luca gave us Debits and Credits in 1494

Time out for a story…

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Nursery Rhymes – 16th Century

Sing a song of sixpence,

a pocket full of rye.

Four and twenty blackbirds,

baked in a pie.

When the pie was opened,

the birds began to sing.

Wasn't that a dainty dish

to set before the king?

The king was in his

counting house,

counting out his money.

The queen was in the parlor,

eating bread and honey.

The maid was in the garden,

hanging out the clothes,

When down came a little bird

and pecked off her nose!

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Academy Awards

The Academy

Awards hired a CPA

firm, Price

Waterhouse, to

audit the Oscar

voting in 1933 and

has used them ever

since

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McKesson Robbins 1938 Fraud

McKesson Robbins Fraud uncovered in 1938 led to an SEC investigation and the developing of

the practice of “top-down” auditing; auditors adhering to standards set by the profession and

included the need to verify Accounts Receivable and Inventory. This case also relieved CPAs

from being assumed to be able to detect fraud.

In 1976 SAS 16 issued the first acknowledgement that auditors need to plan their audit to

search for the occurrence of material irregularities, i.e. fraud, that might affect the financial

statements.

In 2002 SAS 99, as an outgrowth of SOX, set a new fraud standard for auditors. It requires the

auditor to access the risk that fraud might have occurred and materially affect the financial

statement.

Because of this, auditors should learn about the types of fraud and develop a reasoning

process to detect them including acquiring some investigative and analytical skills. Some of

the things to be aware of are incentives, pressures, opportunities and attitudes of the clients’

personnel. Comment: Work on acquiring the skills described in this paragraph.

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Selected Newspaper Headlines in 2008

Accounting

Rule Causes

Huge Write-

downs

Precipitating

Worse Financial

Crises Since the

1930s

Accountants are the single-most cause

of the banking and

credit crises

Accountants Deep-SixBusiness Sale

Accountants Application of Fair Value Rule is

Not Fair

Congress Should Force Accountants to Stop using Fair

Value Amounts on Financial Statements

Accounting Rule to Record Pension Liabilities is Causing Many Loans to

be Called

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What Auditors Do

Determine how the business or organization functions

Examine flow of transactions

Examine, review and comments on internal controls

Separates and analyzes a business’ profit centers

Analytically reviews results

Looks for trends and compares to expectations

Determine that essential business risks are containable and reasonable

Looks at facts and compares to what they should be based on organization’s

stated procedures

Communicate results in a manner that elicits positive change

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Accountants Measure Things!

Sometimes we don’t really want to know the results!

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Would the numbers be more or less meaningful if the players kept track of their stats themselves?

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We dissect how businesses operate and control their employees

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The Auditor Needs Curiosity!

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The Auditor Needs Awareness

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Auditors Need To Be Awake … and Alert

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Auditor’s Need To Walk through and See through the Maze!

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Auditors Need To Work Deliberately

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Time Pressure*

Pick one (or all that apply)

❑ Supersedes learning

❑ Must finish so you can start the next job

❑ Always too much to do

❑ Not enough time allocated to fix my mistakes (give me a break!)

❑ Always there

❑ Tool to stay focused and on track: “Work expands so as to fill the time

available for its completion.” Parkinson’s Law

* Solution is to stay focused, follow budget, work carefully, and don’t get off track.

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Auditors Look To Uncover the Facts

Look for the facts, the fact drivers, trends and relationships

Simple Definition of a FACT

▪ Something that truly exists or happens

▪ Something that has actual existence

▪ A true piece of information

Facts are not opinions or assumptions

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Checklists

Pick one

❑ Chore

❑ Punishment for finishing the job

❑ Mandatory for firm’s compliance

❑ One of your most effective Tools

Hold this thought

for a few minutes!

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Checklists Are an Important Tool

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Checklists

You need to do the checklists while you do the work and in order

▪ It is a guide [road map] to what you are doing

▪ You don’t look at a road map after the trip is finished (and if you did you might

have seen that there was an easier and more direct way)

You need to read the questions and understand them

Some of you fill out the checklists when you are finished

▪ It is not logical and is stupid;

▪ It adds time and wastes part of your life;

▪ And what happens when you see that you missed doing something?

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Ed’s Packing Checklist

Please explain the

value of the checklist if

it is filled out after I

finish packing?

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Ed’s Accounting Firm Business Model

Delegating permits leveraging of work

Leveraging creates opportunities for partners and staff

Delegating signifies trust that what is needed to be done will be done the way it

needs to be done by the due date

The firm’s system should create a method of training, supervision, oversight, and

confidence that the work will be done the way it needs to be done

The system establishes a structure to make it easier to delegate and manage

Checklists are part of the system and make it easier to describe what needs to be

done and how and in what order

Not following the system including using the checklists the right way causes added

work, time, supervision, and destroys the business model

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Polling Question #2

Ed seems fixated, i.e., nutsy, with checklists.

❑ True.

❑ False

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Never Assume the Result!

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Understanding the Business

You cannot audit a client if you do not understand their business

Put yourself in the owner’s shoes. What would you want your auditor to come

back with? That is how you would add value

Quotes from my partner Ruben Cardona

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More from Ruben

Proper Planning Prevents Poor Performance.

I have been using this for years in auditing [and all types of staff

training] speeches I present. Nothing beats a properly planned job.

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Ruben’s A.U.D.I.T Acronym

A: Analyze – Analyze client’s system, transactions, and processes

U: Understanding – Understand what the client does, how sales are

generated, products shipped or services provided and how client

makes money

D: Documentation – Record everything you work on and observe

I: Investigate – The auditor must independently verify and

investigate the information presented to them

T: Testing – Test transactions and sample activities

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Everything You Do Counts!

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Everything You Do Counts!

A baseball team’s loss in April or a football team’s loss in September counts same as

a loss in late September or December

Michael Phelps won Olympics’ 100-meter butterfly race by .01 second

Al Rosen missed Baseball’s Triple Crown in 1953 by .001 in his batting average

Hillary Clinton won 2016 Iowa caucus by 4 votes (701 to 697)

Al Franken won Minnesota Senatorial election by 225 votes

George H. W. Bush voted to break 7 ties in the Senate during the 8 years he was

Vice President and Senate President Pro Tempore

Jordan Spieth won U.S. Open by one putt and received $922,856 more than each of

the two people tied for second

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7 Things You Should Do Before Starting an Audit

1. ___________________________________________

2. ___________________________________________

3. ___________________________________________

4. ___________________________________________

5. ___________________________________________

6. ___________________________________________

7. ___________________________________________

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8 Things You Should Do Before Starting an Audit

1. Look at budget and planning memo for what you will be doing

2. Look at last year’s workpapers for what you will be doing

3. Look over last year’s financial statement and tax return

4. Read last year’s management letter

5. Get an understanding of industry

6. Try to get an update of client’s situation

7. Look over accounting literature to get an overview of special issues

8. Ask your supervisor if there is anything else you should do before you start

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I Hope You Caught the Error

I referred to 7 things on the first slide but gave 8 things on the next

slide

You need to be alert … and notice things

You are alert when you pay attention to what you are doing, seeing,

looking at, and focusing in on what you are being paid to do

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What Is Wrong?

Team batting average

Euros converted to U.S. $

Number sequence

Player AB Hits Average

Mickey 250 100 0.400

Babe 350 100 0.286

Roger 300 60 0.200

Team 900 260 0.295

Profit in Euros 10,000

# Euros in U.S. $ 0.3846

Profit in U.S. $ 26,000

1+1 2

2+2 4

4+4 8

8x8 16

16+16 32

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What Was Wrong?

The team average was .289.

▪ You do not add the averages to get the team average

▪ You divide the team total hits by the total ABs. 260/900 = .289

The exchange rate should be ±110 U.S. $ to 100 €. The Euro example uses 260 which

is way wrong

8 x 8 = 64

Pay attention – think – be aware – be alert

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Art of AccountingAuditor’s Mindset (read on your own)

An auditor’s mindset distinguishes a great accountant from an average one. The mindset involves really looking at items and not

just checking them off. Believe it or not, I developed this by watching ballet.

When I was in college, I looked for low-price places to take dates while also impressing them. I discovered the New York City

Center, which was home to the New York City Ballet, among other cultural groups. I started going frequently, sitting in the

balcony and seeing something different almost every time. One of the things I got hooked on was the George Balanchine

choreographed ballets. They were classical, but somehow “modern.” They must have been good because the company is still

around performing many of the ballets I enjoyed when I was in college.

I became fascinated watching the ballerinas doing their pirouettes and not getting dizzy. I did some reading (note that I still have

that first book I purchased) and found that the dancers focused on a fixed point and only turned their heads at the last second to

again refocus on that same spot. This way they were only looking at one spot and did not “see” everything around them, which is

what would make them lose their balance.

When I started doing audits, everything looked questionable and confusing, and at the end of the day, I did not have a clear

handle on what I was doing or what was going on. One evening I was attending a ballet and it hit me—I was seeing everything

and looking at nothing!

The next morning, I started focusing and looking at what needed to be done and the separate “pieces of paper” representing the

transactions I was auditing. And then I realized that to be a good auditor, you needed to look at what occurred and compare it to

what should have occurred. You cannot do the latter without understanding what happened, and you cannot understand what

happened without actually looking at what happened. Since that early point in my career,

I stopped seeing and started looking—and developed what I call the auditors’ mindset.

By Edward Mendlowitz, CPA Reprinted from www.Accountingtoday.com SEPTEMBER 21,2015

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Initial Planning

Understanding the entity and its environment

Understand the type of entity and its owners and key managers, related parties,

subsidiaries, affiliates or joint ventures and business activities and relationships

How the entity is managed

Industry conditions

Regulatory issues

Industry risks and issues affecting financial reporting

Risks of existing debt structure

Subsequent events that might affect entity, its operations and debt structure…

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Key performance indicators and who uses them

Frequency financial statements distributed, what type of statements and to who.

Who prepares them?

If there are budgets and projections, how often they are reviewed

Frequency of management meetings; who attends; who sets up agenda

Description of open law suits, both as a plaintiff and defendant

Product warranties and size of claims

If there are business or property valuations, why they were prepared

Get copy of buy-sell agreement among the owners, if any

Are there any evident contingent liabilities

Identify areas of potential significant risk of material misstatement

Recent developments in economy that would affect entity and their industry

Unusual accounting principles used by the client…

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Timing and deadlines

Important control systems

Significant IT applications and how the client’s use of IT may affect the audit

Areas susceptible to management override of controls

Materiality at the financial statement level and performance materiality

How materiality will be used to determine the extent of testing

Remain alert for information or other conditions that may indicate a possible

material misstatement due to fraud or error

Follow up on all indications of a material misstatement

Review the application of generally accepted accounting principles to the client’s

facts and circumstances based on the client’s accounting policies

Remember to exercise professional skepticism throughout the engagement

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Organization Chart

Get one – If they do not have one it indicates a lack of clarity about the role,

functions and chains of command of the key personnel

If they have one, look at the chains of reporting and responsibilities, organizational

lines, departments and cross relationships

▪ Look for separations of related functions and for adequacy of personnel

▪ This will also indicate the key people

Very helpful when doing field work and identifying people you will be working with

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Checklists Redux

There are checklists for every facet of the audit

It is essential that checklists be followed and answered deliberately, directly and

without bias or preconceived ideas

It is possible that every checklist is completed perfectly, and the auditor would have

no concept of what the client does. THEREFORE, it is incumbent upon the auditor to

UNDERSTAND everything he or she reviews, examines and touches. The way things

are, once a staff person works on something, they are forever expected to know it,

and will be always be held accountable for that knowledge

On the following slides are suggestions of the essence of what the auditor should

learn about the client

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Narrative Description of Accounting System

Part of the audit process is preparing a narrative description of the accounting

system.

▪ This can be prepared before you start, while working with the checklists or

afterwards as a means of putting everything together and summarizing the

system and controls. It is best being done before you start

Prepare for major transaction classes, and include descriptions of controls

▪ Cash receipts, sales, billing and accounts receivable

▪ Cash disbursements, purchases, payments and accounts payable

▪ Inventory

▪ Property, equipment and major repairs and replacements

▪Major expenses

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Description of Cash Receipts and Billing

Describe flow of information, including the initiating, recording, and processing of

transactions

Salespeople initiate sales; credit manager approves all sales; billing department sends out

monthly statements via billing system integrated with general ledger

Invoices are distributed after each sale is made; if payments are mailed to the company mail

is opened by receptionist or person in charge of receiving mail; checks are restrictively

endorsed by person opening mail; deposit ticket prepared by clerk; deposits brought to bank

by clerk (or scanned to bank account); cash receipts journal integrated with general ledger

prepared by accounts receivable department; incorrect processing is resolved monthly

For payments that are electronically sent similar but applicable procedures should be

documented

Bank reconciliation prepared monthly and reviewed by appropriate party; monthly operating

report prepared; managers compare operations to budget monthly; managers review aging

and revenue results

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Listing of Controls

Credit manager approves sales; sales orders are integrated with invoices and general ledger

Deposit tickets compared to cash receipts journal; accounts receivable manager reviews

aging; manager/owners review aging summaries and large or problem balances

Bank reconciliation prepared independent of cash receipts; managers review aging

Discussed system with appropriate manager

▪ Name: ______________ Position: __________Date: _______

Audit evidence reviewed or observed: Bank statements, deposit tickets, and sales invoices

Performed walkthrough of system and determined that it is operating as described and

controls are in effect. Details written in work papers. For example:

▪ Tested cash receipts on May 14, 20XX and August 9, 20XX

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Risks Related To this Accounting System

___ No significant and/or fraud risk

If yes, describe and include overall and specific audit response

▪ Revenue recognition—sales manager and sales team receive commissions based on

sales activity; which could be an incentive for the sales team to recognize revenue

aggressively.

▪ Overall Response: Experienced staff on engagement, adequate supervision, work

performed at year-end.

▪ Specific Response: Test sales transactions, perform sales cutoff, test subsequent credits

issued.

___ No testing of controls considered necessary. Audit plan includes adequate basic and

further procedures.

___ Controls tested. Results of tests are documented and adequately addressed in audit plan.

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Polling Question #3

Evaluating controls and risks is a key function of auditors

True

False

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On the Following Slides…

Are indications of what you should learn while performing the audit tests using the

checklists, documenting procedures and conducting interviews and discussions with client’s

personnel

Selected areas are described, not every area and some of the selected ones might not apply

to every client you work on

Similar procedures on applicable areas can be applied for audits of not-for-profit

organizations

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Sales and Accounts Receivable

Reviewing the sales and accounts receivable provides a look at how the company does

business, who its customers are, the frequency of purchases, the sizes of the orders, the

returns and any sales allowances, what sales people handle each customer, credit limits,

patterns of payments, whether there are atypical orders, creeping increases in balances

owed, the relationships of the accounts receivable size to the monthly or annual sales, and

who the largest customers were over the previous four or five years and whether there have

been any changes.

Reviewing the aged schedules of accounts receivable will disclose relationships between the

sales billing and the lag in time until the client gets paid. Comparing the current year’s

schedules and amounts with the previous year will show changes – any large or unusual

changes should be reviewed and understood. While working on the account receivable

perform some ratio analytics. How many day’s sales are in the accounts receivable, what is

the monthly sales and how does this year’s monthly sales compare to the previous years? Are

sales concentrated into a few months, and has this concentration changed.

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How are the sales correlated with the inventory? If the client has distinct product lines, can

the analysis be done by major sales categories? Look at the bad debts written off and

compare to prior years and look to see if that customer or a related customer is still

purchasing from the client. Determine whether there are significant transactions with related

entities or people and amount of unpaid balances. Can you tell if there is an order backlog

and how it compares to prior years; and determine why there is a backlog and for what

products.

Review method to recognized revenue; test accuracy of accounts receivable schedule

balances; determine how customer credit balances arose, are handled and check some

transactions that reduced old or dormant credit balances. Compare large differences in

confirmed balances to schedule. Look for large returns in the subsequent year. Check for

subsequent collections of some larger accounts receivable balances. Scan the sales for

unusual or nontypical transactions. Look for yearend shipments to related entities especially

to those with different fiscal years.

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Follow the Cycle

The life of a sale – do for 5 or 10 transactions randomly selected

The sales order is received

Customer credit limit checked

Approved

Accepted for shipment

Shipped and shipping documentation generated

Trace item shipped to perpetual inventory system and verify that quantity was entered

properly

Check selling price to cost price

Prepare invoice for the shipment…

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Entered invoice in billing system and as an accounts receivable

Entered in general ledger

Trace payment from accounts receivable account back to cash receipts journal

Trace cash receipts amount to general ledger

Trace to deposit ticket

Review deposit ticket to bank statement

Trace bank statement to bank reconciliation

Trace bank reconciliation cash balance to general ledger

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Other areas to consider

Inventory including purchases and accounts payable

Payroll

Fixed asset acquisitions or dispositions and retirements

Capital accounts

Specific issues based on the client’s business

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Context

Small changes in certain allowance accounts that removed the “fence”

▪ Question; Can an $18,000 cost of sales item have any relevance to a company

with $50 million in sales and $30 million cost of sales?

Suppose it causes a $10,000 loss to become an $8,000 profit?

Suppose same company, but the profit is $8 million and there was an embezzlement

of $230,000 by a shipping clerk?

Would you answer be different if it was the person in charge of the shipping?

What about if it was the controller? Would it affect your opinion?

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Suppose it was the controller and it had been going on for four years and this year’s

amount was $230,000 and last year’s $150,000 and $80,000 year before and

$20,000 the first year?

What does “present fairly” in the audit report mean?

Define significant, material, context, perception

Definition is based on context and perception

DVD for $15 at Best Buy vs. $10 in the Mall

▪ Do you buy at Best Buy or go to Mall?

Bose speaker for $500 at Best Buy vs. $495 in Mall

▪ Do you buy at Best Buy or go to Mall?

Same $5. Context and perception

Now, material to who?

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Deliver information in clear

language, pertinent charts or

graphs, and keep in mind that

the purpose of your report is to

communicate and articulate

ideas that can be acted upon.

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Extending audit skills to suggest providing added services to clients

Internal control warning letter

This should be sent to every client you perform any type of accounting services for

where you are not engaged to issue an internal control review report of your

findings

This would warn a client about clear deficiencies you observed with some specific

illustrations of changes and a fee for your proposed study

Always emphasize the benefits and value to the client

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Surprise bank reconciliation

Send a proposal to offer to perform a surprise bank reconciliation with the reasons

why and the benefits and value to the client

Ratio analysis

Send client a proposal to perform a ratio analysis using the current and previous

four years financial statements and data stating the benefits and value client can

derive from the analysis and the indicated trends

Part of the analysis should include isolating trends from evident product lines

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Added opportunities

Sustainability, corporate social responsibility reports (CSR), integrated reporting, the

six capitals, environmental, social and governance (ESG), supply chains, and system

and cyber security risk are areas that will need attestation

Companies need to issue reports in these areas and assuage doubt about the

veracity and security in these and many other areas. It will no longer be enough for

the CEO to stand on a podium and announce his or her company is free of risk or

has attained growth in their sustainability or corporate social responsibility goals.

An independent body will be needed to attest to this, and the most trusted advisors

are CPAs.

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Before You Start

Read last year’s financial statement

Read last year’s management letter

Look at organization chart

Look at client’s website

Search web for news stories about client

Review last year’s audit program and work papers on areas you will be working on

Understand the client’s industry

Understand how client does business

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When You Finish

Read final financial statement

Read management letter

Look for your input in the financial statement and the management letter

See that the journal entries are sent to controller

Make sure all your review comments were cleared

Review what you did and look at the big picture of where it fit into the entire job

Look at the completed tax return and try to understand the book to tax adjustments

(if you weren’t involved with the tax accrual)

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Era of No Second Chances

Arthur Andersen (gone)

Lehman Brothers (gone)

Bear Stearns (taken oven by JPM)

Merrill Lynch (taken over by BOA)

Wachovia (taken over by Wells Fargo)

Chipotle, Takata, Volkswagon, Pete Rose and Barry Bonds

Question: Would the results that befell these companies and people have occurred

if they had filled out their RISK ASSESSMENT checklist properly?

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Era of Achievement and Aspiration

Your potential is unlimited and is held back only by your lack of effort and

imagination

Your possibilities are endless

Your best professional opportunities can be through auditing and the skills

auditing requires

Your best use of the newest and latest tools is through auditing

Your best way of finding out how organizations (both businesses and not-for-

profit) operate is through auditing and following the checklist and understanding

what you are reviewing

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I Envy Your Opportunities

YesterdayTomorrow Start

today

Take advantage of what is being handed to you through auditing!

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It’s Up To You!

The mind is it’s own place, and in itself can make a heaven of hell and a hell of heaven.

John Milton

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Go for it!

You

YouYou

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3 things you can do right now because of this program

1. ___________________________________________

2. ___________________________________________

3. ___________________________________________

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Some suggested “3” things you can do

A lot:

Look at what I am seeing – paying more attention and being more alert

Will plan better and will follow Ruben’s 5 Ps and his A.U.D.I.T. Acronym

Will treat checklists more respectfully and be more deliberate with them

Will make sure I understand all the instructions and will pay better attention to

what I am doing

Will pay much more attention to the accounting system and internal controls

Put things in its proper context

Follow the information on the “Before You Start” and “When You Finish” slides

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Polling Question #4

Being an auditor involves doing many different types of things

simultaneously

True

False

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Do not hesitate to contact me

Contact me with any questions about this program, or with

Practice management issues you might have, or

Any services you believe Withum could help you or a client with. Use me

as a window into Withum and I can match you with the right person to get

what you need, done.

Thank you for attending!

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Thank you for attending

You are welcome to call Ed with your questions.

Ed can be reached at:

Ed Mendlowitz

WithumSmith+Brown, PC

1 Tower Center Boulevard, 14th Floor

East Brunswick, NJ 08816

Tel: 732.743.4582

e-mail: emendlowitz@withum.com

Blog: www.Withum.com/partners-network-blog