Gleim CPA Review Updates to Auditing 2011 Edition, 1st Printing June 3, 2011

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1 Page 1 of 7 Gleim CPA Review Updates to Auditing 2011 Edition, 1st Printing June 3, 2011 NOTE: Text that should be deleted from the outline is displayed with a line through the text. New text is shown with a blue background. The PCAOB has issued Audit Standards No. 8 through 15, effective December 15, They are eligible to be tested on the CPA exam beginning July 1, AS Nos. 8 through 15 concern the consideration of risk and materiality and the collection of evidential matter for issuers (public companies). These standards, which apply to the audit of issuers, supersede similar Auditing Standards Board standards, but the ASB standards still apply for the audit of all other entities (nonissuers). Candidates should expect questions on the exam relating to these new standards. However, these new standards are very similar to existing ASB standards. For the few differences, outlines and questions have been updated. Overall, the candidate should have little difficulty with the new PCAOB standards given the common nature of the new and existing standards. Introduction Page 20, Auditing Authoritative Pronouncements Cross-References: These edits update our pronouncement cross-references to reflect the recently effective changes. Statements on Standards for Accounting and Review Services AR Defining Professional Requirements in SSARSs AR Standards for Accounting and Review Services AR Framework for Performing and Reporting on Compilation and Review Engagements AR 80 1, 18 Compilation of Financial Statements AR 90 1, 18 Review of Financial Statements AR 100 1, 18 Compilation and Review of Financial Standards AR Reporting on Comparative Financial Statements AR Compilation Reports on Financial Statements Included in Certain Prescribed Forms AR Communications Between Predecessor and Successor Accountants AR Reporting on Personal Financial Statements Included in Written Personal Financial Plans Statements on Quality Control Standards SQCS 7 1 A Firm s System of Quality Control Standards for Performing and Reporting on Peer Reviews PR Standards for Performing and Reporting on Peer Reviews

2 Page 2 of 7 Other Standards and References 2 Department of Labor: Auditor Independence 20 Government Auditing Standards (Yellow Book) 2 IFAC Code of Ethics for Professional Accountants 5 The Committee of Sponsoring Organizations (COSO) Public Company Accounting Oversight Board AS No References in Auditor s Reports to the Standards of the PCAOB AS No. 2 [Superseded by AS No. 5] AS No Audit Documentation AS No. 4 9 Reporting on Whether a Previously Reported Material Weakness Continues to Exist AS No. 5 9 An Audit of Internal Control Over Financial Reporting That is Integrated with an Audit of Financial Statements AS No. 6 16, 17 Evaluating Consistency of Financial Statements AS No. 7 1 Engagement Quality Review AS No. 8 3 Audit Risk AS No. 9 1 Audit Planning AS No Supervision of the Audit Engagement AS No Consideration of Materiality in Planning and Performing an Audit AS No Identifying and Assessing Risks of Material Misstatement AS No. 13 3, 10 The Auditor s Responses to the Risks of Material Misstatement AS No Evaluating Audit Results AS No Audit Evidence Study Unit 1 Engagement Responsibilities Page 21, 1.1, 1.a.2): The following edits show the effects of the PCAOB s new Standards (AS Nos. 8-15) on Study Unit 1 content. 2) The Sarbanes-Oxley Act of 2002 is federal legislation that has had a dramatic effect on the engagement responsibilities of public accounting firms. This act created the Public Company Accounting Oversight Board (PCAOB). The PCAOB has issued seven 14 currently effective auditing standards (AS No. 1 and AS Nos ) applicable to audits of issuers (companies required to file with the SEC) by public accounting firms.

3 Page 3 of 7 Pages 26-27, 1.2, 2. f.- j.: The following edits show the effects of the PCAOB s new Standards (AS Nos. 8-15) on Study Unit 1 content. f. Some assertions overlap categories. Thus, only eight separate assertions are included in the model. If these are known, they can easily be assigned to the three categories of assertions. The following mnemonic is helpful for learning the assertions (envision management as a large crocodile emerging from a cave): C - Completeness A - Accuracy V - Valuation and Allocation E - Existence C - Cutoff R - Rights and Obligations O - Occurrence C - Classification and Understandability g. The following mnemonic is helpful for learning the categories of assertions: A - Account balances D - Disclosure E - Events P - Presentation T - Transactions h. The PCAOB s AS No. 15, Audit Evidence, describes just five assertions to be applied selectively to the financial statement transactions, balances, and disclosures. These are essentially the same as those previously described issued by the ASB. 1) Existence or occurrence - Assets or liabilities of the company exist at a given date, and recorded transactions have occurred during a given period. 2) Completeness - All transactions and accounts that should be presented in the financial statements are so included. 3) Valuation or allocation - Asset, liability, equity, revenue, and expense components have been included in the financial statements at appropriate amounts. 4) Rights and obligations - The company holds or controls rights to the assets, and liabilities are obligations of the company at a given date. 5) Presentation and disclosure - The components of the financial statements are properly classified, described, and disclosed. h i. An audit performed by an independent, external auditor provides assurance to external users of the financial statements of the objectivity of the auditor s opinion. 1) The auditor may make suggestions about the form or content of the financial statements or draft them based on management s information. However, the auditor s responsibility for the financial statements is confined to the expression of an opinion.

4 Page 4 of 7 i j. The standard independent auditor s report states, An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation (AU 508). Page 28, 1.3., 1.: The following edit shows the effects of the PCAOB s new Standards (AS Nos. 8-15) on Study Unit 1 content. 1.3 ADDITIONAL PROFESSIONAL SERVICES 1. Compilations and Reviews (AR and AR 90) a. The AICPA bylaws designate the Accounting and Review Services Committee as the senior technical committee authorized to issue pronouncements in connection with the unaudited financial statements or other unaudited financial information of a nonissuer (nonpublic entity). Study Unit 3 Risk Assessment Page 95: The following edits to subunit titles in Study Unit 3 reflect the PCAOB s new Standards. 3.1 Pre-Engagement Acceptance Activities Planning and Supervision (AU 311, AS No. 9, and AS No. 10) Audit Risk and Materiality (AU 312, AS No. 8, and AS No. 11) Understanding the Entity and Its Environment (AU 314 and AS No. 12) Analytical Procedures (AU 329) Consideration of Fraud in a Financial Statement Audit (AU 316) Illegal Acts by Clients (AU 317) Practice Simulation Page 98, 3.2: The following edits show the effects of the PCAOB s new Standards (AS Nos. 8-15) on Study Unit 3 content. 3.2 PLANNING AND SUPERVISION (AU 311, AS No. 9, and AS No. 10) 1. Audit Strategy a. Planning continues throughout the audit. It initially involves developing an overall audit strategy. b. The size and complexity of the entity, the auditor s experience with the entity, and the auditor s understanding of the entity and its environment (including internal control) affect planning. The auditor also should consider the following: 1) Characteristics of the engagement and reporting objectives 2) Appropriate materiality levels 3) Areas of high risk of material misstatement 4) Material client locations and account balances

5 5) Whether to seek evidence of the operating effectiveness of controls 6) Relevant entity-specific, industry, or financial developments 7) Consideration of the audit resources required c. The engagement partner is responsible for the engagement and its performance. Page 5 of 7 Page 100, 3.3: The following edit shows the effects of the PCAOB s new Standards (AS Nos. 8-15) on Study Unit 3 content. 3.3 AUDIT RISK AND MATERIALITY (AU 312, AS NO. 8, AND AS NO. 11) Page 101, 3.3, 3.: The following edits show the effects of the PCAOB s new Standards (AS Nos. 8-15) on Study Unit 3 content. 3. Materiality a. The concept of materiality recognizes that some but not all matters, evaluated individually or in the aggregate, are important for fair presentation of the financial statements in conformity with GAAP. 1) The auditor is responsible for planning and performing the audit to obtain reasonable assurance that material misstatements, whether caused by error or fraud, are detected. 2) Materiality is a matter of professional judgment influenced by the needs of reasonable people who use the financial statements. a) Users are assumed to be those who have a reasonable understanding of business and economic activities and who are willing to study the information with appropriate diligence. 3) Materiality judgments consider surrounding circumstances and involve qualitative and quantitative factors. a) It ordinarily is not practical to design audit procedures to detect misstatements that are material based solely on qualitative factors. 4) For an audit of internal control for an issuer, the auditor should use the same materiality considerations as for the audit of the company s financial statements. Page 104, 3.3, 13.: The following edit shows the effects of the PCAOB s new Standards (AS Nos. 8-15) on Study Unit 3 content. 13. Evaluating Findings a. When evaluating audit findings, the auditor considers the individual and aggregate effects of misstatements not corrected by the entity. This consideration addresses qualitative and quantitative factors. Moreover, the consideration and aggregation should include likely misstatement, not merely known misstatement. b. The auditor need not consider misstatements that are clearly trivial as defined by being inconsequential, whether considered individually or in the aggregate.

6 Page 6 of 7 Page 104, 3.4: The following edit shows the effects of the PCAOB s new Standards (AS Nos. 8-15) on Study Unit 3 content. 3.4 UNDERSTANDING THE ENTITY AND ITS ENVIRONMENT (AU 314 AND AS NO. 12) Page 105, 3.4, 7.: The following edits show the effects of the PCAOB s new Standards (AS Nos. 8-15) on Study Unit 3 content. 7. Understanding the Entity a. The understanding extends to such matters as 1) External factors (e.g., the relevant industry and regulatory issues); 2) The nature of the entity (operations, governance, ownership, structure, financing, and investments); 3) Its overall plans (objectives), operational approaches to achieving objectives (strategies), and business risks (which differ from risks of misstatement); 4) Financial performance measurement and review (an indicator of what the entity considers important); and 5) Internal control. (See Study Unit 5.) The auditor uses the understanding of internal control to a) Determine the types of possible misstatements, b) Identify what affects the RMMs, and c) Design further procedures (tests of controls and substantive procedures). b. For an issuer, the auditor should consider 1) Reading public information about the company 2) Obtaining information from earnings calls to investors and rating agencies 3) Gaining an understanding of compensation for senior management 4) Obtaining information about trading activities in the company s securities c. The auditor should consider company performance measures that could create incentives or pressures on management to manipulate the financial information. 8. Basically, the auditor should consider the likely sources of material misstatement and ask what could go wrong? Study Unit 8 Responses to Assessed Risks Page 275, 8.2, 11.: The following edits show the effects of the PCAOB s new Standards (AS Nos. 8-15) on Study Unit 8 content. 11. Substantive Procedures a. Substantive procedures are performed to detect material misstatements at the relevant assertion level. 1) They should respond to the related assessed RMM and planned level of detection risk.

7 Page 7 of 7 b. The auditor should apply substantive procedures to all relevant assertions about material transaction classes, balances, and disclosures. c. The auditor should 1) Examine material entries and other adjustments made in statement preparation. 2) Agree the statements to the accounting records. d. The auditor should evaluate the qualitative aspects of the company s accounting practices, including 1) Selective correction of misstatements 2) Proposed additional adjusting entries that offset misstatements accumulated by the auditor 3) Bias in the selection of accounting principles or in accounting estimates d e. Substantive procedures should be performed that respond specifically and with a high degree of reliability to significant risks. 1) For example, management may have an incentive to recognize revenue prematurely. The specific response may be to (a) seek external confirmation of the terms of sales agreements (e.g., dates, delivery information, and rights of return) and (b) inquire of nonfinancial employees about changes in such agreements. Study Unit 10 Evidence -- Objectives and Nature Page 335: The following edits to subunit titles in Study Unit 10 reflect the PCAOB s new Standards Nature and Sufficiency (AU 326 and AS No. 15) The Confirmation Process (AU 330) Audit Documentation (AU 339 and AS No. 3) The Computer as an Audit Tool Practice Simulation