Question

1.         You are engaged to examine the financial statements of Spitalfields Company for the year ended December 31. Assume that on October 1, Spitalfields borrowed $600,000 from Third National Bank to finance its plant expansion. The long-term note agreement provided for the annual payment of principal and interest over 5 years. The existing plant was pledged as security for the loan. Due to unexpected difficulties in acquiring the building site, the plant expansion did not begin on time. To use the borrowed funds, management decided to invest in stocks and bonds and on October 16, invested the $600,000 in publicly traded securities.

           

Required:

Develop specific assertions (audit objectives) related to securities (assets) based on management’s five (PCAOB) general assertions.

2.         GAAS require auditors to be independent. Included within this standard are the concepts of independence in fact and independence in appearance.

            Required:

            a.         Define independence in fact and independence in appearance.

b.         What two general types of relationships would normally compromise auditors’ independence?

3.         The preparation of audit documentation is an integral part of an auditor’s examination of financial statements. On a recurring engagement, auditors review the audit plans and audit documentation from the prior year to determine their usefulness for the current-year work.

            Required:

            a.         (1) What are the purposes or functions of audit documentation?

                        (2) What records may be included in audit documentation?

b.         What factors affect the auditors’ judgement of the type and content of the audit documentation for a particular engagement?

c.         What should be included in audit documentation to support auditors’ compliance with GAAS?

d.         How can auditors make the mot effective use of the prior-year audit plans in a recurring audit?

           

Answer 1

1.

By definition, management financial statement assertions give rise to questions that can be answered with evidence. The objectives for the audit of Spillanes securities investments at December 31 are to obtain evidence about the assertions implicit in the financial presentation, specifically:

1. Existence. Obtain evidence that the securities are bona fide and held by Spillane or a responsible custodian.

Occurrence. Obtain evidence that the loan transaction and securities purchase transactions actually took place during the year under audit.

2. Completeness. Obtain evidence that all the securities purchase transactions were recorded.

3. Rights. Obtain evidence that Spillane owned the securities.

Obligation. Obtain evidence that $600,000 is the amount actually owed on the loan.

4. Valuation. Obtain evidence of the cost and market value of the securities held at December 31. Decide whether any write-downs to market are required by the appropriate reporting framework.

5. Presentation and disclosure. Obtain evidence of the committed nature of the assets, which should mean they should be in a noncurrent classification like the loan. Obtain evidence that restrictions on the use of the assets are disclosed fully and agree with the loan documents.

2.

a. Independence in fact relates to the auditors state of mind and reflects an unbiased and impartial perspective with respect to the financial statements and other information they audit. Independence in appearance relates to others (particularly financial statement users) perceptions of the auditors independence.

b. The two general types of relationships that compromise auditors independence are financial relationships (owning shares of stock or having an outstanding loan to or from a client) and managerial relationships (acting in a decision-making capacity on behalf of a client or providing advice on systems or information that will be audited).

3.

a. (1) Audit documentation is the auditors record of the procedures performed and conclusions reached in the audit. The functions of audit documentation are to aid the CPA in the conduct of the audit work and to provide support for the auditors opinion and compliance with auditing standards.

(2) Audit documentation can be classified in two categories: (1) permanent files (which contain information that is relevant to ongoing client relationships) and (2) current files (which relate to just one year of the client relationship). The documentation (usually in the form of either electronic files or hard copy work papers) should contain detailed support for the decisions regarding planning and performing the audit, procedures performed, evidence obtained, and conclusions reached.

b. The factors that affect the auditors judgment of the type and content of the audit documentation for a particular engagement include:

(1) The nature of the auditors report.

(2) The nature of the clients business.

(3) The nature of the financial statements, schedules, or other information on which the auditors are reporting and the materiality of the items included therein.

(4) The nature and condition of the clients records and internal controls.

(5) The needs for supervision and review of work performed by assistants.

c. Evidence that should be included in audit documentation to support auditors compliance with generally accepted auditing standards includes:

(1)The financial statements or other information on which the auditors are reporting were in agreement or reconciled with the clients records.

(2)The clients system of internal control was reviewed and evaluated to determine the nature, timing, and extent of audit procedures.   

(3)The audit procedures performed in obtaining audit evidence for evaluation.

(4)How exceptions and unusual matters disclosed by audit procedures were resolved or treated.

(5)The auditors conclusions on significant aspects of the engagement with appropriate commentaries related to each of the relevant financial statement assertions for each significant account and disclosure.

d. Each year, the audit team should perform an audit that allows the auditor to conclude that there are no material misstatements in the financial statements or disclosures. This should be completed in the most efficient manner possible, without sacrificing effectiveness, and the prior years audit plans may aid in doing this. Those audit plans ordinarily contain information useful in the current examination (such as descriptions of the unique features of a clients operations or records, a formalized sequence of audit steps in logical order, and approximate time requirements to perform various phases of the work.) The audit team should decide whether to use aspects of the prior year audit plan or prepare a new audit plan entirely.