2014ER AUD Textbook

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Auditing

UPDATES AND ACADEMIC HELP

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Call1.877.CPA. EXAM (Outside the U.S. +1.630.472.2213) or click on Community and Support at www.becker.com/cpa

This textbook contains information that was current at the time of printing. The eBook and multimedia lectures in your course software will be updated on a regular basis (through software updates) as the content that is tested on the CPA Exam evolves and as we improve our materials. Note the version reference above and click on Community and Support at www.becker.com!cpa for a list of available updates for this version or to see if a newer version of this book is available for ordering.

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BECKER PROFESSIONAL EDUCATION COURSE DEVELOPMENT TEAM

Timothy F. Gearty, CPA, MBA, JD ... Editor in Chief, Financial/Regulation (Tax) National Editor Angeline S. Brown, CPA, MAC ... Director, Accounting Curriculum, Audit/Financial/BEC National Editor

Teresa C. Anderson, CPA, CMA ... Manager, Accounting Curriculum Tom Cox, CPA, CMA, CHFP ... Financial (GASB & NFP) National Editor

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Jeffrey Sherman, JD, CPA (inactive) Roberta Smith, CPA

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Material from Uniform CPA Examination Selected Questions and Unofficial Answers, 1989, 1990, 1991, 1992, 1993, 1994, 1995,1996,1997, 1998, 1999,2000,2001,2002,2003,2004,2005,2006,2007,2008,2009,2010, 2011, 2012, and 2013

copyright © by American Institute of Certified Public Accountants, Inc., is reprinted and/or adapted with permission. Any knowing solicitation or disclosure of any questions or answers included on any CPA Examination is prohibited.

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'-Becker Professional Education I CPA Exam Review Auditing

AUDITING

progra m attendance record

Student: ___________________ _ Location: AUDITING 1 AUDITING 2 Q. Q. E E � � V) V) Q) Q) u u c: c: '" '" "0 _c: "0 c: Q) Q) :i :i AUDITING ₃ AUDITING 4 Q. Q. E E '" _� V; V) Q) Q) u u c: c: '" '" "0 _c: "0 c: Q) Q) :i :i AUDITING 5 AUDITING 6 Q. Q. E E '" _� V; V) Q) Q) u u c: c: '" '" "0 _c: "0 c: Q) Q) :i t: «

IMPORTANT NOTES TO STUDENTS REGARDING "THE BECKER PROMISE"

• You must stamp this sheet at the end of each class attended. This is the only acceptable record of your classroom attendance.

• An overall percentage correct of 90% or higher is required of the homework to qualify for The Becker Promise. • Please fax documentation to 866-398-7375 no later than 45 days following the completion of each section.

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A uditing Becker Professional Education I CPA Exam Review

NOTES

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Becker Professional Education I CPA Exam Review

AUDITING

table of contents

Auditing

Program attendance record ... v Introduction ... Intro-l

AUDITING 1: Audit Reports

1. Audited financial statements: The basics ... Al-3 2. Professional standards ... Al-6

3. Reports on audited financial statements ... ... ... Al-12 4. Reports on comparative financial statements ... Al-45 5. Events occurring after year-end ... Al-52 6. Reporting on other information ... Al-57 7. Appendix: The PCAOB auditor's reporting model ... Al-67 8. Class questions ... ... . . Al-69

AUDITING 2: Other Reports

1. Other engagements, reports, and accounting services ... A2-3 2. Compilation and review of financial statements ... A2-24 3. Reporting on comparative financial statements ... ... A2-53 4. Review of interim financial information ... ... A2-57

5. Letters for underwriters ... A2-69

6. Attest engagements ... A2-71 7. Class questions ... ... ... A2-91

AUDITING 3: Engagement Acceptance, Planning, and Risk Assessment

1. Engagement acceptance and understanding the assignment ... A3-3

2. Planning and supervision ... A3-10 3. Audit risk ... ... ... A3-25

4. Fraud risk ... ... A3-29

5. Compliance with laws and regulations ... . ... A3-37 6. Assessing the risks of material misstatement ... . ... ... A3-40 7. Internal control ... A3-48

8. Responding to the assessed risks of material misstatement ... A3-66 9. Class questions ... ... A3-77

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AUDITING 4: Audit Evidence

1. Audit evidence ... A4-3

2. Audit procedures by transaction cycle ... A4-19 3. Other audit procedures ... A4-50 4. Evaluating audit findings ... A4-58 5. Appendix I: Financial ratios ... A4-64

6. Appendix II: Control procedures and tests of controls ... A4-75

7. Class questions ... ... A4-79

AUDITING 5: Sampling and Communications

1. Audit sampling ... ... A5-3 2. Internal control communications ... A5-22 3. Communication with those charged with governance ... A5-50

4. Management representations ... A5-56 5. Class questions ... As-61

AUDITING 6: Professional Responsibilities, Audit Documentation, Effect of IT, Government Auditing, and Quality Control Standards 1. Professional responsibilities ... A6-3 2. Audit documentation ... A6-31 3. The effect of information technology on the audit.. ... A6-35 4. Government auditing . ... A6-41

5. Quality control standards ... A6-65

6. Class questions ... A6-75

Class question explanations ... CQ-1

Glossary ... ... Glossary-1

Index ... Index-1

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COURSE INTRODUCTION

1. Auditing & attestation content specification outline ... lntro-3

2. Becker's CPA Exam Review-Course introduction ... Intro-6

Introduction ... Intro-6

Lecture series ... I ntro-6

Textbooks ... Intro-6

Course software ... Intro-7

Study planner ... ... Intro-8

Study roadmap ... ... . . ... Intro-8

Flashcards ... ... ... I ntro-9

Becker Community and Support ... I ntro-II The Uniform CPA Exam-Overview ... Intro-ll

Passing the CPA Exam ... ... Intro-13

Managing your stress before the examination ... . . ... Intro-IS

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NOTES

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Becker Professional Education I CPA Exam Review Auditing

AUDIT I N G & ATTESTATION CONTENT SPECIFICATION OUTLINE

A U D ITI N G & A TTE S T A T I O N 4 hours

or: 60 Points � +- 40 points �

Testlet#l Testlet #2 Testlet #3 Testlet #4

30 30 30 7

MC MC MC Task-based

Questions Questions Questions simulations

50-55 minutes 50-55 minutes

I

50-55 minutes

I

60-75 minutes

I. Auditing and attestation: engagement acceptance and understanding the assignment 12-16%

A. Determine nature and scope of engagement

B. Consider the firm's policies and procedures pertaining to client acceptance and continuance

C. Communicate with the predecessor auditor

D. Establish an understanding with the client and document the understanding through an engagement letter or other written communication with the client

E. Consider other planning matters

1. Consider using the work of other independent auditors 2. Determine the extent of the involvement of professionals

possessing specialized skills

3. Consider the independence, objectivity, and competency of the internal audit function

F. Identify matters related to planning and prepare documentation for communications with those charged with governance

II. Auditing and attestation: understanding the entity and its environment (including internal control) 16-20%

A. Determine and document materiality

B. Conduct and document risk assessment discussions among audit team, concurrently with discussion on susceptibility of the entity's financial statement to material misstatement due to fraud

C. Consideration of fraud

1. Identify characteristics of fraud

2. Document required discussions regarding risk of fraud

3. Document inquiries of management about fraud

4. Identify and assess risks that may result in material misstatements due to fraud

D. Perform and document risk assessment procedures 1. Identify, conduct, and document appropriate inquiries of

management and others within the entity

2. Perform appropriate analytical procedures to understand the entity and identify areas of risk

3. Obtain information to support inquiries through observation and inspection (including reading corporate minutes, etc.)

E. Consider additional aspects of the entity and its environment, including: industry, regulatory and other external factors; strategies and business risks; and financial performance F. Consider internal control

1. Perform procedures to assess the control environment, including consideration of the COSO framework and identifying entity-level controls

2. Obtain and document an understanding of business processes and information flows

3. Determine the effect of information technology on the effectiveness of an entity's internal control

4. Perform risk assessment procedures to evaluate the design and implementation of internal controls relevant to an audit of financial statements

5. Identify key risks associated with general controls

in a financial IT environment, including change

management, backup/recovery, and network access (e.g., administrative rights)

6. Identify key risks associated with application functionality that supports financial transaction cycles, including: application access control (e.g., administrative access rights); controls over interfaces, integrations, and

e-Commerce; and significant algorithms, reports, validation, edit checks, error handling, etc.

7. Assess whether the entity has designed controls to mitigate key risks associated with general controls or application functionality

8. Identify controls relevant to reliable financial reporting and the period-end financial reporting process

9. Consider limitations of internal control

10. Consider the effects of service organizations on internal control

11. Consider the risk of management override of internal controls

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Auditing

G. Document an understanding of the entity and its environment, including each component of the entity's internal control, in order to assess risks

H. Assess and document the risk of material misstatements

1. Identify and document financial statement assertions and formulate audit objectives including significant financial statement balances, classes of transactions, disclosures, and accounting estimates

2. Relate the identified risks to relevant assertions and consider whether the risks could result in a material misstatement to the financial statements

3. Assess and document the risk of material misstatement that relates to both financial statement level and specific assertions 4. Identify and document conditions and events that may

indicate risks of material misstatement

I. Identify and document significant risks that require special audit consideration

1. Significant recent economic, accounting, or other developments

2. Related parties and related party transactions

3. Improper revenue recognition

4. Non-routine or complex transactions

5. Significant accounting estimates 6. Illegal acts

III. Auditing and attestation: performing audit procedures and evaluating evidence 16-20%

A. Develop overall responses to risks

1. Develop overall responses to risks identified and use the risks of material misstatement to drive the nature, timing, and extent of further audit procedures

2. Document significant risks identified, related controls evaluated, and overall responses to address assessed risks

3. Determine and document performance materiality/level(s) of tolerable misstatement

B. Perform audit procedures responsive to risks of material misstatement; obtain and document evidence to form a basis for conclusions

1. Design and perform audit procedures whose nature, timing, and extent are responsive to the assessed risk of material misstatement

2. Integrating audits: In an integrated audit of internal control over financial reporting and the financial statements, design and perform testing of controls to accomplish the objectives of both audits simultaneously

3. Design, perform, and document tests of controls to evaluate design effectiveness

4. Design, perform, and document tests of controls to evaluate operating effectiveness

5. Perform substantive procedures 6. Perform audit sampling

7. Perform analytical procedures

8. Confirm balances and/or transactions with third parties 9. Examine inventories and other assets

10. Perform other tests of details, balances, and journal entries

11. Perform computer-assisted audit techniques (CAATs), including data query, extraction, and analysis 12. Perform audit procedures on significant accounting

estimates

13. Auditing fair value measurements and disclosures, including the use of specialists in evaluating estimates

14. Perform tests on unusual year-end transactions 15. Audits performed in accordance with International

Standards on Auditing (ISAs) or auditing standards of another country: determine if differences exist and whether

additional audit procedures are required 16. Evaluate contingencies

17. Obtain and evaluate lawyers' letters

18. Review subsequent events

19. Obtaining and placing reliance on representations from management

20. Identify material weaknesses, significant deficiencies, and other control deficiencies

IV. Auditing and attestation: evaluating audit findings, communications, and reporting 16-20%

A. Perform overall analytical procedures

B. Evaluate the sufficiency and appropriateness of audit evidence and document engagement conclusions

C. Evaluate whether audit documentation is in accordance with professional standards

D. Review the work performed by others, including specialists and other auditors, to provide reasonable assurance that objectives are achieved

Intro-4

E. Document the summary of uncorrected misstatements and related conclusions

F. Evaluate whether financial statements are free of material misstatement

G. Consider the entity's ability to continue as a going concern H. Consider other information in documents containing audited

financial statements (e.g., supplemental information and management's discussion and analysis)

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I. Retain audit documentation as required by standards and regulations

J. Prepare communications

1. Reports on audited financial statements

2. Reports required by government auditing standards

3. Reports on compliance with laws and regulations 4. Reports on internal control

5. Reports on the processing of transactions by service organizations

6. Reports on agreed-upon procedures

Auditing

7. Reports on financial forecasts and projections 8. Reports on pro forma financial information

9. Special reports

10. Reissue reports

11. Communicate internal control related matters identified in the audit

12. Communications with those charged with governance

13. Subsequent discovery of facts existing at the date of the auditor's report

14. Consideration after the report date of omitted procedures

V. Accounting and review services engagements 12-16%

A. Plan the engagement

1. Determine nature and scope of engagement

2. Decide whether to accept or continue the client and engagement including determining the appropriateness of the engagement to meet the client's needs and consideration of independence standards

3. Establish an understanding with the client and document the understanding through an engagement letter or other written communication with the client

4. Consider change in engagement

5. Determine if reports are to be used by third parties B. Obtain and document evidence to form a basis for conclusions

1. Obtain an understanding of the client's operations, business, and industry

2. Obtain knowledge of accounting principles and practices in the industry and of the client

3. Perform analytical procedures for review services

4. Obtain representations from management for review services

5. Perform other engagement procedures

6. Consider departures from generally accepted accounting principles (GAAP) or other comprehensive basis of accounting (OCBOA)

7. Prepare documentation from evidence gathered 8. Retain documentation as required by standards

9. Review the work performed to provide reasonable assurance that objectives are achieved

C. Prepare communications 1. Reports on compilations 2. Reports on reviews

3. Restricted use of reports

4. Communicating to management and others

5. Subsequent discovery of facts existing at the date of the report

6. Consider degree of responsibility for supplementary information

VI. Professional responsibilities 16-20%

A. Ethics and independence

1. Code of Professional Conduct (AICPA)

2. Requirements related to issuers, including the PCAOB, the SEC and the Sarbanes-Oxley Act of 2002, Titles II and III, Section 303

3. Government Accountability Office (GAO)

4. Department of Labor (DOL)

5. Code of Ethics for Professional Accountants (IFAC)

B. Other professional responsibilities 1. A firm's system of quality control

2. General role, structure, and requirements of the PCAOS (Title I and Title IV of the Sarbanes-Oxley Act of 2002)

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Auditing Becker Professional Education I CPA Exam Review

BECKER'S CPA EXAM REVIEW-COURSE I N TRODUCTION

---��

-I N T R O D U C T -I O N

Becker Professional Education's CPA Exam Review products were developed with you, the candidate, in mind. To that end we have developed a series of products designed to tap all of your learning and retention capabilities. Our course is first and foremost a time-management system. The Becker lecture series, comprehensive texts, and course software are designed to be fully integrated but each can also stand alone. The best results are achieved when all the components are used collectively.

Passing the CPA Exam is difficult, but the professional rewards a CPA enjoys make this a challenge all

accounting professionals should meet. You will pass the CPA Examination if you prepare properly. Keep this in mind as you work with our course materials. We created our CPA Exam Review after evaluating the needs of CPA candidates and analyzing the CPA Exam over the years. Those efforts have enabled us to produce a CPA Exam Review unparalleled in today's market. Our course materials comprehensively present topics you must know to pass the examination, teaching you the most effective tactics for learning the material.

L E C T U R E S E R I E S

Becker gives you the option of attending live classes or viewing the lectures on your own using the Becker online course platform or the desktop course software. No matter what format you choose, you will see and hear the most dynamic CPA Exam Review lecturers in the country. Our lecturers are exam-oriented and spend countless hours analyzing past exams and developing strategies to help you pass-this time.

Each section of the Becker course includes a self-study, at-home lecture that is to be viewed by all students, including Live Classroom students. In the Auditing course, the self-study lecture is the A6 lecture. These lectures were added to improve the overall pace of the Becker course, to reduce the amount of work that you must complete with each lecture, and to allow us to better cover the topics currently tested on the CPA Exam. You must view the self-study lectures in order to fully prepare for the CPA Exam.

T E XTBO O K S

Our textbooks, written by our faculty and subject matter experts, are specifically designed to prepare you for the CPA Exam effectively and efficiently. Written in outline form, they follow the same sequence as the lectures providing reduced note-taking and allowing students to concentrate their attention on the presentation. This textbook contains information that was current at the time of printing. The eBook and multimedia lectures in your course software will be updated on a regular basis (through software updates) as the content that is tested on the CPA Exam evolves and as we improve our materials. Note the version reference and click on Community and Support at http://www.becker.com/cpa/ for a list of available updates for this version or to see if a newer version of this book is available for ordering.

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Textbook Icons

Throughout the Becker materials you will find icons that have been designed to assist with your preparation for the CPA Examination. These icons are located in the margins of your textbook for easy identification of important information. Pass Keys Memorize Notations Keyword Search FASB Accounting Standards Codification

Notes, Exceptions, etc.

IFRS-specific Content

International Comparison

C O U R S E S O F T W A R E

Throughout the course materials you will find Pass Keys that have been prepared to assist in your understanding of major concepts. Pass Keys will be identified with this icon in the margins.

Important items within the materials that should be memorized will be identified with this icon in the margins.

As part of the task-based simulation portion of the exam, candidates are required to search professional literature to find the solution to

a given question. A keyword search of the relevant authoritative literature is a candidate's most time-effective tool. Potential keywords to search with will be identified with this icon in the margins.

These numbers represent the location of this topic in the FASB Accounting Standards Codification. These will be identified with this icon in the margins.

When important notes, exceptions, etc., are included within the materials, it will be identified with this icon in the margins.

When IFRS-specific information is included within the materials, it will be identified with this icon in the margins.

When international comparison information is included within the materials, it will be identified with this icon in the margins.

An integral part of Becker's CPA Exam Review program is the use of the course software, which provides access to the nearly 1 00 hours of multimedia lecture content, thousands of multiple-choice questions, and hundreds of simulation tasks, including questions and tasks from prior exams. The multiple-choice questions and simulations reinforce the concepts introduced in the materials, and is organized on a lecture-by-Iecture basis. The software also provides two comprehensive final exams for each part. The Business (BEC) section of the CPA Exam includes simulations that test the candidate's writing skills. We encourage you to watch the

Written Communication Lecture as it will help you gain an understanding of what the examiners are looking for in a well-written response.

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Two other important features of the course software are the Study Planner and the Study Roadmap, both of which are described below.

S T U D Y P L A N N E R

It takes time to study for the CPA Exam. However, all candidates face the challenge of fitting their CPA Exam studies into their busy lives. The course software provides you with a Study Planner that will help you establish a study schedule and manage your study time efficiently and effectively. You have the option of allowing the Study Planner to prepare a study schedule for you, or you can create your own schedule. The Study Planner will allow you to see what you need to accomplish each day and each week as you prepare to take the CPA Exam.

S T U D Y R O A D M A P

With so many elements available to help you study, sometimes it is difficult to know where to begin and how much time should be spent on each element of the Becker Course. Within the course software, each lecture provides you with a Study Roadmap based on Becker's Learn-Practice-Review methodology. The Study Roadmap allows you to see, step-by-step, what you need to do to thoroughly study the information that will be tested on the exam. It also gives you an estimate of the time it will take to complete each step. The Study Roadmap includes the following elements:

LEARN-View the lecture (Estimated time: 4 hours)

PRACTICE-Complete the multiple-choice homework and the practice simulations (Estimated time: 6-8 hours) REVIEW-Review flashcards and take a progress test (Estimated time: 2-3 hours)

Lecture Study Roadmap Example

@

STUDY CENTER F2 : Matching (Revenue & Expenses). Foreign Currency Accounting. and Other F.S.

D

1.Le

a

m 1\

VJew Lecture (4 hOOfs) Overal Starus.:! M Intro-8 Study Roadmap

A2practice

� (5-6 ... ' ,,- (1 - 2 hours) SlrnulMfOn1 I �

o

3. Revfew � ReVIew Ftashcerd. 11 hour!

NMd i!)I;W ttIIp? AdcIIIIoMI ou..donI for key topk(.):

.JoIJrNJ EmrIH and AdJustlng .Journtll Entrtn

Fotwlgn Currency Transactions and Rwen .... RecoQntdon

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Becker also provides you with a Study Roadmap for your review before you take each section of the exam.

You should give yourself at least one week to do a final review before taking the exam. Your final review should include reworking the multiple-choice questions and simulations, taking the two final exams, and completing as many comprehensive Progress Tests as possible.

Review Before Exam Study Roadmap Example

BECKER

••• c ... �

REVIEW BEFORE EXAM: Financial

�

'

1. ReWOrk

�

2 .

Take Final Exams

�

'

_3.Comprehensive Progress Tests Rework all hornewof1c quest100S end rewor1c: the SImU�UOns Complete the FInoI Exoms

Final Exam 1 Progress Tests

Anaf exam 2

F L A S H C A R D S

Flashcards are an important tool to assist in your preparation for the exam. Although we believe that preparing your own flashcards is a valuable learning tool, we recognize that time is a precious commodity when preparing for the exam. For that reason, we also offer enrolled students the opportunity to purchase preprinted flashcards and digital mobile flashcard applications. Flashcards will help you commit to memory the most important principles and rules tested in each section of the exam. The flashcards are indexed by class session to allow you to focus your preparation in your weakest areas.

Flashcards Example:

Front Side

Conceptual Frameworks

Name the single source of authoritative nongovernmental U.S. GMP.

Back Side

The FASS " Accounting Standards Codification" (ASC).

FAR 1·1 FAR H

The printed flashcards and digital mobile flashcards can be purchased by calling our National Student Service Center at 1 -800-868-3900 or online by simply logging on to www.becker.com/cpa and select " Flashcards" from the Courses & Products drop-down menu.

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If you want to supplement the preprinted flashcards, several blank cards are provided with the printed flashcards. If you want to prepare your own flashcards, we recommend the following:

• Prepare flashcards as you review your lecture notes prior to working the multiple-choice questions. You can identify those flashcards you would like to create by making a mark, such as "Fe," in the margin of your outline while viewing the lecture.

• Select major concepts from your class materials (outlines). Do not prepare flashcards for everything

in the outlines (the outlines are already in a summarized format). Only make a flashcard for the major concepts, general rules and exceptions, mnemonics, formulas, and important lists. Items to consider:

./

_Mnemonics

./

_Formulas

./

_{"Heavy on exam" notations}

./

_{"Memorize" notations}

./

_{Other major concepts (noted while reading the explanations to the multiple-choice questions)}

./

_{General rules and exceptions}

• Keep your flashcards as simple as possible, but do not sacrifice correctness for brevity.

• Use 3" x 5" or 5" x 7" cards (whichever size is easiest for you to carry around). Write the question, the

general rule, or the title of the list you are trying to memorize on the front, and write the answer, the exceptions, or the list, as applicable, on the back.

Example:

Front Side

Back Side

","'lMe \-"'e -Pive sOlAvces o-P o\-"'ev cOlMpve"'el\sive il\colMe.

P Pe"sio" Mj�ell\-s

lJ lJllve",li�eJ. :J",ills/losses Oil AF'5 sec"vi\-ies F Foyei:JII c"yyellCY \-v","sl",\-io" MjlAS�II\-s E El'i'ecl-ive povl-io"s oi' c....sh {'low heJ.:Jes R Rev",IIA",\-io" s"ypl"ses (IFR'5 ollly)

A- I

A- I _..._(----_{class number}Code with

• After each class, review all of your flashcards for all of the previous classes. When you believe that you

have a concept memorized, place those cards in a separate pile. Do not stop reviewing those cards, but it is not necessary to review them as often. The more frequently you can review all your cards, the better your retention will be.

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",

_._

-B E C K E R C O M M U N I T Y A N D S U P P O R T

The Becker Community and Support area is your source for course updates, supplemental materials, and unlimited academic support. Just click on Community and Support at:

http://www.becker.com/cpa/ .

You can also access customer service and technical support from Community and Support or by calling

1 -877-CPA-EXAM (Outside the U .S. + 1 -630-472-221 3).

T H E U N I F O R M C P A E X A M - O V E R V I E W

Exam Sections

The CPA Examination consists of four sections:

FINANCIAL ACCOUNTING

&

REPORTING

The Financial section consists of a four-hour exam covering financial accounting and reporting, including International Financial Reporting Standards (IFRS), governmental accounting, and not-for-profit accounting.

AUDITING

&

ATTESTATION

The Auditing section consists of a four-hour exam. This section covers all topics related to auditing, including audit reports and procedures, generally accepted auditing standards, attestation and other engagements, and government auditing.

REGULATION

The Regulation section consists of a three-hour exam, combining topics from business law and federal taxation.

BUSINESS ENVIRONMENT

&

CONCEPTS

The Business section consists of a three-hour exam, covering general business topics such as economics, financial management, information technology, managerial accounting, and process and project management.

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Question Formats

The chart below illustrates the question format breakdown by exam section .

I

Task-based Simulations or Written

Multiple-choice Questions Communication Tasks

Section Percentage Number Percentage Number

Financial 60% 90 40% 7

Auditing 60% 90 40% 7

Regulation 60% 72 40% 6

Business 85% 72 15% 3

Each exam will contain testlets. A testlet is either a series of multiple-choice questions (either 24 or 30

depending on the section), a set of task-based simulations, or a set of written communications. For example, the Auditing examination will contain four testlets. The first three testlets will be multiple-choice questions and the last will contain seven task-based simulation problems, including one research question. Each testlet must be finished and submitted before continuing to the next testlet. Candidates cannot go back to view a previously completed testlet or go forward to view a subsequent testlet before closing and submitting the earlier testlet. Our fi nal exam contains these types of restrictions so you can familiarize you rself with the functionality of the CPA Exam.

Exam Schedule

The computer-based C PA Exam is offered during the first two months of each calendar quarter. Once determined to be eligible to sit, candidates can schedule an exam date directly with Prometric

(www.prometric.com/cpa).

Eligibility and Application Requirements

,-Each state sets its own rules of eligibility for the examination, so the requirements vary from state to state. Please visit www. becker.com/state as soon as possible to determine your eligibility to sit for the exam.

Application Deadlines

With the computer-based exam format, set application deadlines generally do not exist. To ensure that you have a thorough understanding of your state's requirements, you should apply as early as possible.

Grading System

You must pass all four parts of the examination to earn certification as a C PA. You must score 75 or better on a part to receive a passing grade.

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�.

P A S S I N G T H E C P A E X A M

Strategy and Tactics for Taking the Examination

To ensure that you pass the CPA Exam, you should follow these tips.

Tips for Multiple-choice Questions

TIP 1 Control the amount of time you spend on each question.

Auditing

The exam time limits mentioned above are overall time limits. The recommended time to complete the task-based simulation testlet is 60 to 75 minutes. As such, you'll be forced to closely control the amount of time you spend on multiple-choice questions. For Financial and Auditing, you should spend approximately 1% to 2 minutes on each multiple-choice q uestion. For Regulation and Business, you should spend approximately 1 to 1% minutes per question.

TIP 2 Become familiar with the format.

The exam does not contain the typical multiple-choice format such as lettered answers (a, b, c, and d). Instead, candidates are required to click on the radio buttons or the text portion of the answer they are choosing as correct. You will see this functionality in our final exams.

TIP 3 Read all four choices before choosing one as you r answer.

Given that you're working under time constraints, you may be tempted to choose as your answer for any given question the first choice that seems right. This can be a costly m istake because the examiners may include two or more "good" answers among the choices, one of which is the best answer. You'll get no credit for choosing the wrong "good" answer.

TIP 4 Answer every multiple-choice question.

The examiners don't penal ize you for guessing; they don't subtract wrong answers from right answers. Therefore, guess when you must, and realize that you always have at least a 25 percent chance of getting the right answer. In fact, on some questions you may have a 50 percent chance of guessing the right answer because you may immediately recog nize that two of the four choices are wrong.

If you're uncertain about an answer, you can mark that question for later review. You will see this marking functionality in our final exams. Prior to exiting the testlet, you should make sure you have answered all questions.

When you're answering multiple-choice problems that require mathematical calculations and you're u nable to arrive at one of the four given numerical answers, you should perform the following procedure before you record a guess as an answer. First, check the mathematical accu racy of your calculations; that alone may lead you to the correct answer. If that doesn't produce a correct answer, check for an error in your logic by rereading the question. If that doesn't clear the ambiguity, choose your guess to answer the q uestion, and mark it for review at the end of the current testlet if time permits. Remember though that once you submit a testlet, you cannot go back to review it.

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Tactics for Simulations

TIP 1 Work all homework simulations.

We have developed extensive task-based simulations for you to work as homework. You should familiarize yourself with the types of questions and functionalities covered by the tasks. This familiarity will save you time on the actual exam because you will understand how to navigate between tasks and use the various tools that are provided.

TIP 2 Follow recommended progression through tasks.

It is important to have a basic approach when beginning a testlet. We recommend the following:

V

Review each task's instructions.

V

Allocate you r time among the tasks. Remember the approximate time frame of 60-75 minutes for all task-based simulations to be worked . Be sure, however, to take into account any additional time you saved while completing earlier testlets and the difficulty of the particular simulation you are working.

V

Be sure that you have answered all requirements for each task. TIP 3 Use the keyword search function when completing research tasks.

Intro-14

The Research task requires the candidate to answer a question using the appropriate authoritative literature. It should be noted that the most time efficient way to search the authoritative literatu re available on the exam is through the use of a keyword search.

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M A N A G I N G Y O U R S T R E S S B E F O R E T H E E X A M I N A T I O N

Expect to feel tense and u ncertain during the week before the examination. You can manage stress by following several tips.

TIP 1 Remember, every candidate taking the exam likely feels as tense as you do.

Take some comfort from that shared misery and do your best to manage your stress levels.

TIP 2 Use those activities you usually employ to reduce stress.

A uditing

Get as much rest as you can , exercise regularly, and eat balanced nutritional meals. The evidence is overwhelming that adequate rest, exercise, and nutrition minimize the harmful and disruptive physical and psychological effects of tension.

TIP 3 Do not work until you drop.

You'll impair your health and threaten your performance on the examination. Treat yourself to time away from concentrated study. Focus on the fact that the time to study and learn new material is behind you.

TIP 4 _{You may want to try a technique called "imaging."}

Some people report that they improve their performance on difficult or stressful tasks by visualizing that they've already succeeded at the task. I magine that you're taking the examination and handling its demands well . Or, imagine you've received your passing grade. This may boost your confidence.

TIP 5 Remember, the examiners cannot test on every conceivable subject.

The examiners must l imit the amount of detail they demand and the scope of topics on which they can focus during the time allowed for the examination.

TIP 6 Remember, if a question pops up with which you are unfamiliar, don't panic.

The odds are that it will be a surprise to most exam takers. Simply gather your wits about you and prepare the best answer you can. Do not omit the q uestion simply because you are unfamiliar with the topic. Most likely, the examiners are looking for you to exercise professional judgment in tackling the topic.

TIP 7 Remember, if you have followed your study plan, you are well prepared.

You will be able to answer most of the questions on the examination easily, and you'll know how to wrestle with the harder problems in ways that will earn you a passing grade. Even if you've accomplished only most or some of your study goals, take comfort in the knowledge that you're better prepared than many other candidates.

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S U R V I V I N G T H E E X A M I N A T I O N

Make sure that you've arranged your transportation so you arrive with 30 minutes to spare before your set appointment time. This margin should enable you to handle any u nexpected travel delays.

Second, wear comfortable cloth ing. The "layered look" should serve you best. The room in which you take the examination may be perfectly comfortable, but it may be over- or under-heated for the season, and you'll want to be able to adjust to prevailing conditions.

Additional test-center administration procedures are available on either the AICPA exam website (www.cpa-exam.org) or at the Prometric test center website (www.prometric.com/cpa).

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PREPARE TO SUCCEED . . .

Congratulations on you r decision to join the most trusted and recommended C PA Exam Review course in the industry-Becker Professional Education!

U pon the successful completion of our course and passing the CPA Exam, we invite you to consider joining the esteemed faculty of Becker Professional Education. We employ a strong cadre of carefully selected professionals with advanced academic degrees and years of practical experience. Our faculty help students relate to the business world , make tangible connections between theory and practice, and bring immediate relevance to you .

Becker's culture o f passion among its faculty a n d their commitment to keeping professionally up t o date are the key factors driving all aspects of our mission.

As a Becker faculty member, you will help others achieve their career goals and personal potential while earning a supplemental income. You will get the satisfaction of making a positive impact on the quality of the C PA profession. You will also get a unique opportunity to grow personally and professionally:

../

Teach part time without i nterruptin g your fu l l-time career .

../

Experience the satisfaction of making a d ifference .

../

Expand your own expertise .

../

Enhance you r communication and leaders h i p skills .

../

Network with other p rofessionals in your field.

If you are an experienced professional with a CPA and/or an advanced degree, knowledge of the C PA profession with strong communication skills and a desire to help others succeed, you could become a faculty member at Becker Professional Education. Specialty areas of need include financial accounting and reporting, governmental and not-for-profit accounting, taxation, business law, auditing and attestation, economics, cost and managerial accounting.

I n addition to competitive compensation , Becker Professional Education faculty may be eligible for CPE credit (decided by each jurisdiction). Please send a resume or CV to [email protected] if you are interested in preparing future CPAs. If you have questions, you can also contact a Becker faculty recru iter

at 630-706-3406 .

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NOTES

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AUDITING

₁

Audit Reports

1. Audited financial statements: The basics ... 3

2. Professional standards ... 6

3. Reports on audited financial statements ... ... ... 12 4. Reports on comparative financial statements ... ... 45

5. Events occurring after year-end ... . . . ... ... 52

6. Reporting on other information ... ... 57

7. Appendix: The PCAOB auditor's reporting model ... ... 67

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Auditing 1 Becker Professional Education I CPA Exam Review

NOTES

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Becker Professional Education I CPA Exam Review Auditing 1

A U D I T E D F I N A N C I AL S T A T EM E N T S

The Basics

I. THE INDEPENDENT AUDIT FUNCTION

A. The Purpose of an Audit

The purpose of an audit is to provide financial statement users with an opinion on whether the financial statements are presented fairly, in all material respects, in accordance with the

applicable financial reporting framework.

P A S S J( E Y

The applicable financial reporting framework i s the financial reporting framework that i s acceptable i n view of the nature of the entity and the objective of the financial statements, or that is required by law or regulation. Acceptable financial reporting frameworks include general purpose frameworks designed to meet the needs of a wide range of users (e.g., u.s. GAAP and International Financial Reporting Standards [IFRSsJ), and special purpose frameworks (discussed in lecture A-2).

u . S . A U D I T I N G S TA N D A R D S V S . I N T E R N A T I O N A L S T A N D A R D S O N A U D I T I N G

ISAs discuss both compliance frameworks and fair presentation frameworks when discussing applicable financial reporting frameworks. u.s. GAAS does not make any reference to compliance frameworks because all financial reporting frameworks used in the United States are fair presentation frameworks. A fair presentation framework is a financial reporting framework that requires compliance with the requirements of the framework and: - acknowledges explicitly or implicitly that to achieve fair presentation of the financial statements, it may be

necessary for management to provide disclosures beyond those speCifically required by the framework; and - acknowledges explicitly that it may be necessary for management, in extremely rare circumstances, to depart

from a requirement of the framework to achieve fair presentation of the financial statements.

B. Audit F unction Adds " Credibility"

The auditor's report gives credibility to the financial statements. The auditors, as a group independent of management, have an objective view and can report on a company's activities without bias or conflict of interest. Without a report from an independent auditor, a company's financial statements would be meaningless, because the public would have little faith in financial statements issued by the inherently biased company.

C. Responsibilities

The financial statements of an enterprise are prepared by the management of the enterprise, not by the independent auditor. Further, the financial statements are the product and property of the enterprise; the independent auditor merely audits and expresses an opinion on them.

1 . Management Responsibilities

An audit is conducted on the premise that management and, when appropriate, those charged with governance, are responsible for:

a. the preparation and fair presentation of the financial statements in accordance with the applicable financial reporting framework;

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b. the design, implementation, and maintenance of internal control relevant to the

preparation and fair presentation of financial statements that are free of material misstatement due to error or fraud; and

c. providing the auditor with access to information and persons within the entity

needed to complete the audit.

P A S S I( E Y

The preparation and fair presentation of the financial statements requires: 1. identification of the applicable financial reporting framework;

2. preparation and fair presentation of the financial statements in accordance with the framework; and

3. inclusion of an adequate description of the framework in the financial statements. 2. Auditor Responsibilities

The auditor is responsible for expressing an opinion on the financial statements based on the audit. The auditor is also responsible for having appropriate competence and capabilities to perform the audit, complying with relevant ethical requirements, maintaining professional skepticism , and exercising professional judgment throughout the planning and performance of the audit.

D. Performance

In order to express an opinion, the auditor obtains reasonable assurance about whether the financial statements are free from material misstatement, whether due to error or fraud.

1 . Reasonable Assurance

Reasonable assurance is a high, but not absolute, level of assurance. In order to obtain reasonable assurance, the auditor must:

a . plan the work and properly supervise any assistants; b. determine and apply appropriate materiality levels;

c. identify and assess risks of material misstatement, whether due to fraud or error; and

d. obtain sufficient appropriate audit evidence.

2. I nherent Limitations of an Audit

The auditor is unable to obtain absolute assurance that the financial statements are free from material misstatement because of the following inherent limitations:

a. The Nature of Financial Reporting

Some financial statement items are subject to an inherent level of variability because they involve judgment by management or because they involve subjective decisions or assessments or a degree of uncertainty (e.g., accounting estimates). b. The Nature of Audit Procedures

There are practical and legal limits on an auditor's ability to obtain audit evidence, including:

(1) The possibility that management or others may not provide, intentionally or unintentionally, the complete information that is needed for the preparation and presentation of the financial statements or that is requested by the auditor.

(2) Fraud may be concealed in such a way that it is difficult to detect with audit

procedures.

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(3) An audit is neither an investigation into a wrongdoing nor does the auditor have specific legal powers.

c. Timeliness of Financial Reporting and the Balance Between Cost and Benefit

There is an expectation by users of financial statements that the auditor will form an opinion on the financial statements within a reasonable period of time and will achieve a balance between benefit and cost, recognizing that it is impracticable to address all information that may exist. Therefore, it is necessary for the auditor to:

(1) plan the audit so that it is performed effectively;

(2) direct efforts to areas most expected to contain risks of material misstatement; and

(3) use testing and other means of examining populations for misstatement.

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P R O F E S S I O N AL S T A N D A R D S

I . AUDITING STANDARDS

A. Generally Accepted Auditing Standards

IIUil

The auditor is responsible for the performance of a properly planned and executed audit in accordance with generally accepted auditing standards (GAAS). Note that compliance with GAAS is mandatory on all audit engagements.

B.

IIMM'I

C.

Generally accepted auditing standards for the audits of nonissuers are issued by the AICPA's Auditing Standards Board (ASB) in the form of Statements on Auditing Standards (SAS).

The ASB's Statements on Auditing Standards are outlined in Section AU of the AICPA Professional Standards.

P A S S J< E Y

To address concerns about the clarity, length, and complexity of its standards, and to converge its standards with the International Standards on Auditing (ISAs), the ASB redrafted all of its SASs. These clarified SASs were issued by the ASB in late 2011 and are effective for audits of financial statements for periods ending on or after December 15, 2012. The clarified SASs are outlined in Section AU-C of the AICPA Professional Standards, to avoid confusion with the existing AU sections, which remain effective through 2013. The AU-C identifier will revert to AU in 2014. These Becker audit materials are based on the clarified SAS, which are testable on the CPA Exam starting on July 1, 2013.

Generally Accepted Government Auditing Standards

Audits of government organizations, programs, activities, and of entities that receive government funds should be conducted in accordance with generally accepted government auditing standards (GAGAS), as covered later in the course.

Public Company Accounting Oversight Board

The Public Company Accounting Oversight Board (PCAOB) was established pursuant to the Sarbanes-Oxley Act of 2002. The PCAOB establishes auditing and related professional practice standards to be used in the preparation and issuance of audit reports for issuers.

1. Issuers consist of entities subject to the rules of the SEC (primarily public companies).

2. The PCAOB is comprised of five full-time, financially literate members.

a . Two members must b e (or have been) CPAs, and the other three must not b e (or must not have been) CPAs.

b. A CPA can only act as the Chair of the Board if he or she has not practiced as a CPA for the past five years.

c. No members of the Board can receive payments from a public accounting firm

(other than fixed continuing payments, such as retirement payments).

3. Public accounting firms must register with the PCAOB in order to audit a public company. Registered firms are subject to Board inspection, disciplinary proceedings, and sanctions.

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4. peAOB Auditing Standards (AS)

..

a . The PCAOB adopted , on an initial, interim basis, ASB standards, but continues to

review each standard to evaluate whether it should be modified, repealed, replaced , or permanently adopted . The PCAOB has i ssued several of its own Auditing Standards (AS) , which replace ASB Standards for audits of issuers. These Auditing Standards will be covered throughout the course.

J::l

Be sure to visit the Becker website for possible updates to this area.

b. Note that the ASB retains the authority to set performance and reporting standards for audits of financial statements of non issuers.

D. International Standards on Auditing

The International Auditing and Assurance Standards Board (IAASB), a standard setting board of the International Federation of Accountants (IFAC), establishes International Standards on Auditing (ISA). The I FAC is a worldwide organization that establishes and promotes adherence to high-quality professional standards and works toward the international convergence of such standards. I SAs issued by the IAASB do not override the local laws and regulations or national standards that govern the audits of historical financial statements in particular countries. Over 100 countries are using or are in the process of adopting or incorporating the ISAs into their national auditing standards or are using the ISAs as a basis for preparing national auditing standards.

II. STANDARDS FOR ENGAGEMENTS OTHER THAN AUDITS

An audit is merely one type of engagement an accountant may be called u pon to perform. Each type of engagement has a d ifferent set of applicable professional standards, and the requirements, responsibilities, and limitations vary with the nature and scope of the engagement. Below is an overview of standards for engagements other than audits that will be tested on the Auditing and Attestation section of the CPA exam.

A. Statements on Standards for Attestation Engagements

Statements on Standards for Attestation Engagements (SSAE) are issued by the AICPA. These standards apply to attest engagements, covered later in the course. The SSAEs are outlined in Section AT of the AICPA Professional Standards.

B. Statements on Standards for Accou nting and Review Services

The Accounting and Review Services Committee was established by the AICPA to establish standards for privately-held (non issuer) companies not seeking audited statements.

Statements on Standards for Accounting and Review Services (SSARS) are issued by this Committee, and they are applicable to unaudited financial statements or u naudited financial information of a nonpublic entity. SSARS are covered later in the course. The SSARS are outlined in Section AR of the AICPA Professional Standards.

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III. OTHER GUIDELINES

Al-S

A. AICPA Code of Professional Conduct

The AICPA Code of Professional Conduct provides members with guidelines for behavior in the conduct of their professional affairs. I n add ition, it provides assurance to the public that the profession intends to maintain high standards and to enforce compliance with these standards by its members. The Code of Professional Conduct applies to all services

performed in the practice of public accounting. The Code of Professional Conduct is outlined in Section ET of the AICPA Professional Standards.

B. Statements on Quality Control Standards

The AICPA Code of Professional Conduct requires firms providing auditing, attestation, and accounting and review services to adopt a system of quality control. A quality control system consists of policies and procedu res designed , implemented, and maintained to ensure that the firm complies with professional standards and appropriate legal and regulatory

requirements, and that any reports issued are appropriate in the circumstances. Statements on Quality Control Standards (SQCS) are issued by the Auditing Standards Board to provide guidance with respect to quality control. The SQCS are outlined in Section QC of the AICPA Professional Standards.

C. Securities and Exchange Commission (SEC)

1. The Securities Acts of 1933 and 1934 have given this U . S . governmental commission

the authority to set guidelines for U .S. publicly traded companies.

a . The S E C publishes their regulations in the Accounting Series Releases and in

Regulation S-K.

b. Final standards adopted by the PCAOB do not become effective until they are

approved by the SEC.

D. Sarbanes-Oxley Act of 2002

In the wake of the collapse of Enron and WorldCom corporations and the restatement of financial statements of a number of other SEC reporting companies, Congress passed the Sarbanes-Oxley Act of 2002 (hereafter "SOX").

E. IFAC Code of Ethics for Professional Accountants

The International Ethics Standards Board for Accountants (IESBA), a standard setting board of the I nternational Federation of Accountants ( I FAC), establishes the I FAC Code of Ethics for Accountants. The I FAC Code is the foundation for the codes of ethics developed and enforced by member bodies of the I FAC. No I FAC member body or firm issuing reports in accordance with International Auditing and Assurance Standards is allowed to apply less stringent ethics standards than those outlined in the I FAC Code of Ethics for Accountants.