1.

When one talks about “completeness” assertion, the same assertion has different meaning for
account balances, transactions and events, and presentation and disclosure. Please explain the
meaning of “completeness” as one assertion under “presentation and disclosure”.
Completeness: All disclosures that should have been included have been included
2. When was the SEC created? What’s the primary responsibility of the SEC as a federal agency?
When was the annual audit requirement introduced for all publicly traded companies in the
U.S.A?

 SEC was established in June 6, 1934. After the stock market crash in 1929, SEC was established
to protect investors from fraudulent investments and to regulate the securities industry.
 Securities and Exchange Commission(SEC) is responsible for authorizing the GAAP for
companies whose stock is held by the general investing public.
 Effective in 2006, all public companies are required to submit an annual assessment of the
effectiveness of their internal financial auditing controls to the Securities and Exchange
Commission (SEC).

3. Since 1950s, the wording of auditor’s opinion has been switched from “a true and accurate view
of financial position” to “present fairly in all material aspects”. Please provide at least 2 reasons
why “fairness” took over and became the new focus of financial statement audit.

Because financial statements include 1)estimate, 2)assumption, 3)unavoidable inaccuracy, and

lastly, auditors use "sampling method" which focuses on areas of accounting where material
misstatements may exist; some numbers may be inaccurate yet not such inaccuracy would
always result in material misstatement.

4. In late 2001 through 2002, the accounting profession faced a “crisis of credibility.” You are now
familiar with the Enron fraud, but not the Worldcom case. Please consult “Professor Google”
and briefly describe the Worldcom case to me (e.g. what did the CFO do to inflate reported
profit, key accounts involved in this fraud, how large was the total misstatement, who was the
external auditor before Worldcom’s final collapse, and who whistle-blowed this accounting
fraud to the audit committee?). Tip: https://en.wikipedia.org/wiki/MCI_Inc.

5. The Sarbanes-Oxley Act of 2002 established a new regulator over the CPA firms that audit the
publicly traded companies in the U.S. Please name this new regulatory agency and explain the
major responsibilities of this board. (FYI, in the 2020-2021 federal budget, the Trump
administration proposed to consolidate PCAOB into the SEC by 2022. It is not going to happen in
the near future, at least for 2020 and 2021).

 The Sarbanes -Oxley Act of 2002 created the Public Company accounting Oversight Board. the
major responsibilities of this board are:
-Adopting or establishing standard for preparing audit reports relating to auditing, quality
control, attestation, independence and ethics, for registrants with the U.S Securities and
Exchange Commission.
 -Registering, monitoring and regulating certified public accountants and public accounting
firms which audit public companies.
-Inspecting practices of registered firms.
-Investigating audit practice of registered firms and taking disciplinary actions
-Imposing sanctions on registered firms.

6. For how long does the Sarbanes-Oxley Act require auditors of public companies to retain audit
documentation?

The Sarbanes-Oxley Act requires auditors of public companies to prepare and maintain audit
schedules and other information related to any audit report in sufficient detail to support the
auditor's conclusions, for a period of not less than 7 years.

7. What are the impacts of the SOX Act of 2002 on auditors and management? If an executive
tampers accounting records and manipulates reported numbers at a publicly-traded firm, what’s
the maximum prison term he can get under the Sarbanes-Oxley Act of 2002?

 Before the SOX act of 2002 the CPA profession regulated itself, after the SOX Act this self
regulation was eliminated. The PCAOB was established to set audit standards for public firms
and it instituted a closer regulation of the profession including regular monitoring of its
activities. The act also prohibited the auditor from performing certain non-audit services for
audit clients. It also required an integrated audit of the financial statements and internal
controls. For management, the SOX act required the CEO and CFO to certify all the publicly
issued financial statements and required management to issue an internal control report in
the financial statements.
 A maximum 20 year prison term.

8. Who are responsible for the Enron failure? Please list at least three persons (or parties). Why
the Enron CFO established many unconsolidated SPEs overseas?

9. After 2003, AICPA and PCAOB have different regulatory powers in the audit market. Please
describe the details to the professor.

 AICPA:
-Establishes standards for attestation, accounting and review, quality control, independence,
and ethical behavior in respect for non-public companies.
-CPA firms may join the AICPA voluntarily in one or both section:
--Private Companies Practice Section (PCPS)
--Center for Public Company Audit Firms
-AICPA authority is based on its general acceptance by state boards of accountancy, other
legislative organizations, and the courts.
-AICPA Center for Public Company Audit Firms peer review program covers the non-public
practices of firms whose public company practices are inspected by the PCAOB.
 PCAOB:
-Establishes standards for auditing, quality control, and ethical behavior for public companies.
-PCAOB registers CPA firms to audit public companies. It may revoke or bar a CPA from
participation in audit.
-PCAOB has federal authority conferred through legislation.
-Performs inspections of public company auditing practices of registered firms.

10. The professor mentioned that a firm faces both business risk and information risk. Please briefly
discuss the definitions of these two risks? Which risk is directly affected by the auditor?

 Business risk:
- Associated with a firm's survival and profitability
- Business risks result from significant economic conditions, event, circumstances or actions
that might adversely affect the entity's ability to achieve its objectives and execute its
strategies
Information Risk:
- Financial statements will fail to appropriately reflect economic substance of business
activities
- Due to management manipulation, Enron-style - the financial statements will be materially
false and misleading
 Auditing significantly affects information risk. The credibility that an auditor assured
document is being used to base business decisions off of significantly lowers the risk that
information is inaccurate.

11. Please list the four management assertions on account balances and five management
assertions on transactions. Please briefly explain those assertions to your professor. Professor
might give you examples and ask you to identify the relevant account balance assertions or
accounting transaction assertions.

 Five transaction-level assertions:

1. Accuracy: the assertion is that the full amounts of all transactions were recorded, without
error
2. Classification: the assertion is that all transactions have been recorded within the correct
accounts in the general ledger
3. Completeness: the assertion is that all business events to which the company was subjected
were recorded
4. Cutoff* the assertion is that all transactions were recorded within the correct reporting
period
5. Occurrence: the assertion is that recorded business transactions actually took place
 Four management assertions on account balance:
1. Completeness: the assertion is that all reported asset, liability, and equity balances have
been fully reported
2. Existence: the assertion is that all account balance exists for assets, liabilities, and equity
3. Rights and obligations: the assertion is that the entity has the rights to the assets it owns
and is obligated under its reported liabilities
 4. Valuation: the assertion is that all asset, liability, and equity balances have been recorded at
their proper valuations

12. Distinguish between fraudulent financial reporting and misappropriation of assets. Discuss the
likely difference between these two types of frauds on the fair presentation of financial
statements.
 Misappropraition of assets represents the theft of assets by employees. Fraudulent financial
reporting is the intentional misstatement of financial information by management or a theft
of assets by management, which is covered up by misstating financial statements.
Misappropriation of assets ordinarily occurs either because of inadequate internal controls or
a violation of existing controls. The best way to prevent theft of assets is through adequate
internal controls that function effectively. Many times theft of assets is relatively small in
dollar amounts and will have no effect on the fair presentation of fs, although there are some
cases of material theft of assets. Fraudulent financial reporting is inherently difficult to
uncover because it is possible for one or more members of management to override internal
controls. In many cases the amounts are extremely large and may affect the fair presentation
of fs.
 Fraudulent financial reporting: management fraud - intentional overstatement of sales near
the balance sheet date to increase reported earnings
 Misappropriate of assets: employee fraud - clerk taking cash at the time a sale is made and
not entering the sale in the cash register
 Fraudulent financial reporting harms users by providing them incorrect financial statement
information for their decision making.
When assets are misappropriated, stockholders, creditors, and others are harmed because
assets are no longer available to their rightful owners

13. What’s the purpose of audit according to the 11 AICPA audit principles?
The purpose of an audit is to provide financial statements users with an opinion by the auditor on
whether the financial statements are presented fairly, in all material respects, in accordance with
the applicable financial reporting framework. An auditor’s opinion enhances the degree of
confidence that intended users can place in the financial statements.

14. What is “professional skepticism”? Why professional skepticism is important to today’s auditors.

 Professional Skepticism is an attitude that includes a questioning mind, being alert to

conditions that may indicate a possible deviation or misstatement due to error or fraud, and a
critical assessment of evidence
 Professional skepticism plays a fundamentally important role in the audit, and forms an
integral part of the auditor’s skill set. It facilitates the appropriate exercise of professional
judgment, particularly regarding decisions about:

 the nature, timing and extent of audit procedures to be performed to reduce the risk to an
appropriate level;
 whether sufficient appropriate audit evidence has been obtained and whether more needs to
be done to achieve the objectives of the relevant assurance standards;
 the evaluation of management’s judgments (particularly regarding the application of the
entity’s applicable financial reporting framework in the context of an annual audit);
 the drawing of conclusions based on the audit evidence obtained.

The application of professional skepticism enhances the effectiveness of an audit procedure and
of its application and reduces the possibility that we might select an inappropriate audit
procedure, misapply an appropriate audit procedure, or misinterpret the audit results

15. Explain why auditors need an understanding of the client’s industry.

 It helps to assess the risk that financial statements might contain material misstatement
(retailing) or even help auditors to identify risky accounts
 Used to establish and overall audit strategy, design the audit plan and audit program (most
efficient allocation of time)

16. In today’s world, why auditor can only provide reasonable assurance as to the fairness of
financial statements?

1. Most audit evidence results from TESTING A SAMPLE of a population. Sampling inevitably
includes some risk of not uncovering a material misstatement.
2. Accounting presentations contain complex estimates, which inherently involve uncertainty
and can be affected by future events.
3. Fraudulently prepare financial statements are often extremely difficult for the auditor to
detect

17. Who is primarily responsible for the fairness of the financial statements at a publicly traded
firm? The management, board of directors, auditor, or the SEC?

The management is primarily responsible for representing fair financial statements in a

publicly traded company. The auditor and SEC is responsible for testing the fairness of the
financial statements and issuing an opinion regarding them.

18. In the banking industry, “non-performing loan ratio” is a useful risk indicator. Please explain to
the professor what is non-performing loan? BTW, some countries also call it “non-accrual loan
ratio”. Tip: Definition is available at
https://www.investopedia.com/terms/n/nonperformingloan.asp; U.S. historical data/graph are
available here: https://fred.stlouisfed.org/series/NPTLTL.

A nonperforming loan (NPL) is a loan in which the borrower is in default due to the fact that
they have not made the scheduled payments for a specified period. Although the exact
elements of nonperforming status can vary depending on the specific loan's terms, "no
payment" is usually defined as zero payments of either principal or interest. The specified
 period also varies, depending on the industry and the type of loan. Generally, however, the
period is 90 days or 180 days.

19. Apex LLP is the auditor of ZCoupon Inc., a private startup with 20 employees based in Santa Ana,
California. Its 2016 audit report contains one paragraph on auditor’s responsibility. It is copied
and pasted below. Please identify wording errors and correct them. “Our responsibility is to
express an opinion on these consolidated financial statements based on our audits. We
conducted our audits in accordance with auditing standards established by PCAOB. Those
standards require that we plan and perform the audit to obtain great confidence as to whether
the consolidated financial statements are free of financial misstatement”.

Our responsibility is to express an opinion on these consolidated financial statements

based on our audits. We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the consolidated financial
statements are free of material misstatement

20. Who sets up the accounting standards in the U.S.A? PCAOB, AICPA or the SECor others?

Established in 1973, the Financial Accounting Standards Board (FASB) is the independent,
private- sector, not-for-profit organization based in Norwalk, Connecticut, that establishes
financial accounting and reporting standards for public and private companies and not-for-
profit organizations that follow Generally Accepted Accounting Principles (GAAP).

21. When are analytical procedures useful? Before the audit, during the audit, or at the end of
annual audit?

Analytical procedures are an important part of the audit process and consist of evaluations of
financial information made by a study of plausible relationships among both financial and
nonfinancial data. Analytical procedures range from simple comparisons to the use of complex
models involving many relationships and elements of data. A basic premise underlying the
application of analytical procedures is that plausible relationships among data may reasonably
be expected to exist and continue in the absence of known conditions to the contrary.
Particular conditions that can cause variations in these relationships include, for example,
specific unusual transactions or events, accounting changes, business changes, random
fluctuations, or misstatements. Mostly useful during and at the end of the annual audit.

22. What are the primary and secondary functions of audit working papers (documentation)?

 The primary functions of audit working papers are to provide the principal support for the
representation in the auditor's' report that the audit was performed in accordance with
generally accepted auditing standards and provide support for audit opinion.
 The secondary functions of audit working paper include (1) assisting both the continuing audit
team members and auditors new to the engagement in planning and performing the audit, (2)
assists audit team members responsible for supervising and reviewing the quality of the work
performed, (3) demonstrates the accountability of the various audit team members for the
 work performed, and (5) assists internal firm quality control reviewers, inspection or peer
review individuals, and successor auditors in performing their respective roles

23. Confirmation through an independent third-party has been widely used to obtain reliable audit
evidence to verify some asset or liability accounts on the balance sheet. Please list at least 3
asset accounts which can be audited by confirmation.

 Cash in Bank
 Accounts Receivable
 Notes Receivable
 Marketable Securities

24. Today, American auditors can easily verify client’s asset or liability accounts through electronic
confirmation. Please name the firm that provides this online econfirmation platform?

Confirmation.com, Thomson Reuters

25. Please explain to the professor briefly the definition of “materiality” as defined by the FASB?

The magnitude of an omission or misstatement of financial information that makes it

probable that the judgement of a reasonable person relying on the info could have been
changed or influenced by the omission/misstatement

26. Internal control has one fundamental principle: Segregation of duties. Please briefly describe
how a credit sale transaction could be separated into 4 different stages and assigned to 4
different departments (or groups of employees).

One employee/department cannot finish a whole process of a transaction.

1. Authorization of transactions (credit manager approves purchase)
2. record-keeping (salesperson initiates sale)
3. custody of assets
4. execution of transaction (warehouse issues inventory)

27. Please list five components of internal controls.

1. Control environment
2. Risk assessment
3. Control activities
4. Accounting information systems
5. Moitoring control

28. The professor shows that monthly bank cash reconciliation helps to detect cash fraud
perpetrated by low-level employees. Please briefly explain how monthly bank cash
reconciliation, an internal control practice, could be useful in identifying cash embezzlement.
 Bank reconciliations are an essential internal control tool and are necessary in preventing and
detecting fraud. They also help identify accounting and bank errors by providing explanations
of the differences between the accounting record’s cash balances and the bank balance
position per the bank statement.

The bank reconciliation ensures that all transactions that have gone through the bank
statements have been reviewed and checked, thus reducing the probabilities of errors in the
data used to prepare accounts. Bank statements also ensure completeness by helping to
ensure that all payments and receipts that have gone through the bank account have also
been recorded in the accounting records. Any differences are identified and explained

This function requires a segregation of duties, which means that the person who performs the
bank reconciliations should not also have access to the recording of transactions in the
accounting records or processing of cash disbursements or receipts. Any differences identified
between the accounting records and the bank statements should be adjusted by a person
other than the one doing the reconciliations.

29. Under “risk assessment”, students are required to know “factors Indicative of Increased
Financial Reporting Risk”.
1. Changes in the regulatory or operating environment
2. Changes in personnel
3. Implementation of a new or modified information system
4. Rapid growth of the organization
5. Changes in technology affecting production process or information systems
6. Introduction of new lines of business, products, or processes
7. Corporate restructuring (and M&A)
8. Expansion or acquisition of foreign operations
9. Adoption of new accounting principles or changing accounting principles

30. What are “general controls” and what are “application controls”?
 general controls - apply to all or multiple types of transactions including all information
processing controls.
 application controls - apply to the processing of a single type of transaction relating to input,
processing, and output of data.

31. Publicly-traded firms in the U.S. regularly file two kinds of financial accounting reports with the
SEC: 10-K and 10-Q. Please explain the differences.

 Form 10K is an annual report and is more comprehensive than a 10Q, which is a quarterly
report that consists primarily of the quarterly financial statements and the
management’s discussion and analysis disclosure. 10K has all details like business, property,
 staff, financial data, executive compensation, etc. whereas 10Q has a submission of matters
put to the vote of security holders. 10K is substantially greater in scope than a 10Q.

32. (Chapter 25) Compilation, review, and exam (audit) provide different levels of assurance. Please
briefly describe their differences here

An audit provides the highest level of assurance on an organization’s financial statements. An

audit provides assurance that an organization’s financial statements are free of material
misstatement and are fairly presented based upon the application of generally accepted
accounting principles

A review provides limited assurance on an organization’s financial statements. During a

review, inquiries and analytical procedures present a reasonable basis for expressing limited
assurance that no material modifications to the financial statements are necessary; they are in
conformity with generally accepted accounting principles. This “does it make sense” analysis
is useful when the organization needs some assurance about their financial statements, but
not the higher level of assurance provided by an audit

A compilation provides no assurance on an organization’s financial statements. The CPA takes

financial data provided by the nonprofit and puts them in a financial statement format that
complies with generally accepted accounting principles. There are no testing or analytical
procedures performed during a compilation.