Auditing and Assurance Services A Systematic Approach 10th Edition SM Download

Chapter 07 - Auditing Internal Control over Financial Reporting
Solution Manual for Auditing and Assurance Services A

Systematic Approach 10th Edition Messier Glover Prawitt
0077732502 9780077732509
Full download link at:
Solution manual: https://testbankpack.com/p/solution-manual-for-auditing-
and-assurance-services-a-systematic-approach-10th-edition-messier-glover-
prawitt-0077732502-9780077732509/
Test bank: https://testbankpack.com/p/test-bank-for-auditing-and-assurance-
services-a-systematic-approach-10th-edition-messier-glover-prawitt-0077732502-
9780077732509/
CHAPTER 7
AUDITING INTERNAL CONTROL OVER FINANCIAL
REPORTING
Answers to Review Questions
7-1 Following are management’s and the auditor’s responsibilities under Section 404 of the
Sarbanes-Oxley Act of 2002:
Management’s Responsibilities
 Accept responsibility for the effectiveness of the entity's ICFR.
 Evaluate the effectiveness of the entity's ICFR using suitable control criteria.
 Support its evaluation with sufficient evidence, including documentation.
 Present a written assessment of the effectiveness of the entity’s ICFR as of the end of
the entity’s most recent fiscal year.
Auditor’s Responsibilities
 The auditor must plan and perform the audit to obtain reasonable assurance about
whether the entity maintained, in all material respects, effective internal control as of
the date specified in management's assessment.
 The audit of internal control should be “integrated” with the financial statement audit,
and should express an opinion on the effectiveness of the entity’s ICFR.
7-2 “Likelihood” refers to the probability that a misstatement will not be prevented or detected.
For a significant deficiency or a material weakness to exist, the likelihood of such an
occurrence must be either “reasonably possible” or “probable.”
“Magnitude” refers to the significance that the control deficiency could have on the
financial statements according to the judgment of a prudent official who considers the
7-1
© 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
possibility of further, undetected, misstatements. If the auditor’s likelihood assessment is

“reasonably possible” and if the magnitude of the deficiency is assessed as “significant,”
then either a significant deficiency or material weakness exists depending on the magnitude
of the potential effects of the deficiency on the entity’s financial statements.
7-3 All of the following controls would typically be tested (see Table 7-2):
 Entity-level controls (see Table 7-1).
 Controls over initiating, authorizing, recording, processing, and reporting significant
accounts and disclosures and related assertions embodied in the financial statements.
 Controls over the selection and application of accounting policies that are in conformity
with GAAP.
 Antifraud programs and controls.
 Controls, including IT general controls, on which other controls are dependent.
 Controls over significant nonroutine and nonsystematic transactions, such as accounts
involving judgments and estimates.
7-2
7-4 Management and the auditor make similar decisions deciding which locations or business
units to include for testing. Thus, the choice of which locations to include in the assessment
of internal control is based on the presence of entity-level controls and the financial
reporting risk at each individual location or business unit. Willis & Adams provide the
following flowchart as part of its Policy Statement on Identifying Significant Business
Units or Locations (see the policy statement for more details):
Multi-location Testing Consideration Flowchart
Is the location or business unit Yes Evaluate documentation and test

individually important? significant controls at each
location or business unit.
No
Are there specific significant Yes Evaluate and test controls over
risks? specific risks.
No
Are there locations or business Yes No further action required for

units that are not important even such units.
when aggregated with others?
No
Are there documented company- Yes Evaluate documentation and test

level controls over this group? company-level controls over this
group.
No
Some testing of controls at
individual locations or business
units is required.
7-3
7-5 The SEC allows considerable flexibility to management in how it should document its
assessment. Reasonable support would include the basis for management’s assessment,
such as documentation of the methods and procedures it utilizes to gather and evaluate
evidence. Such documentation would include the design of the controls management has
placed in operation to adequately address identified financial reporting risks, including the
entity-level and other pervasive elements necessary for effective ICFR. Management is not
required to identify and document every control in a process. Documentation should focus
on those controls management concludes are adequate to address the entity’s financial
reporting risks. Such evidence for management’s assessment ordinarily includes
documentation of how management formed its conclusion about the effectiveness of the
company’s entity-level controls and other pervasive elements of ICFR that its control
framework describes as necessary for an effective system of internal control.
7-6 The steps in the auditor’s process for an audit of ICFR include (see Figure 7-2):
 Plan the audit of ICFR.
 Identify controls to test using a top-down, risk-based approach.
 Test the design and operating effectiveness of selected controls.
 Evaluate identified control deficiencies.
 Form an opinion on the effectiveness of ICFR.
7-7 (Refer to Table 3-2). The following factors can be used to judge the objectivity of the
internal audit function:
 Whether the organizational status of the IAF, including the function’s authority and
accountability, supports the ability of the function to be free from bias, conflict of
interest, or undue influence of others to override professional judgments (e.g., the IAF
reports to audit committee or an officer with appropriate authority, or if the function
reports to management, whether it has direct access to audit committee).
 Whether the IAF is free of any conflicting responsibilities (e.g., having managerial or
operational duties or responsibilities that are outside of the IAF).
 Whether audit committee oversees employment decisions related to the IAF.
 Whether any constraints or restrictions placed on the IAF by management or audit
committee exist, for example, in communicating the IAF’s findings to the external
auditor.
 Whether the internal auditors are members of relevant professional bodies and their
memberships obligate their compliance with relevant professional standards relating to
objectivity or whether their internal policies achieve the same objectives.
The competence of internal audit function can be determined by assessing the following
factors:
 Whether the IAF is adequately and appropriately resourced relative to the size of the
entity and the nature of its operations.
 Whether established policies for hiring, training, and assigning internal auditors to
internal audit engagements exist.
 Whether the internal auditors have adequate technical training and proficiency in
auditing. (e.g., the internal auditors’ possession of a relevant professional designation
and experience).
7-4
 Whether the internal auditors possess the required knowledge relating to the entity’s
financial reporting and the applicable financial reporting framework and whether the
IAF possesses the necessary skills to perform work related to the entity’s financial
statements.
 Whether the internal auditors are members of relevant professional bodies that oblige
them to comply with the relevant professional standards, including continuing
professional development requirements.
7-8 The steps in the top-down, risk-based approach to obtaining an understanding of ICFR
include:
 Identify entity-level controls – Because these controls have a pervasive effect on ICFR,
the auditor needs a thorough understanding of entity-level controls. The two major
categories of controls included here are: (1) the control environment and (2) the period-
end financial reporting process.
 Identify significant accounts and disclosures and their relevant assertions - To complete
this step, the auditor evaluates risk factors related to the financial statement accounts
and disclosures. The risk factors include:
• Size and composition of the account.
• Susceptibility to misstatement due to errors or fraud.
• Volume of activity, complexity, and homogeneity of the individual transactions
processed through the account or reflected in the disclosure.
• Nature of the account or disclosure.
• Accounting and reporting complexities associated with the account or disclosure.
• Exposure to losses in the account.
• Possibility of significant contingent liabilities arising from the activities reflected
in the account or disclosure.
• Existence of related-party transactions in the account.
• Changes from the prior period in account or disclosure characteristics (AS5, 29).
 Understand likely sources of misstatement – In order to complete this step, the auditor
needs to do the following:
• Understand the flow of transactions related to the relevant assertions.
• Identify the points within the entity's processes at which a misstatement – including
a misstatement due to fraud – could arise that, individually or in combination with
other misstatements, would be material.
• Identify the controls that management has implemented to address these potential
misstatements.
• Identify the controls that management has implemented over the prevention or
timely detection of unauthorized acquisition, use, or disposition of the company's
assets that could result in a material misstatement of the financial statements (AS5,
34).
 Select controls to test – Table 7-4 shows factors the auditor should consider when
identifying controls to test.
7-5
7-9 The period-end financial reporting process controls include procedures used to enter
transaction totals into the general ledger; initiate, authorize, record, and process journal
entries in the general ledger; record recurring and nonrecurring adjustments to the annual
and quarterly financial statements; and draft annual and quarterly financial statements and
related disclosures.
The auditor’s evaluation of the period-end financial reporting process includes the inputs,
procedures performed, and outputs of the processes the company uses to produce its annual
and quarterly financial statements. The auditor should also consider the extent of IT
involvement in each period-end financial reporting process element, who participates from
management, the number of locations involved, types of adjusting entries, and the nature
and extent of the oversight of the process by appropriate parties, including management,
the board of directors, and the audit committee.
7-10 Walkthroughs help the auditor to confirm his or her understanding of control design and
transaction process flow, to determine whether all points at which misstatements could
occur have been identified, to evaluate the effectiveness of the design of controls, and to
confirm whether controls have been placed in operation. Walkthroughs typically do not
provide evidence of the operating effectiveness of controls. A typical walkthrough involves
observation, inquiry, and inspection of documents.
7-11 The circumstances that should be regarded as indicators of a material weakness include
(see Table 7-7):
• Identification of fraud, whether or not material, on the part of senior management.
• Restatement of previously issued financial statements to reflect the correction of a
material misstatement.
• Identification by the auditor of a material misstatement of financial statements in the
current period in circumstances that indicate that the misstatement would not have
been detected by the company's internal control over financial reporting.
• Ineffective oversight of the company's external financial reporting and internal
control over financial reporting by the company's audit committee (AS5, 69).
These circumstances are “red flags” for potential problems in the control environment.
Because the nature of the audit report depends on the significance of such weaknesses, the
PCAOB does not want them to be overlooked.
7-12 Remediation is when an entity determines that it has a material weakness and takes steps
to correct it. If management corrects a material weakness before the “as of” date, and both
management and the auditor can adequately test the operating effectiveness of the control,
management can assert that ICFR is effective.
7-13 AS5 requires that the auditor appropriately document the processes, procedures, judgments,
and results relating to the audit of internal control. The auditor’s documentation must
include the auditor’s understanding and evaluation of the design of each of the components
of the entity's ICFR. The auditor also documents the process used to determine, and the
7-6
points at which misstatements could occur within, significant accounts, disclosures, and
major classes of transactions. The auditor must justify and document the extent to which
he or she relied upon work performed by others. Finally, the auditor must describe the
evaluation of any deficiencies discovered as well as any other findings that could result in
a modification to the auditor's report.
7-14 The auditor’s unqualified opinion on the effectiveness of an entity’s internal control
signifies that the entity’s internal control is designed and operating effectively in all
material respects. Significant deficiencies relate to possible financial statement errors that
are less than material, and therefore do not require a departure from an unqualified opinion.
A serious scope limitation requires the auditor to disclaim an opinion. An adverse opinion
is required if a material weakness is identified. Figure 7-4 illustrates the types of auditor’s
reports and the circumstances leading to each.
7-15 The auditor will issue an adverse opinion on the effectiveness of internal control if a
material weakness is identified.
7-16 If the scope of the auditor’s work is limited, the auditor may disclaim an opinion, depending
on the severity of the limitation and whether or not management intentionally imposes it.
7-17 When a significant period of time has elapsed between the time period covered by the tests
of controls in the service auditor's report and the date of management's assessment,
additional procedures should be performed. The auditor should consider the results of
relevant procedures performed by management or the auditor, how much time has passed
since the service auditor's report, the significance of the activities of the service
organization, whether errors have been identified in the service organization's processing,
and the nature and significance of any changes in the service organization's controls. As
these factors increase in significance, the need for the auditor to obtain additional evidence
increases.
7-18 Generalized audit software (GAS) includes programs that allow the auditor to perform tests
on computer files and databases. GAS enables auditors to conduct similar computer-
assisted audit techniques in different IT environments. Custom audit software is generally
written by auditors for specific audit tasks. Such programs are necessary when the entity's
computer system is not compatible with the auditor's GAS or when the auditor wants to
conduct some testing that may not be possible with the GAS.
Some functions that can be performed by GAS are: (1) file or database access, (2) selection
of transactions that meet certain criteria, (3) arithmetic functions, (4) statistical analyses,
and (5) report generation.
7-7
Answers to Multiple-Choice Questions
7-19 d 7-27 c
7-20 b 7-28 a
7-21 c 7-29 c
7-22 c 7-30 a
7-23 c 7-31 c
7-24 b 7-32 a
7-25 d 7-33 d
7-26 d
Solutions to Problems
7-34
Control 1: Monthly Manual Reconciliation
Nature, Timing, and Extent of Procedures
Objective of the Test: To determine whether misstatements in accounts receivable

(existence, valuation, and completeness) would be detected on a timely basis.
Test the company's reconciliation control by selecting a sample of reconciliations based
upon the number of accounts, the dollar value of the accounts, and the volume of
transactions affecting the account. Perform the following tests on the reconciliation
process:
a. Make inquiries of personnel performing the control. Ask the employee performing the
reconciliation the following questions:
 What documentation describes the account reconciliation process?
 How long have you been performing the reconciliation work?
 What is the reconciliation process for resolving reconciling items?
 How often are the reconciliations formally reviewed and signed off?
 If significant issues or reconciliation problems are noticed, to whose
attention do you bring them?
 On average, how many reconciling items are there?
 How are old reconciling items treated?
 If need be, how is the system corrected for reconciling items?
 What is the general nature of these reconciling items?
 Who performs this function when you are ill or on vacation?
b. Observe the employee performing the control. For nonrecurring reconciling items,
observe whether each item included a clear explanation as to its nature, the action that
had been taken to resolve it, and whether it had been resolved on a timely basis.
c. Reperform the control for two months by inspecting the reconciliations and
reperforming the reconciliation procedures. Scan through the file of all reconciliations
prepared during the year and note whether they had been performed on a timely basis.
7-8
d. Make inquiries of company personnel and determine that the reconciliation procedures
have not changed from interim to year-end.
Control 2: Daily Manual Preventive Control
Objective of the Test: To determine whether misstatements in cash (existence) and accounts
payable (existence, valuation, and completeness) would be prevented on a timely basis.
Test the control that a cash disbursement is made only after matching the invoice with the
receiving report and purchase order.
Select 25 disbursements (voucher packages) from the cash disbursement registers from
January through September. Perform the following procedures:
a. Examine the invoice to see if it includes the signature or initials of the accounts payable
clerk, evidencing the clerk's performance of the matching control.
b. Reperform the matching control corresponding to the signature by examining the invoice
to determine that (a) its items matched to the receiving report and purchase order and (b) it was
mathematically accurate.
c. Update the testing through the end of the year by asking the accounts payable clerk
whether the control was still in place and operating effectively. Perform a walkthrough
of one transaction in December.
Control 3: Programmed Preventive Control and Weekly Information Technology-

Dependent Manual Detective Control
Objective of the Test: To determine whether misstatements in cash (existence) and accounts
payable/inventory (existence, valuation, and completeness) would be prevented or detected
on a timely basis.
Test the programmed application control of matching the receiving report, purchase order, and
invoice as well as the review and follow-up control over unmatched items. To test the programmed
application control, perform the following procedures:
a. Identify, through discussion with company personnel, the software used to process
receipts and purchase invoices.
b. Determine, through further discussion with company personnel, that they do not modify the core
functionality of the software, but sometimes make personalized changes to reports to meet the
changing needs of the business.
c. Establish, through further discussion, that the inventory module operated the receiving
functionality, including the matching of receipts to open purchase orders.
d. Identify, through discussions with the entity and review of the supplier's documentation,
7-9
the names, file sizes (in bytes), and locations of the executable files (programs) that
operate the functionality under review.
e. Identify the objectives of the programs to be tested; i.e., whether appropriate items are
received (for example, match a valid purchase order), appropriate purchase invoices
are posted (for example, match a valid receipt and purchase order, non-duplicate
reference numbers) and unmatched items (for example, receipts, orders or invoices) are
listed on the exception report.
f. Determine whether the programmed control is operating effectively by performing a
walkthrough in the month of July.
Test the detect control and follow up on the Unmatched Items Report, by performing the
following procedures in the month of July for the period January to July:
a. Make inquiries of the employee who follows up on the weekly-unmatched items

reports and determine why items appear on it.
b. Observe the performance of the control.
c. Reperform the control.
d. Determine that the company had not made significant changes in its controls from interim
to year-end by discussing with company personnel the procedures in place for making
such changes.
7-10
NOTE: In answering Problems 7-35 and 7-36, you should refer to the Audit Policy of Willis &
Adams LLP on Evaluating Control Deficiencies. A copy of the policy can be downloaded from
the firm's web site at (www.mhhe.com/messier9e). The decision chart is included here.
Box 1. Does the deficiency relate directly to NO

the achievement of one or more financial
statement assertions?
YES
Box 2. Is the likelihood of a misstatement NO

resulting from the deficiency (or combination
of deficiencies) at least reasonably possible?
Box 4. Is the deficiency (or combination of
deficiencies) important enough to merit NO
YES Deficiency
attention by those responsible for oversight
of the company’s financial reporting?
Box 3. Is the magnitude of the potential NO
deficiency material to either the interim or
YES
annual financial statements?
YES
Box 5. Do compensating controls exist and

operate effectively at a level of precision YES
sufficient to prevent or detect a misstatement
that could be material to interim or annual
financial statements?
NO Box 6. Would a well-informed, competent

and objective individual (i.e., prudent NO Significant
official) conclude the deficiency is a Deficiency
material weakness?
YES
Material
Weakness
7-11
7-35
a. Based only on these facts, this deficiency represents a significant deficiency for the
following reasons: First, the deficiency satisfies Box 1 – it relates to a financial
statement assertion. Second, the controls do not effectively address the detection of
misstatements as evidenced by situations in which transactions that were not material
were improperly recorded. Therefore, there is a reasonable possibility that a
misstatement could occur. Thus, the answer to Box 2 is “yes.” In addressing Box 3, the
magnitude of a financial statement misstatement resulting from this deficiency would
reasonably be expected to be significant but not material because individual sales
transactions are not material. Furthermore, the risk of material misstatement is limited
to revenue recognition errors related to shipping terms as opposed to broader sources
of error in revenue recognition. Thus, the answer to Box 3 is “no.” Because the
misstatements that could occur from this deficiency are significant, the answer to Box
4 is “yes.” However, the possible misstatements are not material so the answer to Box
6 is “no,” leading to a conclusion of a significant deficiency. It should be noted that
there is a compensating detective controls that operates monthly and at the end of each
financial reporting period that should reduce the likelihood of a material misstatement going
undetected. However, the compensating detective controls are only designed to detect
material misstatements.
b. Based only on these facts, this deficiency represents a material weakness for the
statement assertion. Second, the controls do not effectively address the detection of
misstatements as evidenced by improper revenue recognition that has occurred.
Therefore, the likelihood of material misstatements occurring is probable. Thus, the
answer to Box 2 is “yes.” The answer to Box 3 is “yes” since the magnitude of a
financial statement misstatement resulting from this deficiency would reasonably be
expected to be material. Individual sales transactions are frequently material and gross
margin can vary significantly with each transaction. The answer to Box 5 is “no” since
the compensating detective controls based on a reasonableness review are ineffective.
Taken together, the magnitude and likelihood of misstatement of the financial statements
resulting from this internal control deficiency meet the definition of a material weakness (Box 6).
7-12
c. Based on only these facts, this deficiency represents a material weakness for the
statement assertion. Second, the likelihood of material misstatement of the financial
statements resulting from this internal control deficiency is reasonably possible (even
assuming that the amounts were fully reserved for in the company's allowance for
uncollectible accounts) due to the likelihood of material misstatement of the gross
accounts receivable balance (Box 2 is answered “yes”). The magnitude of a financial
statement misstatement resulting from this deficiency would reasonably be expected to
be material, because the frequency of occurrence allows insignificant amounts to
become material in the aggregate (Box 3 is answered “yes”). The answer to Box 5 is
“yes” since there are no compensating controls present. It is concluded that a prudent
official would deem this deficiency to be a material weakness (answer to Box 6 is
“yes”).
7-36
a. Based only on these facts, the combination of these significant deficiencies represents a
material weakness for the following reasons: First, the deficiency satisfies Box 1 – it
relates to a financial statement assertion. Second, the combination of these deficiencies
was evaluated as representing a reasonably possible likelihood that a misstatement could
occur (Box 2 is answered “yes”). Third, the gross amount of the transactions totaled an
amount greater than materiality, so Box 3 is answered “yes.” Fourth, there are no
effective compensating controls, i.e., no timely reconciliations (Box 5 is answered “no”).
Finally, it is likely that a prudent official would conclude that these deficiencies represent
a material weakness (answer to Box 6 is “yes”).
b. Based only on these facts, the auditor should determine that the combination of these significant
deficiencies represents a material weakness for the following reasons: First, the deficiency
satisfies Box 1 – it relates to a financial statement assertion. Second, the combination
of these deficiencies was evaluated as representing a reasonably possible likelihood that
a misstatement could occur (Box 2 is answered “yes”). Third, the balances of the loan
accounts affected by these deficiencies have increased over the past year and are expected to
increase in the future. In addition, the growth in loan balances, coupled with the combined
effect of the deficiencies described, results in a reasonably possible likelihood that a material
misstatement of the allowance for credit losses or interest income could occur. Thus, Box 3 is
answered “yes.” Fourth, there are no effective compensating controls (Box 5 is answered
“no”). Finally, it is likely that a prudent official would conclude that these deficiencies
represent a material weakness (answer to Box 6 is “yes”).
7-13
7-37 (Note that these cases were taken from disclosures made by companies subject to SOX
404.)
a. Case 1 would be deemed a material weakness because the company did not have proper
controls over the accounting for and disclosure of derivatives that were associated with
warrants. The company’s management acknowledged that it did not have the expertise
within the company to properly evaluate the analysis of the warrants under ASC 815.
The inability to perform such analysis by entity personnel would suggest that there is a
high likelihood that a material misstatement could occur since we can assume that this
financial statement account (and it related disclosures) are highly material.
b. Case 2 is a material weakness because management acknowledges that its controls over
the preparation of the tax provision was not adequate, and resulted in what can be
assumed to be material errors. Without proper controls, there is a high likelihood that
a misstatement can occur. It is also likely that the tax provision and related accounts
are material to the financial statements.
c. Case 3 is a material weakness for a number of reasons. First, there was a computational
error in the update of the calculation of the allowance for loan losses. Second, the
monitoring controls for reviewing the calculation did not identify the error in a timely
manner. Finally, an error did occur and the allowance for loan losses account for a bank
would be highly material.
7-38
a. The auditor must determine whether the restatements are significant or material
deficiencies. If material, an adverse opinion will probably be issued, otherwise an
unqualified report may be given. If the misstatement resulted in a restatement of the
financial statements, the misstatement would likely be considered material.
b. If other controls over financial reporting are present, the auditor may issue an
unqualified opinion. However, if the deficiency carries a high risk of material
misstatement, then an adverse opinion should be issued. In most cases when oversight
is considered seriously deficient, an adverse opinion would be issued.
c. The auditor would most likely issue an adverse opinion because of the importance of
the audit committee in the control process.
d. If the ineffective monitoring component is a material deficiency, then an adverse

opinion should be issued. Otherwise, an unqualified opinion may be given. Because
the auditor determined that an effective internal audit function was critical to effective
monitoring, an adverse opinion would most likely be considered appropriate.
e. The significance of financial fraud by the CFO is a material weakness and an adverse
opinion should be issued.
7-14
f. Depending on the amount of risk of material misstatement due to the ineffective control
environment, the auditor will issue an adverse opinion or an unqualified opinion. In
most cases, an ineffective control environment will result in an adverse opinion because
it is considered a pervasive entity-level control.
g. Given the lack of management’s concern for internal control, which can be considered
a control environment issue, an adverse opinion would most likely be issued, depending
on the nature and severity and the combined effect of the significant deficiencies that
were left uncorrected.
7-39
a. The auditor would most likely issue an unqualified opinion on the effectiveness of
internal control. Significant deficiencies do not necessitate an adverse opinion. In this
case, the likelihood is extremely low that the deficiencies taken individually or together
will result in a material misstatement, meaning that there is no material weakness. If
the significant deficiencies remain uncorrected in future years, the auditor may
conclude that management’s attitude toward internal control reflects a poor control
environment and may issue an adverse opinion.
b. A disclaimer of opinion on the effectiveness of internal control because the auditor has
a scope limitation. The auditor must have sufficient appropriate evidence to conclude
that the entity’s ICFR is effective—surmising based on partial results does not
constitute a high level of assurance.
c. Unqualified opinion on the effectiveness of internal control. The audit of internal

control is “as of” the report date. In other words, so long as the auditor has sufficient
evidence that the entity’s internal control was operating effectively as of the end of
the reporting period, an unqualified opinion can be expressed. This gives
management an opportunity to remediate weaknesses and avoid an adverse opinion so
long as enough time is left for management to reassess and for the auditor to retest
controls and obtain sufficient competent evidence that controls were effective as of
the report date.
d. An adverse opinion with respect to effectiveness of ICFR. The presence of a material

weakness as of the report date necessitates an adverse opinion with respect to internal
control.
e. The auditor would most likely issue a disclaimer on the effectiveness of internal control
due to a scope limitation. The auditor’s inability to collect sufficient data to assess the
operating effectiveness of the control constitutes a scope limitation, and the opinion
should be modified accordingly. However, after the auditor completes testing in the
following year and if controls were found to be operating effectively, an interim report
on the effectiveness of internal controls could be issued.
7-15
f. Adverse opinion on the effectiveness of internal control. Because the significant

deficiencies identified, taken together, produce a “moderately low” risk of material
misstatement in the financial statements, this likelihood assessment is within the range
of “reasonably possible,” and thus, this combination of deficiencies is considered a
material weakness.
7-40
a. As long as the auditor agrees with company’s assessment of controls, an unqualified
report can be issued. However, AS5 indicates that controls must operate for a sufficient
time period to accommodate management and auditor testing. This does not appear to
be possible in the scenario when the changes were made after management’s
assessment. The auditor should explicitly disclaim any opinion with respect to the
information about corrective actions and plans to implement new controls as disclosed
by management. However, after the auditor completes testing in the following year and
if controls were found to be operating effectively, an interim report on the effectiveness
of internal controls could be issued.
b. The auditor should issue an adverse opinion if he or she does not believe sufficient time
has passed to gather sufficient, competent evidence that the control deficiencies have
been corrected. However, after the auditor completes testing in the following year and
if controls were found to be operating effectively, an interim report on the effectiveness
of internal controls could be issued.
7-41 The audit report should include the proper title; introductory, scope, definition, limitations,
opinion, and explanatory paragraphs; and should describe the reason for the material
weakness. An example can be found in Exhibit 7-6.
7-42 The audit report should include the proper title; introductory, scope, definition, limitations,
and opinion paragraphs; and should describe the reason for the material weakness. The
combined report would be similar to the report in Exhibit 7-6 except that the material
weakness explanatory paragraph would be added and the opinion paragraph would be
modified to reflect the adverse opinion over ICFR.
7-43 The auditors' report contains the following deficiencies:
Introductory Paragraph
 This paragraph needs to state why the company’s internal control did not maintain
effective control by including a brief description of the material weakness.
 This paragraph should not indicate that it is the auditor’s responsibility to report on
management’s assessment of ICFR and on the effectiveness of ICFR. AS5 eliminated
the requirement for a separate auditor opinion on management’s assessment, and now
simply requires an auditor opinion on the effectiveness of the entity’s ICFR.
7-16
Scope Paragraph
 The audit for public companies is conducted according to “the standards of the Public
Company Accounting Oversight Board” not according to “generally accepted auditing
standards.”
 The audit only provides reasonable assurance about whether effective internal control
was maintained in all material respects.
 The scope paragraph need not include a statement that the auditor evaluated
management’s assessment process.
Definition Paragraph
 The audit only provides reasonable assurance.
 Financial statements are prepared with respect to generally accepted accounting
principles, not auditing principles.
Inherent Limitations Paragraph

 The limitations paragraph should state that due to inherent limitations, even effective
ICFR might fail to prevent or detect misstatements.
Explanatory Paragraph
 Should be located before the opinion paragraph.
 Must contain the definition of a material weakness as stated in AS5.
 Must contain a description of the specific material misstatement identified at the
entity.
Opinion Paragraph
 “Maintained ineffective internal control” is not correct wording. The paragraph should
read, “did not maintain effective internal control...”The auditor is no longer required to
issue an opinion on management’s assessment, and no such opinion should be offered.
 The auditors should state that the company has not maintained effective internal control,
and should not use the phrase “except for” in this context. The auditor’s opinion with
respect to the effectiveness of ICFR should be adverse rather than qualified.
The dates of the auditor’s reports on financial statements and on ICFR should be the
same. The opinion paragraph uses February 15, 2013 as the date of the financial
statement opinion.
7-44 a. 2
b. 3
c. 1
7-17
7-45 The substantive auditing procedures Brown may consider performing include the following:
Using the perpetual inventory file:
 Recalculate the beginning and ending balances (prices x quantities), foot, and print out
a report to be used to reconcile the totals with the general ledger (or agree beginning
balance with the prior year's working papers).
 Calculate the quantity balances as of the physical inventory date for comparison to the
physical inventory file. (Alternatively, update the physical inventory file for purchases
and sales from January 6 to January 31, for comparison to the perpetual inventory at
January 31, 2013.)
 Select and print out a sample of items received and shipped for the periods (1) before
and after January 5 and January 31, 2013, for cutoff testing, (2) between January 5 and
January 31, 2013, for vouching or analytical procedures, and (3) prior to January 5, 2013,
for tests of details or analytical procedures.
 Compare quantities sold during the year to quantities on hand at year-end. Print out a
report of items for which turnover is less than expected. (Alternatively, calculate the
number of days' sales in inventory for selected items.)
 Select items noted as possibly unsalable or obsolete during the physical inventory
observation and print out information about purchases and sales for further
consideration.
 Recalculate the prices used to value the year-end FIFO inventory by matching prices
and quantities to the most recent purchases.
 Select a sample of items for comparison to current sales prices.
 Identify and print out unusual transactions. (These are transactions other than purchases
or sales for the year, or physical inventory adjustments as of January 5, 2013.)
 Recalculate the ending inventory (or selected items) by taking the beginning balances
plus purchases, less sales (quantities and/or amounts), and print out the differences.
 Recalculate the cost of sales for selected items sold during the year.
Using the physical inventory and test count files:
 Account for all inventory tag numbers used and print out a report of missing or duplicate
numbers for follow-up.
 Search for tag numbers noted during the physical inventory observation as being voided
or not used.
 Compare the physical inventory file to the file of test counts and print out a report of
differences for the auditor follow-up.
 Combine the quantities for each item appearing on more than one inventory tag number
for comparison to the perpetual file.
 Compare the quantities in the file to the calculated quantity balances in the perpetual
inventory file as of January 5, 2013. (Alternatively, compare the physical inventory file
updated to year-end to the perpetual inventory file.)
7-18
 Calculate the quantities and dollar amounts of the book-to-physical adjustments for each
item and the total adjustment. Print out a report to reconcile the total adjustment to the
adjustment recorded in the general ledger before year-end.
 Using the calculated book-to-physical adjustments for each item, compare the quantity
and dollar amount of each adjustment to the perpetual inventory file as of January 5,
2013, and print out a report of differences for follow-up.
INTERNET ASSIGNMENTS
7-46 The opinion paragraph of the audit report will indicate whether the report is for both audits.
Note that even separate reports on each of the audits (of financial statements and controls)
will refer to the conclusion reached on the other audit. In a combined report, the introductory
paragraph will refer to the fact that the auditor audited both the entity’s financial statements
and ICFR. In a separate opinion, the introductory paragraph will refer only to the audit that
is being separately reported on.
7-47 The opinion paragraph of an integrated audit will indicate the auditor’s opinion with respect
to the effectiveness of internal control. The explanatory paragraph will offer the definition
of a material weakness in general terms, and will describe the particular material
weakness(es) resulting in the adverse opinion.
7-19

Auditing and Assurance Services A Systematic Approach 10th Edition SM Download

Uploaded by

Copyright:

Available Formats

Auditing and Assurance Services A Systematic Approach 10th Edition SM Download

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Auditing and Assurance Services A Systematic Approach 10th Edition SM Download

Uploaded by

Copyright:

Available Formats

Chapter 07 - Auditing Internal Control over Financial Reporting

Solution Manual for Auditing and Assurance Services A

possibility of further, undetected, misstatements. If the auditor’s likelihood assessment is

Multi-location Testing Consideration Flowchart

Is the location or business unit Yes Evaluate documentation and test

Are there locations or business Yes No further action required for

Are there documented company- Yes Evaluate documentation and test

Answers to Multiple-Choice Questions

Nature, Timing, and Extent of Procedures

Objective of the Test: To determine whether misstatements in accounts receivable

Control 2: Daily Manual Preventive Control

Nature, Timing, and Extent of Procedures

Control 3: Programmed Preventive Control and Weekly Information Technology-

Nature, Timing, and Extent of Procedures

a. Make inquiries of the employee who follows up on the weekly-unmatched items

Box 1. Does the deficiency relate directly to NO

Box 2. Is the likelihood of a misstatement NO

Box 5. Do compensating controls exist and

NO Box 6. Would a well-informed, competent

d. If the ineffective monitoring component is a material deficiency, then an adverse

c. Unqualified opinion on the effectiveness of internal control. The audit of internal

d. An adverse opinion with respect to effectiveness of ICFR. The presence of a material

f. Adverse opinion on the effectiveness of internal control. Because the significant

7-43 The auditors' report contains the following deficiencies:

Inherent Limitations Paragraph

You might also like