Professional Documents
Culture Documents
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Contributors
Technical Review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Kelen Camehl
Production Coordinator . . . . . . . . . . . . . . Mariela de la Torre; Jennifer Schencker
Production . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Lynn J. Brown
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Introduction
CCH's Top Auditing Issues for 2015 CPE Course helps professionals stay abreast of the most significant new
auditing standards and important developments. It does so by identifying the events of the past year that have
developed into hot issues and by reviewing the opportunities and pitfalls presented by these changes.
This course is structured in four Modules. The first Module covers risk assessment and audit documentation.
Chapter 1 provides a top-level summary and overview of the definitions and significant requirements of the Risk
Assessment sections of the Clarified Statements on Auditing Standards, and additional practical implementation
guidance in selected key areas.
Chapter 2 provides in-depth coverage of the AICPA’s AU-C section 230, Audit Documentation, and a summary
of the documentation requirements lodged in other AU-C sections.
The content of Module 1 is:
x Chapter 1 Risk Assessment Standards Overview
x Chapter 2 Audit Documentation
The second Module covers Financial Reporting Framework for Small- and Medium-sized Enterprises.
Chapter 3 introduces FRF for SMEs and provides an overview of the accounting model.
Chapter 4 describes the general principles for the statements of financial position, operations, and cash flow. It
also describes the very brief guidance in the framework for derivatives and sales of financial assets. Treatment
of changes in accounting principle and correction of errors is described.
Chapter 5 describes the requirements in the framework for inventory, PP&E, discontinued operations, and
equity. It also covers the broader, general topics of commitments, contingencies, related party transactions, and
subsequent events.
Chapter 6 describes the accounting for investments, with a focus on the simplicity in the FRF for SMEs
framework. Consolidation and acquisition of another entity through business combination is explained.
Chapter 7 describes the general principles used to guide revenue recognition. It also describes the accounting
for intangible assets and leases.
Chapter 8 describes the accounting for retirement and other postemployment benefits and also income taxes.
Both areas are noticeably simpler than the corresponding rules in GAAP.
The content of Module 2 is:
x Chapter 3 FRF for SMEs – An Alternative to GAAP – Introduction
x Chapter 4 FRF for SMEs – An Alternative to GAAP – Basic Financial Statements
x Chapter 5 FRF for SMEs – An Alternative to GAAP – General Issues
x Chapter 6 FRF for SMEs – An Alternative to GAAP – Investments and Consolidation
x Chapter 7 FRF for SMEs – An Alternative to GAAP – Revenue, Intangibles, Leases
x Chapter 8 FRF for SMEs – An Alternative to GAAP – Pensions, Income Taxes
The third Module covers a mix of topics dealing with quality control and peer review, internal audit, and GAAP
relief for private business.
Chapter 9 summarizes the definitions and requirements of SQCS 8, relevant to the monitoring element of quality
control, the provisions of PRP Section 10,000, and provides commentary on the elements of an effective
monitoring program, and offers guidance on monitoring steps for practical implementation.
Chapter 10 summarizes the definitions and requirements of SQCS 8, relevant to engagement quality control
review, provides commentary on the elements of an effective engagement quality control review program, and
¶103 INTRODUCTION
The Clarified Statements on Auditing Standards contain six AU-C sections under the heading of Risk
Assessment and Response to Assessed Risks:
x AU-C Section 300, Planning an Audit
x AU-C Section 315, Understanding the Entity and Its Environment and Assessing the Risks of Material
Misstatement
x AU-C Section 320, Materiality in Planning and Performing an Audit
x AU-C Section 330, Performing Audit Procedures in Response to Assessed Risks and Evaluating the
Audit Evidence Obtained
x AU-C Section 402, Audit Considerations Relating to an Entity Using a Service Organization
x AU-C Section 450, Evaluation of Misstatements Identified During the Audit
With the adoption of the Clarified Standards effective for audits of periods ended on or after December 31, 2012,
these Sections effectively replaced the previously existing Statements on Auditing Standards (SAS) Nos. 104-
111.
This revision did not see significant new requirements in this group of standards. As with the Clarity project in
general, there has been some reorganization of content. The many unconditional requirements of the previous
standards have all been changed to presumptively mandatory requirements—those that should, rather than
must be observed. The Application and Other Explanatory Material (AOEM) now provides many of the detailed
procedures/considerations that were previously contained within the requirements.
This chapter provides a top-level summary and overview of the definitions and significant requirements of these
Sections, and additional practical implementation guidance in selected key areas.
STUDY QUESTIONS
___________________________________________________________________________
1. AU-C Section 315 identifies certain assertions which it groups into which of the following broad categories?
a. Existence, rights and obligations, completeness, and valuation and allocation
b. Account balances at period end, classes of transactions and events, and presentation and
disclosure
c. Occurrence, rights and obligations, completeness, classification, understandability,
accuracy and valuation
2. Which of the following statements regarding the term relevant assertion is correct?
a. Auditors should consider the effects of internal control in determining the relevance of an
assertion.
b. A relevant assertion is a financial statement assertion that has a reasonable possibility of
containing a material misstatement.
c. A relevant assertion is an explicit representation by management that is embodied in the
financial statements.
d. Auditors should deem assertions that have at least a remote possibility of containing one
or more material misstatements to be relevant assertions.
___________________________________________________________________________
¶105 REQUIREMENTS
Throughout all AU-C Sections, presumptively mandatory requirements are signaled by the word "should."
Auditors must comply with presumptively mandatory requirements in all cases in which they are relevant, except
in rare circumstances when that procedure would not be effective in achieving the intent of the requirement.
AU-C Sections also contain AOEM paragraphs which are cross-referenced to the related requirements. They
provide additional guidance and explanations for carrying out the requirements of the standard. These are an
integral part of each requirement. Even though they contain no requirements, auditors should read and
understand their entire text, and should be prepared to justify departures from them in their work.
These Sections contain only presumptively mandatory requirements. There are no unconditional requirements.
The following sections provide an overview, by AU-C Section, of the significant performance requirements of
these Sections. The documentation requirements are covered in detail in the chapter entitled "Audit
Documentation".
AU-C Section 300, Planning an Audit
AU-C Section 300 states that planning an audit involves establishing an overall audit strategy, and developing
an audit plan. The auditor's objective is to plan the audit so that it will be effectively performed.
This Section contains the following requirements:
Involvement of key engagement team members. The engagement partner and other key engagement team
members should be involved in planning the audit. This includes planning and participating in an engagement
team discussion.
Preliminary engagement activities. At the beginning of the audit, auditors should:
x Evaluate whether the client and engagement should be continued.
x Evaluate compliance with relevant ethical requirements.
x Establish an understanding of the terms of the engagement.
Planning activities. Auditors should establish an overall audit strategy that:
x Sets the scope, timing and direction of the audit
x Guides the development of the audit plan
In establishing an overall audit strategy, auditors should:
x Identify engagement characteristics that define its scope
STUDY QUESTION
___________________________________________________________________________
3. According to AU-C Section 300, a properly developed audit plan should describe:
a. Characteristics that define the scope of the engagement
b. The nature and extent of planned further audit procedures at the financial statement level
c. Planned risk assessment procedures
d. Knowledge obtained on other engagements performed for the entity
___________________________________________________________________________
STUDY QUESTIONS
___________________________________________________________________________
4. An auditor's consideration of whether any of the risks identified are significant risks should take into
account all of the following except:
a. Whether the entity's internal controls would mitigate the risk
b. Whether the risk is a fraud risk
c. Whether the risk is related to recent significant economic developments
d. Whether the transaction involves related parties
5. Auditors should identify and assess the risks of material misstatement at the:
a. Financial statement and relevant assertion levels
b. Transaction class, account balance and disclosure level
c. Financial statement level only
d. Relevant assertion level only
___________________________________________________________________________
AU-C Section 320, Materiality in Planning and Performing an Audit
AU-C Section 320 addresses the auditor's responsibility to apply the concept of materiality in planning and
performing an audit. The auditor's objective is to apply this concept appropriately.
AU-C Section 320 recognizes that misstatements are considered to be material if they could reasonably be
expected, individually or in the aggregate, to influence the economic decisions of statement users. Judgments
about materiality are made in light of the surrounding circumstances, and may be affected by both the size and
nature of a misstatement. Auditors make these judgments based on a consideration of the common financial
information needs of the users as a group. The possible effects on specific individual users is not considered
because their needs may vary widely.
This Section states that materiality determination is a matter of professional judgment. It is reasonable for
auditors to assume that financial statement users:
x Have a reasonable understanding of business and economic activities and accounting
x Are willing to study the financial statements with reasonable diligence
x Understand that financial statements are prepared, presented and audited to levels of materiality.
x Recognize that there are inherent uncertainties in the measurement of financial statement amounts.
x Make reasonable economic decisions based on financial statement information.
Materiality determined in planning the audit does not necessarily dictate an amount below which uncorrected
STUDY QUESTION
___________________________________________________________________________
6. AU-C Section 320 makes all of the following assumptions relating to financial statement users except:
a. Financial statement users are willing to study the statements with appropriate diligence.
b. They have a reasonable understanding of economic and business activities and
accounting.
c. The individual needs of specific individual financial statement users have been considered
by the auditor in determining materiality.
d. Financial statement users recognize that there are uncertainties inherent in the
measurement of financial statement amounts.
___________________________________________________________________________
AU-C Section 330, Performing Audit Procedures in Response to Assessed Risks and Evaluating the
Audit Evidence Obtained
This Section addresses the auditor's responsibility to design and implement responses to identified and
assessed risks of material misstatement and to the audit evidence obtained. The auditor's objective is to obtain
sufficient appropriate audit evidence about the assessed risks of material misstatement by designing and
implementing appropriate responses to those risks.
AU-C Section 330 contains the following requirements:
Overall responses. Auditors should design and implement overall responses to assessed risks of material
misstatement at the financial statement level.
Audit procedures at the relevant assertion level. Auditors should design and perform further audit procedures
based on, and responsive to, the assessed risks of material misstatement at the relevant assertion level. In
designing those procedures, auditors should:
x Consider the reasons for the assessed risks of material misstatement at the relevant assertion level for
each transaction class, account balance and disclosure, including:
- Inherent risk, which is the likelihood of material misstatement due to particular
characteristics of the transaction class, account balance or disclosure.
STUDY QUESTIONS
___________________________________________________________________________
7. Auditors should test controls:
a. When substantive procedures do not by themselves provide sufficient appropriate
evidence at the relevant assertion level
8. Which of the following statements about the requirements of AU-C Section 330 related to substantive
procedures is correct?
a. Substantive procedures should be performed in all audits for all relevant assertions
related to each class of transactions, account balance, and disclosure regardless of
materiality.
b. Substantive procedures should be performed in all audits for all relevant assertions
related to each material class of transactions, account balance, and disclosure regardless
of the assessed risk of material misstatement.
c. Substantive procedures performed on each material class of transactions, account
balance, and disclosure should include tests of details and substantive analytical
procedures.
d. Substantive procedures are performed to detect material misstatements down to the
transaction class, account balance and disclosure level.
___________________________________________________________________________
AU-C Section 402, Audit Considerations Relating to an Entity Using a Service Organization
This Section addresses the user auditor's responsibility for obtaining sufficient appropriate audit evidence in an
audit of a user entity that employs a service organization. It expands on the application of AU-C Sections 315
and 330 to the audit of a service organization's user entity.
The user auditor's objectives are to:
x Obtain an understanding of services provided by the service organization, and their effect on the user
entity's internal control, in order to identify and assess risks of material misstatement.
x Design and perform audit procedures responsive to those risks.
AU-C Section 402 contains the following requirements related to risk assessment:
Obtaining an understanding of services provided. User auditors should:
x Obtain an understanding of how the user entity employs the services of a service organization in its
operations, including:
- Their nature and significance
- Their effect on the user entity's internal control
- The nature and materiality of data processed
- The financial reporting processes affected
- The degree of interaction between the service organization and user entity
- The relationship between the service organization and user entity, including contractual
terms
x Evaluate the design and implementation of user entity controls related to the services provided and
transactions processed by the service organization
x Determine whether their understanding is sufficient to provide a basis for identifying and assessing
risks of material misstatement
STUDY QUESTION
___________________________________________________________________________
9. In responding to assessed risks related to a user entity's use of a service organization, user auditors
should:
a. Obtain evidence about the operating effectiveness of service organization controls by
reading a type 1 service auditor's report when the risk assessment includes an
expectation of their effectiveness
b. Evaluate the design and implementation of user entity controls related to the transactions
processed and services provided by the service organization
c. Obtain an understanding of the nature and significance of the services provided by the
service organization to the user entity's operations
d. Determine whether sufficient appropriate evidence concerning the relevant assertions is
available from the user entity's records
___________________________________________________________________________
AU-C Section 450, Evaluation of Misstatements Identified During the Audit
AU-C Section 450 addresses the auditor's responsibility and objectives in evaluating the effects of:
x Identified misstatements on the audit
x Uncorrected misstatements, if any, on the financial statements
AU-C Section 450 contains the following requirements:
Accumulation of misstatements. Auditors should accumulate misstatement identified during the audit, other
than those that are clearly trivial.
OBSERVATION
The AOEM states explicitly that "clearly trivial" is not just another term for "not material." Clearly
trivial matters will be of a smaller and wholly different order of magnitude than materiality
determined under AU-C Section 320. They will be clearly inconsequential, either individually or in
the aggregate, whether judged by any criteria of size, nature or circumstance. A matter is not
clearly trivial if there is any doubt about whether it is.
Consideration of misstatements. Auditors should determine whether the overall audit strategy and audit plan
need revisions if:
x The nature and circumstances of identified misstatements indicate that other misstatements may exist
that could be material when aggregated with other misstatements, or
x The aggregate of misstatements accumulated in the audit approaches materiality.
Communication and correction of misstatements. Auditors should:
x Timely communicate all misstatements accumulated during the audit to the appropriate level of
management.
x Request management to correct those misstatements. If management refuses to correct the
misstatements, consider the substantive reasons for and evaluate whether the financial statements as
a whole are free from material misstatement.
STUDY QUESTION
___________________________________________________________________________
10. According to AOEM of AU-C Section 450, which of the following statements about "clearly trivial"
misstatements is correct?
a. Immaterial misstatements are considered clearly trivial.
b. Clearly trivial misstatements are determined solely with reference to their size.
c. A misstatement may be considered clearly trivial individually, without regard to its effects
when aggregated with other misstatements.
d. A matter cannot be considered clearly trivial if there is any doubt about whether it is.
___________________________________________________________________________
¶203 INTRODUCTION
The codified Clarity Standards do not contain significant new documentation requirements for auditors. They do,
however, rearrange some of the documentation requirements into different sections, and move some of the
requirements of previous standards into the new "Application and Other Explanatory Material" (AOEM) sections.
This chapter provides in-depth coverage of the AICPA's AU-C Section 230 which is the main source of
requirements on this topic, and a summary of the documentation requirements lodged in 20 other relevant AU-C
Sections.
The chapter also offers observations, examples, and illustrations to provide guidance in some of the most
commonly observed implementation issues for audit documentation.
¶205 OBJECTIVES
AU-C Section 230 states that the auditor's objectives are to prepare audit documentation that provides:
x A sufficient and appropriate record of the basis for the auditor's report
x Evidence that the audit was planned and performed in accordance with GAAS and applicable legal and
regulatory requirements.
¶206 DEFINITIONS
AU-C Section 230 defines the following terms:
Audit Documentation
The record of audit procedures performed, relevant evidence obtained, and conclusions the auditor reached.
Terms such as workpapers or working papers are sometimes also used.
Audit File
One or more folders or other storage media in physical or electronic form, containing the audit documentation for
a specific engagement.
Documentation Completion Date
The date, no later than 60 days after the report release date on which the auditor has assembled for retention a
final and complete set of documentation in an audit file.
Experienced Auditor
An individual, either internal or external to the firm, who has practical audit experience and a reasonable
understanding of:
x Audit processes
x GAAS
x Applicable legal and regulatory requirements
x The entity's business environment
x Auditing and financial reporting issues relevant to the entity's industry
OBSERVATION
The AOEM section of AU-C Section 230 prescribes that having practical audit experience means
having skills and competencies that will enable an auditor to perform the audit. It does not mean
that the auditor is required to have performed comparable audits.
Report Release Date
The date the auditor grants the entity permission to use his or her report in connection with the financial
statements.
STUDY QUESTIONS
___________________________________________________________________________
1. Which of the following statements with respect to the documentation completion date under AU-C Section
230 is correct?
a. The documentation completion date should be the same as the report release date.
b. The documentation completion date may be no later than 45 days after the report release
date.
c. The documentation completion date may be no later than 60 days after the report release
date.
d. The documentation completion date is the date on which the auditor obtained sufficient
appropriate audit evidence to support the opinion.
¶207 REQUIREMENTS
Throughout AU-C Section 230 (and other AU-C sections) unconditional requirements are identified by the word
"must," and are required to be performed in all circumstances where they are applicable. Presumptively
mandatory requirements are signaled by the word "should." Auditors must comply with presumptively mandatory
requirements in all cases in which they are relevant, except in rare circumstances when that procedure would
not be effective in achieving the intent of the requirement.
AU-C Section 230 also contains AOEM paragraphs which are cross-referenced to the related requirements.
They provide additional guidance and explanations for carrying out the requirements of the standard. These are
an integral part of each requirement. Even though they contain no unconditional requirements, auditors should
read and understand their entire text, and should be prepared to justify departures from it in their work.
Unconditional Requirement
AU-C Section 230 contains the following unconditional requirement.
Departure from a relevant requirement. When, in rare circumstances, an auditor finds it necessary to depart
from a relevant presumptively mandatory requirement, the auditor must document the justification for the
departure, and how the alternative procedures performed were sufficient to achieve the objectives of the
presumptively mandatory requirement.
STUDY QUESTION
___________________________________________________________________________
4. AU-C 230 lists each of the following items that may ordinarily be contained in audit documentation, except:
a. Audit plans
b. Summaries of significant findings or issues
c. Complete copies of all contracts or agreements inspected as part of the audit work
d. Representation letters
___________________________________________________________________________
Matters arising after the date of the auditor's report. When, in rare circumstances, auditors perform new or
additional procedures or draw new conclusions after the date of the auditor's report, they should document the:
x Circumstances encountered
x New or additional procedures performed
x Audit evidence obtained
x Conclusions reached
PostSAS 103
P/F- Title Pre-SAS 103 Date entered Date trf'd Trf'd by
Entered by
1 Articles of Incorporation x
2 By Laws x
Employee handbook, rev
3 10/1/05 x 2/2/10-pmh
Employee handbook, rev
3.1 1/1/10 2/2/10-pmh
4 Lease agreements:
First Street property-3yrs
4.1 ending 12/14 1/15/12-pmh 1/7/15-pmh
First Street property-3 yrs
4.2 ending 12/17 1/7/15-pmh
5 Bonus plan-eff 1/1/14 1/8/15-pmh
In this illustration, National Distribution Corporation's articles of incorporation, and by-laws, have been in the
permanent file since before the effective date of SAS 103, and are unchanged for the current period. The
employee handbook (10/1/05 revision) was inserted in the active file before the effective date of SAS 103, and
Conclusions:
1. Based on the audit findings, is the original fraud risk X
assessment still valid?
2. Have the audit procedures adequately addressed the X
assessed fraud risks?
3. Based on the audit findings, is there reason to suspect that x
material misstatement to the F/S has occurred due to fraud? If
yes, see AU-C Section 240 for further action.
STUDY QUESTION
___________________________________________________________________________
5. Which of the following statements best applies to the documentation requirements of AU-C Section 320?
a. Auditors should document the factors considered in determining materiality.
b. Auditors should not document materiality at levels below the financial statements taken as
STUDY QUESTION
___________________________________________________________________________
6. AU-C Section 600 requires auditors to document all of the following except:
a. Communication of the group engagement team's requirements to the component auditors
b. The basis for the determination that the component auditor's report meets GAAS
requirements, when the component auditor's report states that the audit was performed in
accordance with PCAOB standards
c. An indication of significant components
d. The nature, timing and extent of the group engagement team's involvement in the
component auditor's work, when the group auditor is assuming responsibility for that work
___________________________________________________________________________
AU-C Section 915, Reports on Application of Requirements of an Applicable Financial Reporting
Framework. AU-C Section 915 states that the reporting accountant should document the rationale for not
consulting with the continuing accountant, if the reporting accountant determines that consultation is not
necessary.
AU-C Section 930, Interim Financial Information. AU-C Section 930 requires auditors to prepare
documentation in connection with a review of interim financial information that will enable an experienced auditor
with no previous connection to the review to understand:
x The nature, timing and extent of the review procedures performed
x The results of those procedures
¶303 INTRODUCTION
For a generation or more of accountants, there has been a longing for "small GAAP."
What that phrase refers to is the desire to have a simple and easy way to present financial information for a
small and simple organization without some of the extremely complicated accounting treatments and disclosure
requirements of "regular" GAAP. There is a perception among practitioners that the proper accounting for
sophisticated transactions and comprehensive disclosures create a burden for smaller organizations.
This chapter will introduce the Financial Reporting Framework for Small- and Medium-Sized Entities (FRF for
SMEs). Subsequent chapters will provide detail in the framework with discussion on how it compares to GAAP.
This new reporting methodology will be referred to as either the "framework" or "FRF for SMEs" in this chapter.
A critical distinction is necessary—FRF for SMEs is not generally an accepted accounting principle. It is neither
"small GAAP" nor GAAP light nor GAAP without some of the detailed rules.
This new framework is not GAAP.
In one sentence, FRF for SMEs is one more in a collection of other comprehensive basis of accounting
frameworks that might be an acceptable alternative to GAAP for some companies in some circumstances. Just
as modified cash basis or tax basis might be appropriate for some entities, FRF for SMEs might be an
appropriate alternative for others.
¶304 WHAT IS FRF FOR SMES, WHERE DID IT COME FROM, AND WHERE DOES
IT FIT IN THE WORLD OF ACCOUNTING RULES?
The FRF for SMEs was drafted and published by the American Institute of Certified Public Accountants (AICPA)
with assistance from a task force appointed for the project.
STUDY QUESTION
___________________________________________________________________________
1. Which of the following factors suggests that FRF for SMEs might be appropriate for an entity?
a. Owners of the entity hire managers to run the organization.
b. Lenders to the organization have access to managers of the entity.
c. The entity operates in an industry with specialized accounting principles that are widely
known.
d. The entity meets substantially all of the specific requirements to use the framework.
STUDY QUESTION
___________________________________________________________________________
2. Which of the following statements is correct with respect to going concern issues within the framework?
a. The time frame for assessing whether an organization as a going concern is 12 months
from the statement of financial position date.
b. If an organization is not a going concern, the FRF for SMEs framework is still appropriate
if the circumstances and management's plans to address the situation are appropriately
disclosed in the notes to the financial statements.
c. Management needs to prepare a detailed analysis each year to assess whether the entity
is a going concern.
d. The external accountant is responsible for assessing whether the entity as a going
concern or not.
___________________________________________________________________________
Financial Statements
A complete set of financial statements includes a statement of financial position, a statement of operations, a
statement of changes in equity, and a statement of cash flows. The changes in equity could be included in one
of the other statements. Disclosures in notes that are necessary for any items presented in the body of the
statements are an integral part of the statements.
A single financial statement is allowed, such as preparing a statement of financial position only. If a statement of
financial position and statement of operations are presented, then a statement of cash flows should also be
presented.
STUDY QUESTION
___________________________________________________________________________
¶403 INTRODUCTION
CPAs trying to help their clients find simpler and easier ways to present financial information have long
suggested one of the other comprehensive basis of accounting (known as OCBOA), such as modified cash
basis or income tax basis. A new alternative is available.
In June 2013 the AICPA published the Financial Reporting Framework for Small- and Medium-Sized Entities.
Known as FRF for SMEs, this framework is categorized as one of the OCBOAs.
This chapter is one in a series describing FRF for SMEs. The first chapter is FRF for SMEs—An Alternative to
GAAP—Introduction. It describes how FRF for SMEs fits into the various options for financial reporting, and
describes the basic financial concepts in the framework. That chapter also describes the general principle for
transitioning financial statements to the first presentation under FRF for SMEs.
This chapter will summarize the general approach to the statement of financial position, statement of operations,
and statement of cash flows. It will also address how to handle accounting changes, changes in estimates,
correction of errors, along with risk and uncertainty disclosures under the framework. The focus will be areas
where FRF for SMEs differs from GAAP along with the general approach under the framework. It is worth
addressing the philosophical approach because the framework is intentionally less specific than GAAP and more
principles-focused.
STUDY QUESTION
___________________________________________________________________________
1. Which of the following statements regarding accounting for restructuring of a debt under FRF for SMEs is
correct?
a. Any gain or loss on the restructuring is amortized over the term of the new debt
instrument.
b. The new debt instrument is recognized in accordance with its terms and any difference
from the carrying value of the old debt is recognized in the statement of activity.
c. Any gain or loss on the restructuring is presented as either an extraordinary item or a
component of other comprehensive income, at the choice of management. Management's
election should be disclosed in the notes.
d. The gain or loss on modification of the loan terms is determined using present value
concepts.
STUDY QUESTION
___________________________________________________________________________
2. All of the following statements about accounting and disclosure under the FRF for SMEs framework are
correct except:
a. For financial assets, the amounts and maturity dates beyond one year should be
disclosed separately.
b. An entity that issues a financial instrument with liability and equity components should
classify the components as a liability or equity based on the substance of the contract.
c. Guidance for derivatives under FRF for SMEs is substantially less detailed than GAAP yet
still provides extensive guidance for recognition and measurement for several types of
derivatives.
d. Disclosure of investments and investment income needs to be broken out into four
STUDY QUESTION
___________________________________________________________________________
3. Which of the following comments about treatment of accounting changes and corrections of errors is
correct?
a. An entity may voluntarily change in accounting principle if the new principal is clearly
preferable in the circumstances.
b. One part of retrospective application of a change in accounting principle is to adjust the
opening balance of equity for the earliest period presented.
c. Material accounting errors in prior period financial statements are corrected on a
prospective basis.
d. For a change in accounting principle, it is not necessary to restate the opening balance of
equity for the earliest period presented if doing so would be significantly inefficient.
___________________________________________________________________________
Risks and Uncertainties
The framework requires entities to disclose general types of risks and uncertainties they face. Readers familiar
with GAAP requirements will recognize the following discussion. Disclosures are needed in four areas.
Nature of operations. An entity should disclose the major products or services along with its principal markets
with the locations mentioned. These disclosures do not need to be quantified but could describe relationships
such as predominantly or about equally.
Use of estimates. The notes should explain that financial statements prepared in accordance with the FRF for
SMEs framework require estimates by management.
Significant estimates. An entity should describe significant estimates for which it is reasonably possible that:
x The estimate will change in the near term (defined as one year from the date of the statement of
financial position), and
x The impact of the change will be material.
Three of the illustrations provided by the framework of possible significant estimates are litigation liabilities,
inventory with rapid technological obsolescence, and real estate loan valuation allowances.
Concentrations. An entity should disclose certain concentrations if:
x A concentration exists as of the financial statement date,
x The entity is vulnerable to a near-term severe impact from the risk from the concentration (near-term is
one year from the financial statement date), and
x The possibility that events could cause a severe impact in the near-term is at least reasonably
possible.
¶503 INTRODUCTION
CPAs trying to help their clients find simpler and easier ways to present financial information have long
suggested an other comprehensive basis of accounting (known as OCBOA), such as modified cash basis or
income tax basis. A new alternative is available.
In June 2013 the AICPA published the Financial Reporting Framework for Small- and Medium-Sized Entities.
Known as FRF for SMEs, this framework is categorized as one of the OCBOAs.
This chapter is one in a series describing FRF for SMEs. The first chapter is FRF for SMEs—An Alternative to
GAAP—Introduction. It describes how FRF for SMEs fits into the various options for financial reporting, and
describes the basic financial concepts in the framework. That chapter also describes the general principle for
transitioning financial statements to the first presentation under FRF for SMEs.
This chapter will describe several areas of the statement of financial position, including inventory, PP&E, and
equity. It will also address general areas such as commitments, contingencies, related parties, and subsequent
¶504 INVENTORIES
Inventories are measured at the lower of cost or net realizable value.
Much of the discussion in the framework for inventories, such as including cost of conversion and other costs
necessary to get inventory to the present location and condition, and allocating overhead to production runs, will
be familiar to anyone who already understands GAAP.
The framework specifically mentions standard cost and retail method as allowable along with FIFO, LIFO, and
weighted average cost formulas.
Specialized industries, such as agriculture, have unique inventory accounting policies. Those policies are
allowed by FRF for SMEs even though they are not specifically mentioned, as long as those policies are an
accepted industry practice and the policies are adequately disclosed.
Financial statement should disclose:
x Accounting policies used to measure inventories including the cost formula in place.
x Total carrying amount of inventories.
x Amount of inventory in different classifications, depending on the nature of the inventory, such as
merchandise, material, work in progress, or finished goods.
x Cost of goods sold for the period.
A write-down to lower of cost or net realizable value should be presented in the statement of operations separate
from cost of goods sold. The practice of writing inventories down below cost to net realizable value is consistent
with the view that assets are not carried in excess of amounts expected to be realized from their sale or use.
¶505 PP&E
Measurement of PP&E is at cost. In addition to purchase price of the asset, this would include, but is not limited
to, expenditures necessary to place the item in service such as broker commissions, installation costs, legal
fees, site preparation costs, and freight.
If an item is constructed or developed over time, the cost would include direct construction and also
development costs along with overhead costs that are directly attributable to the item. This would include interest
cost if it is the entity's accounting policy to capitalize those costs. However, it should be noted that capitalization
of carrying costs should cease when an item is substantially complete and ready for productive use.
The framework does not contain any comment indicating an entity should assess long-lived assets for
impairment.
OBSERVATION
This is a significant difference between FRF for SMEs and GAAP. PP&E does not need to be
assessed periodically for impairment as is required by GAAP. Accordingly, there is no need to go
through the process of assessing future cash flows in comparison to carrying value.
¶507 EQUITY
Acquisition or Redemption of Shares
When an entity acquires its own previously issued shares there are two alternatives for accounting: the cost
method and constructive retirement. State law may have provisions that prescribe a specific accounting
treatment of treasury stock.
Cost method. With the cost method, the acquired shares are measured at cost and presented as a deduction
from stockholders' equity until cancelled, retired, or resold.
When acquired shares are subsequently resold, the treasury stock account is credited and the excess of
proceeds over cost would be credited to additional paid-in capital. If proceeds are less than what the shares
were acquired for, the deficit would be charged to additional paid-in capital.
For retirement of stock under the cost method, the treasury stock account is credited with the offset allocated to
the capital stock (again at par or stated value) and additional paid-in capital.
Constructive retirement method. With the constructive retirement method, the par value or stated value is
debited to the capital stock account. The difference between reacquisition price and par or stated value is
allocated between additional paid-in capital and retained earnings.
The resale of shares should be handled as if it was an original issue. Capital stock should be credited for par or
fair value with the remainder credited to additional paid-in capital.
STUDY QUESTION
___________________________________________________________________________
1. Which of the following statements about equity is correct?
a. When the constructive retirement method is applied to shares which are acquired, the
amount paid for the shares is recorded as a contra account to equity.
b. When shares are acquired, the framework indicates entities should look to state law to
determine the appropriate accounting treatment and therefore the framework does not
provide accounting guidance for such acquisition.
c. If an entity issues stock options under a stock-based compensation plan, the options are
not recognized in the statement of financial position but only reflected as disclosures in
the notes.
d. The accounting for stock-based compensation plans under FRF for SMEs is identical to
the requirements of GAAP.
___________________________________________________________________________
Equity disclosures under the framework, other than stock-based compensation, will be familiar to those who are
aware of the GAAP financial reporting framework.
An entity that is unincorporated should clearly describe the name under which it does business. In addition, the
notes should disclose that the financial statements do not include all of the financial resources, revenues, and
¶508 COMMITMENTS
Commitments for items such as construction projects, agreements to reduce debt or maintain working capital, or
purchase obligations should be disclosed if they provide material information for current financial position or
operations in the future.
¶509 CONTINGENCIES
Definitions
The framework defines three levels of probability to assess the likelihood of a future event taking place. Those
levels are:
x Probable—the future event is likely to occur. This does not mean virtually certain.
x Remote—the chance for the future event is slight.
x Reasonably possible—the chance for the future event is more than remote but less than likely.
These terms are used in a variety of places throughout the FRF for SMEs framework.
OBSERVATION
These definitions will be familiar to readers. The wording is not identical to GAAP, but the
meanings are the same. The key phrases likely to occur and slight are identical.
When assessing the likelihood of an event, all information should be taken into consideration that is available
through the date the financial statements are available to be issued.
Contingent Gains and Losses
Contingent losses. A contingent loss should be accrued when both of the following conditions are met:
x The likelihood is probable that a future event will verify an asset value has diminished or a liability
exists as of the date of the financial statement, and
x The loss amount can be reasonably estimated.
Sometimes the amount of a contingent loss can be mitigated with a counterclaim against the party or a claim
against another party, such as an insurance company. The likelihood of a successful recovery needs to be
virtually certain in order to include a potential recovery in determining the amount of a contingent loss. If the
likelihood such recovery is virtually certain, it would be presented gross on the statement of financial position, not
netted against the liability.
The process of estimating the amount of a contingent loss may generate a range of possible losses. If a
particular amount within that range is a better estimate than others, that amount should be accrued. If a
particular amount is a better estimate than the others, the minimum of the range should be accrued. See the
following disclosures for a requirement to disclose such a range.
STUDY QUESTION
___________________________________________________________________________
2. Which of the following statements with respect to contingencies is correct?
a. Guarantees by an entity are measured using the fair value of the guarantee, which is
approximated by the expenditure that would be necessary to transfer the guarantee to
another party.
STUDY QUESTION
___________________________________________________________________________
3. All of the following accounting treatments under FRF for SMEs are different from GAAP except:
a. It is not necessary to assess long-lived assets for impairment.
b. Stock-based compensation option grants are not recognized in the statement of financial
position.
c. The concept of other comprehensive income and presentation thereof in the statement of
operations does not exist in the FRF for SMEs framework
d. Presentation of discontinued operations as a separate caption on the statement of
operations is an accounting choice by management depending on which approach is
considered to be more informative for users.
___________________________________________________________________________
¶603 INTRODUCTION
CPAs trying to help their clients find simpler and easier ways to present financial information have long
suggested one of the other comprehensive basis of accounting (known as OCBOA), such as modified cash
basis or income tax basis. A new alternative is available.
In June 2013 the AICPA published the Financial Reporting Framework for Small- and Medium-Sized Entities.
Known as FRF for SMEs, this framework is categorized as one of the OCBOAs.
This chapter is one in a series describing FRF for SMEs. The first chapter is FRF for SMEs—An Alternative to
GAAP—Introduction. It describes how FRF for SMEs fits into the various options for financial reporting, and
describes the basic financial concepts in the framework.
This chapter will summarize the accounting for investments. It will describe the option to either consolidate
subsidiaries or account for them on the equity method. It will then explain the accounting for business
combinations.
A key point needs to be repeated—FRF for SMEs is not generally accepted accounting principles. It is neither
"small GAAP" nor GAAP light nor GAAP without some of the detailed rules.
In one sentence, FRF for SMEs is another in the group of OCBOA frameworks that might be an acceptable
alternative to GAAP for some companies in some circumstances. Just as modified cash basis or tax basis might
STUDY QUESTION
___________________________________________________________________________
1. All of the following statements about accounting for investments are correct except:
a. Investments are presented using three categories in the financial statements and the
same three corresponding categories are used for investment income so that the returns
on investments under different accounting methods can be seen.
b. Entities have the option of accounting for subsidiaries either using consolidation or using
the equity method.
c. If subsidiaries are being considered for consolidation, the level of control at which
consolidation would be recorded is 50 percent of equity interests.
d. Investments in debt or equity securities that are held for sale are accounted for at fair
value.
___________________________________________________________________________
¶605 SUBSIDIARIES
Accounting Policy Choice
As previously mentioned, an entity has a choice to consolidate or not consolidate its subsidiaries. An entity can
choose between these two accounting policies:
x Consolidated subsidiaries, or
x Account for subsidiaries using the equity method.
The choice of accounting policies must be applied to all subsidiaries.
If an entity chooses the equity method, the accounting and disclosures are described in the preceding section
titled Equity, debt, and other investments.
If material differences in the basis of accounting exist between a parent and subsidiary, preparation of
consolidated financial statements is precluded and the equity method would be used.
Consolidated Financial Statements
Financial statements should be described as being prepared on a consolidated basis when an entity chooses
the consolidation accounting policy. Each of the basic financial statements should be labeled accordingly.
The lender to a parent company may be more interested in the cash flows results of operations of the parent
than the consolidated results. If a lender looks to the parent for repayment of the loan, unconsolidated financial
statements may be more useful.
Consolidation begins at the date the parent gains control and continues while the parent holds control. This
means the parent does not retroactively consolidate for the period of time before gaining control.
At the point that a parent ceases to have control of a subsidiary, consolidation ceases. Financial statements prior
to cessation of consolidation are not restated retroactively on a nonconsolidated basis.
STUDY QUESTION
___________________________________________________________________________
2. All of the following statements about accounting for business combinations are correct except:
a. The general concept is that all assets acquired and liabilities assumed should be
measured at their market value as of the date of acquisition.
b. An entity can make an accounting policy choice to either recognize identifiable intangible
assets or not recognize them.
c. Retirement and other postemployment benefits are recognized using only the plan assets
and accrued benefit obligation; previously deferred items such as unamortized actuarial
gain or loss and unamortized prior service cost are not recognized.
d. After recognizing acquired assets and assumed liabilities it is possible an entity may have
a bargain purchase from a business combination. In such a case the amount of bargain
purchase is used to reduce intangible assets to zero with any remaining amount of
bargain purchase deferred and amortized.
___________________________________________________________________________
Measurement Period
It may sometimes take longer than the end of the reporting period to accumulate all of the information to prepare
all the necessary calculations for a business combination. While the entity gathers all needed information, the
entity should report provisional amounts in the financial statements. During a measurement period, the acquirer
should retrospectively adjust any of those provisional amounts for which new information is obtained regarding
STUDY QUESTION
___________________________________________________________________________
3. All of the following statements about accounting for a business combination are correct except:
a. Any changes made to provisional amounts during the measurement period are recognized
as a gain or loss in the statement of operations at the close of the measurement period.
b. During the measurement period after a combination, the acquirer should retrospectively
adjust any amounts recorded on a provisional basis.
c. The measurement period after a business combination ends at the earlier of one year
after the acquisition date or when the acquirer gathers all information that was needed to
correctly record the combination.
d. Acquisition-related costs for a business combination are expensed as incurred.
___________________________________________________________________________
¶703 INTRODUCTION
CPAs trying to help their clients find simpler and easier ways to present financial information have long
suggested one of the other comprehensive basis of accounting (known as OCBOA), such as modified cash
basis or income tax basis. A new alternative is available.
In June 2013 the AICPA published the Financial Reporting Framework for Small- and Medium-Sized Entities.
Known as FRF for SMEs, this framework is categorized as one of the OCBOAs.
This chapter is one in a series describing FRF for SMEs. The first chapter is FRF for SMEs—An Alternative to
GAAP—Introduction. It describes how FRF for SMEs fits into the various options for financial reporting, and
describes the basic financial concepts in the framework. That chapter also describes the general principle for
transitioning financial statements to the first presentation under FRF for SMEs.
This chapter will describe the accounting for intangible assets, including goodwill. Revenue recognition is
covered by spelling out basic general principals. Finally, accounting for leases and nonmonetary transactions will
be described.
A key point needs to be repeated often—FRF for SMEs is not generally accepted accounting principles. It is
neither "small GAAP" nor GAAP light nor GAAP without some of the detailed rules.
In one sentence, FRF for SMEs is another in the group of OCBOA frameworks that might be an acceptable
alternative to GAAP for some companies in some circumstances. Just as modified cash basis or tax basis might
be appropriate for some entities, FRF for SMEs might be an appropriate alternative.
STUDY QUESTIONS
___________________________________________________________________________
1. All of the following are criteria to recognize intangible assets except:
a. Identifiable
b. Indefinite life
c. Control
d. Future economic benefits
2. For an internally-generated intangible asset that is being capitalized, all of the following costs are eligible
for capitalization except:
a. Training staff on using the new asset
b. Employee salaries, wages, and benefits to develop the item
c. Cost of materials and services to generate the item
d. Fees to register intangible asset if the item needs to be registered
___________________________________________________________________________
Goodwill
Goodwill is recognized in a statement of financial position at the initial amount less accumulated amortization.
Amortization term for goodwill is the same period as used for federal income tax purposes. If the goodwill is not
amortized for federal income tax, then the amortization term is 15 years.
¶705 REVENUE
The brief guidance in the framework covers revenue from:
x Sales of goods
x Services
x Interest, dividends, and royalties
Revenue from leasing arrangements will be covered later in this chapter. Revenue from investments handled
under the equity and cost methods are covered in the previous chapter in this module.
Recognition
For sales of goods, revenue is recognized upon performance, which requires fulfilling two conditions:
x The seller has transferred significant risks and rewards of ownership to the buyer, all significant acts
are completed, and the seller does not have continuing involvement or control over the goods that are
usually associated with ownership.
x Consideration to be received can be measured with reasonable assurance. This would include the
ability to determine extent for which goods may be returned.
This assumes that the collection is reasonably assured.
For service transactions and long-term contracts, revenue is also recognized upon performance which could be
determined under either the percentage of completion method or completed contract method. Performance
would be achieved when consideration can be measured with reasonable assurance.
For both sales of goods and services, performance has been achieved when three criteria have all been met:
x Persuasive evidence of the arrangement is in existence
¶706 LEASES
Accounting for leases under the FRF for SMEs framework will be quite familiar to those who have a working
knowledge of the GAAP framework.
The basic perspective in FRF for SMEs is that the transfer of substantially all the benefits and risks of ownership
is in substance an acquisition of an asset in return for a future stream of payments. For a lessor, the transfer of
substantially all the benefits and risks of an asset is a sale.
From the perspective of a lessee, a lease would transfer substantially all the benefits and risks of ownership if
any of the following conditions are present at the inception of the lease:
x The lease transfers ownership by the end of the lease term.
x The lease provides for a bargain purchase option.
x The length of the lease indicates that the leasee will receive substantially all of the economic benefits
from the leased property during the lease term. This would be the case if the lease term is for 75
percent or more of the remaining economic life of the leased property.
x The lessor will recover the investment in the property. This would be the case if the present value of
lease payments, exclusive of executory cost, is equal to 90 percent or more of the market value of the
property at the start of the lease. The interest rate used to determine the present value of payments
would be the lower of the lessee's incremental borrowing rate or the interest rate implicit in the lease if
that is known.
Since land has an indefinite useful life, the lease of land would be operating, unless the terms of the lease
indicate there is a reasonable assurance that ownership will transfer by the end of the lease.
From the perspective of a lessor, a lease transfers substantially all of the benefits and risks of ownership if all of
the following conditions are met:
STUDY QUESTION
¶803 INTRODUCTION
CPAs trying to help their clients find simpler and easier ways to present financial information have long
suggested one of the other comprehensive basis of accounting (known as OCBOA), such as modified cash
basis or income tax basis. A new alternative is available.
In June 2013 the AICPA published the Financial Reporting Framework for Small- and Medium-Sized Entities.
Known as FRF for SMEs, this framework is categorized as one of the OCBOAs.
This chapter is one in a series describing FRF for SMEs. The first chapter is FRF for SMEs—An Alternative to
GAAP—Introduction. It describes how FRF for SMEs fits into the various options for financial reporting, and
describes the basic financial concepts in the framework. That chapter also describes the general principle for
transitioning financial statements to the first presentation under FRF for SMEs.
This chapter will describe the accounting treatment for income taxes and retirement and other postemployment
benefits. The framework allows significant latitude for entities to choose a very simple accounting treatment.
A key point needs to be repeated in each of the chapters in this series—FRF for SMEs is not generally accepted
accounting principles. It is neither "small GAAP" nor GAAP light nor GAAP without some of the detailed rules.
In one sentence, FRF for SMEs is another in the group of OCBOA frameworks that might be an acceptable
alternative to GAAP for some companies in some circumstances. Just as modified cash basis or tax basis might
be appropriate for some entities, FRF for SMEs might be an appropriate alternative.
STUDY QUESTION
___________________________________________________________________________
STUDY QUESTION
___________________________________________________________________________
2. Which of the following is a part of applying the deferral and amortization approach?
a. Obtain the annual actuarial calculation of the accrued benefit obligation.
b. Determine interest cost on the accrued benefit obligation using the discount rate
established at the initiation of the plan.
c. Determine the fair value of the plan assets.
d. Determine the expected return on plan assets.
___________________________________________________________________________
Determination of cost for the period. Periodic pension cost consists of:
x Current service cost
x Interest cost on the accrued benefit obligation
x Expected return on plan assets
x Amortization of prior service costs
x Amortization of net actuarial gain or loss
x Increase or decrease in valuation allowance for the carrying amount of an accrued benefit asset
x Gain or loss from a settlement or curtailment
x Expense for termination benefits
Entities with two or more plans. If an entity has multiple plans using the deferral and amortization approach,
the cost, accrued benefit obligation, and plan assets should be determined for each plan.
Unfunded plans may be aggregated for measurement only when they provide:
x Different benefits to the same group of employees, or
x Same benefits to different groups of employees.
Plans that are overfunded or underfunded may not be netted for presentation on the statement of financial
position. Some plans may have an accrued benefit asset (plan assets greater than accumulated benefit
obligation) at the same time as other plans have an accrued benefit liability (accumulated benefit obligation
greater than plan assets). Those plans may be netted only if:
x The entity has the right to use one plan's assets to pay benefits for another plan
x Entity intends to exercise that right
As with the immediate recognition approach, under the deferral and amortization approach an accrued benefit
asset (i.e. plan assets greater than accumulated benefit obligation) is recognized in the statement of financial
position only to the extent that it will be recoverable in the future either through reduced contributions or refunds
from the plan.
STUDY QUESTION
___________________________________________________________________________
3. All of the following statements about income tax accounting are correct except:
a. Income tax rates used to measure income tax liabilities and income tax assets are those
rates that are reasonably expected to be in effect when the underlying temporary
differences are expected to reverse.
b. If the tax assets and tax liabilities of an entity acquired in a business combination has
implication that a deferred tax asset of the parent may now be realized, the impact should
be recognized in income currently and not become part of accounting for the business
combination.
c. If different tax rates apply to capital gains and losses than the rates applicable to other
taxable income, the appropriate tax rate for measuring those gains and losses should
reflect how the underlying asset will be taxed.
d. The cost or benefit of current and deferred income taxes that are related to discontinued
operations are presented on the statement of operations along with the results of
discontinued operations.
___________________________________________________________________________
Presentation
Income tax expense that is a part of net income before discontinued operations is presented separately on the
face of the statement of operations.
Income tax liabilities and income tax assets. On a statement of financial position, income tax assets and
liabilities should be presented separately from other assets and liabilities. The current portion of income tax
assets and liabilities should be presented separately from the deferred portion.
When an entity presents a statement of financial position classified as current and noncurrent, the current and
noncurrent portion the deferred income tax assets and liabilities should also be presented as current and
noncurrent. The classification of liabilities and assets which generated the deferred income tax is used to
determine how to classify the deferred income tax between current and noncurrent.
The current tax liability and current tax asset should only be offset if the items relate to the same tax authority for
the same entity. Likewise for deferred income tax asset and liabilities, which should only be offset if they relate to
the same entity and the same tax authority. The current and noncurrent portion of deferred income tax balances
should not be offset.
Disclosure
An entity should disclose the following:
¶903 INTRODUCTION
Monitoring is a key element of quality control for firms with accounting or auditing practices. Yet, it is one of the
least understood and most poorly applied elements. Guidance on monitoring comes from two sources:
x SQCS 8, which contains the requirements for monitoring
x Section 10,000, "Monitoring Guidance," of the AICPA Peer Review Program Manual (PRP Section
10,000), which contains implementation provisions
Monitoring applies to all firms with accounting or auditing practices, even small firms that perform no services
above the compilation level.
This chapter summarizes the definitions and requirements of SQCS 8 relevant to the monitoring element of
quality control, and the provisions of PRP Section 10,000. It also provides commentary on the elements of an
effective monitoring program, and offers guidance on monitoring steps for practical implementation.
¶904 DEFINITIONS
SQCS 8 defines the following terms related to monitoring for purposes of the SQCSs:
Engagement Documentation
The record of work performed, and the results and conclusions thereof, also known as working papers or
workpapers.
Engagement Partner
The partner or other person in the firm who is responsible for the engagement, its performance, and the firm's
report on it. When required, the engagement partner has appropriate authority from a legal, regulatory, or
professional body.
Firm
An organization engaged in the practice of public accounting that is in a form permitted by law or regulation and
whose characteristics conform to resolutions of the Council of the AICPA.
STUDY QUESTION
___________________________________________________________________________
1. The difference between monitoring and inspection is that:
a. Monitoring is a retrospective evaluation of a firm's QC policies and procedures, while
inspection is an ongoing consideration and evaluation of that system.
b. Inspection is designed to provide the firm with reasonable assurance that its QC system is
appropriately designed and functioning properly, while monitoring is not.
c. Monitoring is an ongoing evaluation and consideration of a firm's QC system, while
inspection is a retrospective evaluation that includes a review of selected completed
engagements.
d. Inspection is designed to provide a basis for reliance by outside parties on the firm's QC
system, while monitoring is performed strictly for internal purposes.
___________________________________________________________________________
¶905 REQUIREMENTS
SQCS 8 contains the following presumptively mandatory requirements. Presumptively mandatory requirements
are signaled in the professional standards by the word should.
Auditors must comply with presumptively mandatory requirements in all cases in which they are relevant, except
in rare circumstances when that procedure would not be effective in achieving the intent of the requirement.
There are no unconditional requirements related to monitoring.
Monitoring the Firm's QC Policies and Procedures
Firms should establish a monitoring process designed to provide reasonable assurance that their QC policies
and procedures are relevant, adequate, and operating effectively. This process should:
x Include an ongoing consideration and evaluation of the QC system, including inspection or periodic
review of engagement documentation, reports, and clients' financial statements for a selection of
completed engagements
STUDY QUESTION
___________________________________________________________________________
2. In distinguishing between systemic and non-systemic deficiencies, SQCS 8 notes that:
a. Deficiencies in individual engagements indicate that the firm's QC system is inadequate.
b. Non-systemic deficiencies do not indicate that the QC system is inadequate.
c. Systemic deficiencies do not require corrective action.
d. QC systems should not be subject to inherent limitations.
___________________________________________________________________________
Auditing Standards
In addition to the requirements of SQCS 8, which apply to a firm's accounting and auditing practice, firms with an
auditing practice should also comply with the requirements of AU-C Section 220, Quality Control for an
Engagement Conducted in Accordance with Generally Accepted Auditing Standards. It states that an effective
QC system includes a monitoring process that provides the firm with reasonable assurance that QC policies and
procedures are relevant, adequate, and operating effectively. AU-C Section 220 requires the engagement
partner to consider:
x The results of the firm's monitoring process as evidenced in the latest information circulated to the
engagement partner by the firm and, if applicable, other network firms
x Whether deficiencies noted in that information may affect the audit engagement
STUDY QUESTION
___________________________________________________________________________
3. Monitoring activities include evaluating all of the following except:
a. Compliance with the firm's QC policies and procedures
b. The relevance and adequacy of the firm's QC policies and procedures
c. The appropriateness of the firm's practice aids
d. Whether qualified external persons have been engaged to investigate any complaints or
allegations
___________________________________________________________________________
¶1003 INTRODUCTION
Engagement quality control review is a key component of the engagement performance element of quality
control for firms with accounting or auditing practices. However, it is one of the least understood and most poorly
applied components. The requirements for EQCR are prescribed by SQCS 8. These requirements apply to all
firms with accounting or auditing (A&A) practices, even small firms that do not perform services above the
compilation level.
This chapter summarizes the definitions and requirements of SQCS 8 pertaining to EQCR, provides commentary
on the elements of an effective EQCR program, and offers practical implementation guidance.
¶1004 DEFINITIONS
SQCS 8 defines the following terms related to EQCR for purposes of the SQCSs:
Engagement Documentation
The record of work performed, and the results and conclusions thereof, also known as working papers or
workpapers.
Engagement Partner
The partner or other person in the firm who is responsible for the engagement, its performance, and the firm's
report on it. When required, the engagement partner has appropriate authority from a legal, regulatory, or
professional body.
Engagement Quality Control Review
A process designed to provide an objective evaluation, prior to the report release, of the significant judgments
made by the engagement team, and the conclusions it reached in formulating the report. The EQCR process is
only for those engagements, if any, that the firm has determined in accordance with its policies and procedures
that an EQCR is necessary.
Engagement Quality Control Reviewer
A partner or other suitably qualified person (or team of persons), either within or outside of the firm, not a part of
the engagement team, with sufficient and appropriate experience and authority to objectively evaluate the
STUDY QUESTION
___________________________________________________________________________
1. According to the definitions of SQCS 8, which of the following statements with respect to EQCR is correct?
a. It should be completed before the report is released.
b. It is a post-issuance review of a specific engagement.
c. It should be conducted by the engagement partner.
d. It should be conducted by a suitably qualified external person.
___________________________________________________________________________
¶1005 REQUIREMENTS
SQCS 8 contains the following presumptively mandatory requirements related to EQCR. Presumptively
mandatory requirements are signaled in the professional standards by the word should. Practitioners must
comply with presumptively mandatory requirements in all cases in which they are relevant, except in rare
circumstances when that procedure would not be effective in achieving the intent of the requirement. There are
no unconditional requirements related to EQCR.
STUDY QUESTION
___________________________________________________________________________
2. According to SQCS 8's requirements, EQCR should include:
a. Reviewing all engagement documentation concerning judgments made by the
¶1006 COMMENTARY
Recent peer reviews indicate that many firms have a poor understanding of EQCR. The key elements to
understand are that a EQCR is:
x A pre-report issuance procedure, not a post-issuance exercise such as an inspection
x Conducted by persons with no previous connection to the engagement
The most common misconceptions or shortcomings observed by the peer review program include:
x Mistaking EQCR for pre-issuance review conducted by the engagement partner or other members of
the engagement team
x Mistaking EQCR for post-issuance reviews, such as inspections that are conducted in connection with
the firm's monitoring program
x Mistakenly believing that all engagements should be subjected to EQCR
x Mistakenly believing that professional standards mandate EQCR for certain types of engagements
x Failing to specify criteria for engagements to be subjected to EQCR.
x Writing inappropriate or impractical EQCR criteria, such as:
- All A&A engagements. Such a criterion is far in excess of what would be practicable for
most firms, and would be so expensive that it would not likely be observed consistently.
- All audit (or, all review, or all full-disclosure) engagements. This criterion might be
appropriate for a firm that does only one, or a very few of any of these engagements. For any
firm that performs numerous such engagements, this would create the same problem as the
criterion immediately above.
- Only those engagements that in the engagement partner's judgment should be subjected to
EQCR. This criterion is inappropriate because it is not specific enough and it leaves the
decision entirely up to the engagement partner, which is contrary to the intent of the
standard. EQCR criteria have to be objective enough that an engagement that falls within
them will be readily determinable. However, it is legitimate to include one or more subjective
criteria like this one along with other objectively determinable criteria, so that jobs that have
some characteristic that is not covered by the firm's other criteria could be selected based on
a subjective determination. This could be nothing more than the engagement partner's feeling
of not "being comfortable" with the engagement.
- Other criteria that the firm does not reasonably expect to comply with on a consistent basis.
This would cause the firm to have a compliance deficiency in the application of its QC
system, and could lead to finding or deficiencies in its peer review, especially if deficiencies
are found in specific engagements that should have been detected by EQCR.
It is legitimate to write EQCR criteria such that only once in a while would any engagement fall under them. This
might not be appropriate for firms with diverse and complex practices, or for growing firms that are frequently
taking on clients and engagements in new industries and levels of service. On the other hand, stable firms with
specialty practices that do not often take on new clients and that seldom venture outside of their specialty areas
might safely adopt criteria that it only rarely expects an engagement to meet (e.g., accepting an engagement
STUDY QUESTION
___________________________________________________________________________
3. Common misconceptions or shortcomings surrounding EQCR noted by the AICPA Peer Review Program
include all of the following except:
a. All A&A engagements should be subjected to EQCR.
b. Professional standards require specific types of engagements to undergo EQCR.
c. EQCR should be conducted by persons having no previous connection to the
engagement.
d. Engagements should be selected for EQCR at the engagement partners' sole discretion.
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¶1103 INTRODUCTION
As the American Institute of Certified Public Accountants (AICPA) Peer Review Program continues to evolve,
important changes affecting the administrative processes, substantive requirements, and the qualification
process for becoming a peer reviewer have been made. These include:
x The implementation of the initial phases of an electronic system for documenting and administering
peer reviews, called the Peer Review Information System Manager, or PRISM
x Revisions to the AICPA's Peer Review Program Manual (PRPM) that contain important changes to
previous practice
x Additional training courses and new avenues for qualification to serve as a peer reviewer
This chapter provides an update and overview of these changes and their practical implications for the peer
review process.
STUDY QUESTION
___________________________________________________________________________
2. The April 2014 revision of the PRPM contains which of the following changes to previous practice?
a. The Review Captain Checklist for engagement reviews has been deleted.
b. Peer reviewers are no longer required to fill out the Team Captain Checklist for system
reviews.
c. Peer reviewers are required to submit the Summary Review Memorandum for system
reviews in Microsoft Excel trade; format.
d. Peer reviewers are required to file the firm's representation letter as a part of the peer
STUDY QUESTION
___________________________________________________________________________
3. The minimum requirements to become a peer reviewer include which of the following?
a. Be associated with a firm that has received a peer review rating of pass on its most recent
system or engagement review within the last five years.
b. Be currently active in public practice as a partner of a firm.
c. Have at least three years of recent experience in public accounting in the accounting or
auditing function.
d. Be an AICPA member in good standing.
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¶1203 INTRODUCTION
In February 2014, the Auditing Standards Board issued Statement on Auditing Standards Number 128, Using
the Work of Internal Auditors (SAS 128).
STUDY QUESTION
___________________________________________________________________________
1. When determining whether the work of the internal audit function can be used to obtain audit evidence, an
external auditor should consider all of the following factors except:
a. Relative efficiency of work performed by internal audit function in relation to external audit
staff
b. Competency of the internal audit function
c. Whether the internal audit function uses a systematic and disciplined approach
d. Extent to which several factors support objectivity of the internal audit function
___________________________________________________________________________
Determining the Nature and Extent of Work of the Internal Audit Function That Can Be used to Obtain
Audit Evidence
The auditor should consider the work that has been performed by the internal audit function or is planned to be
performed in relation to the external auditor's overall audit strategy and audit plan.
While assistance can be provided by an entity's internal audit function, it is important to note that the external
auditor should make all significant judgments in the audit engagement.
This would include items such as:
x Assessing risks of material misstatement
x Evaluating:
- Sufficiency of test performed
- Appropriateness of management's assessment of going concern assumption
- Significant accounting estimates
- Adequacy of disclosures
Those matters along with other significant judgments would not be appropriate areas for the internal audit
function to address.
To prevent undue use of the internal audit function, the external auditor should plan to use less work of the
function and perform more of the work directly when:
x More judgment is needed to plan or perform the audit procedures or evaluate the resulting audit
evidence
x Assessed risk of material misstatement at the assertion level is higher, particularly regarding significant
risks
x Less support for the objectivity of internal auditors is provided by their status in the organization and
their policies and procedures
STUDY QUESTION
___________________________________________________________________________
2. Which of the following is the most accurate description of when the external auditor reperforms work
completed by internal auditors?
a. Reperformance is required when the internal audit function has an impaired objectivity.
b. Reperformance is a presumptively mandatory requirement when competency of the
internal audit function is not assessed at a very high level.
c. Reperformance is required in each area where the internal audit function has performed
work gathering audit evidence to support the audit opinion.
d. Reperformance is required when the internal audit function has performed work gathering
audit evidence but the areas to be reperformed are based on professional judgment of the
external auditor.
___________________________________________________________________________
STUDY QUESTION
___________________________________________________________________________
3. Which of the following statements about documentation requirements is most accurate?
a. The external auditor is required to prepare a quantitative calculation of the extent of
involvement on the engagement by the internal audit function.
b. The external auditor is required to document that involvement by the internal audit
function still leaves external auditor in the position of being sufficiently involved in the
audit.
c. If the internal audit function is tasked with gathering audit evidence regarding an
evaluation of the adequacy of disclosures, such evaluation should be documented.
d. If the involvement by the internal audit function or individual internal auditors exceeds a
specified threshold of total effort on the engagement (based on qualitative and quantitative
factors) the external auditor is required to document the level of involvement does not
impair the external auditor's ability to support the audit opinion.
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¶1303 INTRODUCTION
The last couple generations of accountants have been yearning for "Little GAAP."
While that phrase may not have been defined with any precision, the underlying wish has been to find an
alternative to the ever increasing complexity of accounting rules with evermore voluminous disclosure
requirements.
While that long dreamed of place may never be realized, there is a new option within the GAAP framework for
private businesses.
The Financial Accounting Standards Board (FASB) has created the Private Company Council (PCC). In one
sentence, the PCC will carve out for private companies certain exceptions from some GAAP requirements.
The PCC will identify specific issues for specific relief and develop proposed rules to address those carve outs.
Those proposals are developed in consultation with FASB. After going through a comment period, the rules will
be considered by FASB, and if approved will be issues as an Accounting Standards Update (ASU). Those
changes will then be incorporated into the Accounting Standards Codification. If that process sounds familiar, it
is because that's the procedure currently in use for other changes in accounting rules.
The PCC has proposed and FASB has approved three Accounting Standards Updates which allows simplified
STUDY QUESTION
___________________________________________________________________________
1. Which of the following best describes factors that will be used by FASB and PCC in evaluating accounting
alternatives?
a. The cost and complexity of an accounting issue would be given priority over the user-
relevance of the information provided.
b. Identifying areas where users of private company financial statements have different
needs in terms of display requirements will be a priority.
c. Effective dates will typically be the same for private companies as for public companies.
d. For disclosures, consideration will be given to whether users of private company financial
statements have higher levels of access to management than users of public company
financial statements.
___________________________________________________________________________
¶1306 GOODWILL
In January 2014, FASB issued Accounting Standards Update No. 2014-02, Intangibles—Goodwill and other
(Topic 350)—Accounting for Goodwill - a consensus of the Private Company Council.
Stakeholders of private companies provided PCC with feedback indicating the benefits of goodwill accounting
after initial recognition don't justify the costs.
Users of private company financial statements provided feedback they do not consider the information to the
decision-useful. The reason is that users generally disregard goodwill accounting in analyzing the financial
condition and results of operations of a private company.
Preparers and auditors provided feedback about the high cost and complexity in addressing goodwill impairment
testing.
STUDY QUESTION
___________________________________________________________________________
2. Which of the following best describes the transition required for the interest rate swap accounting
alternative?
a. Either the modified retrospective approach or full retrospective approach may be used.
b. The alternative may only be applied prospectively to covered interest rate swaps entered
into after the date the private company elects to follow this alternative.
c. The full retrospective approach must be used.
d. The accounting alternative must be applied to all swaps that meet the criteria specified in
the accounting alternative.
___________________________________________________________________________
¶1403 INTRODUCTION
The standards on audit evidence comprise twelve sections in the clarified standards:
AU-C Section 500, Audit Evidence
AU-C Section 501, Audit Evidence—Specific Considerations for Selected Items
AU-C Section 505, External Confirmations
AU-C Section 510, Opening Balances—Initial Audits, Including Reaudit Engagements
AU-C Section 520, Analytical Procedures
AU-C Section 530, Audit Sampling
AU-C Section 540, Auditing Accounting Estimates, Including Fair Value Accounting Estimates and Related
Disclosures
AU-C Section 550, Related Parties
AU-C Section 560, Subsequent Events and Subsequently Discovered Facts
AU-C Section 570, The Auditor's Consideration of an Entity's Ability to Continue as a Going Concern
AU-C Section 580, Written Representations
AU-C Section 585, Consideration of Omitted Procedures After the Report Release Date
This chapter is intended as a top-level summary and overview of the significant definitions and requirements of
those standards. Auditors should consult the full text of the specific standards for detailed guidance.
STUDY QUESTION
___________________________________________________________________________
1. When derivatives or securities are measured or disclosed at fair value, AU-C Section 501 auditors should:
a. Independently develop a valuation model for the securities or derivatives.
b. Obtain an understanding of valuation models used by broker-dealers or other third party
sources used in estimating fair value, when applicable.
c. Employ a specialist to assess the valuation model used.
d. Trace stated values to prices on publicly traded exchanges.
___________________________________________________________________________
Inventory. When inventory is material, auditors should obtain sufficient appropriate evidence about its existence
and condition by:
x Attending physical inventory counting, unless impracticable, to:
- Evaluate management's instructions and procedures for counting and recording
- Observe performance of count procedures
- Inspect inventory
- Perform test counts
x Performing audit procedures to determine whether final inventory records accurately reflect actual
counts.
When inventory is counted at other than the balance sheet date, auditors should, in addition to the above
procedures, obtain evidence about whether changes between the count date and the balance sheet date are
properly recorded.
When unable to attend inventory counting due to unusual circumstances, auditors should make or observe some
counts on an alternative date and perform audit procedures on the intervening transactions.
When attendance at inventory counting is impracticable, auditors should perform alternative procedures to
obtain sufficient appropriate evidence about the condition and existence of inventory. A modified auditor's
opinion is required if this is not possible.
STUDY QUESTION
___________________________________________________________________________
2. If a written confirmation response that the auditor has determined to be necessary is not received, the
auditor should:
a. Obtain sufficient appropriate audit evidence through other available sources.
b. Perform alternative audit procedures.
c. Determine the implications for the audit, and the auditor's opinion.
d. Modify the auditor's opinion.
___________________________________________________________________________
Exceptions. Auditors should investigate exceptions to determine if they indicate misstatements.
OBSERVATION
Not all exceptions represent misstatements. Exceptions may also be caused by:
STUDY QUESTION
___________________________________________________________________________
4. Documentation requirements for substantive analytical procedures include requirements to record all of the
following except:
a. Scanning of untested expense balances
b. Additional auditing procedures performed to investigate significant unexpected differences
arising from the analytical procedure
c. The results of the comparison of the expectation to the amounts recorded in the financial
statements, or to ratios derived from those amounts
d. The factors considered in developing the expectations used, unless those expectations
are obvious from the documentation of the work performed
___________________________________________________________________________
STUDY QUESTION
___________________________________________________________________________
5. Which of the following statements about AU-C Section 530 is correct?
a. It applies only to statistical sampling.
b. It requires auditors to project the results of the sample to the population as a whole.
c. It defines tolerable misstatement as the maximum monetary amount of misstatement that
the auditor is willing to accept in the financial statements taken as a whole without
modifying his or her audit opinion.
d. When a planned substantive test is not applicable to a selected item, it requires auditors
to regard the item as a misstatement.
___________________________________________________________________________
STUDY QUESTION
___________________________________________________________________________
6. The concept of estimation uncertainty recognizes that:
a. The reestimation in the current period of a prior period's accounting estimate calls into
question the auditor's professional judgment made based on available information in prior
periods.
b. The difference between the outcome of an accounting estimate and the amount originally
STUDY QUESTION
___________________________________________________________________________
7. Upon discovery that a significant related party transaction outside the normal course of business has
occurred auditors should do all of the following except:
a. Obtain evidence that the transaction has been properly approved.
b. Report the transaction to those charged with governance.
c. Inspect underlying contracts or agreements to evaluate the business rationale for the
transaction.
d. Regard it as an area of significant risk.
___________________________________________________________________________
STUDY QUESTION
___________________________________________________________________________
8. Which of the following statements best applies to AU-C Section 570?
a. The absence of a reference in an auditor's report to substantial doubt about going concern
guarantees the entity's ability to continue as such.
b. Auditors are required to design special auditing procedures to detect conditions that
indicate substantial doubt about going concern.
c. AU-C Section 570 defines a reasonable period of time as a period not to exceed one year
after the date of the auditor's report.
d. AU-C Section 570 applies to audits of financial statement audits prepared on the cash or
tax basis.
___________________________________________________________________________
Considering management's plans. After considering identified conditions or events in the aggregate, if the
auditor has substantial doubt about going concern, the auditor should obtain information about management's
plans to mitigate their effects. The auditor should:
x Assess the likelihood that adverse effects would be mitigated for a reasonable period of time
x Identify the elements of management's plans that are particularly significant to overcoming those
adverse effects
x Perform audit procedures to obtain evidence about those elements, including, when applicable,
considering the adequacy of support regarding the ability to obtain additional financing or the planned
disposal of assets
x Assess the likelihood that management's plans can be implemented
When prospective financial information is particularly significant to management's plans, the auditor should:
x Ask management to provide that information
x Consider the adequacy of support for significant underlying assumptions
x Give special attention to assumptions that are:
- Material
- Especially sensitive
- Susceptible to change
- Inconsistent with historical trends
x Read the prospective financial information
x Compare prior periods' prospective financial information to actual results
x Compare the current period's prospective financial information to actual results to date
x Discuss the effect on that information of factors that the auditor is aware of, but that are not reflected in
the information, with management and, if necessary, request revision of the information
Considering financial statement effects. If the auditor has substantial doubt about going concern after
considering management's plans, the auditor should consider:
x The possible effects on the financial statements
x The adequacy of related disclosures
¶1503 INTRODUCTION
This chapter examines fraud in the financial statement audit from two perspectives:
x An academic and professional perspective that is concerned with conceptual models for assessing
fraud risk. These models have evolved considerably over several decades. Updated models provide
expanded frameworks for auditors to use in assessing fraud risk.
x A professional liability insurance company's perspective, which in some cases is dealing with mitigation
of damages caused by an auditor's failure to detect fraud, and in others, is attempting to reconcile
within the legal system the public's perception of the auditor's responsibility for detecting fraud versus
the actual requirements of professional standards and good practice.
Both of these perspectives offer lessons for auditors. The conceptual models provide expanded frameworks for
understanding the fraud perpetrator's thought processes, and thus for assessing the risk of material
misstatement due to fraud. The insurance claims provide an "after the fact" view of what the auditor could have
or might have done to avoid or lessen the effect of a malpractice claim.
STUDY QUESTION
___________________________________________________________________________
1. The classic fraud triangle is best suited as a tool for assessing the likelihood of fraud by which of the
following types of perpetrator?
a. Perpetrators acting in collusion
b. Individual, first-time perpetrators
c. Predatory, career-criminal perpetrators
d. Highly compensated senior management
___________________________________________________________________________
Fraud Scale
The fraud scale was developed in the 1980s because a reliable profile of occupational fraud perpetrators did not
exist. This model assesses fraud risk by evaluating the relative forces of:
x Pressure
x Opportunity
x Personal integrity
It substitutes personal integrity for the element of rationalization in the classic fraud triangle. It is structured as a
continuum rather than a triangle. In that continuum, as pressure and opportunity increase and personal integrity
decreases, fraud risk increases.
This model is particularly applicable to fraudulent financial reporting, because sources of pressure, such as
analysts' forecasts, management earnings guidance, or a history of earnings or sales growth, are observable
inputs. An individual's decisions and decision-making processes can also be observed. Thus, his or her
commitment to ethical decision-making can be assessed. When auditors consider an individual's decisions in an
ethical context, they can assess the risk of that person committing fraud.
Fraud Diamond
The fraud diamond adds an individual's capabilities as a fourth element to the classic triangle. This model
suggests that even though the three classic triangle elements are present, frauds, especially some of the
multibillion-dollar financial statement frauds, could not occur without the right person with the right capabilities to
implement its details. It asks who could turn a fraud opportunity into a reality. The authors of this model suggest
four observable perpetrator traits for frauds that span extended periods and involve large sums:
x Position or function of authority within the organization
x Capacity to understand the accounting system and exploit internal weaknesses, and possibly to
leverage responsibility and abuse authority to complete and conceal the fraud
x Confidence that the fraud will go undetected, and in the ability to talk their way out of trouble if caught
x Capability to handle the stress that arises in an otherwise good person who commits a fraud
This model requires that auditors observe, assess, and document the capabilities of top executives, key
personnel, and employees who could perpetrate and conceal fraud.
STUDY QUESTION
___________________________________________________________________________
2. The new fraud diamond posited by Jack Dorminey and his colleagues replaces the classic triangle
elements of pressure and rationalization with _______________________ for the predatory fraud
perpetrator.
a. Criminal mind-set and arrogance
b. Ideology and coercion
c. Capability and personal integrity
d. Ego and entitlement
___________________________________________________________________________
STUDY QUESTION
___________________________________________________________________________
3. Recent malpractice claims involving fraud at a large national insurer highlight the truth of all of the following
statements except:
a. There are differences in the public's perception versus the auditor's perception of the
auditor's responsibilities for fraud detection.
b. Auditors indemnify their clients against losses from fraud by issuing an unqualified audit
opinion.
c. Clear communication between the auditor and the client regarding the auditor's
responsibilities for fraud detection is necessary.
d. Strict adherence to professional standards does not guarantee that an auditor will not be
sued for malpractice.
___________________________________________________________________________
___________________________________________________________________________
CPE NOTE: When you have completed your study and review of chapters 14-15, which comprise Module 4, you
may wish to take the Quizzer for this Module. Go to CCHGroup.com/PrintCPE to take this Quizzer online.
___________________________________________________________________________
2. a. Incorrect. AU-C Section 315 states that determination of whether an assertion is relevant is made without
regard to the effect of internal controls.
b. Correct. According to AU-C Section 315, a relevant assertion is a financial statement assertion that
has a reasonable possibility of containing one or more misstatements that would be material to the
financial statements.
c. Incorrect. An assertion is a representation by management that is embodied in the financial statements,
whether explicit or otherwise. Not all explicit assertions are necessarily relevant assertions.
d. Incorrect. Under AU-C Section 315's definition, auditors would not ordinarily consider an assertion that had
only a remote possibility of containing one or more material misstatements to be a relevant assertion.
3. a. Incorrect. According to AU-C Section 300, a description of the characteristics that define the scope of the
engagement is a component of the audit strategy, rather than the audit plan.
b. Incorrect. The audit plan should describe the nature and extent of planned further audit procedures down to
the relevant assertion level, rather than at the financial statement level.
c. Correct. AU-C Section 300 requires the audit plan to describe the planned risk assessment
procedures.
d. Incorrect. Consideration of knowledge obtained on other engagements performed for the entity is a part of
the audit strategy, rather than the audit plan.
4. a. Correct. Certain risks have inherent properties that cannot be mitigated by internal controls.
Therefore, AU-C Section 315 requires auditors to consider whether identified risks represent significant
risks without regard to the effects of internal control.
b. Incorrect. Fraud carries with it inherent risks due to its covert nature. For this reason, when significant fraud
risk exists, it should enter into consideration of whether a particular identified risk is a significant risk.
c. Incorrect. Significant economic developments may form a part of an entity's environment, and are important
to an auditor's understanding of an entity and may be relevant to risk assessment. For these reasons, they
should be considered when considering whether an identified risk is significant.
d. Incorrect. Related party transactions are usually regarded as having heightened risk for misstatement.
Auditors should, therefore, take into consideration whether a transaction involves related parties in determining if
5. a. Correct. AU-C Section 315 requires auditors to identify and assess risks of material misstatement at
both the financial statement and the relevant assertion levels.
b. Incorrect. In identifying and assessing risks of material misstatement, auditors consider the financial
statement assertions that are relevant to significant transaction classes, account balances and disclosures. They
make their assessments at the relevant assertion level, rather than for the transaction class, balance or
disclosure itself.
c. Incorrect. While it is true that auditors are required to assess the risks of material misstatement at the
financial statement level, they are also required to make this assessment at another level.
d. Incorrect. It is correct that auditors are required to assess the risks of material misstatement at the relevant
assertion level. They are, however, also required to make this assessment on another level.
6. a. Incorrect. AU-C Section 320 makes a number of assumptions about the competence and diligence of
financial statement users, one of which is their willingness to study the statements with appropriate diligence.
b. Incorrect. AU-C Section 320 assumes that financial statement users have appropriate knowledge of business
and economic activities and accounting.
c. Correct. AU-C Section 320 states that auditors do not consider the individual needs of specific
individual financial statement users, because their needs may vary so greatly.
d. Incorrect. Under AU-C Section 320, financial statement users are assumed to recognize that there are
uncertainties inherent in the measurement of financial statement amounts, such as accounting estimates and
judgments used in preparing the statements.
9. a. Incorrect. A type 1 report does not contemplate a service auditor testing controls at a service organization.
Therefore it does not provide evidence about the operating effectiveness of the service organization's controls.
b. Incorrect. Evaluating the design and implementation of user entity controls related to the transactions
processed and services provided by a service organization is in itself a risk assessment procedure rather than a
response to an assessed risk.
c. Incorrect. Obtaining an understanding of the nature and significance of the services provided by a service
organization to the user entity's operations is in itself a risk assessment procedure rather than a response to an
assessed risk.
d. Correct. As part of their response to assessed risks related to a user entity's use of a service
organization, user auditors should determine whether sufficient appropriate evidence concerning the
relevant assertions is available from the user entity's records. If it is not, they should perform, or use
another auditor to perform further audit procedures at the service organization.
10. a. Incorrect. The AOEM is explicit in stating that the terms "clearly trivial" and "immaterial" are not
synonymous.
b. Incorrect. Other criteria in addition to size enter into the determination of whether a misstatement is clearly
trivial.
c. Incorrect. Misstatements should be evaluated in light of their aggregate effects with other misstatements in
determining whether they can be considered clearly trivial.
d. Correct. Many factors, both quantitative and qualitative, enter into the determination of whether a
misstatement is clearly trivial. For this reason, a misstatement cannot be considered clearly trivial if
there is any doubt about whether it is.
2. a. Correct. AU-C Section 230 defines the report release date as the date that the auditor grants
permission for the audit report to be used in connection with the financial statements.
b. Incorrect. Under AU-C Section 230, as well as under PCAOB standards, the documentation completion date
3. a. Incorrect. For observation procedures, acceptable identifiers should include both when and where the
observation was made as well as the process or subject of the observation, persons involved and their
responsibilities.
b. Incorrect. For inquiry procedures, acceptable identifiers should include the date and subject matter of the
inquiry and the positions of the persons inquired of, as well as their names.
c. Incorrect. For systematic samples, an acceptable document identifier should include the starting point, such
as "the 5th item," as well as the population of documents and interval.
d. Correct. Unique item numbers, for example invoice, purchase order or check numbers are acceptable
document identifiers according to AU-C Section 230.
4. a. Incorrect. Audit plans (also known as audit programs) are a required element of all audit documentation.
b. Incorrect. AU-C Section 230 lists summaries of significant findings or issues as one of the elements ordinarily
included in audit documentation.
c. Correct. It is not necessary to keep complete copies of all contracts or agreements that are inspected
during an audit. It is, however, required that abstracts or copies of important documents such as
contracts or agreements be retained if they are necessary for an experienced auditor to understand the
work performed and the conclusions reached.
d. Incorrect. Representation letters are a required element of all audit documentation.
5. a. Correct. AU-C Section 320 contains a requirement for auditors to document the factors considered
determining materiality, including, when applicable, materiality at the transaction class, account balance
and disclosure level.
b. Incorrect. Auditors are required to document performance materiality, which is less than materiality for the
financial statements as a whole.
c. Incorrect. Auditors are required to document changes made to materiality levels during the audit.
d. Incorrect. AU-C Section 320 does not contain a specific requirement to document uncorrected misstatements
from prior periods. However, AU-C Section 450 requires auditors to consider the effects of uncorrected prior
periods' misstatements on the current financial statements, transaction classes, account balances and
disclosures.
6. a. Incorrect. AU-C Section 600 requires documentation of the written communication to the component
auditors of the group engagement team's requirements.
b. Correct. Only when the component auditor's report does not state that the audit was performed in
2. a. Correct. The framework indicates the time horizon is 12 months from the statement of financial
position date for considering the impact of known and available information.
b. Incorrect. If an entity is not a going concern, the framework indicates that FRF for SMEs is not appropriate.
c. Incorrect. The level of analysis to assess going concern depends on the circumstances. A brief analysis is
needed when the organization has a series of profitable years and access to alternative sources of financing. If
the entity finds itself with poor results or limited financing sources, then a detailed analysis would be indicated.
d. Incorrect. Management of the entity and not the external accountant is responsible for assessing going
concern issues.
3. a. Incorrect. Regardless of the titles used for the financial statements, notes must prominently state that FRF
for SMEs is the financial reporting framework used for preparing the financial statements.
b. Incorrect. The framework does allow a single financial statement, such as either a statement of financial
position or a statement of activity. If both a statement of financial position and statement of activity are
presented, then the financial statements should include a statement of cash flows.
c. Incorrect. The framework does not require a description of the differences between FRF for SMEs and
GAAP. When the financial statements are being audited, it would be the audit standards which indicate the
auditor should assess whether principal differences are explained, not the framework itself.
d. Correct. Where there is an option between several alternatives, the notes do need to explain which
option management is applying.
2. a. Incorrect. Disclosing the amount and maturity dates beyond the one-year timeframe for financial assets is
required under the framework.
b. Incorrect. This is the extent of specific guidance in the framework for financial instruments with liability and
equity components. They are classified based on the substance of the contract.
c. Correct. Unlike the extensive guidance for derivatives in GAAP, the extent of guidance for derivatives
in the FRF for SMEs framework is a comment that derivatives are recognized in the financial statements
based on the net cash paid or received at settlement.
d. Incorrect. Both investment assets and investment income need to have separate disclosure of the following:
x Nonconsolidated subsidiaries and non-proportionally consolidated joint ventures
x Investments valued using the cost method
x Investments valued using the equity method
x Investments valued using market values.
3. a. Incorrect. The threshold for a voluntary change in accounting principle is the financial statements will
provide reliable and more relevant information. A clear preference criterion is not stated as part of the
framework.
b. Correct. Adjusting the opening balance of equity is one component of a change in accounting
principle. In addition, other items the financial statements should be restated as if the new accounting
policy had been applied for each year that is presented in the financial statements.
c. Incorrect. Material accounting errors should be corrected on a retrospective basis that is correcting the
financial statements of previous periods as if the accounting had been performed correctly.
d. Incorrect. The threshold for not restating the earliest period presented is impracticable, not a measure of
efficiency. The framework provides a description of what would be impracticable.
2. a. Incorrect. Guarantees are recognized based on the criteria spelled out for loss contingencies, specifically
the likelihood of a future payment is probable and amount is subject to reasonable estimation.
3. a. Incorrect. FRF for SMEs does not require an assessment of long-lived asset impairment. This is a
significant difference from GAAP, in the author's assessment.
b. Incorrect. Under FRF for SMEs stock-based compensation is not recognized until the stock is issued. This is
a significant difference from GAAP.
c. Incorrect. The other comprehensive income concept does not exist in the FRF for SMEs framework.
d. Correct. If discontinued operations are present, FRF for SMEs requires such items to be presented as
a separate component on a statement of operations between the captions of income before discontinued
operations and net income. The same presentation is required under GAAP.
2. a. Incorrect. There are some exceptions, but the general concept is assets and liabilities are measured at
market value.
b. Incorrect. One of the many places where the framework allows latitude is in the recognition of intangible
assets acquired in a business combination. An entity is allowed to make an accounting policy choice between
recognizing those intangible assets or not. This option may be exercised on an item by item basis.
c. Incorrect. Previously deferred items, such as those mentioned in the answer do not roll into the recognition of
retirement and other postemployment benefits. Any unamortized transition obligations or assets are also
excluded. This results in the accrued benefit asset or accrued benefit liability being the difference between plan
assets and accrued benefit obligation.
d. Correct. If there is a bargain purchase it is recognized as gain a statement of operations. It is not used
to reduce any assets. It is not deferred.
3. a. Correct. Any changes to the provisional amounts during the measurement period will flow into the
residual amount which was either goodwill or gain on bargain purchase. In addition, any changes to
2. a. Correct. These costs should not be capitalized because they are not a part of the development
phase.
b. Incorrect. Salaries and wages to develop an intangible asset during the development phase are capitalizable.
c. Incorrect. Cost of materials and services to develop an intangible asset are capitalizable
d. Incorrect. If it is appropriate to register an item based on its nature, fees to do so are capitalizable.
3. a. Incorrect. In contrast to GAAP, which requires scheduled increases in lease payments to be adjusted to a
straight-line basis, the FRF for SMEs framework provides an accounting policy choice for entities. They may
choose to adjust the payments to a straight-line basis, or they may expense increase as incurred.
b. Correct. These concessions should be adjusted to a straight-line basis over the term of the lease.
c. Incorrect. Unless there is a reasonable assurance that ownership will transfer by the end of the lease, a lease
for land should be accounted for as an operating lease.
d. Incorrect. The transfer of substantially all the benefits and risks of ownership is considered by the framework
to be a capital lease which consists of acquiring an asset and a related liability for future payments.
2. a. Incorrect. An actuarial calculation only needs to be prepared every three years. In the intervening years
management needs to roll the evaluation forward using available information and assumptions.
b. Incorrect. The discount rate should be revised as of each measurement date. The discount rate should be
changed as long-term interest rates fluctuate.
c. Incorrect. The FRF for SMEs framework does not make use of fair value. Instead, plan assets should be
measured at market value.
d. Correct. Determining the expected return on plan assets is one of the steps necessary in applying this
approach.
3. a. Correct. The income tax rates and laws used to measure income tax liabilities and assets should be
those which are in effect as of the date of the statement of financial position, not the laws and rates
expected to be in effect sometime in the future.
b. Incorrect. If a deferred tax asset that was not otherwise realizable before the business combination becomes
realizable, it should not become a part of the accounting for the business combination. Instead, it would flow into
the current year tax determination.
c. Incorrect. If there are different tax rates involved, the appropriate rate to use is based on how the underlying
asset will be taxed
d. Incorrect. The tax impact related to discontinued operations should be presented in the separate section for
discontinued operations.
2. a. Incorrect. SQCS 8 indicates that deficiencies in individual engagements do not necessarily mean that the
firm's QC system is inadequate.
b. Correct. According to SQCS 8, a non-systemic deficiency is not an indicator of an inadequacy in the
QC system.
c. Incorrect. SQCS 8 states that repetitive or systemic deficiencies require prompt corrective action.
3. a. Incorrect. Evaluation of the firm's compliance with its own QC policies and procedures is considered to be
a monitoring activity.
b. Incorrect. Monitoring activities include evaluating the relevance, adequacy and operating effectiveness of the
firm's QC policies and procedures.
c. Incorrect. Evaluating the appropriateness of the firm's practice aids and guidance materials is listed as a
monitoring activity.
d. Correct. There is no requirement to have all complaints or allegations investigated by outside
persons. Firms may, however, decide to engage a suitably qualified outside firm or person to investigate
complaints or allegations when, for example, it is not practicable to have a partner not involved with the
engagement to supervise the investigation.
2. a. Incorrect. SQCS 8 requires a reviewing of selected, but not all engagement documentation concerning
only the significant judgments made by the engagement team.
b. Incorrect. SQCS 8 permits, but does not require consultation with the engagement partner during the conduct
of the engagement. It further notes that firms should establish policies and procedures to establish the degree to
which the EQCR reviewer can consult on the engagement without losing objectivity.
c. Incorrect. SQCS 8 requires the EQCR reviewer and the engagement partner to discuss significant issues and
findings. This requirement does not extend to the entire engagement team.
d. Correct. SQCS 8 requires that EQCR include reading the financial statements or other subject matter
of the engagement, including the draft report.
3. a. Incorrect. There is no requirement that all A&A engagements be subjected to EQCR. Except in firms with
very few A&A engagements, such a requirement would likely lead to inefficiencies and compliance difficulties.
b. Incorrect. Professional standards do not specify which types of engagements should undergo EQCR.
c. Correct. SQCS 8 requires that EQCR be conducted by persons having no previous connection to the
engagement.
d. Incorrect. It is legitimate for engagements to be selected for EQCR at the engagement partners' discretion,
however this cannot be the sole selection criterion.
2. a. Incorrect. The Review Captain Checklist for engagement reviews has been renamed as the Review
Captain Summary, but has not been deleted.
b. Incorrect. Peer reviewers are still required to fill out the Team Captain checklist for system reviews, but are
no longer required to submit it to the administering entity.
c. Incorrect. Peer reviewers may submit the Summary Review Memorandum for system reviews in either the
new Microsoft Exceltrade; format, or in the Adobe Acrobattrade; format.
d. Correct. The April 2014 revision of the PRPM introduced a requirement for peer reviewers to file the
firm's representation letter as a part of the peer review documentation submitted to the administering
entity. Previously, reviewers were required to obtain, but not to submit this letter.
3. a. Incorrect. In order to qualify as a peer reviewer, a person is required to be associated with a firm that has
received a peer review rating of pass on its most recent system or engagement review, which is ordinarily within
the last three years and six months.
b. Incorrect. In order to qualify as a peer reviewer, a person is required to be currently active in public practice.
This may be either as a partner of a firm enrolled in the program, or as a person at a supervisory level in the
accounting or auditing function as a manager or with equivalent supervisory responsibilities.
c. Incorrect. The PRPM requires at least five, rather than three years of recent experience in public accounting
in the accounting or auditing function in order to qualify for service as a peer reviewer.
d. Correct. The PRPM requires AICPA membership in good standing as a qualification for serving as a
peer reviewer.
3. a. Incorrect. No such requirement exists. In addition the portion of work performed by the internal audit
function is not addressed as an issue in the standard.
b. Correct. When the internal audit function is involved to gather audit evidence or when internal
auditors provide direct assistance, the external auditor is required to document that the level of
involvement does not affect the external auditor's ability to conclude. The phrasing used in the standard
is what's described in the question: the left in the position of being sufficiently involved in the audit.
c. Incorrect. Evaluating adequacy of disclosures is explicitly mentioned as a task which could not be assigned
to the internal audit function. This is a significant judgment which the external auditor should carry out.
d. Incorrect. The requirement to document that were performed by the internal audit function together evidence
or provided by internal auditors in direct assistance applies any time that involvement exists. There is no
threshold where the requirement comes into play. The phrasing used in the standard is the external auditor must
document he or she is left in the position of being sufficiently involved in the audit.
2. a. Correct. The ASU allows private companies to choose either of these options, which provide
substantial latitude.
b. Incorrect. Prospective application is not allowed.
c. Incorrect. The accounting alternative allows other approaches in addition to full retrospective.
d. Incorrect. The accounting alternative may be applied on a swap-by-swap basis, not to all swaps that meet the
criteria.
2. a. Incorrect. The auditor's determination that a written response is necessary is, in effect, a determination that
sufficient appropriate audit evidence cannot be obtained through other sources.
b. Incorrect. AU-C Section 505 states that alternative procedures are not acceptable when the auditor has
already determined that a written response is necessary.
c. Correct. When a written response that the auditor has determined to be necessary is not received, AU-
C Section 505 requires the auditor to determine the implications for the audit, and for his or her opinion.
d. Incorrect. Under these circumstances, auditors may consider whether a modified opinion is necessary.
However, there is no automatic requirement to modify the opinion.
3. a. Incorrect. AU-C Section 510 requires successor auditors to determine whether opening balances reflect
appropriate application of accounting policies.
b. Correct. According to AU-C Section 510, successor auditors are required to evaluate whether current
period audit procedures provide evidence about opening balances either by performing specific
procedures related to those balances or reviewing the predecessor's audit documentation. This section
does not require them to do both.
c. Incorrect. AU-C Section 510 requires successor auditors to determine whether the prior period's closing
balances have been brought forward correctly.
d. Incorrect. AU-C Section 510 requires that the successor auditor request management to authorize the
predecessor auditor to allow a review of his or her audit documentation.
5. a. Incorrect. AU-C Section 530 applies to both statistical and nonstatistical sampling.
b. Correct. AU-C Section 530 requires auditors to project sample results to the entire population from
which the sample was drawn. Failure to do so is one of the most common departures from professional
standards that the AICPA practice monitoring programs cite in audit sampling.
c. Incorrect. According to AU-C Section 530, tolerable misstatement is a monetary amount set by the auditor.
The auditor seeks to obtain an appropriate level of assurance that the actual misstatement in the population the
actual misstatement in the population does not exceed this amount.
d. Incorrect. When a planned substantive test is not applicable to a selected item, auditors are required to
select a replacement item.
6. a. Incorrect. The reestimation in the current period of a prior period's accounting estimate does not call into
question the auditor's professional judgment made based on available information in prior periods. It may, rather,
be the result of estimation uncertainty.
b. Incorrect. The difference between the outcome of an accounting estimate and the amount originally
recognized or disclosed does not necessarily indicate a misstatement in the prior period's financial statements. It
may, rather, be the result of estimation uncertainty.
c. Correct. The definitions in AU-C Section 540 state that both accounting estimates and their related
disclosures are subject to an inherent lack of measurement precision. This inherent lack of precision is
known as estimation uncertainty.
d. Incorrect. The reestimation in the current period of a prior period's accounting estimate does not necessarily
indicate a management bias, but may rather be the result of estimation uncertainty.
7. a. Incorrect. AU-C Section 550 requires auditors to obtain evidence that significant related party transactions
outside the normal course of business have been properly authorized and approved.
b. Correct. Auditors have a responsibility under AU-C Section 550 to communicate to those charged with
governance significant findings and issues concerning related parties. However, this communication
would seldom be made immediately upon discovery of such a transaction. Auditors would ordinarily
perform further audit procedures on the transaction before concluding that this communication was
appropriate.
c. Incorrect. AU-C Section 550 requires auditors to inspect underlying contracts or agreements to evaluate
whether the business rationale for such a transaction suggests that it may have been entered into for fraudulent
purposes.
8. a. Incorrect. The absence of a reference in an auditor's report to substantial doubt about going concern is not
a guarantee of the entity's ability to continue as such. This is so because auditors cannot always predict future
events or conditions that may cause going concern problems.
b. Incorrect. AU-C Section 570 contains no requirement for auditors to design special procedures to detect
conditions that indicate substantial doubt about going concern. Risk assessment procedures and the further
audit procedures designed to gather evidence in response to them are normally expected to be sufficient for this
purpose.
c. Incorrect. AU-C Section 570 defines a reasonable period of time as a period not to exceed one year after the
date of the financial statements, rather than the date of the auditor's report date.
d. Correct. AU-C Section 570 applies to audits of financial statement audits prepared using special
purpose frameworks such as the cash or tax basis, as well as to general purpose frameworks such as
GAAP.
9. a. Correct. Auditors have grounds for either withdrawing from an audit engagement or disclaiming an
opinion when they have sufficient doubt about management's integrity to conclude that their written
representations are not reliable.
b. Incorrect. For purposes of AU-C Section 580, the financial statements, the assertions therein, and supporting
books and records are defined as being outside of management's written representations.
c. Incorrect. When management does not provide written representations, auditors can either withdraw from the
engagement or disclaim an opinion.
d. Incorrect. The representations should be dated as of the date of the auditor's report.
2. a. Correct. The new fraud diamond holds that predators do not require pressure, only a proclivity to
commit fraud, or a "criminal mind-set." Similarly, such people are typically arrogant and require no
rationalization for their actions.
b. Incorrect. Ideology and coercion are elements of the "MICE" model. Neither figures explicitly in the new fraud
diamond.
c. Incorrect. Capability is the fourth element in the original fraud diamond. Personal integrity is one of the
elements of the fraud scale. Neither figures explicitly in the new fraud diamond.
3. a. Incorrect. Recent malpractice claims illustrate that the public tends to hold a much more inclusive view of
the auditor's responsibilities for fraud detection than is either prescribed by professional standards or perceived
by the auditor.
b. Correct. Recent malpractice claims suggest that the public, or at least some members of the public,
think that an unqualified audit opinion is an indemnification against losses from fraud. This perception
must often be addressed within the legal system even though it is clearly not supported by the
requirements of professional standards.
c. Incorrect. As both a proactive measure to avert misunderstandings, and as a defensive measure when
misunderstandings nevertheless arise, clear communication between the auditor and the client regarding the
auditor's responsibilities for fraud detection is essential. The communication needs to be documented as well.
d. Incorrect. Claims arising from the Madoff case illustrate that auditors sometimes get sued even when they
have adhered strictly to professional standards.
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