Dr. Raymond N. Johnson, CPA MODERN AUDITING 7th Edition Developed by: Raymond N. Johnson Portland Sate University John Wiley & Sons, Inc. William C. Boynton California Polytechnic State University at San Luis Obispo Raymond N. Johnson Portland State University Walter G. Kell University of Michigan

Dr. Raymond N. Johnson, CPA Understanding Assertions Transaction class Account balances Disclosures

Dr. Raymond N. Johnson, CPA Understanding the Business and Industry Key Questions –How material is the transaction class to the audit client? –What business risks exist within the transaction class? –What expectations do you have regarding industry norms? Business practices Expected controls Expected ratios

Dr. Raymond N. Johnson, CPA Understanding the Business and Industry Example Industries Retail grocery Household appliance manufacturer Computer manufacturer Hotel / Resort School district Key Issues Significance of transaction class Business risks Expectations –Business practices –Controls –Ratios

Dr. Raymond N. Johnson, CPA Audit Risk Model AR = IR x CR x AP x TD 1.Assess IR 2.Consider preliminary audit strategy 3.Perform analytical procedures 4.Evaluate internal controls 5.Assess TD and perform remaining substantive tests

Dr. Raymond N. Johnson, CPA Inherent Risk Purchases and accounts payable –“Short-term” completeness problems Inventory –Net realizable value of inventory –Obsolete inventory –Overstatement of inventory to overstate profits Payroll –Employee fraud and payroll overstatements

Dr. Raymond N. Johnson, CPA Analytical Procedures Accounts payable –AP Turns –Evidence of understated payables Inventory –Inventory turns –Inventory growth relative to CGS –Manufacturing inputs to finished goods output –Quality control Payroll –Average payroll in key employee classes –Payroll costs per units of output (accomplishment) –Benefits and taxes to gross payroll

Dr. Raymond N. Johnson, CPA 5 Elements of Internal Control Control Environment Risk Assessment Information and Communication Control Activities Monitoring

Dr. Raymond N. Johnson, CPA Control Environment Establishes the tone that ensures a high level of control consciousness Establishes a tone of accountability for use of resources You must assume a strong control environment to place reliance on specific control activities

Dr. Raymond N. Johnson, CPA Control Activities Authorization Segregation of duties Safeguarding of assets Information processing controls –Computer general controls –Computer application controls Performance reviews

Dr. Raymond N. Johnson, CPA Direct Tests of User Controls Figure 10-2

Dr. Raymond N. Johnson, CPA Low CR Assessment based on Application Controls Figure 10-2

Dr. Raymond N. Johnson, CPA High CR Assessment based on Application Controls Figure 10-2 Inference

Dr. Raymond N. Johnson, CPA Designing or Evaluating Computer Application Controls Understand key functions –Initiating transactions –Delivery or receipt of good or services –Recording transactions –Consideration

Dr. Raymond N. Johnson, CPA Purchasing Understand key functions –Initiating transactions Purchase requisition Purchase order –Delivery or receipt of good or services Receiving report –Recording transactions Vendor’s invoice Voucher –Consideration Check

Dr. Raymond N. Johnson, CPA Inventory Understand key functions –Initiating transactions Production order Material requirements report –Delivery or receipt of good or services Materials issue slip Time ticket Move ticket –Recording transactions Daily production activity report Completed production activity report

Dr. Raymond N. Johnson, CPA Payroll Understand key functions –Initiating transactions Personnel authorization –Delivery or receipt of good or services Clock card Time ticket –Recording transactions & consideration Payroll register (journal) Payroll Check (from imprest bank account)

Dr. Raymond N. Johnson, CPA Substantive Tests Initial procedures –Understand the business and industry –Test accuracy of data provided for audit Analytical procedures Tests of details of transactions Tests of details of balances Tests of details of balances – accounting estimates Procedures required by GAAS Tests of presentation and disclosure

Dr. Raymond N. Johnson, CPA CHAPTER 15 AUDITING THE EXPENDITURE CYCLE

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