Section 404 Audits Sarbanes-Oxley Act section 404 chapter 10 Section 404 Audits Sarbanes-Oxley Act section 404

Societe Generale junior trader gambled more than the entire net worth of the bank

JP Morgan Chase

Committee of Sponsoring Organizations National Commission on Fraudulent Financial Reporting the “Treadway Commission” 1987 Committee of Sponsoring Organizations “COSO”

organizations that sponsored the Treadway Commission COSO Committee of Sponsoring Organizations organizations that sponsored the Treadway Commission American Institute of Certified Public Accountants American Accounting Association Institute of Internal Auditors Institute of Management Accountants Financial Executives Institute

Mandeep how does COSO define internal controls ?

COSO internal controls day 1 handout Internal control is a process, effected by those charged with governance, management, and other personnel that is designed to provide reasonable assurance about the achievement of the entity’s objectives with regard to the reliability of financial reporting effectiveness and efficiency of operations compliance with applicable laws and regulations

Foreign Corrupt Practices Act 1977 any corporation that has a class of securities registered, or that is required to file reports under the Securities and Exchange Act of 1934

U.S. Code TITLE 15--COMMERCE AND TRADE CHAPTER 2B SECURITIES EXCHANGES

(ii) transactions are recorded as necessary (2) Every issuer pursuant to section 78l or … shall– make and keep books, records, and accounts, which, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the issuer; (B) devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that– (i) transactions are executed in accordance with management's general or specific authorization; (ii) transactions are recorded as necessary to prepare financial statements in conformity with GAAP, to maintain accountability for assets; (iii) access to assets is permitted only in accordance with management's general or specific authorization; and (iv) the recorded accountability for assets is compared with the existing assets at reasonable intervals and appropriate action is taken with respect to any differences; and

Sarbanes-Oxley Act 2002 § 7262. Management assessment of internal controls (a) Rules required The Commission shall prescribe rules requiring …. an internal control report, which shall— (1) state the responsibility of management for establishing and maintaining an adequate internal control structure and procedures for financial reporting; and (2) contain an assessment, as of the end of the most recent fiscal year of the issuer, of the effectiveness of the internal control structure ... (b) Internal control evaluation and reporting …, each registered public accounting firm that …issues the audit report for the issuer shall attest to, and report on, the assessment made by the management of the issuer.

PCAOB auditor’s report on internal control We have audited internal control over financial reporting as of Dec. 31, 2013, based criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). MMC’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company's internal control over financial reporting based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audits of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinion. A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, MMC maintained, in all material respects, effective internal control over financial reporting as of December 31, 2013, based on COSO criteria.

Rachel Which section of the auditing standards most directly discusses internal controls?

Johanna Why are auditors required to understand the client’s internal controls?

AU-C 315 Understanding the Entity & Its Environment & Assessing RoMM .03 The objective of the auditor is to identify and assess the risks of material misstatement, whether due to fraud or error, at the financial statement and relevant assertion levels through understanding the entity and its environment, including the entity's internal control, thereby providing a basis for designing and implementing responses to the assessed risks of material misstatement.

Brianna what is the definition of control risk?

Control Risk The risk that a misstatement that could occur in an assertion about a class of transaction, account balance, or disclosure and that could be material, either individually or when aggregated with other misstatements, will not be prevented, or detected and corrected, on a timely basis by the entity's internal control.

Denise Discuss reasonable assurance.

Reasonable Assurance Reasonable assurance. In the context of an audit of financial statements, a high, but not absolute, level of assurance.

Clint Under Sarbanes-Oxley management must report on the effectiveness of the company’s internal controls. With Regard to Internal Controls, what STATEMENTS must MANAGEMENT include in their annual report ?

Section 404 of Sarbanes-Oxley management must make the following statements page 159 1 management is responsible for effective internal controls over financial reporting 2 management’s assessment of the effectiveness of the internal controls 3 the framework used to evaluate the effectiveness of the internal controls

Evaluate the Effectiveness management must evaluate the design of internal controls management must test the operating effectiveness of those controls

Erin what framework will management use to evaluate the effectiveness of internal controls?

Joseba In the standard unmodified audit report What is management’s responsibility with regard to the financial statements?

Management’s Responsibilty Management is responsible for the preparation and fair presentation of these financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error.

Controls over Sig Classes of Transactions

AU-C 315 The objective of the auditor is to identify and assess the risks of material misstatement, whether due to fraud or error, at the financial statement and relevant assertion levels through understanding the entity and its environment, including the entity's internal control,

Page 160 (Design of Internal Control) Risks related to all relevant assertions Evaluating Significant classes of transactions Identify points in the transactions where material misstatements could occur Identify how each significant class of transactions Initiated Authorized Recorded Processed through the accounting system Reported in the financial statements and disclosures

AU-c 315.84 the accounting system Procedures and records designed to Initiate, authorize, record, process, and report entity transactions Maintain accountability for the assets, liabilities & equity Transfer information to the general ledger Capture information other than transactions that is relevant to the financial statements. e.g. depreciation and amortization of assets, changes in the recoverability of receivables. Ensure information that is required to be disclosed is accumulated, recorded, processed, summarized, and appropriately reported in the financial statements. transactions adjusting journal entries disclosures

Makinzie In the standard unmodified audit report What is the auditor’s responsibility?

Auditor’s Responsibilty Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor's judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity's preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity's internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.

Auditors must document their understanding

The classes of transactions that are significant page 160/169 The classes of transactions that are significant Procedures by which those transactions are: Initiated, authorized & recorded what accounting records exist, Processed through the accounting system into the GL, and reported in the financial statements. How the info system captures other events that are significant to the financial statements Reporting process used to prepare the financial statements, including significant estimates and disclosures.

COSO – 5 components of internal control Naomi COSO – 5 components of internal control what are the five components of the internal control framework ?

COSO components of internal controls Control environment Risk assessment Control procedures Information and communication Monitoring

COSO components of internal controls Control environment Risk assessment Control procedures Info & Comm --- Accounting System is part of Monitoring

1. Control environment management’s integrity and ethical values commitment to competence board of directors and audit committee management’s philosophy & operating style organizational structure human resource policies and practices page 163

1. Control environment – Audit Committee Bd of Directors - Audit Committee – Outside Directors Appointment of auditors Resolve differences between management and auditors Oversight of internal audit Approval of non-audit services by auditor page 163

COSO components of internal controls Control environment Risk Assessment (p 165) Control procedures Information and communication Monitoring

2. Risk assessment How does the audit client manage risk? Internal control is a process, effected by those charged with governance, management and other personnel that is designed to provide reasonable assurance about the achievement of the entity’s objectives in the following three categories: Focus on risk oversight page 89

Saul what can you assume when the Expected Rate of Return for an investment or project exceeds the interest rate on gov’t insured savings accounts ?

business is about managing risk otherwise companies should invest their money in gov’t insured savings accounts companies invest in risky assets and the auditors must understand how the company manages risks to convert those assets into cash receipts

COSO Enterprise Risk Management Internal environment Objective Setting Event identification Risk assessment Risk response Control activities procedures Information and communication Monitoring

COSO components of internal controls Control environment Risk assessment Control procedures Information and communication Monitoring

3. Control Procedures Adequate segregation of duties Proper authorization of transactions & activities Adequate documents & records Physical controls over assets & records Independent checks on performance

The classes of transactions that are significant page 160/169 The classes of transactions that are significant Procedures by which those transactions are: Initiated, authorized & recorded what accounting records exist, Processed through the accounting system into the GL, and reported in the financial statements. How the info system captures other events that are significant to the financial statements Reporting process used to prepare the financial statements, including significant estimates and disclosures.

3. Control Procedures Must separate p. 166 Custody of Assets from Accounting (Record-Keeping) Authorization of Trx from Custody of Related Assets Operational Responsibility from Record-Keeping IT Duties from User Departments

3. Control Procedures Must separate Custody of Assets Authorization of Transactions involving those assets Record-Keeping

3. Control Procedures Adequate documents and records Pre-numbered documents Checks Purchase orders Shipping documents

Stephanie if you discover a check that was not recorded to which financial statement assertion does an unrecorded check relate ?

COSO components of internal controls Control environment Risk assessment Control procedures Information and communication Monitoring

4. Information & Communication / Monitoring Account balances are used to prepare external financial statements Internal reports are part of management’s feedback for Monitoring operations

COSO components of internal controls Control environment Risk assessment Control procedures Information and communication Monitoring

5. Monitoring Internal audit Compare reports with your knowledge of the business Customer complaints Vendor complaints Regulators’ reports Periodic reconciliations

Understanding Internal Controls Obtain an understanding of internal controls The design of internal controls Document understanding Assess Control Risk (preliminary) Test Operating Effectiveness of controls Assess Control Risk (after ToC’s)

The classes of transactions that are significant page 160/169 The classes of transactions that are significant Procedures by which those transactions are: Initiated, authorized & recorded what accounting records exist, Processed through the accounting system into the GL, and reported in the financial statements. How the info system captures other events that are significant to the financial statements Reporting process used to prepare the financial statements, including significant estimates and disclosures.

How –gain an understanding Internal Controls Internal Control Questionnaire p. 172 Prior year’s work papers p. 174 Inquiries of client Examine documents Observe activities – Perform Walkthroughs

Internal Controls Questionnaire p. 173 Recorded sales are for shipments actually made to existing customers Existing sales transactions are recorded Recorded sales are for the amount of goods shipped and are correctly billed and recorded Sales transactions are properly included in master files and correctly summarized Recorded sales transactions are properly classified Sales are recorded on the correct dates

Internal Controls Questionnaire p. 173 (62-161)-176-207-252 Recorded sales are for shipments actually made to existing customers Existing sales transactions are recorded Recorded sales are for the amount of goods shipped and are correctly billed and recorded Sales transactions are properly included in master files and correctly summarized Recorded sales transactions are properly classified Sales are recorded on the correct dates Occurrence Completeness Accuracy Classification Cutoff

Page 59

Document- our understanding of Internal Controls Internal Control Questionnaire p. 173 Narative Flowchart

Must assess Control Risk for each fin statement assertion for each sig class of transaction

Control Risk Matrix p. 176 Look at the headings of the columns Audit Objectives / Assertions Must have a control(s) in place for each assertion / objective

see p. 176 Control Risk Matrix p. 252

Tests of Controls if a control is well designed test if control is operating effectively

Internal Control Communications

Adrian what is a Control Deficiency? page 176 --- look at the last 2 lines in Figure 5

Control deficiency (day one handout) when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to prevent, or detect and correct misstatements on a timely basis

Control deficiency if a control is not properly designed Or well designed control may not operate as designed or the person performing the control is not sufficiently qualified

Alyxandria what is a Material Weakness in internal control?

Material weakness A deficiency, or a combination of deficiencies, in internal control, such that there is a reasonable possibility that a material misstatement of the entity's financial statements will not be prevented, or detected and corrected, on a timely basis.

David what is a Significant Deficiency in internal control ?

Significant deficiency A deficiency, or a combination of deficiencies, in internal control that is less severe than a material weakness yet important enough to merit attention by those charged with governance.

Material weakness

Communications regarding Internal Control Reportable Conditions significant deficiencies material weaknesses Those charged with governance of the company audit committee board of directors senior management

Effectiveness of Internal Controls and Audit Approaches

for private companies non-SEC companies not covered by Sarbanes-Oxley

Emmanuel After evaluating the design of the controls you do not believe the client’s controls would prevent, or detect and correct misstatements even if properly implemented You believe the controls are INeffective How will you preliminarily assess CR ?

Kyle After evaluating the design of the controls you do not believe the client’s controls would prevent, or detect and correct misstatements even if properly implemented You believe the controls are INeffective You preliminarily assess CR = High Which audit approach will you take?

Laura You believe it would cost less to perform Tests of Contols than $ubstantive Test$ which audit approach will you take ?

Lauren Which types of audit tests will you perform Tests of Controls evaluate design of controls Tests of Controls test operating effectiveness none some extensive Substantive Tests analytical procedures test of details of account balances none limited extensive

Raquel After evaluating the design of the controls you believe the client’s controls would prevent, or detect and correct misstatements if properly implemented You believe they would be Effective if implemented How will you preliminarily assess CR ?

Sumner After evaluating the design of the controls you believe the client’s controls would prevent, or detect and correct misstatements if properly implemented You believe they would be Effective if implemented You preliminarily assess CR = Low Which audit approach will you take?

Ariana You believe it would cost less to perform Tests of Contols than $ubstantive Test$ which audit approach will you take ?

Haley Which types of audit tests will you perform Tests of Controls evaluate design of controls Tests of Controls test operating effectiveness none some extensive Substantive Tests analytical procedures test of details of account balances none limited extensive

After evaluating the design of the controls you believe the client’s controls would prevent, or detect and correct misstatements if properly implemented You believe they would be Effective if implemented

Iris You believe it would cost less to perform $ubstantive Test$ than Tests of Contols which audit approach will you take ?

Jake Which types of audit tests will you perform Tests of Controls evaluate design of controls Tests of Controls test operating effectiveness none some extensive Substantive Tests analytical procedures test of details of account balances none limited extensive

for private companies non-SEC companies not covered by Sarbanes-Oxley

Must do extensive Subst Tests preliminarily assess Subst Tests Less costly than ToC controls effective (CR =Low) extensive limit subst tests => analytical procedures ineffective (CR = MAX) Must do extensive Subst Tests

Understand internal controls Document understanding Evaluate the design of the controls Preliminarily assess control risk Document prelim CR assessment If CR < Low & $ToC < $Sub$t Tests Design and perform ToC Document results of ToC and CR assessment Design and perform limited Subst Tests Document results of Subst Tests If CR = Max or $Sub$t < $ToC Design and perform extensive Subst Tests

for public companies SEC companies covered by Sarbanes-Oxley

Joyce After evaluating the design of the controls you believe the client’s controls would prevent, or detect and correct misstatements if properly implemented You believe they would be Effective if implemented How will you preliminarily assess CR

Maria After evaluating the design of the controls you believe the client’s controls would prevent, or detect and correct misstatements if properly implemented You believe they would be Effective if implemented You preliminarily assess CR = Low Which audit approach will you take?

Mitch You believe it would cost less to perform Tests of Contols than $ubstantive Test$ which audit approach will you take ?

Abhinav Which types of procedures will you perform Tests of Controls evaluate design effectiveness Tests of Controls test operating effectiveness none some extensive Substantive Tests analytical procedures test of details of account balances none limited extensive

Albert You believe it would cost less to perform $ubstantive Test$ than Tests of Contols which audit approach will you take ?

Emily Which types of procedures will you perform Tests of Controls evaluate design effectiveness Tests of Controls test operating effectiveness none some extensive Substantive Tests analytical procedures test of details of account balances none limited extensive

Hailey After evaluating the design of the controls you do not believe the client’s controls would prevent, or detect and correct misstatements even if properly implemented You believe the controls are INeffective How will you preliminarily assess CR ?

Jesse After evaluating the design of the controls you do not believe the client’s controls would prevent, or detect and correct misstatements even if properly implemented You believe the controls are INeffective You preliminarily assess CR = High Which audit approach will you take?

Jordan You believe it would cost less to perform Does it matter which types of tests are least expensive? which audit approach will you take ?

Phil Which types of audit tests will you perform Tests of Controls evaluate design effectiveness Tests of Controls test operating effectiveness none some extensive Substantive Tests analytical procedures test of details of account balance none limited extensive

analytical procedures preliminarily assess Subst Tests Less costly than ToC controls effective (CR < Low) can limit subst tests analytical procedures ineffective (CR = MAX) must do some ToC Extensive Subst Tests Tests of Details

Understand internal control structure Document understanding Evaluate the Design Effectiveness of ICS Design and perform ToC to assess CR Document results of ToC and CR assessment If CR > Low Design and perform extensive Subst Tests Document results of Subst Tests

Audit Documentation Workpapers Must document Record of compliance with GAAS

109 AICPA Statement on Auditing Standards Understanding the December 2006 Statement on Auditing Standards 109 AICPA Understanding the Entity and its Environment and Assessing the Risks of Material Misstatement

Assessing CR < Max

Assessing control risk Identify: specific control objectives (assertions) points in the flow of transactions where specific types of misstatements could occur specific controls procedures designed to prevent or detect these misstatements Evaluate the design of control procedures perform tests of the operating effectiveness of controls

For each significant class of transactions For each Management Assertion we will need to assess CR If we assess CR < Max for an Assertion must identify a Control Procedure (strength) Then design & perform a Test of Controls to see if that Procedure is effective

credit sales

Accounts receivable Sales occurrence

Accounts receivable Sales completeness

Accounts receivable Sales accuracy

Assess control risk Identify: significant classes of transactions objectives assertions points where errors or fraud could occur specific controls that would prevent or detect these errors Link specific controls with the assertions to which they relate Evaluate the design of the control Test the operating effectiveness of the control