 Hello, and welcome to this session in which we will discuss engagement wrap-up, which is part of completing the audit. Now we are toward the end. We have certain procedures. We have certain steps we have to undertake in order to close wrap-up the audit. So once the auditor completed the audit procedures regarding loss contingencies and subsequent event, now they are ready to conclude the audit. Now we are ready to conclude. At this stage, at this stage, this is the final opportunity for the team to do what? To assess the gathered evidence. Why? At this point, we learned so much about the company throughout the audit. Now we have a better picture of the company itself. Now we can form an opinion on the financial statements and decide what type of opinion we are going to issue. But few remaining tasks remain on hand that we have to complete, and those are the final analytical procedures, AP. Now you might be saying, hold on a second. I think we did the analytical procedures. Yes, we did the analytical procedures during the risk assessment at the beginning of the audit. We also conducted analytical procedures throughout the audit. That was an optional step. At the end, we have to do the final analytical procedures. We have to evaluate audit findings, and we're going to have a lot of findings. And as a result of evaluating the audit findings, we are going to reassess materiality because that could change. We are at the end of the audit. We know so much about the company. We might reassess the audit risk, which is inherent risk, control risk, fraud risk. We're going to have final evaluation of this. Also, we are going to evaluate the statements found during the audit. In this session, I'm going to focus on one, a little procedures, and two, and two, I'm only going to discuss reassessing materiality or reassessing audit risk. The third point, which is evaluating the statement found during the audit, would merit its own recording because it's important that you understand this topic, especially for the CPA exam inside out. Also, we're going to finalize the working paper. We're going to perform an engagement quality review, and we're going to complete the documentation for the audit. And I will have different session for these topics. Let's go ahead and get started with final analytical procedures. Before we proceed any further, I have a public announcement about my company, farhatlectures.com. Farhat Accounting Lectures is a supplemental educational tool that's going to help you with your CPA exam preparation, as well as your accounting courses. My CPA material is aligned with your CPA review course, such as Becker, Roger, Wiley, Gleam, Miles. My accounting courses are aligned with your accounting courses, broken down by chapter and topics. My resources consist of lectures, multiple choice questions, true-false questions, as well as exercises. Go ahead, start your free trial today. What are analytical procedures? Because analytical procedures, as I mentioned, they are used during risk assessment, which is at the beginning of the audit. During the audit, as a response, again, this is an optional step. And this is a required step toward the end. Analytical procedures are ratios analysis, connecting financial with non-financial data, looking at trend, looking at industry standard. Analytical procedures are cheap, but an effective and a very strong method in learning about red flags and learning about the company. So in the final stage, the procedures confirm whether the financial statements align with the auditor revised expectation. What happened here is this. Basically, we have quasi-definal numbers. Now we are running the analytical procedures again. And we already know we have certain expectation in mind. We're going to see, those are the expectation, those are the actual analytical procedures. Do they align or is there a discrepancy between them based on the evidence that we collected throughout the audit? For example, an auditor may expect a lower value for inventory after recommending and witnessing an adjustment to account for this account for absolute inventory. Well, if throughout the audit, we notice we needed to write down a lot of inventory, well, we accept inventory to have a lower percentage of sales or of current assets. Well, is this really true when we run the analytical procedures? Also, keep in mind, analytical procedures take into account industry trend. For example, if the revenue is declining in the computer manufacturing industry, well, we expect that revenue will decline if we are auditing a computer manufacturing company. So that also considered part of the analytical procedures. And any inconsistencies between what we expect as auditors in the final financial statement would require us to do what? Take a look at additional audit procedures to gather more evidence to reduce the risk of material misstatement at acceptable levels. Something is not right. I mean, believe me, guys, I know you might be, you know, if you're studying for the CPA exam, just believe me. And if you are a seasoned auditor, you know this, that if you audit the company for one to two years or more, looking at analytical procedures, it will tell you exactly what's going on within the company. If you understand the company, it's a very, as I mentioned, cheap or cost effective way to learn about any misstatement or red flags real quick. Now, the specific procedures that you would utilize, depending on the auditor's judgment, how much work you have to do, and also depend on the client. Then we have to do what? After we do the final analytical procedures, we have to evaluate the audit findings. And evaluating the audit findings would involve us to be involved in three different things. Orators engage in the following activities. One, we assess materiality that we made throughout the audit. And that materiality was said at the beginning was was changed maybe throughout the audit. And at the end, it could be assessed as well. We are going to reassess the audit risk, considering the finding throughout the audit, which include inherent risk, control risk, and fraud risk. And we are going to assess, evaluate the identified misstatements discovered during the audit. And this will be a separate session by itself. Starting with the assessing materiality, which is basically final evaluation of the materiality. Now, during the audit, conclusion, auditory assess the initially determined materiality level to ensure it's suitable based on the procedure outcome. Why? Because at the beginning, we set materiality at a certain number. Now, during the audit, we might have revised it. Why? Because we learned about the company. How? Well, we conducted analytical procedures. We did test of detail. Then we learned. We learned whether we were correct at the beginning or we need to increase or reduce materiality. We are aware of new information. This is what I'm trying to say. That could lead to a different materiality determination. Because at the beginning, we kind of not guessed it. We did our best judgment. Let's take a look at the revised materiality example, just to show you why would it be material. Why will be revised? During an audit of a manufacturing company, we set materiality initially at 100,000. And this is based on the company's financial statements, ratios, industry benchmark, our own judgment. However, during the course of the audit, what did we do? We discovered that this company is facing significant lawsuit related to a defective product that could potentially result in substantial financial losses. Is this new information? Yes, it is. So what do we have to do upon learning this new information? Well, we're going to realize that there's a larger, could be a larger impact on the financial statement. So what do we do? We revise materiality. We revise materiality to 50,000. Why? To appropriately reflect the consequences of this lawsuit that we were not aware of. This is an example. You could have all sorts of new information that you learn about. Then you're going to adjust your audit procedures accordingly. You might increase your examination of anything lawsuit related, legal expenses, any related disclosure to ensure the financial statements provide fair and accurate representation of the company's financial position. So by lowering materiality here, you were able to focus more on specific areas. Remember, when you lower materiality, you have to do more work. You can no longer tolerate mistakes. And we learned about materiality in a different session, but lowering means you have to do more work, more audit procedures to address the potential risk and ensure financial statements are reliable. So revising materiality is the first step in audit findings. The second step is evaluating inherent risk, control risk and fraud risk. Same concept in the audit planning stage, you evaluate it inherent risk, control risk, component, control risk fraud, audit fraud, everything at the beginning. But that's based on what you knew about the company, what you learned, especially if you're a new auditor. So this was the initial assessment, considering whatever factor were available at that point. Now, you're going to have an ongoing evaluation. Why? Because as you work, as you do test of control, as you test the detail balances, you are going to learn more about the company. You are going to reassess inherent risk, control risk and fraud risk at the entity level, as well as transaction level. You're going to review control risk assessment at the entity level for significant changes in internal control. You know now more about the company than what you started with. And control risk reassessment is done after test of control. That's why you do test of control. And at the end, you have the big picture you would reassess. For example, during the audit of a manufacturing company, the auditor performs substantive procedures to test the accuracy of inventory balances. Well, they selected 50 inventory items for physical count and compare the recorded quantities in the accounting system or the actual count. Just basically count them. Let's take a look at what's recorded for those 50. Upon comparing the results, what did we find out? We find out significant discrepancies in the recorded quantities for approximately 30% of the sampled item. So 15 items were incorrectly recorded. Is this a serious problem? I would say it is. These discrepancies indicate potential overstatement in the inventory balance. Well, this is new information. This outcome surprises the auditor. Why? Because they had assessed the control environment for inventory as strong and performed test of control that indicated effective inventory management. So we thought initially internal control is good. We tested the internal control. We thought it's working properly. We relied on it. When we got to the substantive procedures, we selected 50 items. 15 of them were misstated. What do we have to do? We have to reassess. We have to reassess our initial assessment of the control risk. The first thing we do is we try to explain the possibilities explanation. You basically have to ask yourself whether you overlooked certain control weaknesses. You did not do a good job assessing the control risk. Or maybe the sample you selected was not representative. Or maybe internal tests performed were incorrect right from the beginning. We did not perform the test properly. Or maybe there was a change in the system or change in people operating the system. It could be any of these reasons, a combination of them. But we need to investigate further until we get to the right answer. The right answer means why, why, what went wrong. The auditor will decide to gather additional evidence by performing more detailed test of control related to inventory. We're going to go back and test those controls. We might review internal control procedures. Do they really have proper segregation of duties? Are they really reconciling the account with the accounting system? Do they have good physical access control to inventory? And we do all of this to do what? To identify deficiencies or breakdown in the internal control. What do we do next? Well, if the auditor find any significant control deficiencies such as, you know, lousy segregation of duties or weaker conciliation process, they'll have to conclude that the control risk for inventory is higher than what we initially thought. We're talking about Tahir about control deficiencies, which increase the risk of material misstatement. Remember, we have control deficiencies, or we might have many control deficiencies that could result to significant deficiencies or material weakness, or we could have, right, right, right from the get go a significant deficiency or a material weakness, which is a more serious problem. What are the significant deficiencies or material weakness? They indicate that the control in place may not effectively prevent or detect error or fraud in a timely fashion. We have serious problem here. In response, what do we have to do? Well, we have to do more work. Expand our substantive testing by selecting a larger sample for the physical count or whatever count we are doing, whatever procedures we are performing, inventory or something else. We might have to do more analytical procedures or perform substantive tests of detail to find out if there's any potential material misstatement in the inventory balance. Here we are blaming what? We are blaming internal control, basically, trying to find out what's the problem with the control. But what if something is fraud related? Now it takes us totally to a different level because now we look at the audit finding there's something wrong and it's a fraud related. If fraud is detected in an account or class of transaction, the materiality here is not an issue. We forget about materiality because fraud is rarely, is rarely isolated to one area. So once a fraud happened in one area, it most likely exists in some other area on the company. Discovery of fraud triggers the auditor to reassess the risk, materiality and how much work to do in terms of other procedures. Now, totally different ballgame. You put a different hat on. Previous assessment of management and employee integrity now are questioned and reviewed, especially if senior management is involved. And we're going to see why senior management is more risky when they are involved. Evaluation of the employee's scope of responsibilities is conducted. Are these people on the top involved in this? Why? Because if people on the top are involved, they might have many areas under their control. It means they have more room to commit fraud. For instance, if a divisional controller is responsible for prematurely recognizing revenue, well, that's a problem that we identify. But there's a good chance of their prematurely recognizing revenue and they are on the top and they're committing fraud in one area while they have the option, the opportunity to commit fraud in other areas. They might be also inclined to partake in other inappropriate practices to manipulate earnings such as capitalizing expenses that should be expensed. What we're talking about here? Well, we're talking about serious material misstatement here. Why? Because people who are committing the fraud are on the top. It doesn't mean if they're on the bottom, it's not, it's not, it's, it's, it's good. But on the bottom, they may not have as much opportunity as someone who's on the top or she's on the top. So the deduction of any fraud necessitates careful reassessment and investigation to address risk and potential impact on financial statement. So here the auditor will have to do more work to support their conclusion when there is fraud. So what to do when the fraud exists? What is the auditor's responsibility? Well, you have to report the fraud. To who? To management at a level above where the fraud occurred. So if it occurred, if it, if it's level three, you go one step above, you report it to level four. Okay. I'm sorry if, if, if, depending on what the level is, if four, three, two, one. So if this is the lowest level and it happened here, you report it to here. If it happens here, you report it to here. So the higher the number, the higher the level, the one level above. So what happened if senior management is involved in the fraud, then you would go to the people in charge of the company, the audit committee, board of directors, people who are in charge. Well, what if these people are involved? Well, you should have been involved in this audit in the first place, right? If you did your due diligence, then we'll see what you do. You might have to just let go and withdraw. But what's the responsibility of the people who are in charge, in charge? The audit committee, the board of directors, what do they have to do? They have to take appropriate action to address the reported fraud, investigate, do internal investigation. You know, you might have to include law enforcement agencies, depending on what type of fraud we are dealing with here. You might, they have to terminate certain employees involving in the fraud activities. Okay. Simply put, they have to take timely action to address the fraud. If no action is taken, well, then you should also withdraw, because if there is no action is taken, it means they're okay. They are tolerating the fraud. And as an auditor, you should not be associated with those people, management, or people in charge of governance. Now, what if the fraud is pervasive? It's large. It's all over the place. Well, the first thing I will consider is consider withdrawing. Okay. So if the auditor encounter pervasive fraud, or significant reputation impact that could hinder the completion of the audit procedures, I will withdraw from the engagement. I will seriously think about withdrawing. Okay. Obviously, you'll have to do some consultation internally, externally, with your legal team, with your legal console, with the audit firm, seek some legal advice to decide what to do. I will also ensure a thorough evaluation of the circumstances and the potential consequences. So what am I looking at here? Small fraud, medium fraud, is the government involved, regulatory agencies? I'll have to look at everything in the possible consequences. Also, you're going to inform the management. Of course, that's an assumed. If the auditor decided to withdraw, they will communicate their decision to the appropriate level of management, or those charged with governance, usually the audit committee. You have to let them know why you are withdrawing, detailed reasons for the withdrawal. Now, what do they have to do? Well, they have to report this. If a publicly traded company management is required to report the change of auditors and the reasons for the change to the SEC using for 8K. Now, they may not tell them it's a fraud. They may tell them it's a disagreement of some sort, but they have to report the reason. Okay. The reporting obligation ensure disclosure, transparency to regulatory authorities, and especially to shareholders, the owner of the company. So what we did in this recording is we looked at what tasks we need to complete at the end of the audit, which is the final analytical procedures, and you have to evaluate the audit findings. And specifically, as a result of this, you might have to reassess materiality. You have to reassess the audit risk, which is inherent risk control risk, basically determine whether the internal control is working properly. And you have to evaluate the misstatement found, misstatements found during the audit. And for the misstatements found during the audit, I will have a separate recording for this, because it does merit, in my opinion, a separate recording because it is important. What should you do now? Go to the FARHAT lectures, look at additional multiple choice, true, false, resources, notes that's going to help you understand and study for this topic, whether you are a CPA exam candidate, or you are an accounting student taken an auditing course. Good luck, study hard and invest in yourself.