 Hello and welcome to the session in which we will discuss integrated audit and specifically one step and integrated audit And that is the top-down approach now in most CPA review courses They spend maybe two to five minutes on this top-down approach I would like to spend maybe 10 to 15 minutes to make sure you understand what we mean by the top-down approach So what is integrated audit integrated audit is this is basically a review It's auditing the financial statements and issuing an opinion on those financial statements And this is what we've been learning up to this point However, in addition to that auditing the internal control over financial reporting and issuing an opinion So on the prior session we learn how to plan the engagement We learn how to plan the engagement for an internal control auditing over financial reporting And remember from the auditor's perspective is to issue an opinion express an opinion How do we express this opinion? We plan the engagement which we already covered this topic in this session We will use the top-down approach, which is test heavily tested on the exam We test and evaluate the design of internal control test and evaluate the operating effectiveness Then we would form an opinion on the effectiveness of internal control Let's discuss the top-down approach a little bit more in the tails before we proceed any further I have a public announcement about my company far hat lectures dot com Farhat accounting lectures is a supplemental educational tool That's gonna 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. No obligation. No credit card required So the top-down approach is basically linking starting at the top and linking the entity financial statement controls or the entity level controls entity level controls, which is Controls that cover everything in the company, which is part of the financial statements level and we connect those to Significant accounts and we're gonna talk about what those are those significant financial statement accounts Then we connect the account to to their assertions and the accounts are generated from the transactions So we'll start at the top look at the most important controls Which is our entity level financial statement level control and drill down to the important accounts in the important accounts We would look at the other important assertions and the accounts are generated are derived from transaction Then we would look at the major classes of transaction. It looks something like this entity level controls Then significant account assertions then we drill down to the classes of transaction Now auditing the internal control is the same as the financial statement audit It's a risk-based approach. What does that mean? It means the higher the risk in a particular area the more work we have to perform the more evidence We have to collect so if we see evidence here on the entity level Then we have to spend more time more resources and it's a serious when the risk is on this level that will explain this So starting with what are entity level controls and this is heavily tested on the CPA exam The entity level control is basically the tone at the top You're dealing with the control environment if you remember one when we talked about internal control Part of it is the control environment and this is basically what we're talking about here What is the tone at the top? What's the role of the audit committee? Is it effective? Is the audit committee exercising oversight over financial reporting and internal control or are they passive? Are they active or are they passive? That's important. What is the integrity and the ethical value of senior management? Why is that important? Because if your manager or if your senior manager or people in charge of the company are not an ethical that will flow down What does that mean? If you think your boss is not ethical, you are more likely to commit an ethical act. Here's what happened 80% of the people let's see 10% 10% 10% and 80% 10% of the people will always do the right thing. This is what research shows This is bit of an exaggeration, but it nevertheless. It's a scientific research. So 10% will always do the right thing They're always good. They're always do the right thing 10% bad Okay, you cannot control. They're gonna be bad people out there and 80% guess what they follow Who do they follow? They follow the people above them So that's important that people above you senior level management are part of this 10% Because of the senior management are part of this 10% you know, you know what I mean bad It's mean an ethical. Okay, I'm just trying to use simple term to make the point So that's why senior management and top the people at the top are important also the board of directors How involved are they in the oversight of the internal control in the oversight of of financial reporting? How do the company assign control throughout the organization? Is this an important topic or not an important topic for management? also in addition to the General controls for the company we have to look at information technology general controls not only the controls for management also the control over our Accounting information system our information system in general when we develop a program do we have proper internal control to make sure the program has Good controls inside of it input control processing control output control when we make changes to a particular program Are we controlling those changes? Are we documenting? Evaluating making sure it makes sense Computer controls over processing do we have computer control over processing and that's usually part of the development stage Do we have an effective anti fraud program? Which is basically a monitoring program once you hear the word monitoring it's part of the entity level you're monitoring everything Do we have a corporate court of conduct that deals with conflict of interest a legal act? So on and so forth How do we supervise the period ending financial reporting process because that's extremely important? This is when we issue the financial statement. This is when things could go wrong because when you're trying to Close the books. This is when you try to commit fraud now all these controls are examples of Entity level entity level means these controls that you're seeing on the screen as well and as others that deals with the Monitoring and control and control environment. They are important It doesn't mean other controls are not important, but if you have an issue in your shipping department. Well, yes That's a problem But if you have a weak internal control or something does not working properly in the internal control in the shipping department It's only affecting shipping and sales Maybe you have problem with completeness. You're not recording all the sales. It could be an issue I'm not saying it's not but it's not entity level So the reason I I show you shipping as an example or purchasing to kind of compare and contrast of controls that affect all the Organization so if these if something happened to these control they affect everyone in the organization versus controls that affect a Part of the organization now once we identify those controls and deal with them The next thing we do is we have to identify significant accounts So what is cool? What is considered a significant account? Well an account that could be that could be subject to a misstatement that could possibly contain a misstatement and that Misstatement individually or an aggregate with other statement could have a material effect on the financial statement How do you know an account is significant? That's the definition now Different accounts will be will have Different importance for different companies, but what do you look at for the account? What are some description because we cannot identify accounts for example? We can always say cash is significant Why because cash the nature of it cash is important you can use it for everything usually it's a lot It could be have a large size volume of transaction is a lot It's not complex unless you are dealing with foreign currency or financial instruments, but for example cash will fit this qualification Also if the account is susceptible to loss due to error or fraud So if we can easily make a mistake in an account, it's significant again I cannot I cannot tell you this or that account because each company will have different significant accounts But all accounts usually are supposed to be considered significant important as long as they are large They affect other account their pervasive Exposure to losses if something goes wrong in this account What is our exposure to loss? Is it gonna create a significant significant? Contingent liability if something goes wrong with that account This is how did how we determine an account if significant or not. Is it a related party account? That's also significant. What about the changing account from period to period? So an account may not be Significant in one period then suddenly we have a large change an increase or a decrease Then we need to look into this account So again, I cannot tell you which account are significant The company will have to determine these accounts are important to us Why those are some of the reasons why they could be important to us now once we identify those accounts We examined the relevant assertions and we talked about the assertion existence or occurrence completeness valuation rights and obligation presentation and disclosure Depending on the account and we we covered this in a separate lesson same concept applies here Now remember accounts are derived from transactions now Also, we have to drill down to major classes of transaction again We are putting an adjective major important classes of transaction What are what are considered major classes of transaction transaction that influence significant financial statement account? Because remember the accounts are the product of the transaction your process of transaction the transaction update the account How do you know? How do we know an account is? How do we know a transaction is a major transaction? Well, if it involves estimate for estimating in this transaction, it's important like for We are estimating lower cost of market absolute inventory absolute inventory bet that warranties those become significant because They are subject to estimate any account that involve that you need a judgment significant judgment For example, certain revenue transaction if you are using percentage of completion, you have to estimate the cost That's a judgment. If you're selling software, you have to estimate Your total revenue. That's significant judgment if the transaction Requires specialized knowledge or expertise. For example, if you are dealing with derivatives financial instrument If you are dealing with value on gold or diamond or you are looking to see at what stage We are done with this computer software that requires specialized knowledge. You have to know programming. How far are we in? How far do we have left? So this is the classes of transaction. Let me go back to the original picture So notice we said transaction creates account and Accounts goes to the financial statements and we have entity control that basically if they're bad if we are bad here Everything will flow down, but this is what we mean by entity level. It starts at the top I'm sorry. This is what we by top-down approach. It starts at the top and it flows down What should you do now? You should go to Farhat lectures and work MCQs look at additional resources in the next session We would look at testing and evaluating the design and operating effectiveness of internal control I might combine those two. I may keep each one separate. I haven't decided yet, but we'll see study hard Good luck. Stay safe. The CPA exam is worth it. Invest in yourself