Auditing Theory
mohala
Chap001_21e_Final.pptxChapter 01
The Role of the
Public Accountant
in the
American Economy
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Types of Services
Assurance Services--The broad range of information enhancement services that are provided by certified public accountants (CPAs). These services include:
Attestation Services—Increase the reliability of information
Other Assurance Services—Putting information into a form or context that facilitates decision making
NonAssurance Services
Tax Services
Management Consulting Services
Other
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Attest Engagements
To attest to information means to provide assurance as to its reliability
Attest engagement:
An examination, review, or agreed-upon procedures engagement performed under the attestation standards related to subject matter or an assertion that is the responsibility of another party
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Forms of Attestation Figure 1.2
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The Attest Function
Management
Subject
Matter
Suitable
Criteria
The CPA
Gathers
Evidence
Subject
Matter*
The Attest
Report
Issues
Report
*May be management’s assertion about the subject matter.
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Suitable criteria
Standards established or developed by groups of experts.
Example: Internal control audit – standards established by the Committee of Sponsoring Organizations (COSO) framework.
Example: Financial statement audit – for a financial statement audit suitable criteria are referred to as the “applicable financial reporting framework.” In the U.S. this is typically Generally Accepted Accounting Standards.
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*Applicable financial reporting framework
Audit of Financial Statements
Management
Prepares
Financial
Statements
Criteria*
(e.g., GAAP)
The
Auditors
Gathers
Evidence
Financial
Statements
The Auditors’
Report
Issues
Report
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Financial Statement Audit
Auditors gather evidence and provide a high level of assurance (referred to as reasonable assurance) that the financial statements follow GAAP, or some other appropriate accounting framework
Audit involves searching and verifying accounting records and examining internal and external evidence
Sufficient evidence is gathered to issue an audit report that states the auditors’ opinion
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Audit Evidence
Evidence focuses on whether financial statements are presented in accordance with GAAP; examples:
Balance sheet
All included assets and obligations exist
Includes all assets and obligations
Assets and obligations are properly valued
Income statement
Sales actually occurred
Sales have been recorded at appropriate amounts
Recorded costs and expenses are applicable to period
All expenses have been recognized
Financial statement amounts
Accurate, properly classified and summarized
Notes are informative and complete
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What Creates the Demand for Audits?
Audits lend credibility to information by reducing information risk, the risk that information is materially misstated.
Financial statement misstatements arise due to--
Accidental errors
Lack of knowledge of accounting principles
Unintentional bias
Deliberate falsification (fraud)
Audits do not directly address business risk, the risk that a company will not be able to meet its financial obligations due to economic conditions or poor management decisions.
United States v. Arthur Young—Supreme Court described the auditors’ role as being that of a public watchdog, requiring both total independence and complete fidelity to public trust.
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History of the Attest Function
| Period | Developments | Audit Objective | Nature of Audit |
| Ancient - 1850 | Audits of city states, individuals & ventures | Detection of fraud | Detailed; No reliance on controls |
| 1850-1905 | Industrial revolution resulted in the need for corporate audits | Detection of fraud & clerical errors | Some testing; No reliance on controls |
| 1905-1940 | Development of stock markets - increased emphasis on earnings | Determination of fairness; detection of fraud & errors | Increased emphasis on testing; Slight reliance on controls |
| 1940-1975 | Development of auditing standards | Determination of fairness | Substantial reliance on controls |
| 1975-1985 | Criticism by Congress; Increased self-regulation | Determination of fairness | Internal control determines scope of audit |
| 1985-1995 | Increased demands for reporting on compliance & internal control | Determination of fairness | Risk assessment determines audit scope; must assess risk of fraud |
| 1995-Present | Panel on Audit Effectiveness; Sarbanes-Oxley Act of 2002 | Determination of fairness | Business risk approach to audits |
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The Accounting Profession’s Credibility Crisis
2000—The Panel on Audit Effectiveness made a variety of suggestions to improve audits.
2001—Enron Bankruptcy
2002—WorldCom Fraud
2002—Sarbanes-Oxley Act Enacted
2003—Public Company Accounting Oversight Board began operations
2010—Dodd-Frank Act
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Other Types of Audits
Compliance Audits
Example: IRS audit of taxpayer’s return
Operational Audits
Example: Effectiveness of operations of receiving department of a manufacturing company
Integrated Audits
Example: Assurance on both the financial statements and effectiveness of internal control over financial reporting
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Other Types of Auditors
Internal Auditors
Government Accountability Office Auditors
Tax Auditors
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Internal Auditors
Employed by a company as employees
They often
Perform operational, compliance and internal control audits
Report to the audit committee of the board of directors and to another high-level management individual (usually the CEO)
The Institute of Internal Auditors is the international organization of internal auditors.
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Government Accountability Office Auditors (GAO Auditors)
Headed by the Comptroller General
Responsibility for supporting Congress
Perform
Compliance, operational and financial audits of government agencies
Examinations of corporations holding government contracts to verify contract payments have been appropriate
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Tax Auditors
Responsible for enforcement of tax laws of various sorts (e.g., state and federal income taxes, property taxes, sales taxes)
Internal revenue agents generally perform compliance audits of income tax returns
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AICPA’s Traditional Role
Establish Standards
Research and Publication
Continuing Professional Education
Self-Regulation
Note: Much of the standards setting and regulation roles relating to public companies (referred to as “issuers”) has been taken over by the SEC and the PCAOB.
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Establishes Standards—Examples
AICPA Auditing Standards Board
Issues official pronouncements on auditing and attestation matters for nonpublic companies (“nonissuers”)
Statements on Auditing Standards (SASs)
Statements on Standards for Attestation Engagements (SSAEs), which provides guidance for attesting to information other than financial statements such as financial forecasts
Accounting and Review Services Committee
Issues Statements on Standards for Accounting and Review Services (SSARS) which are standards for compilations or reviews, not audits of financial statements
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Research and Publication
Publications
Journal of Accountancy (monthly)
The Tax Advisor
Audit publications
Industry Audit and Accounting Guides
Audit Guides
Audit Risk Alerts
Other publications
Statements of Position
Accounting Trends & Techniques Products
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Continuing Professional Education
Necessary to fulfill the requirement for maintaining license to practice as a CPA
Offered by
AICPA
State societies
Other professional organizations
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Professional Regulation
Regulations of Individual CPAs
Code of Professional Conduct – ethical rules for CPAs
Requirements for regular membership in AICPA
Regulation of Public Accounting Firms
Peer reviews of a firm’s accounting and auditing practice must follow A ICPA Peer Review Program
CPA firms not registered and inspected by the PCAOB are subject to peer reviews administered by the State CPA Societies under the direction of the AICPA Peer Review Board
The AICPA National Peer Review Committee administers peer reviews of CPA firms registered and inspected by PCAOB
Center for Audit Quality works to foster high-quality performance
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The CPA Examination
Uniform national examination prepared and graded by the AICPA
Computerized exam includes multiple choice and simulations in four parts
Auditing and Attestation
Financial Accounting & Reporting
Regulation
Business Environment & Concepts
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State Boards of Accountancy
Issue CPA certificates
All boards require successful completion of CPA examination
Education and experience requirements vary
National Association of State Boards of Accounting (NASBA)
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Other Parties
FASB
Sets GAAP for entities other than federal, state and local governments
GASB
Sets accounting standards of financial accounting for state and local government entities
FASAB
Sets accounting standards for the US government
IFAC
Sets international accounting standards
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PCAOB Role
Adopt auditing, attestation, quality control, ethics, and independence standards relating to the preparation of audit reports for SEC registrants
Oversee and discipline CPAs and CPA firms that audit public companies (issuers), including:
Register firms
Perform inspections of firms
Conduct investigations and disciplinary proceedings of firms
Sanction registered firms
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Securities and Exchange Commission (SEC)
Agency of the US government
Oversight responsibility for the PCAOB
Objectives
Protect investors and public by requiring full disclosure of financial information by companies offering securities for sale to the public
Prevent misrepresentation, deceit, or other fraud in the sale of securities
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Registration and Regulation of the Sale of Securities by the SEC
Registration statements
Qualify securities for sales
Contains audited financial statements
Makes SEC major user of financial statements
Periodic reporting requirements, e.g., Form 10-Ks, Form 10-Qs, etc.
Regulation S-X
Sets forth basic accounting regulation
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Types of Professional Services
Attestation and Assurance
Tax
Consulting
Accounting
Personal Financial Planning
Litigation support
Fraud Investigation
Personal Financial Planning
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Organization of the Public Accounting Profession
Sole proprietorship
Partnerships
Professional Corporation
Limited Liability Partnership (LLP)
Limited Liability Company (LLC)
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Categories of Public Accounting Firms
Local
Regional
National
Big 4
Alternative Practice Structures
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Industry Specialization
Firms with detailed knowledge and understanding of a client’s industry
Helps firms
Be more effective at collecting and evaluating audit evidence
Make valuable suggestions to improve client’s operations
Provide client consulting services
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Typical Structure of a National CPA Firm
Partners
Managers
Seniors
Staff
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Responsibilities on an Engagement
Partner—Overall responsibility is to assure that the audit is performed in accordance with professional standards.
Manager—Supervise overall engagement.
Seniors—”In charge” auditor on a daily basis.
Staff—Work under the immediate supervision of the senior.
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