Auditing Theory
mohala
Chap002_21e_Final.pptxChapter 02
Professional Standards
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Three sets of auditing standards
AICPA (Auditing Standards Board) for nonpublic companies in US.
PCAOB for public companies in US
International Auditing Standards with differing levels of authority in the various countries
Three Sets of Auditing
Standards
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Public Company Accounting Oversight Board
Auditing, Attestation, Quality Control, Independence, Ethical Standards for audits of public companies
Registers and regulates auditors of public companies
American Institute of Certified Public Accountants
Auditing, Attestation, Quality Control, Independence, Ethical, Accounting and Review Standards for engagements involving nonpublic companies
Coordinates peer review programs for firms nonpublic attest practice
State Boards of Accountancy
License CPAs and CPA firms to practice in their jurisdictions
Authority of Organizations
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Regulation of the Public Accounting Profession Figure 2.1
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Principles Underling a GAAS Audit 1/6
Purpose of an audit
Premise of an audit
Personal responsibilities of the auditor
Auditor actions in performing the audit
Reporting the results of an audit
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Principles Underling a GAAS Audit 2/6
Purpose of an audit—Provide an opinion that financial statements are in accordance with the applicable financial reporting framework.
In the U.S. the framework is ordinarily GAAP.
The applicable framework corresponds to the “suitable criteria” of an attest engagement.
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Principles Underling a GAAS Audit 3/6
Premise of an audit—Management (and those charged with governance) have responsibility to:
Prepare financial statements in accordance with applicable financial reporting framework.
Provide auditors with needed information and unrestricted access to those in the entity.
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Principles Underling a GAAS Audit 4/6
Personal responsibility of the auditor—Appropriate competence and capabilities to perform audit in accordance with standards, including maintaining professional skepticism and exercising professional judgment throughout the audit.
Professional skepticism—A questioning mind and a critical assessment of audit evidence.
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Principles Underling a GAAS Audit 5/6
Auditor actions in performing the audit
Obtain reasonable assurance about whether financial statements are free from material error or fraud.
The auditor is unable to provide absolute assurance due to:
Nature of financial reporting.
Nature of audit procedures.
Need to conduct audit within a reasonable period of time.
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Principles Underling a GAAS Audit 6/6
Reporting the results of an audit—Express in a written report an opinion on findings (or statement that opinion cannot be expressed).
The opinion is on whether the financial statements are in accordance, in all material respects, with the applicable financial reporting framework.
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The GAAS Hierarchy Figure 2.4
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Auditor Responsibility for the Detection of Errors and Fraud (1/2)
Obtain information to assess inherent risks and fraud risks
Information about the company and its environment
Discussion among audit team members
Inquiries of management and others
Risk assessment analytical procedures, including those involving revenue
Assess the risk of errors and fraud that may cause the financial statements to contain a material misstatement.
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Auditor Responsibility for the Detection of Errors and Fraud (2/2)
Based on that assessment, plan and perform the audit to obtain reasonable assurance that material misstatements, whether caused by errors or fraud, will be detected.
Exercise due care in planning, performing and evaluating the results of audit procedures, and the proper degree of professional skepticism to achieve reasonable assurance that material misstatements due to error or fraud will be detected.
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Auditor Responsibility for Identifying Noncompliance with Laws and Regulations
Noncompliance with laws and regulations that could have a direct and material effect on financial statement amounts and disclosures—same as for errors and fraud. An audit obtains reasonable assurance of detecting noncompliance with these laws and regulations.
Other Laws and regulations (no direct effect on financial statement amounts):
Specific procedures:
Inquire of management as to compliance
Inspect correspondence with licensing or regulatory authorities
Be aware of possible noncompliance.
If information comes to the auditor’s attention, apply audit procedures directed at determining whether noncompliance has occurred. An audit does not provide assurance that noncompliance with these laws will be detected.
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Auditors’ Standard Report – Public Clients
Includes the words “Registered” and “Independent” in the title.
Must be addressed to shareholders and board of directors (additional parties are allowable).
References auditing standards of the PCAOB.
Provides a discussion of auditor and management responsibilities.
Includes a paragraph indicating that the auditors have also issued a report on the client’s internal control over financial reporting, or is a combined report on both the financial statements and internal control.
Includes a Critical Audit Matters Section.
Includes statement on year audit firm began serving the client.
Signed with name of CPA firm not individual partner
Includes the City of the office with responsibility for the audit
Dated no earlier than the date on which the auditors obtained sufficient appropriate audit evidence to support their opinion
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Opinion Paragraph
Opinion on the Financial Statements
We have audited the accompanying balance sheets of X Company (the “Company”) as of December 31, 20X7 and 20X6, the related statements of income, comprehensive income, stockholders’ equity, and cash flows, for each of the three years in the period ended December 31, 20X7, and the related notes [and schedules] (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 20X7 and 20X6, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 20X7, in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”) the Company’s internal control over financial reporting as of December 31, 20X7, based on Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated February 9, 20X8 expressed an unqualified opinion.
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Basis of Opinion
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
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Critical Audit Matters
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.
[Include critical audit matters]
Blue, Gray & Company Certified Public Accountants
We have served as the Company’s auditor since 20X0.
Los Angeles, California
February 9, 20X8
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Auditors’ Standard Report – Nonpublic Clients
Title that includes the word independent
Ordinarily addressed to the company itself, the shareholders, the audit committee and/or the board of directors
Signed with name of CPA firm not individual partner unless the firm is a sole practitioner
Dated no earlier than the date on which the auditors obtained sufficient appropriate audit evidence to support their opinion
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We have audited the accompanying financial statements of ABC Company, which comprise the balance sheets as of December 31, 20X1 and 20X0, and the related statements of income, changes in stockholders’ equity, and cash flows for the years then ended, and the related notes to the financial statements.
The AICPA Standard Auditors’ Report—Introductory Paragraph
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Management’s Responsibility for the Financial Statements
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.
The AICPA Standard Auditors’ Report—Management’s Responsibility Section
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The AICPA Standard Auditors’ Report— Auditors’ Responsibility Section
Auditor’s Responsibility
Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits 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 of 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. 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.
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Opinion
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of ABC Company as of December 31, 20X1 and 20X0, and the results of its operations and its cash flows for the years then ended in accordance with accounting principles generally accepted in the United States of America.
The AICPA Standard Auditors’ Report—Opinion Paragraph
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Other Types of Auditors’ Reports
Standard unmodified report (unqualified per PCAOB standards)
Financial statements follow GAAP and auditor does not add additional commentary for any issue
Other reports
Unmodified with emphasis of matter (or other emphasis)
Example: A lack of consistency in application of accounting principles
Qualified opinion
Scope limitation or departure from GAAP
Adverse opinion
Departure from GAAP so significant that financial statements as a whole are misleading
Disclaimer of opinion
Unable to arrive at an opinion due to a very significant scope limitation
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Applicability of SSAEs Figure 2.6
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Elements of Quality Control
Leadership responsibilities for quality within the firm (“tone at the top”)
Relevant ethical requirements
Acceptance and continuance of clients and engagements
Human Resources
Engagement performance
Monitoring
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QC Element 1: Leadership responsibilities for quality within the firm
Firm’s internal culture recognizes that quality is essential in performing engagements and recognizes the need to:
Perform work that complies with professional standards and regulatory and legal requirements, and
Issue reports that are appropriate in the circumstances.
Firm provides reasonable assurance that those assigned responsibility for quality control have sufficient and appropriate experience, ability, and authority.
Example: Assign management responsibilities so that commercial considerations do not override the quality of work performed.
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QC Element 2: Relevant ethical requirements
Firm and its personnel comply with relevant ethical requirements.
Example: At least annually, the firm should obtain written confirmation of compliance with its independence policies and procedures from all firm personnel who are required to be independent.
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QC Element 3: Acceptance and Continuance
Firm will undertake to accept and continue relationships and engagements only where the firm:
1. Is competent to perform the engagement.
2. Can comply with legal and ethical requirements.
3. Has considered client integrity.
Example: Background information is gathered on all prospective audit clients, including the attitude of principal owners, key management, and those charged with governance on matters such as aggressive accounting and internal control over financial reporting.
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QC Element 4: Human Resources
Firm has personnel with the capabilities, competence, and commitment to ethical principles to:
1. Perform engagements in accordance with professional standards and regulatory and legal requirements.
2. Enable the firm to issue reports that are appropriate in the circumstances.
Example: Design effective recruitment processes and procedures to help the firm select individuals meeting minimum academic requirements established by the firm, and maturity, integrity, and leadership.
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QC Element 5: Engagement Performance
Firm’s engagements are consistently performed in accordance with professional standards and regulatory and legal requirements, with policies and procedures addressing:
Engagement performance.
Supervision responsibilities.
Review responsibilities.
Example: Design policies and procedures that address the tracking of progress of each engagement.
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QC Element 6: Monitoring
Firm’s policies and procedures established to help ensure that the policies and procedures for the other elements are suitably designed and effectively applied.
Example: Communicate, at least annually, the results of monitoring to engagement partners and other appropriate individuals within the firm.
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Quality Control Procedures
Depend on size of firm, number of offices and nature of firm’s practices.
Every CPA firm should have quality control procedures applicable to every aspect of its practice.
Establish controls to provide assurance that the CPA firm meets its responsibilities to clients and public.
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Regulation of the Public Accounting Profession
Public Companies
Public Company Accounting Oversight Board
Registration of public accounting firms that audit public companies
Establish or adopt auditing, quality control, ethics, independence standards relating to audit reports for public companies.
Conduct inspections of public company practice of registered public accounting firms
Nonpublic Companies
AICPA & State Boards of Accountancy
Peer review for nonpublic practice segments of all CPA firms
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PCAOB
Composed of 5 members – only two may be CPAs
Members appointed by SEC and may serve no more than two five-year terms
All accounting firms that audit SEC registrants must register with PCAOB
Pledge to cooperate with PCAOB inquiries
PCAOB can impose monetary damages, suspend firms, or make referrals to Justice Department
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Peer Reviews
Members of AICPA
Conducted by CPAs or other CPA firms
Two types of peer reviews
System review
Study of CPA firms’ system of quality control
Select sample of firms’ engagements and examine related working paper files
Engagement review
Sample of CPA work including reports to evaluate appropriateness
Less in scope than system review
Report: pass, pass with deficiencies, or fail
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PCAOB Inspections
Conducted by PCAOB staff
Focus
Primarily evaluating performance of sample of individual audit and review engagements; a risk based approach to selection engagements.
Selected quality control and management issues only. This differs from a peer review.
Report
Written report to SEC, part of which is made public
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International Accounting Standards
International Financial Reporting Standards (IFRS)
Developed by International Accounting Standards Board (IASB)
SEC accepts IFRS for foreign companies that issue securities in US markets
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International Audit Report
Organized similar to the PCAOB audit report
May state “present fairly, in all material respects” or “give a true and fair view”
Report may also indicate that the financial statements comply with the provisions of the country’s relevant statutes or laws
Requires disclosure of Key Audit Matters for listed companies; Key Audit Matters are virtually equivalent to Critical Audit Issues required in PCAOB audits
May be signed using the personal name of the auditor or the audit firm, or both
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