Professional Standards

Chapter 2

McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.

2-2

Public Company Accounting Oversight Board Auditing, Attestation, Quality Control, Independence,

Ethical Standards for audits of public companies

American Institute of Certified Public Accountants Auditing, Attestation, Quality Control, Independence

Ethical, Accounting and Review Standards for engagements involving nonpublic companies

State Boards of Accountancy License CPAs and CPA firms to practice in jurisdictions

Authority of Organizations

2-3

Regulation of the Public Accounting ProfessionRegulation of the Public Accounting Profession

2-4

Generally Accepted Auditing Generally Accepted Auditing Standards--General StandardsStandards--General Standards

Adequate technical training and proficiency

Independence in mental attitude is to be maintained

Due professional care is to be exercised

2-5

Generally Accepted Auditing Generally Accepted Auditing Standards--Standards of Field WorkStandards--Standards of Field Work

Auditor must adequately plan and properly supervise work

Auditor must obtain a sufficient understanding of entity, and its environment, including internal control to assess risk of material misstatement and to design further audit procedures

Auditor must obtain sufficient appropriate audit evidence to afford a reasonable basis for the opinion

2-6

Generally Accepted Auditing Generally Accepted Auditing Standards--Standards of ReportingStandards--Standards of Reporting

State whether the financial statements are presented in accordance with GAAP

Identify circumstances in which such principles have not been consistently applied

Informative disclosures are adequate unless otherwise stated in the report

Report should clearly state the degree of responsibility being assumed by the auditors by expressing an opinion or stating that one cannot be expressed, and the reason therefor

2-7

Terminology in Auditing Standards Terminology in Auditing Standards (Figure 2.2)(Figure 2.2)

Responsibility

Level

Meaning Words Used to Indicate Responsibility

Unconditional

Responsibility

Auditor must fulfill responsibilities “Must”

“Is required”

“Shall” (PCAOB only)

Presumptively Mandatory

Auditor must comply with requirements unless auditor demonstrates and documents that alternative actions were sufficient to achieve the objectives of the standards

“Should”

Responsibility to Consider

Auditor should consider; whether the auditor complies with the requirements depends on the exercise of professional judgment in the circumstances

“Might”

“Could”

Other phrases indicating a responsibilities to consider

2-8

The GAAS Hierarchy (Figure 2.3)The GAAS Hierarchy (Figure 2.3)

Category Status Audit Guidance1. Standards Auditors should be prepared to justify

departures from these standards.

The 10 GAAS SASs Other standards for PCAOB, govt. audits, etc.

2. Interpretative Publications

Recommendations on the application of the SASs. If not followed, the auditors should be prepared to explain how they complied with the SAS provisions addressed.

Appendices to SASs Interpretation of SASs Auditing guidance in AICPA Audit and accounting Guides AICPA auditing Statements of Position

3. Other Auditing Publications

No authoritative status, but may help the auditor understand and apply the standards

Auditing articles Continuing education programs Textbooks Guidebooks Audit programs Checklists

2-9

Auditor Responsibility for the Auditor Responsibility for the Detection of Errors and Fraud (1 of 2)Detection of Errors and Fraud (1 of 2)

Obtain information to assess the inherent risks and fraud risks

Information about the company and its environment

Discussion among audit team members Inquiries of management and others Planning analytical procedures, including those

involving revenue Assess the risk of errors and fraud that may cause the

financial statements to contain a material misstatement.

2-10

Auditor Responsibility for the Auditor Responsibility for the Detection of Errors and Fraud (2 of 2)Detection of Errors and Fraud (2 of 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 (including those procedures required by AU 316 (SAS No. 99, 113)

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.

2-11

Auditor Responsibility for Auditor Responsibility for the the Detection of Illegal ActsDetection of Illegal Acts

Those that could have a direct and material effect on financial statement amounts--same as for errors and fraud. An audit obtains reasonable assurance of detecting these types of illegal acts.

Those with an indirect effect on financial statement amounts:

Be aware of possible occurrence. If information comes to the auditor’s attention, apply

audit procedures directed at determining whether an illegal act has occurred. An audit does not provide assurance that indirect-effect illegal acts will be detected.

2-12

The Standard Auditors’ Report for The Standard Auditors’ Report for Nonpublic CompaniesNonpublic Companies

Title Addressee Content

Introductory Paragraph Scope Paragraph Opinion Paragraph

Signature Date

2-13

The Standard Auditors’ Report--Introductory Paragraph

We have audited the accompanying balance sheet of XYZ Company as of December 31, 20X1 and the related statements of income, retained earnings, and cash flows for the year then ended . These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.

2-14

The Standard Auditors’ Report—Scope Paragraph

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 of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

2-15

The Standard Auditors’ Report--Opinion Paragraph

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of XYZ Company as of December 31,20X1, and the results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.

2-16

The GAAP HierarchyThe GAAP Hierarchy Authoritative Body Pronouncements Pronouncements of Bodies Composed of

Expert Accountants, That Are Exposed for Public Comment

Pronouncements of Bodies of Expert Accountants That Are Not Exposed for Public Comment

Widely Recognized Practices and Pronouncements

Other Accounting Literature

2-17

Other Types of Auditors’ ReportsOther Types of Auditors’ Reports Standard unqualified report

Financial statements follow GAAP and auditor does not add explanatory language for any issue

Other reports Unqualified with explanatory language

• Example: A lack of consistency in application of accounting principles

Qualified opinion• Examples: Scope limitation or departure from GAAP

Adverse opinion• Examples: Departure from GAAP so significant that financial

statements as a whole are misleading Disclaimer of opinion

• Example: Unable to determine an opinion due to a very significant scope limitation

2-18

Public Company Audit ReportPublic Company Audit Report Title is “Report of Registered Independent

Public Accounting Firm” Refers to standards of the PCAOB rather

than GAAS Includes a fourth paragraph that refers to

report on internal control City and State (or Country) of audit firm

must be included

2-19

Applicability of SSAEs

2-20

Elements of Quality ControlElements of Quality Control

Leadership responsibilities for quality within the firm (“tone at the top”)

Relevant ethical requirements Personnel management Acceptance and continuance of clients and

engagements Engagement performance Monitoring

2-21

QC Element 1: Leadership responsibilities QC Element 1: Leadership responsibilities for quality within the firmfor 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.

Example: Assign management responsibilities so that commercial considerations do not override the quality of work performed.

2-22

QC Element 2: Relevant ethical QC Element 2: Relevant ethical requirementsrequirements

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

2-23

QC Element 3: Acceptance and QC Element 3: Acceptance and ContinuanceContinuance

Firm will undertake to continue relationships and engagements only where the firm:1. Has considered client integrity.

2. Is competent to perform the engagement.

3. Can comply with legal and ethical requirements.

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.

2-24

QC Element 4: Human ResourcesQC 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.

2-24

2-25

QC Element 5: Engagement QC Element 5: Engagement PerformancePerformance

Firm’s engagements are consistently performed in accordance with professional standards and regulatory and legal requirements, with policies and procedures addressing:

1. Engagement performance.

2. Supervision responsibilities.

3. Review responsibilities.

Example: Design policies and procedures that address the tracking of progress of each engagement.

2-26

QC Element 6: MonitoringQC Element 6: Monitoring

Firm’s policies and procedures established for each of the elements are suitably designed and effectively applied.

Example: Working papers, reports, and client financial statements are reviewed to assess compliance with the firm’s quality control policies and procedures.

2-27

Quality Control ProceduresQuality Control Procedures

Not specified by AICPA 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

2-28

Regulation of the Public Accounting Regulation of the Public Accounting ProfessionProfession

Public Companies Public Company Accounting Oversight Board

• Registration of public accounting firms that audit 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

2-29

PCAOBPCAOB

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

2-30

Peer ReviewsPeer 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

2-31

PCAOB InspectionsPCAOB Inspections

Conducted by PCAOB staff Focus:

Primarily evaluating performance of sample of individual audit and review engagements

selected quality control issues only. This differs from a peer review.

Report Written report to SEC, part of which is made

public

2-32

International Accounting International Accounting StandardsStandards

International Financial Reporting Standards (IFRS) Developed by International Accounting

Standards Board (IASB) SEC accepts IFRS for foreign companies that

issue securities in US markets

2-33

International Audit ReportInternational Audit Report

Contains expanded description of management’s responsibility

Contains an enhanced explanation of the audit process

May state “present fairly, in all material respects” or “give a true and fair view”

Report may indicate that the financial statements comply with the provisions of the country’s relevant statutes or laws

Must include city of the auditors’ office May be signed using the personal name of the

auditor or the audit firm or both