principals of auditing ch 2

7/30/2019 Principals of Auditing Ch 2

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Professional Standards

Chapter 2

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


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

Ethical Standards for audits of public companies

American Institute of Certified PublicAccountants Auditing, Attestation, Quality Control, Independence

Ethical, Accounting and Review Standards forengagements involving nonpublic companies

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

Authority of Organizations


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Regulation of the Public Accounting Profession


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Generally Accepted Auditing

Standards--General Standards

Adequate technical training and

proficiency

Independence in mental attitude is to be

maintained

Due professional care is to be exercised


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Standards--Standards of Field Work

Auditor must adequately plan andproperly supervise work

Auditor must obtain a sufficientunderstanding of entity, and itsenvironment, including internal controlto assess risk of material misstatementand to design further audit procedures

Auditor must obtain sufficientappropriate audit evidence to afford areasonable basis for the opinion


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Standards--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 byexpressing an opinion or stating that one cannot

be expressed, and the reason therefor


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Terminology in Auditing Standards

(Figure 2.2)

Responsibility

Level

Meaning Words Used to

Indicate Responsibility

Uncondit ional

Responsib i l i ty

Auditor must fulfill responsibilities Must

Is required

Shall (PCAOB only)

Presumpt ively

Mandatory

Auditor must comply with requirements unless

auditor demonstrates and documents that

alternative actions were sufficient to achieve the

objectives of the standards

Should

Responsib i l i ty 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


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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 AuditingPublications

No authoritative status, but may helpthe auditor understand and apply the

standards

Auditing articles Continuing education

programs

Textbooks

Guidebooks

Audit programs

Checklists


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Auditor Responsibility for the

Detection of Errors and Fraud (1 of 2)

Obtain information to assess the inherent risks andfraud risks

Information about the company and itsenvironment

Discussion among audit team members

Inquiries of management and others

Planning analytical procedures, including thoseinvolving revenue

Assess the risk of errors and fraud that may cause thefinancial statements to contain a materialmisstatement.


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Auditor Responsibility for the

Detection of Errors and Fraud (2 of 2)

Based on that assessment, plan and perform theaudit to obtain reasonable assurance thatmaterial misstatements, whether caused byerrors or fraud, will be detected (including those

procedures required by AU 316 (SAS No. 99,113)

Exercise due care in planning, performing andevaluating the results of audit procedures, and

the proper degree of professional skepticism toachieve reasonable assurance that materialmisstatements due to error or fraud will bedetected.


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Auditor Responsibility for

the Detection 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 typesof illegal acts.

Those with an indirect effect on financial

statement amounts:

Be aware of possible occurrence.

If information comes to the auditors 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.


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The Standard Auditors Report for

Nonpublic Companies

Title

Addressee

Content

Introductory Paragraph

Scope Paragraph

Opinion Paragraph

Signature

Date


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The Standard Auditors Report--

Introductory Paragraph

We have audited the accompanying balance sheet

of XYZ Company as of December 31, 20X1 and therelated 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 ouraudit.


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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 andperform 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 assessingthe 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.


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The Standard Auditors Report--

Opinion Paragraph

In our opinion, the financial statements referred to above

present fairly, in all material respects, the financial positionof 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.


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The GAAP HierarchyAuthoritative Body Pronouncements

Pronouncements of Bodies Composed ofExpert Accountants, That Are Exposed for

Public Comment Pronouncements of Bodies of Expert

Accountants That Are Not Exposed for PublicComment

Widely Recognized Practices andPronouncements

Other Accounting Literature


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Other Types of Auditors Reports

Standard unqualified report

Financial statements follow GAAP and auditor does not add explanatorylanguage 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


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Public 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


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Applicability of SSAEs


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Elements 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


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QC Element 1: Leadership responsibilities

for quality within the firm

Firms internal culture recognizes that quality isessential 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 responsibilitiesso 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 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 aggressiveaccounting 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 thecircumstances.

Example: Design effective recruitment processes and

procedures to help the firm select individuals meeting

minimum academic requirements established by thefirm, and maturity, integrity and leadership.

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QC Element 5: Engagement

Performance

Firms 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.


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QC Element 6: Monitoring

Firms 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 firms quality

control policies and procedures.


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Quality Control Procedures

Not specified by AICPA

Depend on size of firm, number of offices

and nature of firms 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

Conduct inspections of public company practice of

registered public accounting firms

Nonpublic Companies

AICPA & State Boards of Accountancy Peer review for nonpublic practice segments


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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 evaluateappropriateness

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

selected quality control 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

Contains expanded description of managementsresponsibility

Contains an enhanced explanation of the auditprocess

May state present fairly, in all material respects orgive a true and fair view

Report may indicate that the financial statementscomply with the provisions of the countrys relevant

statutes or laws Must include city of the auditors office

May be signed using the personal name of theauditor or the audit firm or both

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