The Audit Market Principles of Auditing: An Introduction to International Standards on Auditing - Ch. 2

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The Audit Market Principles of Auditing An
Introduction to International Standards on
Auditing - Ch. 2

• Rick Stephan Hayes,
• Philip Wallage, and Hans Gortemaker

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• Management controls the accounting systems, the
  internal controls, and the financial reports to
  investors.
• Management is not independent or objective
  because their success depends on positive
  reports.
• The auditor increases the confidence of the
  report users by giving an independent opinion on
  the fairness of these reports.

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Demand for audit services explained by several
different theories

• The Policeman Theory
• The Lending Credibility Theory
• The Theory of Inspired Confidence
• Agency Theory

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Agency Theory

• A company is viewed as the result of 'contracts',
  in which several groups make some kind of
  contribution to the company, given a certain
  'price'.
• Management is seen as the agent, trying to
  obtain contributions from principals such as
  bankers, stockholders and employees.
• Management tries to do what is best for
  management and has a considerable advantage over
  the principals regarding information about the
  company (information asymmetry).
• Cost of an agency relationship are monitoring
  costs, bonding costs, and residual loss.

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Audits Required

• In most countries, audits are now legally
  required for some types of companies (statutory
  audits)
• E.g., listed companies, companies receiving
  government money, certain industries
• Major bourses (including NYSE, NASDAQ, London
  Stock Exchange, Tokyo NIKKEI, and Frankfurt DAX)
  have listing rules that require all companies to
  have an audited annual report.

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Audit Regulation

• Although there is regulation around the world,
  two that may be the most influential are
• The Sarbanes-Oxley Act of 2002 required the U.S.
  Securities and Exchange Commission (SEC) to
  create a Public Company Accounting Oversight
  Board (PCAOB).
• European Union Eighth Council Directive
  84/253/EEC and EU Directive 2006/43/EC

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Independent Oversight

• International Forum of Independent Audit
  Regulators (IFIAR),
• In Australia - Financial Reporting Council,
• In the UK -The Review Board,
• In the Netherlands - Authority for the Financial
  Markets (AFM),
• France - Autorité des marchés financiers(AMF)
• USA -Public Company Accounting Oversight Board

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The International Forum of Independent Audit
Regulators (IFIAR) Core Principles

• comprehensive and well defined accounting and
  auditing principles and standards
• legal requirements for the preparation and
  publication of financial statements according to
  those principles and standards
• an enforcement system for preparers of financial
  statements to ensure compliance with accounting
  standards
• corporate governance practices that support
  high-quality corporate reporting and auditing
  practice and
• effective educational and training arrangements
  for accountants and auditors.

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Who supervises Auditing rules and Auditing Firms?
Public Company Accounting Oversight Board (PCAOB)
Created by the Sarbanes-Oxley Act of 2002
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PCAOBs Audit Standards

• PCAOB has passed 16 audit standards as of
  December 2010.
• They also enforce as temporary standards the
  existing audit standards by the Audit Standards
  Board called Statements of Audit Standards (SAS)

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PCAOBs Audit Standards US classes

• AS No. 1 References in Auditors Reports to the
  Standards of the Public Company Accounting
  Oversight Board
• AS No. 3 Audit Documentation
• AS No. 4 Reporting on Whether a Previously
  Reported Material Weakness Continues to Exist
• AS No. 5 An Audit of Internal Control Over
  Financial Reporting That Is Integrated with An
  Audit of Financial Statements
• AS No. 6 Evaluating Consistency of Financial
  Statements
• AS No. 7 Engagement Quality Review

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PCAOBs Audit Standards US classes

• AS No. 8 Audit Risk
• AS No. 9 Audit Planning
• AS No. 10 Supervision of the Audit Engagement
• AS No. 11 Consideration of Materiality in
  Planning and Performing an Audit
• AS No. 12 Identifying and Assessing Risks of
  Material Misstatement
• AS No. 13 The Auditor's Responses to the Risks
  of Material Misstatement
• AS No. 14 Evaluating Audit Results
• AS No. 15 Audit Evidence

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Communications With Audit Committees (PCAOB Audit
Standard 16)

• http//pcaobus.org/Rules/Rulemaking/Docket030/Rele
  ase_2012-004.pdf (August 15, 2012)
• Replaces AU 310 and 380
• Requires the auditor to record the terms of the
  engagement in an engagement letter, to have the
  engagement letter signed and determine that the
  audit committee has acknowledged and agreed to
  the terms.
• Adds a requirement for the auditor to communicate
  to the audit committee significant unusual
  transactions that are outside the normal course
  of business for the company or that otherwise
  appear to be unusual and to communicate the
  auditor's understanding of the business rationale
  for such transactions.
• improves and enhances current auditor
  communication requirements (pages 9-12)

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PCAOB Audit Standard 1 References in Auditors
Reports to the Standards of the Public Company
Accounting Oversight Board

• adopted as interim standards, on an initial,
  transitional basis, GAAP in AICPAs Auditing
  Standards Board's Statement on Auditing Standards
  No. 95
• the auditor in their opinion must refer to "the
  standards of the Public Company Accounting
  Oversight Board (United States)."

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Report of independent Registered Public
Accounting Firm The Board of Directors and
Shareholders of Wal-Mart Stores, Inc. We have
audited the accompanying consolidated balance
sheets of Wal-Mart Stores, Inc. as of January 31,
2010 and 2009, and the related consolidated
statements of income, shareholders equity, and
cash flows for each of the three years in the
period ended January 31, 2010. These financial
statements are the responsibility of the
Companys management. Our responsibility is to
express an opinion on these financial statements
based on our audits.
We conducted our audits in accordance with the
standards of the Public Company Accounting
Oversight Board (United States). 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 audits provide a reasonable basis for our
opinion.
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In our opinion, the financial statements referred
to above present fairly, in all material
respects, the consolidated fi nancial position of
Wal-Mart Stores, Inc. at January 31, 2010 and
2009, and the consolidated results of its
operations and its cash flows for each of the
three years in the period ended January 31, 2010,
in conformity with U.S. generally accepted
accounting principles. As discussed in Note 8 to
the consolidated financial statements, effective
February 1, 2007, the Company changed its method
of accounting for uncertainty in income taxes. We
also have audited, in accordance with the
standards of the Public Company Accounting
Oversight Board (United States), Wal-Mart Stores,
Inc.s internal control over financial reporting
as of January 31, 2010, based on criteria
established in Internal Control Integrated
Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission and our
report dated March 30, 2010 expressed an
unqualified opinion thereon. Ernst
Young Rogers, Arkansas March 30, 2010
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PCAOB Audit Standard 3 Audit Documentation

• This standard establishes general requirements
  for documentation the auditor should prepare and
  retain in connection with engagements
• Audit documentation is the written record of the
  basis for the auditor's conclusions that provides
  the support for the auditor's representations,
  whether those representations are contained in
  the auditor's report or otherwise
• The auditor must retain audit documentation for
  seven years from the date the auditor grants
  permission to use the auditor's report in
  connection with the issuance of the company's
  financial statements ( report release date ),

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PCAOB Audit Standard 4 Reporting on Whether a
Previously Reported Material Weakness Continues
to Exist

• Establishes requirements and provides direction
  that apply when an auditor is engaged to report
  on whether a previously reported material
  weakness in internal control over financial
  reporting continues to exist as of a date
  specified by management

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Report of Independent Registered Public
Accounting Firm We have previously audited and
reported on management's annual assessment of XYZ
Company's internal control over financial
reporting as of December 31, 200X based on
Identify control criteria, f or example,
"criteria established in Internal
Control-Integrated Framework issued by the
Committee of Sponsoring Organizations of the
Treadway Commission (COSO)." .  Our report,
dated date of report , identified the
following material weakness in the Company's
internal control over financial reporting
Describe material weakness We have audited
management's assertion, included in the
accompanying title of management's report, that
the material weakness in internal control over
financial reporting identified above no longer
exists as of date of management's assertion
because the following control(s) addresses the
material weakness Describe control(s) In
our opinion, the material weakness described
above no longer exists as of date of
management's assertion . ..
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PCAOB Audit Standard 5 An Audit of Internal
Control Over Financial Reporting That Is
Integrated with An Audit of Financial Statements

• This standard establishes requirements when an
  auditor is engaged to perform an audit of
  management's assessment of the effectiveness of
  internal control over financial reporting ("the
  audit of internal control over financial
  reporting") that is integrated with an audit of
  the financial statements.
• If one or more material weaknesses exist, the
  company's internal control over financial
  reporting cannot be considered effective.
• The audit of internal control over financial
  reporting should be integrated with the audit of
  the financial statements.

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Report of Independent Registered Public
Accounting Firm on Internal Control Over
Financial Reporting The Board of Directors and
Shareholders of Wal-Mart Stores, Inc. We have
audited Wal-Mart Stores, Inc.s internal control
over financial reporting as of January 31, 2010,
based on criteria established in Internal Control
Integrated Framework issued by the Committee
of Sponsoring Organizations of the Treadway
Commission (the COSO criteria). Wal-Mart Stores,
Incs management is responsible for maintaining
effective internal control over financial
reporting, and for its assessment of the
effectiveness of internal control over financial
reporting included in the accompanying
Managements Report to Our Shareholders. Our
responsibility is to express an opinion on the
Companys internal control over financial
reporting based on our audit. We conducted our
audit in accordance with the standards of the
Public Company Accounting Oversight Board (United
States). Those standards require that we plan and
perform the audit to obtain reasonable assurance
about whether effective internal control over
financial reporting was maintained in all
material respects. Our audit included obtaining
an understanding of internal control over
financial reporting, assessing the risk that a
material weakness exists, testing and evaluating
the design and operating effectiveness of
internal control based on the assessed risk, and
performing such other procedures as we considered
necessary in the circumstances. We believe that
our audit provides a reasonable basis for our
opinion. A companys internal control over
financial reporting is a process designed to
provide reasonable assurance regarding the
reliability of financial reporting and the
preparation of financial statements for external
purposes in accordance with generally accepted
accounting principles. A companys internal
control over financial reporting includes those
policies and procedures that (1) pertain to the
maintenance of records that, in reasonable
detail, accurately and fairly reflect the
transactions and dispositions of the assets of
the company.
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(2) provide reasonable assurance that
transactions are recorded as necessary to permit
preparation of financial statements in accordance
with generally accepted accounting principles,
and that receipts and expenditures of the company
are being made only in accordance with
authorizations of management and directors of the
company and (3) provide reasonable assurance
regarding prevention or timely detection of
unauthorized acquisition, use or disposition of
the companys assets that could have a material
effect on the financial statements Because of
its inherent limitations, internal control over
financial reporting may not prevent or detect
misstatements. Also, projections of any
evaluation of effectiveness to future periods are
subject to the risk that controls may become
inadequate because of changes in conditions, or
that the degree of compliance with the policies
or procedures may deteriorate. In our opinion
Wal-Mart Stores, Inc. maintained, in all material
respects, effective internal control over
financial reporting as of January 31, 2010, based
on the COSO criteria. We also have audited, in
accordance with the standards of the Public
Company Accounting Oversight Board (United
States), the consolidated balance sheets of
Wal-Mart Stores, Inc. as of January 31, 2010 and
2009, and related consolidated statements of
income, shareholders equity and cash flows for
each of the three years in the period ended
January 31, 2010 and our report dated March 30,
2010 expressed an unqualified opinion
thereon. Ernst Young Rogers, Arkansas March 30,
2010
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PCAOB Audit Standard 6 Evaluating Consistency
of Financial Statements

• This standard establishes requirements for the
  auditor's evaluation of the consistency of the
  financial statements.
• The auditor should recognize the following
  matters in an explanatory (matter of emphasis)
  paragraph a relating to the consistency of the
  company's financial statements in the auditor's
  report if those matters have a material effect on
  the financial statements
• A change in accounting principle
• An adjustment to correct a misstatement in
  previously issued financial statements.

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Auditing Standard 7  Engagement Quality Review

• An engagement quality review and concurring
  approval of issuance are required for each audit
  engagement and for each engagement to review
  interim financial information
• The objective of the engagement quality reviewer
  is to perform an evaluation of the significant
  judgments made by the engagement team and the
  related conclusions reached in forming the
  overall conclusion on the engagement in order to
  determine whether to provide concurring approval
  of issuance
• An engagement quality reviewer must have
  competence, independence, integrity, and
  objectivity

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Auditing Standard 8 Audit Risk

• This standard discusses the auditor's
  consideration of audit risk
• Risk of material misstatement at the assertion
  level consists of the following components
  Inherent risk and Control risk
• The auditor uses the assessed risk of material
  misstatement to determine the appropriate level
  of Detection risk for a financial statement
  assertion.

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Auditing Standard 9 Audit Planning

• Establishes requirements regarding planning an
  audit.
• The engagement partner is responsible for
  planning the audit
• Planning the audit includes establishing the
  overall audit strategy for the engagement and
  developing an audit plan, which includes, in
  particular, planned risk assessment procedures
  and planned responses to the risks of material
  misstatement.

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Auditing Standard 10 Supervision of the Audit
Engagement

• This standard establishes requirements regarding
  supervision of the audit engagement, including
  supervising the work of engagement team members.
• The engagement partner is responsible for the
  engagement and its performance including PCAOB
  standards and the work of engagement personnel,
  specialists, other auditors, internal auditors,
  and others who are involved in testing controls

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Auditing Standard 11 Consideration of
Materiality in Planning and Performing an Audit

• establishes requirements regarding the auditor's
  consideration of materiality in planning and
  performing an audit.
• the Supreme Court of the United States - a fact
  is material if there is "a substantial likelihood
  that the fact would have been viewed by the
  reasonable investor as having significantly
  altered the 'total mix' of information made
  available.

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AS 11 (cont)

• To obtain reasonable assurance about whether the
  financial statements are free of material
  misstatement, the auditor should plan and perform
  audit procedures to detect misstatements that,
  individually or in combination with other
  misstatements, would result in material
  misstatement of the financial statements.

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Auditing Standard No. 12 Identifying and
Assessing Risks of Material Misstatement

• Establishes requirements regarding the process of
  identifying and assessing risks of material
  misstatement of the financial statements.
• The auditor should perform risk assessment
  procedures that are sufficient to provide a
  reasonable basis for identifying and assessing
  the risks of material misstatement, whether due
  to error or fraud.

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AS 12 Continued

• This standard discusses the following risk
  assessment procedures
• Obtaining an understanding of the company and its
  environment (paragraphs 7-17)
• Obtaining an understanding of internal control
  over financial reporting (paragraphs 18-40)
• Considering information from the client
  acceptance and retention evaluation, audit
  planning activities, past audits, and other
  engagements performed for the company (paragraphs
  41-45)
• Performing analytical procedures (paragraphs
  46-48)
• Conducting a discussion among engagement team
  members regarding the risks of material
  misstatement (paragraphs 49-53)
• Inquiring of the audit committee, management, and
  others within the company about the risks of
  material misstatement (paragraphs 54-58)

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Auditing Standard No. 13 The Auditor's Responses
to the Risks of Material Misstatement

• Establishes requirements regarding designing and
  implementing appropriate responses to the risks
  of material misstatement.
• Responses that have an overall effect on how the
  audit is conducted ("overall responses"),
  (paragraphs 5-7) - e.g., appropriate staff
  assignment, supervision, unpredictable audit
  procedures
• Responses involving the nature, timing, and
  extent of the audit procedures to be performed,
  (paragraphs 8-46).

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Auditing Standard No. 14 Evaluating Audit Results

• Establishes requirements regarding the auditor's
  evaluation of audit results and determination of
  whether he or she has obtained sufficient
  appropriate audit evidence which should include
  evaluation of the following
• The results of analytical procedures performed in
  the overall review of the financial statements
  ("overall review")
• Misstatements accumulated during the audit,
  including, in particular, uncorrected
  misstatements
• The qualitative aspects of the company's
  accounting practices
• Conditions identified during the audit that
  relate to the assessment of the risk of material
  misstatement due to fraud ("fraud risk")
• The presentation of the financial statements,
  including the disclosures
• The sufficiency and appropriateness of the audit
  evidence obtained.

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Auditing Standard No. 15 Audit Evidence

• Explains what constitutes audit evidence and
  establishes requirements regarding designing and
  performing audit procedures to obtain sufficient
  appropriate audit evidence.
• Audit evidence is all the information, whether
  obtained from audit procedures or other sources,
  that is used by the auditor in arriving at the
  conclusions on which the auditor's opinion is
  based.

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AS 15 Sufficient Appropriate Audit Evidence

• Sufficiency is the measure of the quantity of
  audit evidence affected by the following
• Risk of material misstatement or the risk
  associated with the control (risk increase ?
  amount of evidence increases)
• Quality of the audit evidence obtained.
• Appropriateness is the measure of the quality of
  audit evidence, i.e., its relevance and
  reliability.

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List of PCAOB Temporary Standards

• AU Section 100 - Statements on Auditing Standards
  -- Introduction
• AU Section 200 - The General Standards
• AU Section 300 - The Standards of Field Work
• AU Section 400 - The First, Second, and Third
  Standards of Reporting
• AU Section 500 - The Fourth Standard of Reporting
  
• AU Section 600 - Other Types of Reports
• AU Section 700 - Special Topics AU Section 800 -
  Compliance Auditing
• AU Section 900 - Special Reports of the Committee
  on Auditing Procedures

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Big Four Firms Non-Big Four

• Deloitte, Ernst Young, KPMG, PricewaterhouseCoop
  ers
• Second Tier Grant Thornton BDO Seidman
  McGladrey Pullen Moss Adams Myer, Hoffman
  McCann Crowe Group, American Express, BKD

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Legal liability of the auditor

• varies from country to country, district to
  district.
• based on one or more of the following
• common law,
• civil liability under statutory law,
• criminal liability under statutory law, and
• liability for members of professional accounting
  organizations.

39
Common Law Ultramares - Touche case (Ultramares
Corporation v Touche et al.)

• the accountants were negligent for not finding
  that a material amount of accounts receivable had
  been falsified when careful investigation would
  have shown it to be fraudulent,
• not liable to a third party bank because the
  creditors were not a primary beneficiary, or
  known party,
• called the Ultramares doctrine, that ordinary
  negligence is not sufficient for a liability to a
  third party because of lack of privity of
  contract between the third party and the auditor.

40
Caparo Industries, PLC v Dickman

• The question in Caparo was the scope of the
  assumption of responsibility of the auditor if a
  clean opinion was given for negligent accounts,
  and what the limits of liability ought to be.
• The House of Lords of the UK, following the Court
  of Appeal, set out a "three-fold test for an
  obligation (duty of care) to arise from
  negligence
• harm must be reasonably foreseeable
• the parties must be in a relationship of
  proximity and
• it must be fair, just and reasonable to impose
  liability.

41
Civil Liability Under Statutory Law

• The Securities Act of 1933 established the first
  U.S. statutory civil recovery rules for third
  parties against auditors.
• Original purchasers have recourse against the
  auditor for up to the original purchase price if
  the financial statements are false or misleading.
• The auditor has the burden of demonstrating that
  reasonable investigation was conducted or that
  all the loss of the purchaser of securities
  (plaintiff) was caused by factors other than the
  misleading financial statements.

42
Sarbanes Oxley Act of 2002 Civil Penalties for
CEOs and CFOs

• If there is a material restatement of a companys
  reported financial results due to the material
  noncompliance of the company, as a result of
  misconduct, the CEO and CFO shall reimburse the
  company for any bonus or incentive or
  equity-based compensation received within the 12
  months following the filing with the financial
  statements subsequently required to be restated
  (Section 304)
• Financial statements filed with the SEC by any
  public company must be certified by CEOs and
  CFOs. If all financials do not fairly present the
  true condition of the company CEOs and CFOs may
  receive fines of up to 1 million. If
  certifications are made knowing the statements
  are incorrect, the fine can be up to 5 million.

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Criminal Liability Under Statutory Law

• The Securities Exchange Act of 1934 in the United
  States sets out (Rule 10b-5) criminal liability
  for the auditor to employ any device, scheme or
  artifice to defraud or intentionally or
  recklessly misrepresent information for third
  party use.
• Not In Text Cases In United States v. Natelli
  (1975) United States v. Weiner (1975) ESM
  Government Securities v. Alexander Grant Co.
  (1986).

44
Sarbanes Oxley Act of 2002 Criminal Penalties for
CEOs, CFOs and Auditors

• To knowingly destroy, create, manipulate
  documents and/or impede or obstruct federal
  investigations is considered felony, and
  violators will be subject to fines or up to 20
  years imprisonment, or both
• All audit reports or related workpapers must be
  kept by the auditor for 7 years. Failure to do
  this may result in 10 years imprisonment.
• CFOs and CEOs who falsely certify financial
  statements or internal controls are subject to 10
  years imprisonment. Willful false certification
  may result in a maximum of 20 years imprisonment

45
Liabilities as Members of Professional
Organizations

• Nearly all national audit professions have some
  sort of disciplinary court.
• The disciplinary court makes its judgment and
  determines the sanction. It may be
• a fine
• a reprimand (either oral or written)
• a suspension for a limited period of time (e.g. 6
  months) or
• a lifetime ban from the profession.

46
In order to hold the auditor successfully legally
liable in a civil suit, the following conditions
have to be met - US Classes

• An audit failure/neglect has to be proven
  (negligence issue).
• The auditor should owe a duty of care to the
  plaintiff (due professional care).
• The plaintiff has to prove a causal
  relationship between her losses and the alleged
  audit failure (causation issue)
• The plaintiff must quantify her losses
  (quantum issue).

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financial risks resulting from litigation for
audit firms

• European Union Commissioner Charlie McCreevy has
  said
• We have concluded that unlimited liability
  combined with insufficient insurance cover is no
  longer tenable. It is a potentially huge problem
  for our capital markets and for auditors working
  on an international scale. The current conditions
  are not only preventing the entry of new players
  in the international audit market, but are also
  threatening existing firms.

48
Suggested Solutions to Auditor Liability

• Some countries (e.g. Germany) have put a legally
  determined cap on the liability of auditors (to
  the client in the case of Germany)
• A system of proportionate liability - an audit
  firm is not liable for the entire loss incurred
  by plaintiffs but only to the extent to which the
  loss is attributable to the auditor.
• In order to protect the personal wealth of audit
  partners, some audit firms are structured as a
  limited liability partnership (e.g. in the UK).

49
Suggested Solutions to Auditor Liability (cont)

• To make insurance of all liability risks
  compulsory using new legislation was one of the
  recommendations of a EU commission.
• Exclude certain activities with a higher risk
  profile from the auditors' liability. A mechanism
  to achieve this outcome would be to introduce
  so-called safe harbour provisions by legislation.

50
Audit Expectations with regard to the following
duties of auditors giving an opinion on

• the fairness of financial statements
• the company's ability to continue as a going
  concern
• the company's internal control system
• the occurrence of fraud and
• the occurrence of illegal acts.

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The Fairness Of Financial StatementsThe
Company's Ability To Continue As A Going Concern

• A large part of the financial community (users of
  audit services) expects that financial statements
  with an unmodified (unqualified) audit opinion
  are completely free from error. The inherent
  limitations of auditing not accepted.
• In most national regulations, auditors need to
  determine whether the audited entity is able to
  continue as a going concern.

52
Opinion on the Companys Internal Control System

• The objective of the auditor is to identify and
  assess the risks of material misstatement
  through understanding the entity and its
  environment, including the entitys internal
  control.
• The United States Sarbanes-Oxley Act of 2002
  requires that company officers certify that
  internal controls are effective and requires that
  an independent auditor verify managements
  analysis

53
Company's Internal Control

• Section 404 of the Sarbanes-Oxley Act requires
  each annual report of a company to contain an
  internal control report which should
•   (1) state the responsibility of management
  for establishing and maintaining an adequate
  internal control structure and procedures for
  financial reporting, and
• (2) contain an assessment, as of the end of
  the fiscal year, of the effectiveness of the
  internal control structure and procedures for
  financial reporting.
• (3) Companies must select suitable criteria
  (COSO-based) against which it may evaluate the
  effectiveness of internal controls for
  authorization, safeguarding assets, and properly
  recording of transactions.
• (4) An independent auditor attests to any
  difference between managements assertions under
  404 and the audit evidence on internal controls

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Opinion on the Occurrence of Fraud

• Both governments and the financial community
  expect the auditor to find existing fraud cases
  and report them.
• Audit history as gone from the fraud detection as
  the objective of an audit to not taking any
  responsibility for fraud, to the current position
  that the auditor is responsible for obtaining
  reasonable assurance the financial statements are
  free from material statement, whether caused by
  fraud or error.

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The Occurrence of Fraud

• ISA 240- the responsibility for the prevention
  and detection of fraud and error rests with both
  those charged with the governance and the
  management.
• ISA 210 states that when planning and performing
  audit procedures and in evaluating and reporting
  the results, auditors should consider the risk of
  misstatements in financial statements resulting
  in fraud.
• In planning the audit, the auditor must assess
  the risk that material fraud or error has
  occurred.

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US Fraud Standard US Classes

• Auditing Standard Number 99 (SAS 99)
• The standard requires that as part of the
  planning process the audit team must consider how
  and where the clients financial statements may
  be susceptible to fraud.
• Gather information by inquiring of management and
  consider ing fraud risk factors

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The Occurrence of Illegal Acts

• Both ISA 250 and most national regulators state
  that the auditors responsibility in this area is
  restricted to designing and executing the audit
  in such a way that there is a reasonable
  expectation of detecting material illegal acts
  which have a direct impact on the form and
  content of the financial statements.
•  The professional regulations in some countries
  require the auditor to inform members of the
  audit committee or board of directors

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Responses to Accounting Controversies

• In response to the controversies there have been
  in two landmark studies (the COSO Report and the
  Cadbury Report which lead to the Combined Code
  and the Turnbull Report) and most recently have
  been legislated into the US
• accounting profession by the
• Sarbanes-Oxley
• Act of 2002.

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COSO Report

• The COSO report was published by the Committee of
  Sponsoring Organizations of the Treadway
  Commission. The COSO report envisaged
• 1 harmonizing the definitions regarding internal
  control and its components
• 2 helping management in assessing the quality of
  internal control
• 3 creating internal control benchmarks, enabling
  management to compare the internal control in
  their own company to the state-of-the-art and
• 4 creating a basis for the external reporting on
  the adequacy of the internal controls.

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Combined Code UK

• In 1998 London Stock Exchange published a new
  Listing Rule together with related Principles of
  Good Governance and Code of Best Practice (called
  the Combined Code).
• The combined code combines the recommendations
  of the so-called Cadbury, Greenbury, and Hampel
  committees on corporate governance.

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The Sarbanes-Oxley Act of 2002 Restrictions on
Auditors

• Auditors must report to the audit committee
• The lead audit partner and audit review partner
  must be rotated every five years.
• A second partner must review and approve audit
  reports.
• It is a felony with penalties of up to 20 years
  in jail to willfully fail to maintain all audit
  or review work papers for seven years.
• Auditors are  prohibited from offering certain
  information system and accounting services.

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Thank You for Your Attention

• Any Questions?