The Financial Statement Auditing Environment

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Chapter 2

• The Financial Statement Auditing Environment

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Problems and Warning Signs
LO 1
1990
2000
During the economic boom of the late 1990s and
the early 2000s, accounting firms aggressively
sought opportunities to market a variety of
high-margin nonaudit services to their audit
clients.
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Problems and Warning Signs
LO 1
4
An Explosion of Scandals
LO 1
WorldCom
Enron
Tyco
Adelphia
Xerox
5
Government Regulation
LO 1
In July 2002, Congress passed the Sarbanes-Oxley
Public Company Accounting Reform and Investor
Protection Act.
The Sarbanes-Oxley Act effectively ended the
professions era of self-regulation, creating
and transferring authority to set and enforce
standards to the Public Company Accounting
Oversight Board (PCAOB).
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Sarbanes-Oxley Act of 2002

• Management
• Boards of Directors
• Audit Committees
• Accounting Firms
• Wall Street Investment Banking Firms
• Law Firms
• Stock Exchanges
• Securities and Exchange Commission

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Context of Financial Statement Auditing
LO 2
The primary context with which an auditor is
concerned is the industry or business of his or
her audit client. For example, if you are
auditing a computer hardware manufacturer, one of
your concerns will be whether your client has
inventories that are not selling quickly and are
becoming obsolete due to industry innovation.
Such inventory might not be properly valued on
the clients financial records. If you are
auditing a jeweler you will probably not be as
worried about obsolescence, but you will be
interested in whether the diamonds and other gems
in inventory are valued properly. You may need to
hire a qualified gemologist to help you assess
the valuation assertion, and you would want to
keep up on the dynamics of the international
diamond and gem markets. In other words, the
context provided by the clients business impacts
the auditor and the audit, and is thus a primary
component of the environment in which financial
statement auditing is conducted.
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A Model of Business
LO 3
Business organizations exist to create value for
their stakeholders. Due to the way resources are
invested and managed in the modern business
world, a system of corporate governance is
necessary, through which managers are overseen
and supervised.
Board of Directors
Audit Committee
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A Model of Business Processes Five Components
LO 4
Financing Process
Purchasing Process
Human Resource Management Process
Inventory Management Process
Revenue Process
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An Overview of Business
LO 4
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Management Assertions
LO 5
Financial statements issued by management contain
explicit and implicit assertions.
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Management Assertions
LO 5
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Auditing Standards
LO 6, 7
Auditing standards serve as guidelines for and
measures of the quality of the auditors
performance.
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The 10 Generally Accepted Auditing Standards
(GAAS)
LO 6, 7
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General Standards
LO 6, 7
Adequate Technical Training Proficiency
Independence
Due Professional Care
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Standards of Fieldwork
LO 6, 7
Adequate Planning Supervised Assistants
Obtain Sufficient Understanding of Client
Environment, including Internal Controls
Obtain Sufficient Appropriate Evidential Matter
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Standards of Reporting
LO 6, 7
GAAP
Consistency
Disclosures
Opinion
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GAAS
LO 6, 7
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Statements on Auditing Standards
(SAS)Interpretations of GAAS
LO 8, 9
GAAS and SAS are considered to be minimum
standards of performance for auditors.
PCAOB adopted, on an interim basis, GAAS and SAS.
Standards issued by PCAOB are called Auditing
Standards (AS).
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Statements on Auditing Standards
(SAS)Interpretations of GAAS
LO 8, 9
SAS are classified by two numbering categories
SAS and AU numbers. The SAS number applies to
the order in which the standards are issued and
are thus chronological. The AU codification
organizes the SAS according to topical content.
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Statements on Auditing Standards
(SAS)Interpretations of GAAS
LO 8, 9
For example, SAS No. 39, Audit Sampling, is
found under AU 350 because the AU 300s relate to
the standards of fieldwork on evidence collection
and evaluation.
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Ethics, Independence, and the Code of
Professional Conduct
LO 10
Ethics refers to a system or code of conduct
based on moral duties and obligations that
indicates how we should behave.
Professionalism refers to the conduct, aims, or
qualities that characterize or mark a profession
or professional person. All professions operate
under some type of code of ethics or code of
conduct.
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Ethics, Independence, and the Code of
Professional Conduct
LO 10
Code of Professional Conduct
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The Auditors Responsibility for Errors, Fraud,
and Illegal Acts
LO 11
The auditor has a responsibility to plan and
perform the audit to obtain reasonable assurance
about whether the financial statements are free
of material misstatement, whether caused by error
or fraud.
The auditor has no responsibility to plan and
perform the audit to obtain reasonable assurance
that misstatements, whether caused by errors or
fraud, that are not material to the financial
statements will be detected.
Because of the nature of audit evidence and the
characteristics of fraud, the auditor is able to
obtain reasonable, but not absolute, assurance
that material misstatements are detected.
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Public Accounting Firms
LO 12
Public accounting firms range in size from a
single proprietor to thousands of owners (or
partners) and thousands of professional and
administrative staff employees.
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Audit Teams
LO 12
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Types of Audit, Attest, and Assurance Services
LO 13
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Types of Audit, Attest, and Assurance Services
LO 13
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Types of Audit, Attest, and Assurance Services
LO 13
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Types of Audit, Attest, and Assurance Services
LO 13
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Types of Auditors
LO 14
External Auditors
Internal Auditors
Government Auditors
Forensic Auditors
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Organizations That Affect the Public Accounting
Profession
LO 15
American Institute of Certified Public
Accountants (AICPA)
Securities and Exchange Commission (SEC)
Public Company Accounting Oversight Board (PCAOB)
Financial Accounting Standards Board (FASB)
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Current Structure of Profession