Auditing

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Auditing
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The Demand for Auditing and Assurance
LO 2
The development of the corporate form of business
and the expanding world economy over the last 200
years have given rise to an explosion in the
demand for the assurance provided by auditors.
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The Demand for Auditing and Assurance
LO 2
A public company is a company that sells its
stocks or bonds to the public, giving the public
a valid interest in the proper use, or
stewardship, over the companys resources.
Managers
Stockholders
Agents
Principals
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What Creates the Demand for Auditing and
Assurance?

• Audits lend credibility to information by
  reducing information risk, the risk that
  information is materially misstated
• Financial statement misstatements arise due to--
• Accidental errors
• Lack of knowledge of accounting principles
• Unintentional bias
• Deliberate falsification
• Audits do not directly address business risk, the
  risk that a company will not be able to meet its
  financial obligations due to economic conditions
  or poor management decisions

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Organization of the Public Accounting Profession

• Sole proprietorship
• Partnerships
• Professional Corporation
• Limited Liability Partnership (LLP)
• Limited Liability Company (LLC)

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Categories of Public Accounting Firms

• Local
• Regional
• National
• Big 4

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The Big Four

• Deloitte
• ErnstYoung
• KPMG
• PricewaterhouseCoopers

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Types of Professional Services

• Audit, Attestation and Assurance
• Tax
• Consulting
• Accounting
• Personal Financial Planning
• Litigation Support
• Fraud Investigation

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Consulting Services Prohibited by the
Sarbanes-Oxley Act

• Bookkeeping
• Financial systems design and Implementation
• Appraisal or valuation services
• Actuarial services
• Internal audit outsourcing
• Management functions or human resource services
• Investment services
• Legal services and expert services
• Certain tax services

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Typical Structure of a National CPA Firm
Partners
Managers
Seniors
Staff Assistant
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Responsibilities on an Engagement

• PartnerOverall responsibility is to assure that
  that audit is performed in accordance with
  professional standards.
• ManagerSupervise overall engagement.
• SeniorsIn charge auditor on a daily basis
• Staff assistantsWork under the immediate
  supervision of the senior

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Need for Professional Ethics

• Responsibility to serve the public
• CPA is representative of the public
• Complex body of knowledge
• Abundance of authoritative pronouncements
• Standards of Admission to the Profession
• Min. standards for education and experience
• Need for public confidence
• CPA product is credibility

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AICPA Code of Professional Conduct

• Designed to provide a framework for expanding
  professional services and responding to changes
  in the profession
• Two sections
• Principles
• Rules
• Additional guidance
• Interpretations
• Ethics Rulings

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AICPA Professional Ethics
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Principles of the Code

• Responsibilities
• The Public Interest
• Integrity
• Objectivity and Independence
• Due Care
• Scope and Nature of Services

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The Rules of the AICPA Code of Professional
Conduct

• Rule Title
• 101 Independence
• 102 Integrity and Objectivity
• 201 General Standards
• 202 Compliance with Standards
• 203 Accounting Principles
• 301 Confidential Client Information
• 302 Contingent Fees
• 501 Acts Discreditable
• 502 Advertising and Other Forms of Solicitation
• 503 Commissions and Referral Fees
• 504 (Deleted)
• 505 Form of Organization and Name

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Independence

• Independence of mind (actual independence)
• Independence of appearance
• Both are required.

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Threats to Independence (and an example of each)

• CPA financial and other personal matters
• Financial Self-Interest of CPACPA owns stock in
  the client
• Adverse Interest Litigation between client and
  CPA firm
• Undue Influence--Pressure from client to reduce
  audit procedures
• Interests of relatives and friends
• FamiliaritySpouse holds a key position with
  client
• CPA Performance of nonattest services
• Self-ReviewCPA firm has provided consulting
  services that relate to audit
• Advocacy of clientCPA promotes client securities
  as part of an initial public offering
• Management ParticipationCPA Serves as officer of
  client

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Rule 102

• Rule 102 Integrity and Objectivity
• Applies to all members of the AICPA and to all
  services provided by CPAs
• Violations
• Makes, or permits or directs another to make,
  materially incorrect entries in a clients
  financial statements or records
• Fails to correct financial statements that are
  materially false or misleading when member has
  such authority
• Signs, or permits or directs another to sign, a
  document containing materially false and
  misleading information

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Rule 201

• Rule 201 General Standards
• Apply to all CPA services
• Member shall comply with following standards
• Professional competence
• Due Professional Care
• Planning and Supervision
• Sufficient Relevant Data

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Rule 202 Standards

• Technical Body
• Auditing Standards Board (ASB)
• Management Consulting Services Executive
  Committee (MCSEC)
• Accounting and Review Services Committee (ARSC)
• ASB, MCSEC, and ARSC
• FASB, GASB and FASAC

• Standards
• Statements on Auditing Standards
• Statements on Standards for Consulting Services
• Statements on Standards for Accounting and Review
  Services
• Statements on Standards for Attestation
  Engagements
• FASB, GASB and FASAC Statements and related
  Interpretations

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Rule 203

• Accounting Principles
• Designates GAAP
• The Statements and Interpretations of
• FASB
• GASB
• FASAB

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Rule 301

• Confidential Client Information
• A member in public practice shall not disclose
  any confidential client information without the
  specific consent of the client.
• Auditors cannot directly disclose illegal acts by
  the client unless they have a legal duty to do so
  
• Confidential but not privileged communications
  with client

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IIA Code of Ethics--Principles

• Internal auditors are expected to apply uphold
  the following principles
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• Integrity. The integrity of internal auditors
  establishes trust and thus provides the basis
  for reliance on their judgment. 
• Objectivity. Internal auditors exhibit the
  highest level of professional objectivity in
  gathering, evaluating, and communi-cating
  information about the activity or process being
  examined. Internal auditors make a balanced
  assessment of all the relevant circumstances and
  are not unduly influenced by their own interests
  or by others in forming judgments.  
• Confidentiality. Internal auditors respect the
  value and ownership of information they receive
  and do not disclose information without
  appropriate authority unless there is a legal or
  professional obliga-tion to do so.  
• Competency. Internal auditors apply the
  knowledge, skills, and experience needed in the
  performance of internal auditing services. 

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Forms of Audit and Attestation of Financial
Statements
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Audit Report

• Providing an independent and expert opinion on
  the fairness of financial statements through an
  audit is the most frequent attestation service
• When performing an audit, the auditors obtain
  reasonable assurance that the statements are in
  conformity with GAAP

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Typical Coverage of Audit Reports

• Reports on the financial statements ordinarily
  include an opinion that is on both the
• Financial statements themselves
• Balance sheet
• Income statement
• Statement of cash flows
• Statement of retained earnings (equity)
• Financial statement disclosures
• The notes to the financial statements are
  considered an integral part of the financial
  statements

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Auditors Standard Report Nonpublic Clients

• Details
• Title includes 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 sole practitioner
• Dated as of the date on which the auditors
  obtained sufficient appropriate audit evidence to
  support their opinion

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The AICPA Standard Auditors Report--Introductory
Paragraph

• We have audited the accompanying consolidated
  balance sheets of ABC Company and its
  subsidiaries, as of December 31, 20X1 and 20X0,
  and the related consolidated statements of
  income, retained earnings, and cash flows for the
  years then ended.

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The AICPA Standard Auditors ReportManagements
Responsibility Paragraph

• Management is responsible for the
  preparation and fair presentation of these
  consolidated 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 consolidated financial
  statements that are free from material
  misstatement, whether due to fraud or error.

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The AICPA Standard Auditors ReportAuditors
Responsibility Paragraphs

• Our responsibility is to express an opinion
  on these consolidated 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 consolidated financial statements are
  free of material misstatement.
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• An audit involves performing procedures to
  obtain audit evidence about the amounts and
  disclosures in the consolidated financial
  statements. The procedures selected depend on the
  auditor's judgment, including the assessment of
  the risks of material misstatement of the
  consolidated 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 consolidated 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 consolidated financial
  statements.
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• 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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The AICPA Standard Auditors Report--Opinion
Paragraph

• In our opinion, the consolidated financial
  statements referred to above present fairly, in
  all material respects, the financial position of
  ABC Company and its subsidiaries as of December
  31, 20X1 and 20X0, and the results of their
  operations and their cash flows for the years
  then ended in accordance with accounting
  principles generally accepted in the United
  States of America.

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Auditors Standard Report Public Clients

• Differences from nonpublic
• Includes the words Registered and Independent
  in the title.
• References standards of the PCAOB rather than
  generally accepted auditing standards.
• Includes less detailed discussions of management
  and auditor responsibilities
• Includes an additional paragraph indicating that
  the auditors have also issued a report on the
  clients internal control over financial
  reporting.
• The report on internal control may either be
  presented separately or combined with the report
  on the financial statements into one overall
  report
• Does not include section headings.

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Exhibit 1 The Auditors Standard Report

• Independent Auditors Report
• We have audited the accompanying balance sheet
  of X Company as of December 31, 20XX, and the
  related statements of income, retained earnings,
  and cash flows for the year then ended. These
  statements are the responsibility of the
  Companys management. Our responsibility is to
  express and opinion on these financial statements
  based on our audit.
• We conducted our audit in accordance with the
  standards of the Public Company Accounting
  Oversight Board. Those standards require that we
  plan and perform the audit to obtain reasonable
  assurance italics added for emphasis 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 italics added for emphasis
  for any opinion.
• In our opinion, the financial statements
  referred to above present fairly italics added
  for emphasis, in all material italics added for
  emphasis respects, the financial position of X
  Company as of at December 31, 20XX, 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.
• Signature
• Date

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Types of Reports with Unmodified Opinions

• 1. Unmodified opinionstandard report. This
  report may be issued only when the auditors have
  obtained sufficient appropriate audit evidence to
  conclude the financial statements are not
  misstated and there is no need to alter the
  report for situations 2, 3 or 4 below.
• 2. Unmodified opinionwith an emphasis of matter
  paragraph. To emphasize a matter appropriately
  presented in the financial statements (e.g., a
  change in accounting principles).
• 3. Unmodified opinionwith an other matter
  paragraph. To emphasize a matter other than
  those presented or disclosed in the financial
  statements (e.g., other information in documents
  containing audited financial statements).
• 4. Unmodified opinion on group financial
  statements. When two or more CPA firms are
  involved in an audit and the group auditor (firm
  that does most of the work) does not wish to take
  responsibility for the work of the component
  auditors.

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Types of Reports with Modified Opinions

• 1. A qualified opinion. A qualified opinion
  states that the financial statements are
  presented fairly in conformity with generally
  accepted accounting principles except for the
  effects of some matter.
• 2. An adverse opinion. An adverse opinion states
  that the financial statements are not presented
  fairly in conformity with generally accepted
  accounting principles.
• 3. A disclaimer of opinion. A disclaimer of
  opinion means that due to a significant scope
  limitation, the auditors were unable to form an
  opinion or did not form an opinion on the
  financial statements.

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Summary of Emphasis of Matter Paragraphs and
Group Audits
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Summary of Appropriate Auditors Reports
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Reports to SEC

• Forms filed with SEC which include audited
  financial statements
• Forms S-1 through S-11 (registration statements)
• Forms SB-1 and SB-2 (registration for small
  businesses)
• Form 8-K (current report)
• Form 10-Q (quarterly report)
• Form 19-K (annual report)
• Auditors should be well versed on requirements of
  each form

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ISSUES AFFECTING THE PROFESSION

• Expectations gap
• Litigation
• Earnings management and fraud
• Implementation/maintenance of SOX
• Globalization

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End of Auditing