Upload
earl-grant-booker
View
251
Download
3
Tags:
Embed Size (px)
Citation preview
GBW Ch. 2 8th ed2
TOPICS
Audit & Attestation standardsAuditing conceptsAudit riskMateriality in financial statement audit
GBW Ch. 2 8th ed3
EARLY DEVELOPMENT OF STANDARDS
1941 Accounting Series Release (ASR)#21 SEC requires audit report Audit conducted in accordance with
generally accepted standards
1948 AICPA approves generally accepted auditing standards (GAAS)
GBW Ch. 2 8th ed4
RECENT DEVELOPMENT OF STANDARDS
1970s practitioners criticized GAAS as not sufficiently specific1986 Attestation standards developed Umbrella for engagement standards GAAS applies exclusively to financial
statement audits
GBW Ch. 2 8th ed5
COMPARING GAAS & ATTESTATION
Attestation GAAS
Broad range of engagementsincluding audit
Financial statement audit
Umbrella for all attest services
Audit one of many attest engagements
GBW Ch. 2 8th ed6
GENERAL STANDARDSAttestation GAAS
Adequate technical training Adequate technical training
Adequate knowledgeAssertion can be evaluated by reasonable criteria & consistently measured or estimated
Independence in mental attitude
Independence in mental attitude
Due professional care Due professional care
GBW Ch. 2 8th ed7
FIELDWORK STANDARDS
Attestation GAAS
Adequately planned & supervised
Adequately planned & supervised
Understanding internal control
Sufficient evidence Sufficient competent evidential matter
GBW Ch. 2 8th ed8
REPORTING STANDARDSAttestation GAAS
Assertion identified
Conclusion about conformity with established criteriaState significant reservations
Conclusion about conformity with GAAPConsistent use of GAAPAdequate informative disclosures
Limited use to parties agreeing on procedures
Opinion on statements as a whole
GBW Ch. 2 8th ed9
STANDARDS FOR PUBLIC COMPANY ENGAGEMENTS
Sarbanes-Oxley Act of 2002 Creates Public Company Accounting
Oversight Board (PCAOB) Delegates authority to PCAOB to
Oversee, regulate accounting and auditing professions
Develop accounting, auditing standards or Accept accounting standards from FASB Accept auditing standards from AICPA
GBW Ch. 2 8th ed11
INDEPENDENCE EXPLAINED
In fact State of mind Attitude of impartiality
In appearance Free of overt interest in client
GBW Ch. 2 8th ed12
CONSULTING & PUBLIC COMPANY ENGAGEMENTS 2000
… consulting & other services may shorten the distance between the auditor & management. Independence—if not in fact, then certainly in appearance—becomes a more elusive proposition. … In this dual role, the auditor, who guards the integrity of the numbers, now both oversees & answers to management.
Arthur Levitt, Jr., “Renewing the Covenant with Investors” Speech at NYU Center for Law & Business, 5/10/00.
GBW Ch. 2 8th ed13
SEC PUBLIC COMPANIES INDEPENDENCE REFORMS 2000
Engagement team model of independence Team & immediate family prohibited from
investments in clients
Increased restrictions for IT and internal audit consultingRequired disclosure audit/nonaudit fees in proxy statement
GBW Ch. 2 8th ed14
SARBANES-OXLEY, & INDEPENDENCE 2002
Establishes PCAOBAddresses accountability for corporate & criminal fraudLimits audit firm’s consulting services to public company clientsClient board of directors to approve consulting services provided by auditor
GBW Ch. 2 8th ed15
SERVICES PROHIBITED BY SARBANES-OXLEY
For public companies:Bookkeeping, other accounting servicesInformation systems design, implementationValuation or appraisal servicesActuarial servicesInternal audit outsourcing servicesManagement functions, human resourcesBroker, dealer, investment advisorLegal, expert servicesOther services to be determined
GBW Ch. 2 8th ed16
SEC, INDEPENDENCE, & PUBLIC COMPANIES 2003
Further independence regulations Rotate engagement partner 5-7 years Restrict firm’s independence for 1
year when client hires member of audit team
Violates independence if auditor’s compensation based on selling service other than attest
Require auditor report certain matters to client’s audit committee Critical accounting policies
GBW Ch. 2 8th ed17
DUE CARE EXPLAINED
Care when providing professional servicesAdequate training for professional services
GBW Ch. 2 8th ed18
DUE CARE IN LAW
Every man who offers his service to another & is employed assumes the duty to exercise such skill as he possesses with reasonable care & diligence. …if one offers his service, he is understood as holding himself out to the public as possessing the degree of skill commonly possessed by others in the same employment & if his pretensions are unfounded, he commits a species of fraud upon every man who employs him . . .
Cooley on Torts
GBW Ch. 2 8th ed19
DUE CARE & WORLDCOM 2002
2nd largest long-distance carrier restated financial statements for 5 quarters Network access fees capitalized instead of
expensed Overstated net income by $11 billion Overstated balance sheet by $75 billion Not GAAP
Auditor knew but did not challenge
GBW Ch. 2 8th ed20
DUE CARE &PRUDENT PRACTITIONER
Foresee unreasonable risk to othersAttend to extra risksConsider unusual circumstances or relationshipsIdentify unfamiliar situation & take precautionsResolve doubtKeep currentReview work of assistants
GBW Ch. 2 8th ed21
DUE CARE OPERATIONALIZED
Auditor obtains knowledge of business to understand events, transactions, practices with significant effect on financial statementsPlan audit to limit audit risk to low levelAssess possible errors on balance sheet
GBW Ch. 2 8th ed22
EVIDENCE EXPLAINED
Underlying accounting data Journals, ledgers,
reconciliations, accounting manuals
Corroborating information Receiving reports, invoices,
contracts, representations from 3rd parties
GBW Ch. 2 8th ed23
EVIDENCE
Basis for all decisions Evidential matter Planning & supervision Internal control
GBW Ch. 2 8th ed24
EVIDENCE: SUFFICIENCY & COMPETENCE
Sufficiency Quantity useful evidence collected at
reasonable cost
Competence Validity: varies with source Relevance: related to assertion
GBW Ch. 2 8th ed25
EVIDENCE HIERARCHY
Independent sources more reliable than management
Banks, debtors
Evidence obtained directly more persuasive than indirect evidence from management
Physical examination, observation, computation, inspection
Effective internal control systems produce more reliable evidence
GBW Ch. 2 8th ed26
PLANNING & SUPERVISION EXPLAINED
Planning Developing objectives & strategy
Supervision Directing assistants toward objectives Determining when objectives are met
GBW Ch. 2 8th ed27
INTERNAL CONTROL
Policies & procedures of management & board of directorsProvides reasonable assurance their objectives will be achievedAuditor must understand client’s internal controls To plan audit To design audit tests
GBW Ch. 2 8th ed28
REPORTING EXPLAINED
Report states conclusion Attestation report
Whether management’s assertion conforms with stated criteria
Audit report Whether financial statements conform
to GAAP
GBW Ch. 2 8th ed29
AUDIT REPORT CONCLUSION
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the company . . ., & the results of its operations and its cash flows . . ., in conformity with generally accepted accounting principles.
GBW Ch. 2 8th ed30
STRATEGY FOR RISK
Risk of omissions or misstatementsDesign engagement to control material omissions or misstatementsProvide reasonable not absolute assurance of detecting omissions or misstatements
GBW Ch. 2 8th ed31
ATTESTATION RISK
Probability that attester may unknowingly fail to modify a written conclusion about an assertion that is materially misstated
D. N. Ricchiute, Auditing, 8th ed.
GBW Ch. 2 8th ed32
AUDIT RISK
Probability that auditor may unknowingly fail to modify opinion on financial statements that are materially misstated
D. N. Ricchiute, Auditing, 8th ed.
GBW Ch. 2 8th ed33
COMPONENTS OF AUDIT RISK
Client sources of risk Inherent risk Control risk
Auditor source of risk Detection risk
GBW Ch. 2 8th ed34
COMPONENTS OF AUDIT RISK DEFINED
Inherent risk Risk that errors will occur
Control risk Risk that internal controls won’t prevent,
detect, correct errors
Detection risk Risk that audit procedures won’t find
errors
GBW Ch. 2 8th ed35
INHERENT RISK SOURCES
Risk that errors will occurBusinessIndustryManagement’s predisposition to manage earningsAggressive use of GAAPSpecific accounts Liquid assets vs. nonliquid assets
GBW Ch. 2 8th ed36
CONTROL RISK SOURCES
Risk that internal controls won’t prevent, detect, correct errorsOutdated technologyOutdated softwareLack of respect for controls by top management
GBW Ch. 2 8th ed37
DETECTION RISK SOURCES
Likelihood that errors could occur and not be detected by audit proceduresNature of audit proceduresExtent of audit proceduresTiming of audit proceduresAuditor’s judgment
GBW Ch. 2 8th ed39
AUDITOR’S BUSINESS RISKThe probability that a practitioner
might incur damages despite issuing an appropriate report Ex.: litigation
Factors affecting auditor’s business risk Aggressive financial reporting Management integrity or reputation Conflicts of interest & regulatory
problems Industry characteristics
GBW Ch. 2 8th ed40
AUDITOR’S RESPONSE TO BUSINESS RISK
If business risk is higher, adjust audit risk assessment Set audit risk lower Decrease acceptable level of detection risk Increase evidence Drop client
If assurance levels all same, do not adjust audit risk
GBW Ch. 2 8th ed41
AUDIT FAILURE DEFINED
Failing to perform procedures that would reduce audit risk to a relatively low level Ex.: SunbeamSunbeam’s auditor a) identified
reserves not in compliance with GAAP; b) proposed adjustments which management rejected; c) accepted reserves as stated after incorrectly applying materiality analysis
GBW Ch. 2 8th ed42
MATERIALITY
The magnitude or an omission or misstatement of accounting information that, in the judgment of a reasonable person relying on the information, would have been changed or influenced by the omission or misstatement.1
Statement of Financial Accounting Standards No. 2, “Qualitative
Characteristics of Accounting Information,” Stamford: FASB, 1980, par
132.
GBW Ch. 2 8th ed43
MATERIALITY IN PRACTICE
Preliminary estimate of materiality for planning guides audit effort, evidence collection SAS No. 22, “Planning & Supervision”
GBW Ch. 2 8th ed44
AUDIT RISK, MATERIALITY, AUDIT EFFORT
Inverse relationship between audit risk and materiality Low audit risk suggests it would take
larger amounts to be material
Inverse relationship between materiality and audit effort (hours worked) Higher materiality threshold suggests
less audit effort
GBW Ch. 2 8th ed45
QUANTITATIVE MATERIALITY CRITERIA
Effect on Net income Total assets Total revenue
GBW Ch. 2 8th ed46
SAS 99 ON MATERIALITY
Auditors should Not rely solely on quantitative
materiality criteria Judge materiality of misstatements
both individually & in aggregate Recognize that intentional but
immaterial misstatements are inappropriate & may be unlawful
GBW Ch. 2 8th ed47
QUALITATIVE MATERIALITY CONSIDERATIONS
Misstatement may not be immaterial if: Affects debt compliance requirements Masks change in earnings Conceals unlawful transaction Prompts undue expectations Hides failure to meet analysts’ expectations Associated with an estimate Affects management’s compensation