Professional Standards

Chapter 02

McGraw-Hill/Irwin Copyright © 2012 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 Public Accountants Auditing, Attestation, Quality Control, Independence

Ethical, Accounting and Review Standards for engagements 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 ProfessionRegulation of the Public Accounting Profession

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Principles Underlying a GAAS Principles Underlying a GAAS Audit 1/6Audit 1/6

Purpose of an audit Premise of an audit Personal responsibilities of the auditor Auditor actions in performing the audit Reporting results of an audit

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Principles Underlying a GAAS Principles Underlying a GAAS Audit 2/6Audit 2/6

Purpose of an audit—Provide an opinion on financial statements are in accordance with the applicable financial reporting framework. The framework is ordinarily GAAP. The applicable framework corresponds to the

“suitable criteria” of an attest engagement.

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Principles Underlying a GAAS Principles Underlying a GAAS Audit 3/6Audit 3/6

Premise of an audit—Management (and those charged with governance) have responsibility to: Prepare financial statements in accordance

with applicable financial reporting framework. Provide auditor with needed information and

unrestricted access to those in the entity.

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Principles Underlying a GAAS Principles Underlying a GAAS Audit 4/6Audit 4/6

Personal responsibility of the auditor—Appropriate competence and capabilities to perform audit in accordance with standards, including maintaining professional skepticism and exercising professional judgment throughout the audit. Professional skepticism—A questioning mind

and a critical assessment of audit evidence.

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Principles Underlying a GAAS Principles Underlying a GAAS Audit 5/6Audit 5/6

Auditor actions in performing the audit Obtain reasonable assurance about whether

financial statements are free from error or fraud.

The auditor is unable to obtain absolute assurance due to:

• Nature of financial reporting.• Nature of audit procedures.• Need to conduct audit within a reasonable period

of time.

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Principles Underlying a GAAS Principles Underlying a GAAS Audit 6/6Audit 6/6

Reporting the results of an audit—Express in a written report an opinion on findings (or statement that opinion cannot be expressed). The opinion is on whether the financial

statements are in accordance, in all material respects, with the applicable financial reporting framework.

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The 10 Generally Accepted The 10 Generally Accepted Auditing StandardsAuditing Standards

General Standards Standards of Field Work Reporting Standards

NOTE: These standards only apply to audits conducted according to PCAOB standards. The preceding “Principles” replaced the 10 GAAS standards for nonpublic company audits.

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Generally Accepted Auditing Generally Accepted Auditing Standards--General StandardsStandards--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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Generally Accepted Auditing Generally Accepted Auditing Standards--Standards of Field WorkStandards--Standards of Field Work

Auditor must adequately plan and properly supervise work

Auditor must obtain a sufficient understanding of entity, and its environment, including internal control to assess risk of material misstatement and to design further audit procedures

Auditor must obtain sufficient appropriate audit evidence to afford a reasonable basis for the opinion

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Generally Accepted Auditing Generally Accepted Auditing Standards--Standards of ReportingStandards--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 by expressing an opinion or stating that one cannot be expressed, and the reason therefor

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Terminology in Auditing Standards Terminology in Auditing Standards (Figure 2.3)(Figure 2.3)

Responsibility

Level

Meaning Words Used to Indicate Responsibility

Unconditional

Responsibility

Auditor must fulfill responsibilities “Must”

“Shall” (PCAOB only)

“Is required” (PCAOB only)

Presumptively Mandatory

Auditor must comply with requirements unless auditor demonstrates and documents that alternative actions were sufficient to achieve the objectives of the standards

“Should”

Responsibility to Consider

Auditor should consider; whether the auditor complies with the requirements depends on the exercise of professional judgment in the circumstances

“May”

“Might”

“Could”

Other phrases indicating a responsibilities to consider

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The GAAS Hierarchy (Figure 2.3)The GAAS Hierarchy (Figure 2.3)

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Auditor Responsibility for the Auditor Responsibility for the Detection of Errors and Fraud (1 of 2)Detection of Errors and Fraud (1 of 2)

Obtain information to assess the inherent risks and fraud risks

Information about the company and its environment

Discussion among audit team members Inquiries of management and others Risk assessment analytical procedures, including

those involving revenue Assess the risk of errors and fraud that may cause the

financial statements to contain a material misstatement.

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Auditor Responsibility for the Auditor Responsibility for the Detection of Errors and Fraud (2 of 2)Detection of Errors and Fraud (2 of 2)

Based on that assessment, plan and perform the audit to obtain reasonable assurance that material misstatements, whether caused by errors or fraud, will be detected.

Exercise due care in planning, performing and evaluating the results of audit procedures, and the proper degree of professional skepticism to achieve reasonable assurance that material misstatements due to error or fraud will be detected.

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Auditor Responsibility for Client Auditor Responsibility for Client Identifying Noncompliance with LawsIdentifying Noncompliance with Laws

Noncompliance with laws that could have a direct and material effect on financial statement amounts and disclosures--same as for errors and fraud. An audit obtains reasonable assurance of detecting noncompliance with these laws.

Other Laws (no direct effect on financial statement amounts):

Specific procedures:• Inquire of management as to compliance• Inspect correspondence with licensing or regulatory authorities

Be aware of possible occurrence. If information comes to the auditor’s attention, apply audit

procedures directed at determining whether noncompliance with a law has occurred. An audit does not provide assurance that noncompliance with these laws will be detected.

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The Standard Auditors’ Report for The Standard Auditors’ Report for Nonpublic CompaniesNonpublic Companies

Title Addressee Content Sections (paragraphs)

Introductory (“We have audited”) Management’s responsibility Auditor’s Responsibility Opinion Paragraph

Signature (firm name) City and state of office issuing audit report Date

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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.

The AICPA Standard Auditors’ Report--Introductory Paragraph

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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.

The AICPA Standard Auditors’ Report—Management’s Responsibility Paragraph

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The AICPA Standard Auditors’ Report:Auditors’ 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.

 

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.

 

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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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.

The AICPA Standard Auditors’ Report--Opinion Paragraph

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GAAPGAAP FASB issues GAAP for nongovernmental entities

Authoritative: FASB Codification and Accounting Standards Updates

Nonauthoritative Pronouncements:• Widely recognized practices• FASB concepts Statements• AICPA Issues Papers• International Financial Reporting Standards• Various others

Other sources of GAAP GASB--State and local governments FASAB--Federal government

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Other Types of Auditors’ ReportsOther Types of Auditors’ Reports Standard unmodified report (unqualified per PCAOB standards)

Financial statements follow GAAP and auditor does not add additional commentary for any issue

Other reports Unmodified with emphasis of matter (or other emphasis)

• Example: A lack of consistency in application of accounting principles

Qualified opinion• Scope limitation or departure from GAAP

Adverse opinion• Departure from GAAP so significant that financial statements as a

whole are misleading Disclaimer of opinion

• Unable to arrive at an opinion due to a very significant scope limitation

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Public Company Audit ReportPublic Company Audit Report Title is “Report of Registered Independent

Public Accounting Firm.” Refers to standards of the PCAOB rather

than GAAS. Includes a paragraph that refers to report

on internal control. Somewhat more brief than the nonpublic

company report.

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Applicability of SSAEs

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Elements of Quality ControlElements of Quality Control

Leadership responsibilities for quality within the firm (“tone at the top”)

Relevant ethical requirements Acceptance and continuance of clients

and engagements Human Resources Engagement performance Monitoring

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QC Element 1: Leadership responsibilities QC Element 1: Leadership responsibilities for quality within the firmfor quality within the firm

Firm’s internal culture recognizes that quality is essential 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 responsibilities so that commercial considerations do not override the quality of work performed.

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QC Element 2: Relevant ethical QC Element 2: Relevant ethical requirementsrequirements

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 QC Element 3: Acceptance and ContinuanceContinuance

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 aggressive accounting and internal control over financial reporting.

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QC Element 4: Human ResourcesQC 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 the circumstances.

Example: Design effective recruitment processes and procedures to help the firm select individuals meeting minimum academic requirements established by the firm, and maturity, integrity and leadership.

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QC Element 5: Engagement QC Element 5: Engagement PerformancePerformance

Firm’s 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: MonitoringQC Element 6: Monitoring

Firm’s 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 firm’s quality control policies and procedures.

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Quality Control ProceduresQuality Control Procedures

Depend on size of firm, number of offices and nature of firm’s 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 Regulation of the Public Accounting ProfessionProfession

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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PCAOBPCAOB

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 ReviewsPeer 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 evaluate

appropriateness• Less in scope than system review

Report: pass, pass with deficiencies, or fail

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PCAOB InspectionsPCAOB Inspections Conducted by PCAOB staff Focus

Primarily evaluating performance of sample of individual audit and review engagements; a risk based approach to selection and inspection is used.

Selected quality control and management 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 International Accounting StandardsStandards

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 ReportInternational Audit Report

Contains expanded description of management’s responsibility and explanation of the audit process similar to the nonpublic company audit report

May state “present fairly, in all material respects” or “give a true and fair view”

Report may indicate that the financial statements comply with the provisions of the country’s relevant statutes or laws

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