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 Profession

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Principles Underlying a GAAS

Audit 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

Audit 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

Audit 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

Audit 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

Audit 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

Audit 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

Auditing 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

Standards--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

Standards--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

Standards--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

(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)

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Auditor Responsibility for the

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

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

Identifying 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

Nonpublic 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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GAAP

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’ 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 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 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

for 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

requirements

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

Continuance

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 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

Performance

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: 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 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

Profession

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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PCAOB

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 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 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

Standards 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 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