ACCT 3109 – Auditing

Quality Auditing: Why It Matters

Chapter 1

Fall Semester, 2021/22

Dr. Sammy Fung

1
An Overview of External Auditing
● External auditors performing a financial statement audit
provide independent assurance on:
● Reliability of the financial statements
● Internal control effectiveness

● Integrated audit: Provided when an external auditor is

engaged to perform an audit of the effectiveness of
internal control over financial reporting that is integrated
with an audit of financial statements

2
Decision Makers’ Need for Reliable Information and
the Role of a Financial Statement Audit
● Decision makers need information that is transparent and
unbiased
● Exhibit 1.1 identifies potential financial statement users
and the decisions they make based on financial and
internal control information

3
Exhibit 1.1

4
Need for Independent Assurance
● The need for independent assurance arises from several
factors:
● Potential bias
● Remoteness
● Complexity
● Consequences

5
Need for Independent Assurance
● Potential bias
● Management has incentives to bias financial information to convey a
better impression of financial data than real circumstances might
merit
● Remoteness
● Organization and users of its financial information are distant from
each other in terms of either geographic distance or the extent of
information available to the both parties
● Complexity
● Difficulty in determining a proper presentation of complex
transactions, information, and processing systems
● Consequences
● With unreliable information, investors lose a significant source of
information needed to make important decisions

6
What Is a Financial Statement Audit?
● A systematic process of objectively obtaining and
evaluating evidence regarding assertions about
economic actions and events to ascertain the degree
of correspondence between those assertions and
established criteria; and communicating the results to
interested users

7
Overall Objective of an Audit
● Obtain reasonable assurance about whether the financial
statements are free from material misstatement
● Report on the financial statements based on the auditor’s
findings
● To accomplish these objectives, the auditor:
● Complies with relevant ethical and professional conduct
requirements
● Conducts the audit in accordance with professional auditing
standards
● Exercises professional judgment, professional skepticism, and
critical thinking
● Obtains sufficient appropriate evidence, via a structured
process, on which to base the auditor’s opinion

8
Exhibit 1.4

9
Providers of External Auditing Services
● Sole-practitioner firms
● Local and regional firms
● Large multinational professional services firms such as
the Big 4
● KPMG
● Deloitte Touche Tohmatsu (Deloitte in the United States)
● PricewaterhouseCoopers (PwC)
● EY

10
Skills and Knowledge Needed by External Auditors
● Technical knowledge
● Leadership skills
● Teamwork skills
● Communication skills
● Decision-making skills
● Critical thinking skills
● General professionalism
● CPA license

11
Check Your Basic Knowledge (1-3)
1-3 Which of the following are the responsibilities of the
external auditor in auditing financial statements?
a. Maintaining internal controls and preparing financial
reports.
b. Providing internal assurance on internal control and
financial reports.
c. Providing internal oversight of the reporting process.
d. Providing independent assurance on the financial
statements.

12
Check Your Basic Knowledge (1-4)
1-4 Which of the following factors does not create a demand for
external audit services?
a. Potential bias by management in providing information.
b. Requirements of the state boards of accountancy.
c. Complexity of the accounting processing systems.
d. Remoteness between a user and the organization.

13
Achieving Audit Quality
● Performed in accordance with generally accepted
auditing standards (GAAS)
● GAAS provides reasonable assurance about the audited
financial statements and related disclosures:
● Presented in accordance with GAAP
● Are not materially misstated whether due to errors or fraud

14
Financial Reporting Council’s Audit Quality
Framework
● Identifies five primary drivers of audit quality
● Audit firm culture
● Skills and personal qualities of audit partners and staff
● Effectiveness of the audit process
● Reliability and usefulness of audit reporting
● Factors outside the control of auditors that affect audit quality

15
Exhibit 1.5

16
Audit Firm Culture
● Audit firm culture contributes to audit quality
● Audit firm leaders influence culture
● Value and reward audit quality
● “Do the right thing”
● Provide appropriate time and resources
● Ensure monetary considerations do not adversely affect audit
quality
● Seek guidance as needed
● Provide quality systems
● Foster evaluation and compensation practices
● Monitor audit quality

17
Skills and Qualities of the Engagement Team
● Auditors positively contribute to audit quality when they:
● Understand the client’s business
● Adhere to auditing and ethical standards
● Exhibit professional skepticism
● Address issues identified during the audit
● Ensure appropriate levels of experience and supervision for
staff performing audit work
● Ensure mentoring and on-the-job training opportunities for
staff performing audit work
● Participate in training

18
Effectiveness of the Audit Process
● The audit process contributes in a positive way to audit
quality when:
● The audit methodology is well structured
● Quality technical support is available when auditors encounter
unfamiliar situations requiring assistance or guidance
● Ethical standards are communicated and achieved, thereby
aiding auditors’ integrity, objectivity, and independence
● Auditors’ evidence collection is not constrained by financial
pressures

19
Reliability and Usefulness of Audit Reporting
● Audit reporting contributes positively to audit quality when:
● Audit reports are written in a way that clearly and unambiguously
conveys the auditor’s opinion on the financial statements and
addresses the needs of users of financial statements
● Auditors appropriately conclude as to the truth and fairness of the
financial statements (e.g., in the United States, concluding that the
financial statements are fairly presented in accordance with GAAP)
● The auditor communicates with the audit committee about:
● Audit scope (in other words, what the auditor is engaged to
accomplish)
● Threats to auditor objectivity
● Important risks identified and judgments that were made in reaching
the audit opinion
● Qualitative aspects of the client’s accounting and reporting and
possible ways of improving financial reporting

20
Factors Outside the Control of Auditors
● Some factors affecting audit quality are outside of the
direct control of the external auditor, such as client
corporate governance
● Good corporate governance includes audit committees
that are robust in dealing with issues and a greater
emphasis by the client on getting things right as opposed
to getting done by a particular date

21
Check Your Basic Knowledge (1-7)
1-7 Audit quality involves which of the following?
a. Performing an audit in accordance with GAAS to provide reasonable assurance that the
audited financial statements and related disclosures are presented in accordance with
GAAP and providing assurance that those financial statements are not materially
misstated whether due to errors or fraud.
b. Performing an audit in accordance with GAAP to provide reasonable assurance that the
audited financial statements and related disclosures are presented in accordance with
GAAS and providing assurance that those financial statements are not materially
misstated whether due to errors or fraud.
c. Performing an audit in accordance with GAAS to provide absolute assurance that the
audited financial statements and related disclosures are presented in accordance with
GAAP and providing assurance that those financial statements are not materially
misstated whether due to errors or fraud.
d. Performing an audit in accordance with GAAS to provide reasonable assurance that the
audited financial statements and related disclosures are presented in accordance with
GAAP and providing assurance that those financial statements contain no
misstatements due to errors or fraud.

22
Check Your Basic Knowledge (1-8)
1-8 Which of the following factors is not a driver of audit quality
as discussed by the FRC?
a. Audit firm culture.
b. Skills and personal qualities of client management.
c. Reliability and usefulness of audit reporting.
d. Factors outside the control of auditors

23
Professional Conduct Requirements that Help
Auditors Achieve Audit Quality
● Codes of professional conduct and related guidance on
professional responsibilities
● Organizations providing such guidance for U.S. auditors
include:
● AICPA – American Institute of Certified Public Accountants
● SEC – Securities and Exchange Commission
● PCAOB – Public Company Accounting Oversight Board

24
AICPA Requirements: Code of Professional Conduct
● AICPA has a code of professional conduct to aid auditors
in conducting a quality audit
● The Code applies to professional services performed by
AICPA members
● Compliance with the Code
● Depends primarily on the voluntary cooperation of AICPA
members
● Depends secondarily on public opinion, reinforcement by
peers, and ultimately, on disciplinary proceedings

25
Principles Of Professional Conduct
● AICPA’s Code of Professional Conduct consists of a set of
principles of professional conduct
● Topics include:
● Responsibilities
● Public interest
● Integrity
● Objectivity and independence
● Due care
● Scope and nature of services
● Refer to Exhibit 1.6 for a summary

26
Exhibit 1.6

27
Conceptual Framework
● AICPA’s Code of Professional Conduct includes a
conceptual framework for members in public practice
● This framework incorporates a “threats and safeguards”
approach to help auditors analyze relationships and
circumstances that the Code does not specifically address

28
Conceptual Framework Threats
● Threats are circumstances that could result in an auditor
lacking independence in fact or in appearance
● Threats to independence include:
1. Self-review threat
2. Advocacy threat
3. Adverse interest threat
4. Familiarity threat
5. Undue influence threat
6. Self-interest threat
7. Management participation threat

29
Conceptual Framework Safeguards
● Safeguards are actions or other measures that may
eliminate a threat or reduce a threat to an acceptable
level
● These safeguards include:
● Safeguards created by the profession, legislation, or regulation
● Safeguards implemented by the audit client
● Safeguards implemented by the audit firm

30
Independence Rule
● The Independence Rule requires that a member in public
practice be independent in the performance of
professional services as required by standards
promulgated by bodies designated by the AICPA
● Covered Member
● Financial Interests
● Employment of Family Members
● Loans
● Performing Other Nonaudit Services
● Network Firms

31
SEC and PCAOB: Other Guidance on Professional
Responsibilities
● The Securities and Exchange Commission (SEC) and Public
Company Accounting Oversight Board (PCAOB) have
independence requirements that apply only to auditors of
public companies
● These two organizations have complementary
independence requirements

32
SEC’s Commitment to Independence
● The independence requirement serves two related, but
distinct, public policy goals:
● Foster high-quality audits by minimizing the possibility that any
external factors will influence an auditor’s judgments
● Promote investor confidence in the financial statements of
public companies

33
Impairment of Auditor Independence
● Auditor independence is impaired when auditor has a
relationship that:
● Creates a mutual or conflicting interest between the
accountant and the audit client
● Places the accountant in the position of auditing his or her
own work
● Results in the accountant acting as management or an
employee of the audit client
● Places the accountant in a position of being an advocate for
the audit client

34
Additional Requirements For Professional Conduct
● Auditors of public companies have additional
requirements for professional conduct that extend
beyond those of the AICPA
● Requirements include:
● Preapproval of services
● Fee disclosures
● Audit partner rotation
● Not performing prohibited services

35
Prohibited Services
● The types of nonaudit services that audit firms can provide to public
company audit clients are more restricted than those that can be
provided to non-public companies
● Prohibited nonaudit services for public company audit clients
include:
● Bookkeeping or other services related to the accounting records or
financial statements of the audit client
● Financial information systems design and implementation
● Appraisal or valuation services, fairness opinions, or contribution-in-kind
reports
● Actuarial services
● Internal audit outsourcing services
● Management functions or human resources
● Broker or dealer, investment adviser, or investment banking services
● Legal services and expert services unrelated to the audit
● Any other service that the PCAOB determines, by regulation, is
impermissible

36
International Professional Requirements That Help
Auditors Achieve Audit Quality
● The International Ethics Standards Board for Accountants
(IESBA), under the International Federation of
Accountants, outlines fundamental principles that should
guide auditors’ ethical decision making.

37
IESBA Code of Ethics for Professional Accountants
● Five fundamental principles
● Integrity
● Objectivity
● Professional Competence and Due Care
● Confidentiality
● Professional Behavior
● In addition to these five principles, the Code contains
specific standards addressing many of the same topics
contained in the AICPA’s Code of Professional Conduct.

38
Check Your Basic Knowledge (1-11)
1-11 Which of the following is not a threat to auditor
independence?
a. Self-review threat.
b. Advocacy threat.
c. Adverse interest threat.
d. Regulatory interest threat.

39
Frameworks for Professional and Ethical Decision
Making
● To achieve audit quality, auditors need to make quality
decisions throughout the audit
● Quality decisions are:
● Unbiased
● Meet the expectations of reasonable users
● Comply with professional standards
● Incorporate sufficient appropriate evidence

40
Importance of Professional Skepticism in Making
Professional Judgments
● The auditor must exercise professional skepticism during
the whole audit process:
● Professional skepticism is an attitude that includes a
questioning mind and a critical assessment of audit evidence
● Critically question contradictory audit evidence
● Carefully evaluate the reliability of audit evidence
● Reasonably question the authenticity of documentation
● Reasonably question the honesty and integrity of
management, individuals charged with governance, and third-
party evidence providers

41
Importance of Client Acceptance and Continuance
Decisions to Audit Quality
● Conducting a quality audit begins with client acceptance and
continuance decisions
● New clients become part of an audit firm’s portfolio based on
the client acceptance decision, which includes an evaluation of
the client’s relative risk and audit fee profile
● Each year, the audit firm makes a client continuance decision
to determine whether the audit firm should continue to
provide services in the next period
● Similar to the client acceptance decision, the client
continuance decision is based on a consideration of the
client’s relative risk and audit fee profile
● Discontinued clients are those the audit firm decides to
eliminate from its portfolio

42
Exhibit 1.11

43
Risks Considered in Client Acceptance
and Continuance Decisions
● Audit firms consider many key risks when making client
acceptance and continuance decisions
● Types of key risks
● Client entity characteristics
● Independence risk factors
● Third-party/due diligence risk factors
● Quantitative risk factors
● Qualitative risk factors
● Entity organizational or governance risk
● Financial reporting risk

44
Other Considerations in Client Acceptance
and Continuance Decisions
● An audit firm should not perform an audit that it is not
qualified to perform
● Firms should not provide audit services if they do not have the
size or expertise to serve the client as the client grows larger,
becomes more geographically dispersed, or increases in
complexity
● Auditors should provide audit services only when the
preconditions for an audit are present
● Management’s use of an acceptable financial reporting framework
● The agreement of management that it acknowledges and
understands its responsibilities
● https://www.scmp.com/business/banking-
finance/article/3086966/deloitte-resigns-auditor-50-hong-
kong-listed-companies
45
46