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Auditing: Integral to the Economy
Copyright © 2010 South-Western/Cengage Learning
Audit Opinion Formulation Process
The Audit Function
• Perform tests on an organization’s records to determine that they are accurate. • Interpret FASB, IASB, GASB, and other authoritative pronouncements to ensure that financial statements are fairly presented. • Make judgments about the fairness of complex accounting processes and then test, the organization’s system of internal control over financial reporting. • Do all this in a totally objective, unbiased, and professionally skeptical manner.
LO 1: Auditing “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.” .
management. . • Auditing is specific attestation service where the auditor gathers evidence to determine whether the financial statements are fairly presented in accordance with Generally Accepted Accounting Principles and issues an opinion to be used by third-party users. evaluating the evidence against objective criteria. and the Board of Directors. and communicating the conclusion reached.What is Attestation? • Attestation involves gathering evidence about assertions.
• Communicating the audit conclusion to interested parties.Auditing Process • Gathering evidence to attest to assertions. . • Evaluating those assertions against objective criteria.
– Less because public accounting firms provide a variety of other assurance and non-audit services. governmental auditing. – More because it includes internal and operational auditing. .LO 2: Auditing: A Special Function • Auditing is both more and less than public accounting. and other services that evaluate and report on managerial performance.
• Computer systems are complex.Challenges of the Profession • Detect material fraud and assure that users of financial statements are free from fraud. • Time pressure to get audit done. • Many companies are global. • Need to generate sufficient audit fees. • Complex accounting transactions and organizational structures. .
Users of Audited Financial Statements .
• Complexity of the transactions. or processing systems such that it is difficult to determine their proper presentation without a review by an independent expert. that is. • Riskiness of Investments: Investors need to manage their risk and thereby minimize financial surprises. • Remoteness between a user and the organization or trading partner. the providing party may want to convey a better impression than real circumstances merit.The Need for Assurance Services • Potential bias in providing information. information. .
• Four of the largest bankruptcies ever . .each in companies where financial statement misrepresentation had taken place.LO 3: The Accounting Profession’s Decade of Unprecedented Turmoil and Change • The failure of one of the largest public accounting firms (Andersen). • Billions of investment and retirement dollars lost. • Perception that auditors were not independent from their clients.
– Acknowledgment of greater public expectations of auditors. – Audit standard setting moved to a new quasi-public organization. – Required reporting on internal controls. – Improved independence of the external audit function.Changes in the Profession: Increased Demand for Accountability • The Sarbanes-Oxley Act of 2002 provided critical improvements related to auditing and the financial statements. . • The Act focused on: – Improved corporate governance.
• Sarbanes requires Boards of Directors be independent of the organization and exercise oversight over management and the audit function. . a failure of Boards of Directors to oversee management. and effectively utilize the audit function. most notably. • Further. the Board of Directors. through its audit committee. is the "client" of the public accounting firm.Improved Corporate Governance • The lack of corporate governance was a major factor in business failures.
• Treadway Commission’s report on Fraudulent Financial Reporting in 1987 advanced the need for public reporting on internal control. • Effective internal control system that produces reliable information should be established. . • Report deficiencies in public reports so that its impact can be assessed. companies had poor internal controls over financial reporting.LO 4: Required Reporting on Internal Controls • In most cases of major fraud. • Sarbanes requires the CEO and CFO of SEC registered companies to assess and publicly report on the quality of its internal controls over financial reporting.
• Auditor independence has been strengthened by requiring: 1. 3. Increased oversight of potential independence conflicts by the audit committee. The audit committee has the authority to hire and fire the external auditors. Mandatory rotation of the audit engagement partner every five years. 4.Audit Standard Setting and Auditor Independence • The audit function must be independent and objective if assurances are to be trusted by third parties. • Non-public companies and smaller audit firms are not required to follow all these guidelines. . Consulting work cannot be performed for audit clients. 2.
– The PCAOB has authority to develop audit standards for audits of publicly traded companies. .Audit Standard Setting Moved • The public lost confidence in the ability of the profession to serve the public interest. • No more than two members can be CPAs. – The PCAOB is also charged with performing peer review of all public accounting firms that perform audits of public companies. • Sarbanes created the Public Company Accounting Oversight Board (PCAOB). – The PCAOB is comprised of five public members appointed by the SEC.
." • Assurance services involve three components: – Information or a process on which the assurance is provided. or its context. for decision makers. – An assurance service provider. – A user or group of users who derive value from the assurance provided.LO 5: The AICPA’s Definition of Assurance Services • The AICPA's Special Committee on Assurance Services defines assurance as: “Independent professional services that improve the quality of information.
Independence from parties requesting assurance 3. Agreed upon criteria to evaluate quality of presentation 4. Subject matter knowledge 2. Expertise in the process of gathering and evaluating evidence .What are the Attributes Needed to Perform Assurance Services? 1.
Limited or negative assurance (such as a review of financial statements) 3. No assurance (such as a compilation of financial statements) .What are the Levels of Assurance Provided? 1. Positive assurance (such as an audit opinion) 2.
Healthcare Performance Measurement: Provide information about the quality of services provided by healthcare providers.The AICPA's Special Committee on Assurance Services has identified six areas of potential service: 1. 5. Risk Assessment: Quality of processes implemented by an organization to identify. Information System Reliability: Quality of controls to ensure system security. 3. 2. reliability. . timeliness. measure. Business Performance Measurement: Processes to identify. 6. and accuracy. and manage risks. assess. Elder Care Plus: Provide assurance whether the needs of the elderly are being met by various caregivers. and communicate alternative measures of performance. 4. Electronic Commerce: Provide assurance that systems and tools are designed and functioning with integrity and security.
What are Attest Services? • Attest services are a subset of assurance services. • Attest services always involve a report sent to a third party. • Attest services always involve evaluation of an assertion made by one party to a third party. .
• Understanding Accounting System Complexity: Auditor must understand the challenges posed in a system in which traditional source documents do not exist. auditor must have sound conceptual understanding of financial reporting and auditing. • Internal Auditing Expertise: Auditor must be able to analyze the organization’s internal controls to determine if there are weaknesses.LO 6: Requirements to Enter the Public Accounting Profession • Accounting and Auditing Expertise: In addition to technical knowledge. • Knowledge of Business and its Risks: Auditor must understand the basic structure of a business in order to identify significant risks affecting the client. .
Who Are the Providers of Assurance Services? • The Public Accounting Profession • The Internal Audit Profession • The Governmental Audit Profession .
ranging sole-practitioners to large multinationals such as the Big 4.000 CPA firms in the United States. • The SEC has prohibited accounting firms from providing most consulting services to public companies that they audit. • These firms provide a variety of services in the areas of assurance and financial statement services. .The Public Accounting Profession • More than 45. • Such restriction on services has not been specified by the AICPA or regulatory authorities for public accounting firms that do not audit SEC registered clients. and consulting. tax planning and compliance.
detailed audit work. seniors and staff are usually assigned to only one audit at a time. – Next. managers review the detailed audit work performed by staff auditors. – Partners and managers may be involved in a number of audit engagements being conducted simultaneously. – Staff auditors perform the basic. – Partners (or owners) are at the top and are responsible for the overall conduct of each audit. – Seniors are responsible for overseeing much of the day-today activities on a specific audit.Organization of CPA Firms • The organizational hierarchy of CPA firms has been described as a pyramidal structure. .
control.The Internal Audit Profession • Internal auditing is defined as: “An independent. It helps an organization accomplish its objectives by bringing a systematic. disciplined approach to evaluate and improve the effectiveness of risk management. and governance processes. objective assurance and consulting activity designed to add value and improve an organization's operations." .
• Internal auditors perform operational audits designed to evaluate the effectiveness. • Internal auditors provide consulting services such as analyzing problems and identifying potential solutions. or the effectiveness of processes and operations. .Internal Auditors Add Value to an Organization • Internal auditors evaluate processes to identify and management risk. and efficiency with which resources are employed. economy. develop and implement effective internal controls. • Internal auditors assure management and the Board of Directors on the company's compliance with policies or regulatory requirements.
and local agencies. • Governmental auditors perform all the types of audits that internal auditors perform including compliance. and performance audits.Governmental Auditing Profession • Employed by various Federal. operational. . state.
. capital markets. • The AICPA has long served as the primary governing organization of the public accounting profession. It has the authority to establish GAAP for publicly traded companies. Membership in the AICPA is voluntary. and to prosecute companies who violate SEC laws. It provides a variety of continuing education programs and administers the Uniform CPA Examination.S.LO 8: Professional and Regulatory Organizations • The PCAOB established as part of the Sarbanes-Oxley Act of 2002 has authority to set auditing standards for audits of public companies and to perform quality reviews of all registered CPA firms. • The SEC oversees the PCAOB and all companies publicly traded on the U.
capital market. • Has prosecutorial authority. • Has the authority to establish GAAP for publicly traded companies.S.The Securities and Exchange Commission (SEC) • Established by Congress in 1934 to regulate the capital market system. . • Over site of PCAOB and all public companies required to register with it to gain access to the U.
The American Institute of Certified Public Accountants (AICPA) • Primary governing body of the public accounting profession • Continues to develop standards for audits of non-public companies • Administers the Uniform CPA Examination .
Professional and Regulatory Organizations • The State Boards of Accountancy are responsible for certifying and licensing CPAs in their state. • The Institute of Internal Auditors issued internal auditing standards and administers the Certified Internal Auditor program. The GAO develops auditing standards for governmental audits. General Accounting Office is the nonpartisan audit agency for Congress. S. • The U. education and experience requirements vary by state. . While all state boards require passage of the Uniform CPA Examination.
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