Chapter 01

The Role of the Public Accountant in the American Economy

McGraw-Hill/Irwin

Copyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Assurance services
The

broad range of information enhancement services that are provided by certified public accountants (CPAs). Two types:

Increase reliability of information Putting information into a form or context that facilitates decision making.

1-2

Types of Services
Assurance

Services

Attestation Services
Example: Audits of Financial Statements, Examinations of Internal Control

Other Assurance Services

Example: CPA ElderCare Prime Plus Services

NonAssurance

Services

Tax Services Management Consulting Services Other

1-3

Attestation Services
To

attest to information means to provide assurance as to its reliability Attest engagement:

A practitioner is engaged to issue or does issue an examination, a review, or an agreedupon procedures report on subject matter or an assertion about subject matter that is the responsibility of another party (e.g. management)
1-4

The Attest Function

Management Subject Matter Suitable Criteria The CPA Gathers Evidence Issues Report Subject Matter* The Attest Report

*May be managements assertion about the subject matter.

1-5

Suitable criteria

Standards established or developed by groups of experts. Example: Internal control audit standards established by a committee of experts on internal control Example: Financial statement audit standards are GAAP. For a financial statement audit suitable criteria are referred to as the applicable financial reporting framework.
1-6

Forms of Attestation

1-7

Audit of Financial Statements

Management Prepares Financial Statements Criteria (e.g., GAAP) The Auditors Gathers Evidence Issues Report Financial Statements The Auditors Report

*Applicable financial reporting framework

1-8

Financial Statement Audit

Auditors gather evidence and provide a high level of assurance that the financial statements follow GAAP, or some other appropriate basis of accounting Audit involves searching and verifying accounting records and examining other documents Evidence necessary to issue an audit report that states auditors opinion

1-9

Audit Evidence
Evidence focuses on whether financial statements are presented in accordance with GAAP; examples:
Balance sheet contains all liabilities Income statement

Sales really occurred Sales have been recorded at appropriate amounts Recorded costs and expenses are applicable to period All expenses have been recognized Accurate, properly classified and summarized Notes are informative and complete

Financial statement amounts

1-10

What Creates the Demand for Audits?

Audits lend credibility to information by reducing information risk, the risk that information is materially misstated Financial statement misstatements arise due to-

Accidental errors Lack of knowledge of accounting principles Unintentional bias Deliberate falsification

Audits do not directly address business risk, the risk that a company will not be able to meet its financial obligations due to economic conditions or poor management decisions
1-11

History of the Attest Function

Period Ancient - 1850 1850-1905 Developments Audits of city states, individuals & ventures Industrial revolution resulted in the need for corporate audits Development of stock markets - increased emphasis on earnings Development of auditing standards Criticism by Congress; Increased self-regulation Increased demands for reporting on compliance & internal control Panel on Audit Effectiveness; SarbanesOxley Act of 2002 Audit Objective Detection of fraud Detection of fraud & clerical errors Determination of fairness; detection of fraud & errors Determination of fairness Determination of fairness Determination of fairness Determination of fairness Nature of Audit Detailed; No reliance on controls Some testing; No reliance on controls Increased emphasis on testing; Slight reliance on controls Substantial reliance on controls Internal control determines scope of audit Risk assessment determines audit scope; must assess risk of fraud Business risk approach to audits

1905-1940

1940-1975 1975-1985

1985-1995

1995-Present

1-12

The Accounting Professions Credibility Crisis

2000The

Panel on Audit Effectiveness made a variety of suggestions to improve audits. 2001Enron Bankruptcy 2002WorldCom Fraud 2002Sarbanes-Oxley Act 2003Public Company Accounting Oversight Board began operations
1-13

Financial Audits
Audit

of the financial statements of an

entity

Covers the balance sheet and related statements of income, retained earnings and cash flows Goal is to determine if prepared in conformity with GAAP Performed by CPAs Users include management, investors, bankers, creditors, financial analysts, government agencies

1-14

Other Types of Audits

Compliance

Audits Audits

Example: IRS audit of income tax return Example: Effectiveness of operations of receiving department of a manufacturing company

Operational

Integrated

Audits

Example: Assurance on both the financial statements and effectiveness of internal control over financial reporting
1-15

Other Types of Auditors

Internal

Auditors Government Accountability Office Auditors Tax Auditors

1-16

Internal Auditors
Employed

by a company as an employee They often

perform operational and compliance audits address internal control report to the audit committee of the board of directors and to the president

The

Institute of Internal Auditors is the international organization of internal auditors.

1-17

Government Accountability Office Auditors (GAO Auditors)

Headed

by the comptroller general Responsibility of supporting Congress Perform

Compliance, operational and financial audits of government agencies Examinations of corporations holding government contracts to verify contract payments have been proper

1-18

Tax Auditors
Responsible

for enforcement of tax laws of various sorts (e.g., state and federal income taxes, property taxes, sales taxes) Internal revenue agents generally perform compliance audits of income tax returns

1-19

AICPAs Traditional Role

Establish Standards Research and Publication Continuing Professional Education Self-Regulation

Note: Much of the standards setting and regulation roles relating to public companies (referred to as issuers) has been taken over by the SEC and the PCAOB.

1-20

Establishes Standards--Examples
AICPA

Auditing Standards Board

Issues official pronouncements on auditing matters for nonpublic companies (nonissuers) Statements on Auditing Standards (SASs) Statements on Standards for Attestation Engagements (SSAEs) Guidance for attesting to information other than financial statements such as financial forecasts

Accounting and Review Services Committee

Statements on Standards for Accounting and Review Services (SSARS) Standards for compilations or reviews not audits of financial statements
1-21

Research and Publication

Publications Journal of Accountancy (monthly) The Tax Advisor Audit publications Industry Audit and Accounting Guides Audit Risk Alerts Auditing Practice Releases Other publications Accounting Research Studies Statements of Position Accounting Trends & Techniques
1-22

Continuing Professional Education

Development

of continuing professional education programs Necessary for continuing education requirement for CPA certificate Offered by

AICPA State societies Other professional organizations

1-23

Professional Regulation
Regulations

of Individual CPAs

Code of Professional Conduct ethical rules for CPAs Requirements for regular membership in AICPA

Regulation

of Public Accounting Firms

Division for Public Accounting Firms

Center for Public Company Audit Firms Private Companies Practice Section (PCPS)
1-24

The CPA Examination

Uniform

national examination prepared and graded by the AICPA Computerized exam includes multiple choice and simulations in four parts
Auditing and Attestation Financial Accounting & Reporting Regulation Business Environment & Concepts

1-25

State Boards of Accountancy

Issue

CPA certificates All boards require successful completion of CPA examination Education and experience requirements vary National Association of State Boards of Accounting (NASBA)

1-26

Other Parties
FASB

Sets GAAP for entities other than federal, state and local governments
Standards of financial accounting for state and local government entities Accounting standards for the US government

GASB

FASAB

1-27

PCAOB Role

Adopt auditing, attestation, quality control, ethics and independence standards relating to the preparation of audit reports for SEC registrants Oversee and discipline CPAs and CPA firms that audit public companies, including

Register firms Perform inspections of firms Conduct investigations and disciplinary proceedings of firms Sanction registered firms

1-28

Securities and Exchange Commission (SEC)

Agency

of the US government Oversight responsibility for the PCAOB Objectives

Protect investors and public by requiring full disclosure of financial information by companies offering securities for sale to the public Prevent misrepresentation, deceit, or other fraud in the sale of securities
1-29

Securities and Exchange Commission (SEC )

Registration

statements

Qualify securities for sales Contains audited financial statements Makes SEC major user of financial statements

Protects

investors Regulation S-X

Basic accounting regulation

1-30

Types of Professional Services

Attestation Tax Consulting Accounting

and Assurance

Personal

Financial Planning Litigation support Fraud Investigation Personal Financial Planning

1-31

Organization of the Public Accounting Profession

Sole

proprietorship Partnerships Professional Corporation Limited Liability Partnership (LLP) Limited Liability Company (LLC)

1-32

Categories of Public Accounting Firms

Local

Regional
National Big

4 Alternative Practice Structures

1-33

Industry Specialization
Firms

with detailed knowledge and understanding of a clients industry Helps firms

Be more effective at collecting and evaluating audit evidence Make valuable suggestions to improve clients operations Provide the client consulting services

1-34

Typical Structure of a National CPA Firm

Partners Managers Seniors

Staff Assistant

1-35

Responsibilities on an Engagement
PartnerOverall

responsibility is to assure that that audit is performed in accordance with professional standards. ManagerSupervise overall engagement. SeniorsIn charge auditor on a daily basis. Staff assistantsWork under the immediate supervision of the senior.
1-36

Elements of Public Accounting Work

Professional

Developments

Stay current on developments within the profession

Seasonal

fluctuations with clients

Busy season from December through April Need to maintain independence

Relationships

1-37