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Chapter 02

Professional
Standards

McGraw-Hill/Irwin

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


reserved.

Authority of Organizations

Public Company Accounting Oversight Board

American Institute of Certified Public Accountants

Auditing, Attestation, Quality Control, Independence,


Ethical Standards for audits of public companies

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

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Regulation of the Public Accounting Profession

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Principles Underling 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 Underling a GAAS


Audit 2/6

Purpose

of an auditProvide 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 Underling a GAAS


Audit 3/6

Premise

of an auditManagement (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 Underling 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 skepticismA questioning mind


and a critical assessment of audit evidence.
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Principles Underling 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 Underling 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.

Gener
Trainin
Indepe
Profes

Field W
Planni
Interna
Eviden

Accou
Consis
Disclo
Opinio
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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 auditors 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)


Managements responsibility
Auditors Responsibility
Opinion Paragraph

Signature (firm name)


City and state of office issuing audit report
Date

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The AICPA Standard Auditors


Report--Introductory Paragraph

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.

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The AICPA Standard Auditors Report


Managements Responsibility Paragraph

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.

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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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The AICPA Standard Auditors


Report--Opinion Paragraph

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.
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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

Firms 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

Firms engagements are consistently performed in


accordance with professional standards and regulatory
and legal requirements, with policies and procedures
addressing:
1.
2.
3.

Engagement performance.
Supervision responsibilities.
Review responsibilities.

Example: Design policies and procedures that address


the tracking of progress of each engagement.

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QC Element 6: Monitoring
Firms

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 firms quality
control policies and procedures.

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Quality Control Procedures


Depend

on size of firm, number of offices


and nature of firms 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

An audit
designed
reasonab
Primarily evaluating performance of sample of assuranc
individual audit and review engagements; a risk detecting
misstate
based approach to selection and inspection is to :
Errors; fr
used.
noncomp
Selected quality control and management issues all laws

Focus

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 managements


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 countrys relevant
statutes or laws
May be signed using the personal name of the
auditor or the audit firm or both

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