AH CH01, 02, 19

Why is studying auditing different from studying other accounting topics? How might understanding auditing concepts prove useful for consultants, business managers, and other business decision makers?

Auditing is more conceptual in natures. Learning a framework of analytical and logical skills. Understanding auditing can improve decision-making for businesses.

Discuss why there is a demand for auditing services in a free-market economy. What evidence suggests that auditing would be demanded even if it were not required by government regulation?

Information asymmetry (conflict of interest between an absentee owner and manager). Agents agree to be monitored. Businesses can benefit.

What is meant by the statement “The agency relationship between absentee owners and managers produces a natural conflict of interest”?

Differences in the two parties’ goals and information asymmetry. Managers generally have more information. If both want to maximize self-interest, managers may not act in the best interest of the owner.

Why is independence such an important requirement for auditors? How does independence relate to the agency relationship between owners and managers?

Users may lose confidence in the auditor’s ability to report objectively and truthfully.

Auditing

A systematic process of:

1. 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

2. communicating the results to interested users

Attest Services

occur when a practitioner issues a report on subject matter, on an assertion about subject matter, that is the responsibility of another party.

Assurance services

independent professional services that improve the quality of information, or its context, for decision makers.

How does auditing relate to assurance and attest services?

Auditing is specific form of “attest service,” which is a specific category of “assurance service.”

Assurance services serve to improve the quality or context of information for decision making for other parties.

Attest Services intend to reduce information risk to parties relying on information provided by a party that is creating, or making assertions about, subject matter of interest.

Audit Risk

the risk that the auditor may unknowingly fail to appropriately modify his or her opinion on financial statements that are materially misstated.

Materiality

the magnitude of an omission or misstatement of accounting information that makes it probable that the judgement of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement.

How are audit risk and materiality reflected in the auditor’s report?

“the financial statements present fairly in all material respects”

“reasonable assurance” implies there is some risk that a material misstatement could be present in the financial statements and the auditor will fail to detect it.

What are the major phases of an audit?

1. Client acceptance/continuance

2. Preliminary engagement activities

3. Plan the audit

4. Consider and audit internal control

5. Audit business processes and related accounts

6. Complete the audit

7. Evaluate results and issue audit report

What are the primary elements involved in the planning phase of an audit?

Use knowledge about the client and any controls in place to plan the audit and perform preliminary analytical procedures. The outcome of the planning process is a written audit plan that sets forth the nature, extent, and timing of the audit procedures to be performed. The purpose of this phase is to plan an effective and efficient audit.

Identify the three main sections of the auditor’s standard unqualified report for a public company

1. Opinion on the financial statements

2. Basis for opinion

3. Critical audit matters

Discuss why the emergence of advanced audit technologies, such as audit data analytics, is placing an even greater premium on auditors’ knowledge of fundamental business, accounting, and auditing concepts, and on their ability to exercise professional judgement.

Helps remove tedious tasks performed by junior auditors. Auditors will spend more time reasoning through fundamental business, accounting, and auditing concepts. An auditors’ knowledge in these areas will enable them to provide greater benefit to clients by asking the right questions and identifying new, more effective ways to collect, analyze, and interpret results.

Briefly discuss why auditors must often exercise creativity and innovation in auditing financial statements. Give an example.

Auditors face situations where no standard audit procedure exists. Auditors must exercise creativity and innovation when planning and administering audit procedures where little or no guidance or precedent exists. Also requires logic and common sense.

Compare and contrast management’s responsibility for the entity’s financial statements with the auditor’s responsibilities for detecting errors and fraud in the financial statements.

Management is responsible to prepare financial statements that fairly present the company’s financial condition and operations in accordance with established accounting standards. The auditor is responsible to issue an opinion in regard to the financial statements prepared by management.

Why might understanding the characteristics of an entity’s business model be important for a financial statement auditor?

Corporate governance, objectives, strategies, processes, controls, transactions, and financial statements. The entity’s information and internal control systems must be designed to ensure that these transactions are properly executed, captured, and processed in order to produce accurate financial statements. A firm understanding of these components in order to understand relevant risks and to plan the nature, timing, and extent of the audit so that it is efficient and effective.

What roles do information systems and systems of internal control play in the high-level model of business discussed in the chapter?

Effective internal control provides safeguards to ensure the:

1. reliability of financial reporting

2. compliance with laws and regulations

3. the effectiveness and efficiency of operations

What kind of organization is the PCAOB, why was it formed, and what does it do?

The PCAOB is a quasi-governmental organization overseen by the SEC. It was formed to provide governmental regulation of the standards used in conducting public company audits because of a perceived failure of the profession to adequately regulate itself.

SEC

governmental regulatory agency. It has congressional authority.

Identify three documents required by the Securities Exchange Act of 1934 that are commonly encountered by auditors.

10K (annual), 10Q (quarterly), and 8K (material corporate event)

Purpose of an Audit and Premise upon which an Audit is Conducted

This section explains the purpose and value of a financial statement audit and lays out the responsibilities of management and those charged with governance.

Responsibilities

The section describes the responsibilities of the auditor regarding their capabilities, professional skepticism, and ethical behavior.

Performance

This section describes the auditor’s responsibilities in performing an effective audit. This includes their reasonable, rather than absolute, assurance that the financial statements are free of material misstatements and the cost versus benefit analysis in determining procedures.

Reporting

This section describes the responsibility of the auditor for expressing an opinion and providing a written report of that opinion.

Why auditing standards are important for evaluating whether an auditor has done an adequate audit, especially when the auditor fails to detect a material misstatement in the financial statements.

Standards hold auditors accountable.

Why is independence such an important standard for auditors? How does auditor independence relate to the agency relationship between owners and managers discussed in CH01?

Users may lose confidence is an auditor’s ability to report objectively and truthfully on the fin

What entities are involved in establishing standards and rules for the professional conduct of public accountants? Who establishes such standards for auditors of public versus private companies?

The AICPA for non public-company audits and maintains a Code of Professional Conduct. The SEC has legal authority to oversee the public accounting profession but allows private-sector FASB and AICPA to set accounting and auditing standards.

PCAOB set auditing standards for public companies. The SEC and PCAOB set rules regarding conduct and independence of public-company auditors.

Including the preface, what are the four major “Parts” of the AICPA Code of Professional Conduct? To what group of CPAs is each of the Code applicable?

Preface: All CPAs

1: Public CPAs. Independence.

2: CPAs not working as auditors. Does not require independence. Requires integrity and objectivity.

3: CPAs not in audit or business. No acts discreditable to the profession.

Six Principles of Professional Conduct

Responsibilities

The public interest

Integrity

Objectivity and independence

Due care

Scope and nature of services

Eleven major sections of the Rules of Conduct in Part 1 of the Code of Professional Conduct?

1. Integrity and objectivity

2. Independence

3. General Standards

4. Compliance with Standards

5. Accounting principles

6. Acts discreditable

7. Contingent fees

8. Commissions and referral fees

9. Advertising and other forms of solicitation

10. Confidential client information

11. Form of organization and name

Personal loans from a financial institution are allowed by the Rules of Conduct?

• Automobile loans and leases collateralized by the automobile

• Loans fully collateralized by the cash surrender value of an insurance policy

• Loans fully collateralized by cash deposits at the same financial institution

• Credit cards and cash advances on checking accounts where the aggregate outstanding balance is reduced to $10,000 or less by the payment due date.

What is meant by normal lending procedures, terms, and requirements

reasonably comparable to those relating to loans of a similar character given to other borrowers during the period in which the loan to the member is given.

Identify four circumstances in which confidential entity information can be disclosed under the Rules of Conduct without the entity’s permission.

1. To meet disclosure and performance requirements under GAAP and GAAS

2. To comply with a valid subpoena

3. To allow a review of a member’s professional practice under the authority of the AICPA, a state CPA society, or a state board of accountancy

4. To comply with an investigative or disciplinary proceeding

5. To allow a review of a CPA’s professional practice in conjunction with the purchase, sale, or merger of the practice.

Examples of acts that are considered discreditable under the Rules of Conduct.

1. discrimination and harassment in employment practices

2. Solicitation or disclosure of CPA examination questions and answers

3. Failure to file tax return or pay tax liability

4. Negligence in the preparation of financial statements or records

5. Failure to follow requirements of governmental bodies, commissions, or other regulatory agencies

6. Confidential information obtained from employment or volunteer activities

7. False, misleading, or deceptive acts in promoting or marketing professional servies

8. Improper use of the CPA credential

   1. Failure to comply with records requests

Advertising that might be false, misleading, or deceptive

1. creating false or unjustifiable expectations of favorable results.

2. Implying an ability to influence any court, tribunal, regulatory agency, or similar body or official.

3. Claiming services require a fee when it is likely at the time of representation that such fees will be substantially increased and the prospective client was not advised.

4. Making any other representations that would be likely to cause a reasonable person to misunderstand or be deceived.

What is the purpose of a CPA firm’s establishing a system of quality management?

1. The firm’s risk assessment process

2. Governance and leadership

3. Relevant ethical requirements

4. Acceptance and continuance of client relationships and specific engagements

5. Engagement performance

6. Resources

7. Information and communication

8. The monitoring and remediation process