ACC557 Exam 1 (Slides)

Integrity and Objectivity Rule

In the performance of any professional service, a member shall maintain objectivity and integrity, shall be free of conflicts of interest, and shall not knowingly misrepresent facts or subordinate his or her judgment to others.

Define Accounting

Recording, classifying and summarizing of economic events to provide financial information for decision making.

Auditors Focus On

determining whether recorded information properly reflects the economic events that occurred during the accounting period.

Define Auditing

the accumulation and evaluation of evidence about accounting information to determine and report on the degree of correspondence between the information and established criteria

Who should perform an audit?

competent and independent person

Who makes GAAP

Financial Accounting Standards Board (FASB)

Who makes IFRS

International Accounting Standards Board (IASB)

What is Audit Evidence

All information used by the auditor in arriving at the conclusions on which the auditor's opinion is based

Examples of Audit Evidence

-Transaction Data

-Communication with Outsiders

-Observations

-Client Testimony

Auditor Competence

Derived from a blending of education and experience. Passing the CPA exam is a good assessment of competence.

Auditor Independence

Establishes standards for external auditor independence, to limit conflicts of interest. It also addresses audit partner rotation, and It restricts auditing companies from providing non-audit services (e.g., consulting) for the same clients.

Audit Report

The final stage in the auditing process which communicates the auditor's findings to users

What is the benefit of an audit on financial information?

Reduces information risk to the users of financial information

Information Risk

the risk that information upon which a business decision is made is inaccurate

Remoteness of Information (Cause of Information Risk)

Decision makers do not have firsthand knowledge and must rely on information provided by others.

Biases and Motives of the Provider (Cause of Information Risk)

Information is provided by someone whose goals are inconsistent with those of the decision maker and may be biased.

Voluminous Data (Cause of Information Risk)

Higher volumes of transactions increase the likelihood of undetected errors.

Complex Exchange Transactions (Cause of Information Risk)

Transactions are increasingly complex and more difficult to record properly. Complex accounting standards are difficult to interpret and apply.

User verifies information (Reduction of Information Risk)

The user may go to the business to verify the information. This is often costly and impractical.

User Shares Information Risk with Management (Reduction of Information Risk)

Management is responsible for providing reliable information, and may be held responsible in a lawsuit if inaccurate information is provided.

Audited Financial Statements are Provided (Reduction of Information Risk)

External auditors are engaged to provide assurance that the financial statements are reliable.

Define Assurance Service

an independent professional service that improves the quality of information for decision-makers

Who can provide assurance services?

CPAs or other professionals

What does Section 404(b) of the Sarbanes-Oxley act do?

requires the auditor of a public company to report on the effectiveness of internal control over financial reporting.

Define Attestation Service

A type of assurance service in which the CPA firm issues a report about a subject matter or assertion that is the responsibility of another party

Primary Categories of Attestation Services

• Audits of historical financial statements

• Audits of internal control over financial reporting

• Reviews of historical financial statements

• Other attestation that may be applied to a broad range of

subjects

Attestation Vs. Assurance

Attestation is a subset of assurance services where an accountant provides an independent opinion or report on a specific subject matter, such as financial statements, following established standards (e.g., audits or reviews). Assurance, on the other hand, is broader and includes any service that enhances the reliability or relevance of financial and non-financial information for decision-makers (e.g., sustainability reporting or data integrity checks). While all attestation services are assurance services, not all assurance services involve attestation.

Non-Assurance Services

CPA firms perform numerous other services that generally fall outside the scope of assurance services. Three specific examples are:

1. Accounting and bookkeeping services

2. Tax services

3. Management consulting services

Operational Audit

evaluates the efficiency and effectiveness of any part of an organization's operating procedures and methods

Compliance Audit

Determines whether the auditee is following specific procedures, rules, or regulations set by some higher authority

Financial Statement Audit

Determines whether the financial statements are stated in accordance with specific criteria. The criteria are normally U.S. GAAP or international accounting standards.

Certified Public Accounting Firms

Responsible for auditing financial statements of all publicly traded companies, most other large companies, smaller companies, and noncommercial organizations

(AKA: External Auditors/Independent Auditors)

Government Accountability Office (GAO)

A federal legislative agency that audits (investigates) other agencies of the federal government and reports it's findings to Congress (makes sure they are not spending more money than the government has appropriated for them).

Government Accountability Office Auditor

an auditor working for the U.S. Government Accountability Office (GAO); the GAO reports to and is responsible solely to Congress

Internal Revenue Agents

Auditors who work for the Internal Revenue Service (IRS) and conduct examinations of taxpayers' returns. Responsible for Enforcing Federal Tax Laws.

Internal Auditors

company employees who continuously evaluate the effectiveness of the company's internal control systems.

Function similarly to GAO Auditors

To maintain independence, internal auditors often report to an audit committee of the board of directors.

Sarbanes-Oxley Act and SEC regulations limit auditors from offering many consulting services to their public company audit clients, HOWEVER...

Audit firms are still permitted to consult public companies that are not their audit clients.

Moreover, they can provide both consulting services and audit services to clients that are PRIVATE companies.

Three main factors that affect the structure of all CPA firms:

1. The need for independence from clients

2. The importance of a structure to encourage competence

3. The increased litigation risk faced by auditors

CPA Proprietorship

A sole proprietorship business owned and operated by a CPA. It is the simplest business structure where the CPA provides accounting, auditing, tax, and consulting services independently, without forming a partnership or corporate entity.

CPA General Partnership

Is a business structure where two or more CPAs come together to jointly own and operate a firm. In this type of partnership, the CPAs share both the profits and the liabilities of the firm.

CPA General Corporation

Is a business structure where a CPA firm is organized as a corporation, typically providing accounting, auditing, and consulting services. This structure is less common than other arrangements (e.g., LLPs or PCs) because CPA firms often prioritize limited liability structures specific to professional services.

CPA Professional Corporation

Is a business structure specifically designed for licensed professionals, such as CPAs. It is a type of corporation that allows CPAs to provide accounting, auditing, tax, and consulting services while benefiting from certain legal and financial protections.

CPA Limited Liability Companies

Is a business structure where CPAs provide accounting and advisory services under a legal entity that combines the liability protection of a corporation with the operational flexibility and tax advantages of a partnership. However, specific state laws regulate whether CPAs can operate as an LLC, and some states may require CPA firms to register as Professional Limited Liability Companies (PLLCs) instead.

CPA Liability Partnership

Is a business structure that allows partners to share management responsibilities while limiting personal liability for the actions of other partners. It is a common choice for CPA firms because it balances flexibility, liability protection, and compliance with state regulations.

Staff Assistant

0-2 Years Experience

Performs most of the detailed audit work.

Senior or In-Charge Auditor

2-5 years Experience

Coordinates and is responsible for the performance of audit procedures, including supervising and reviewing staff work.

Manager and Senior Manager

5-10 years Experience

Helps the in-charge plan and manage the audit, reviews the in-charge's work, and manages relations with the client. A manager may be responsible for more than one engagement at the same time.

Partner

10+ years Experience

Reviews the overall audit work and is involved in significant audit decisions. A partner is an owner of the firm and therefore ahs the ultimate responsibility for conducting the audit and serving the client.

What established the Public Company Accounting Oversights Board (PCAOB)

The Sarbanes-Oxley Act

What does the Public Company Accounting Oversights Board (PCAOB) do?

Provides oversight for auditors of public companies including:

• Establishing auditing, attestation, and quality control standards for public company audits.

• Performing inspections of audit engagements and quality controls.

The Securities and Exchange Commission (SEC)

A federal government agency that assists in providing investors with reliable information upon which to make investing decisions.

The Securities Act of 1933

Requires most companies planning to issue new securities to the public to submit a registration statement to the SEC for approval.

The Securities Exchange Act of 1934

Provides additional protection for investors by requiring public companies to file detailed annual reports with the commission.

The Securities Acts of 1933 and 1934

Require financial statements and the opinion of an independent public accountant as part of the registration statement and subsequent reports

Form S-1

"S" forms must be completed prior to issuing new securities to the public

Form 8-K

report significant events of interest to investors

Form 10-K

annual report with detailed financial information, including audited financial statements

Form 10-Q

quarterly report containing certain financial information and auditor reviews of financial statements

Where are CPAs licensed?

in the state in which they practice, but significant influence is exerted by their professional organization, the American Institute of Certified Public Accountants (AICPA).

Who can join the AICPA?

Restricted to CPAs. Membership is voluntary, so not all CPAs are members, but it is the largest professional association for CPAs in the United States.

What does the AICPA do?

Sets standards and rules in four major areas

• Auditing standards

• Compilation and review standards

• Other attestation standards

• Code of Professional Conduct

Other AICPA Functions

-writes and grades the CPA Exam.

-supports its own research staff and provides grants to others for research.

-publishes the Journal of Accountancy, industry audit guides, and periodic updates to the Codification of Statements on Auditing Standards and the Code of Professional Conduct.

International Standards on Accounting is applicable to

entities outside of the United States

AICPA Auditing Standards are applicable to

private entities in the United States

PCAOB Auditing Standards are applicable to

U.S. Public Companies and other SEC Registrants, including broker-dealers.

Parts of Standard Unmodified Opinion Audit Report

1. Report title

2. Audit report address

3. Opinion section

4. Basis for opinion

5. Management's responsibility

6. Auditor's responsibility

7. Signature and address of CPA firm

8. Audit report date

Conditions for Standard Unmodified Opinion Audit Report

1. Includes all financial statements

2. Sufficient appropriate evidence accumulated

3. Financial statements are presented fairly in

accordance with GAAP or other framework

4. No circumstances requiring the addition of an

emphasis-of-matter paragraph or modification

PCAOB refer to the standard unmodified opinion audit report as...

an "unqualified opinion" audit report

The Two Significant Auditor Reporting Differences for Public Companies

1. Auditors must disclose critical audit matters

(CAMs).

2. Auditors of larger public companies must issue an

opinion on internal control over financial

reporting.

PCAOB defines a Critical Audit Matter as...

Any matter arising from the audit of the financial statements that was communicated or required to be communicated to the audit committee and that

(1) relates to accounts or disclosures that are material to the

financial statements and

(2) involved especially challenging, subjective, or complex

auditor judgment

PCAOB Auditing Standard 5

requires the audit of internal control to be integrated with the audit of financial statements.

Emphasis-Of-Matter Paragraph

A paragraph added to an auditors' report that provides information fundamental to users' understanding of the financial statements (such as consistency or going-concern uncertainties).

Causes of Emphasis-Of-Matter Paragraph

• Lack of consistent application of GAAP (Change in Accounting Principal)

• Substantial doubt about going concern

• Auditor agrees with departure from promulgated accounting

principles (Moving from GAAP to IFRS or Vice Versa)

• Emphasis of other matters

• Reports involving other auditors (specific assets of a company audited by a different firm)

Explanatory paragraph because of emphasis of other matters:

• The existence of material related party transactions

• Important events occurring subsequent to the balance sheet date

• The description of accounting matters affecting the comparability of the financial statements with those of the prior year

• Material uncertainties disclosed in the footnotes such as unusually important litigation or regulatory action

• A major catastrophe that has had or continues to have a significant effect on the entity's financial position

Three conditions requiring a modification to the audit opinion:

1. The scope of the audit has been restricted (scope

limitation).

2. The financial statements have not been prepared

in accordance with generally accepted accounting

principles (GAAP departure).

3. The auditor is not independent.

Qualified Opinion

Can be used for a scope limitation or departure from GAAP, but only when the auditor concludes that the overall financial statements are fairly stated.

Adverse Opinion

Used when financial statements are so materially misstated or misleading that they do not present fairly the financial position of the entity. This is uncommon and is rarely used.

Disclaimer of Opinion

Used when the auditor cannot form an opinion on the financial statement due to a severe scope limitation, lack of knowledge on the part of the auditor, or lack of independence.

Materiality

A misstatement in the financial statements can be considered material if knowledge of the misstatement will affect a decision of a reasonable user of the statements.

Amounts are Immaterial:

a standard unmodified opinion audit report is appropriate

Amounts are material but do not overshadow the financial statements as a

whole:

A qualified opinion using "except for" is appropriate. Delineate what is fairly stated from what is not.

Amounts are so material or so pervasive that overall fairness of the

statements is in question:

A disclaimer or adverse opinion is appropriate.

Material Scope Restriction by Client or Other Factors

Issue a Disclaimer Audit Report

Auditor Is Not Independent

Issue a Disclaimer Audit Report, regardless of materiality.

Ethics Defined

Set of moral principles or values

Citizenship

Obeying laws, voting, conserving resources

What is an Ethical Dilemma?

a situation a person faces in which a decision must be made about appropriate behavior.

Rationalizing Unethical Behavior

1. Everybody does it

2. If it's legal, it's ethical

3. Likelihood of discovery and consequences

4. Self-Interests

"Professional" Defined

a responsibility for conduct that extends beyond satisfying individual responsibilities and beyond the requirements of our society's laws and regulations.

What does a CPA Professional recognize?

a responsibility to the public, to the client, and to fellow practitioners, including honorable behavior, even if that means personal sacrifice.

Independence Rule

A member in public practice shall be independent in the performance of professional services as required by standards promulgated by bodies designated by Council

Independence of Mind

the auditor's state of mind that enables an unbiased viewpoint in the performance of professional services; also described as "independent in fact"

Independence in appearance

the extent to which others (particularly financial statement users) perceive auditors to be independent. Ex. Auditor and Controller are not relatives.

Financial Interests - Independence Rule

The Code prohibits covered members from owning any stock or other direct investment in audit clients.

Covered Members - Independence Rule

Any person who is in a position to influence an attest engagement.

The prohibition of direct ownership also applies to...

the covered member's immediate family, which includes spouse, spousal equivalent, and dependents.

Indirect Financial Interest - Independence Rule

a close, but not direct, ownership relationship between the auditor and the client; an example is the ownership of a mutual fund which holds the client's stock.

Materiality of Financial Interests

Any direct ownership interest is prohibited, regardless of materiality. Materiality affects only whether ownership is a violation of independence for indirect ownership.

Financial Interests of Close Relatives

Close relatives are defined as parent, sibling, or nondependent child. Ownership by a close relative is usually not a violation of independence unless the ownership is material to the relative, or enables the relative to exercise significant influence over the attest client.

Other Violations of Financial Interest Independence Violations

• Loans, other than normal lending procedures

• Employment of immediate and close family members

• Joint closely held investments with clients

• Director, officer, management, or employee of a company