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Chapter 1: The Role of Public Accountant

Core Concepts: Services & Risk

Types of Services (Service Pyramid)

• Assurance Services (Broadest): Services aimed at improving the quality of information for decision makers.

  • Attestation Services: Specifically focused on increasing the reliability of information.
  • Other Assurance Services: Involves putting information into a better context or form to assist decision-making.

• Non-Assurance Services: All other services CPAs provide, including but not limited to:

  • Tax Services
  • Management Consulting Services
  • Other Services: E.g. bookkeeping.

Key Risk Definitions

• Information Risk: The risk that information is materially misstated, and audits reduce this risk.

  • Causes of Misstatement:
  • Accidental errors
  • Lack of knowledge
  • Unintentional bias
  • Fraud

• Business Risk: The risk that a company will fail due to adverse economic conditions or poor decisions. Note that audits do NOT directly address this risk.

The Attest Function & Audits

The Attestation Process

1. Management makes an Assertion about a Subject Matter.
2. Evaluation against Suitable Criteria: This may include standards such as COSO (Committee of Sponsoring Organizations) or GAAP (Generally Accepted Accounting Principles).
3. Evidence Gathering & Report Issue: The CPA compiles evidence and issues a report on findings.

Suitable Criteria Examples (The “Rulebooks”)

• Internal Control Audits: Criteria based on the COSO framework.
• Financial Statement Audit: Criteria based on applicable financial reporting frameworks (typically GAAP in the U.S.).

The Financial Statement Audit

• Goal: To provide a high (reasonable) level of assurance that financial statements comply with GAAP.
• Process: Gather sufficient evidence to issue an opinion.
• Audit Evidence Examples (What auditors check):
  • Existence/Occurrence: Are assets/sales real?
  • Completeness: Are all assets/expenses accounted for?
  • Valuation: Are assets and liabilities valued correctly?
  • Rights/Obligations: Does the company rightfully own the assets/owe liabilities?
  • Presentation & Disclosure: Are notes complete and informative?

History & Other Audit Types

The Credibility Crisis Timeline (2000-2010)

• 2000: Panel on Audit Effectiveness established.
• 2001: Enron bankruptcy occurs, leading to significant public outcry.
• 2002: WorldCom Fraud unveils severe issues in accounting practices.
• 2002: Sarbanes-Oxley Act (SOX) enacted to enhance regulatory oversight.
• 2003: PCAOB (Public Company Accounting Oversight Board) began operations.
• 2010: Dodd-Frank Act introduced reforms in the financial industry.

Other Types of Audits (C.O.I. Framework)

• Compliance Audits: Ensuring adherence to rules (e.g., IRS audit of a tax return).
• Operational Audits: Focusing on efficiency and effectiveness (e.g., auditing a receiving department's processes).
• Integrated Audit: Combining a financial statement audit with an audit of internal controls over financial reporting; required for public companies.

Types of Auditors

• Internal Auditors: Employees of the company reporting to the Audit Committee and management; focus on operational and compliance audits.
• GAO (Government Accountability Office) Auditors: Work for Congress, auditing government agencies and contractors.
• Tax Auditors: Enforce tax laws (e.g., IRS agents).

Key Players & Regulators

The AICPA (American Institute of Certified Public Accountants)

• Roles:

  • National professional organization for CPAs.
  • Traditional roles now partially covered by the SEC/PCAOB for public companies. Primarily sets standards for nonpublic companies.

• Key Functions:

  • Establish Standards:
  • ASB (Auditing Standards Board): Issues Statements on Auditing Standards (SAS) for nonissuers.
  • ARSC (Accounting and Review Services Committee): Issues Statements on Standards for Accounting and Review Services (SSARS).
  • Research & Publication: Publishes the Journal of Accountancy.
  • Continuing Professional Education (CPE): Required for maintaining CPA license.
  • Self-Regulation: Manages peer reviews for firms.
  • CPA Exam: Prepares and grades the Uniform CPA Examination.

The PCAOB (Public Company Accounting Oversight Board)

• Created by SOX (2002).

• Oversight by SEC: Protects investors through oversight.

• Roles:

  • Oversees audits of public companies and SEC-registered entities.

• Key Duties (R.I.I.D. Mnemonic):

  • Register public accounting firms.
  • Issue/Establish standards (auditing, quality control, ethics).
  • Inspect registered firms.
  • Discipline firms and individuals.

The SEC (Securities and Exchange Commission)

• Role: U.S. government agency overseeing PCAOB.
• Objective: Protect investors by mandating full disclosure.
• Key Tools:
  • Registration Statements: Required for new securities containing audited financials.
  • Periodic Reporting: Includes Forms 10K (annual) and 10Q (quarterly).
  • Regulation S-X: Basic accounting regulation by the SEC.

Other Standard Setters

• FASB: Sets GAAP for non-governmental entities (public & private).
• GASB: Sets accounting standards for state and local governments.
• FASAB: Sets standards for U.S. federal government accounting.
• IFAC: Sets international accounting standards through its board, IASB.

Professional Structure & the CPA Exam

The CPA Exam (Starting 2024)

• Core Sections (Mandatory for all):

  • AUD (Auditing)
  • FAR (Financial Accounting and Reporting)
  • REG (Regulation)

• Discipline Sections:

  • BAR
  • ISC
  • TCP

Organization of Firms

• Legal Structure: Possible structures include:

  • Sole Proprietorship
  • Partnership
  • Professional Corporation
  • Limited Liability Partnership (LLP)

• Firm Sizes/Categories:

  • Local
  • Regional
  • National
  • Big 4 (the four largest accounting firms)

• Team Structure on an Audit:

  • Partner: Overall responsibility, final sign-off of audit report.
  • Manager: Supervises the entire audit engagement.
  • Senior/Supervisor: In-charge role on a daily basis.
  • Staff: Conducts detailed work under supervision.

Chapter 2: Professional Standards

Professionalism & The Auditors

What is a “Professional”?

• Common View: A “pro” signifies a person with high levels of skill or expertise, akin to athletes.
• Profession’s View (CPI): A profession entails a responsibility and dedication to the public interest.

Key Traits of a CPI Profession (The “License to Operate”)

• Recognition of a Profession Requires:
  • Specialized body of knowledge.
  • Formal education process.
  • Standards for admission (e.g., CPA Exam).
  • Code of ethics to guide conduct.
  • License granted by the state.
  • Obligation to society (serving public interest).

The CPA License: Rights and Responsibilities

• Granted by: State Boards of Accountancy.
• Requirements: Education, CPA Exam, and relevant experience.
• Rights Granted: Unique right to sign an audit.
• Responsibilities Accepted:
  • Adhere to professional standards (e.g., GAAS).
  • Follow a code of professional conduct.
  • Pursue Continuing Professional Education (CPE) courses.

The Three Sets of Auditing Standards

The Standards Are Set By…

• Public Companies (Issuers) in the U.S.: Set by PCAOB (Public Company Accounting Oversight Board).
• Nonpublic Companies (Nonissuers) in the U.S.: Established by AICPA (through Auditing Standards Board, ASB).
  • These are referred to as GAAS (Generally Accepted Auditing Standards).
• Companies Anywhere (Internationally): Set by IAASB (International Auditing and Assurance Standards Board).
  • These standards are called International Standards on Auditing (ISA).

Who Sets the Rules for Auditing a Private Tech Startup in Texas?

• AICPA.

Who Sets the Rules for Auditing Apple?

• PCAOB.

Principles Underlying a GAAS Audit (The “P.A.P.R.” Framework)

Key Components:

• Purpose: To provide an opinion regarding whether financial statements align with applicable financial reporting frameworks (e.g., GAAP).
• Premise: Management is responsible for:
  • Preparing financial statements.
  • Sharing all information and providing unrestricted access to auditors.
• Responsibilities of the Auditor:
  • Competence and Capabilities: Auditors must demonstrate appropriate skills and capabilities.
  • Professional Skepticism: A mindset involving questioning and critical analysis of evidence.
  • Professional Judgment: Application of knowledge and experience to inform decisions during audits.

Actions & Reporting

• Actions:
  • Obtain reasonable assurance (not absolute assurance) that statements are materially free from misstatement (error or fraud).
• Reporting:
  • Auditors must express a written opinion or state that an opinion cannot be expressed.

Auditor Responsibility for… (The “Levels of Responsibility”)

The Auditor’s Report (A Side-by-Side Comparison)

Key Differences Between Public and Nonpublic Company Reports

New/Important Concepts in Reports

• Critical Audit Matters (CAMs):

  • Required for public companies, referring to matters that present especially challenging, subjective, or complex auditor judgment. Communicating CAMs does not change the opinion on financial statements.

• Key Audit Matters (KAMs):

  • Similar to CAMs but required for international audits of listed companies under different standards.

Other Types of Audit Opinions (Beyond the “Clean” Opinion”)

• Unmodified (Unqualified): Financial statements follow GAAP.
• Qualified: Some issues exist, but they are not pervasive (for example, a scope limitation or departure from GAAP).
• Adverse: Significant GAAP departure renders statements misleading.
• Disclaimer: Auditor cannot provide an opinion due to massive scope limitations.

Quality Management (Control) for CPA Firms

• CPA firms need systems in place to ensure compliance with professional standards.

The 8 Components of AICPA Quality Management Standards (The R.G.R.A.R.I.M.M. Mnemonic)

1. Risk Assessment Process: Identifying and responding to risks of quality.
2. Governance and Leadership: Commitment to quality from the top management ("Tone at the top").
3. Relevant Ethical Requirements: Including independence confirmations.
4. Acceptance and Continuance: Client integrity and competence assessments in taking/keeping clients.
5. Engagement Performance: Involves supervision, consultation, documentation of engagements.
6. Resources: Human, technological and intellectual resources.
7. Information and Communication: Sharing quality-related information within the firm.
8. Monitoring and Remediation: Inspecting engagements and resolving identified quality issues.

PCAOB Quality Control Elements

• Similar to AICPA, with specific focus areas.
• Elements include Personnel Management, Independence/Integrity, Acceptance/Continuance, Engagement Performance, and Monitoring.

Reviews and Inspections (The “Layers of Review”)

1. Engagement Quality Review:
   • A “cold review” conducted by a partner not involved with the team before report issuance; required for public companies audits.
2. Inspections of Completed Engagements:
   • Internal inspections to assess compliance with quality control policies.
3. Peer Reviews:
   • Required for AICPA members. Two types:
     • System Review: In-depth assessment of the firm's quality control system for audit practices.
     • Engagement Review: Examines a sample of reports for firms with minimal audit engagements.
4. PCAOB Inspections:
   • Conducted by PCAOB staff to review registered firms’ audits of public companies, resulting in reports issued to SEC.

Other Key Audits (Special Cases)

Governmental Audits (Yellow Book)

• Issued by the GAO, with additional requirements beyond GAAS for entities receiving federal funds.

Single Audit Act

• Applicable to state/local governments or non-profits spending over $750,000 in federal awards; necessitates auditing financial statements and compliance with federal programs.

Employee Benefit Plan Audits (ERISA)

• Required by the DOL for retirement plans with specific requirements, including a review of the plan document; “limited scope” audits allowed under certain conditions.

Chapter 3: Professional Ethics

The Foundation: Ethics & The Code

Why Ethics?

• CPAs hold a unique responsibility to serve the public interest, given the credibility of their work.
• Public confidence in the profession hinges on the ethical integrity maintained by CPAs.
• The Code of Professional Conduct outlines these responsibilities, providing guidelines and rules that are essential for fulfilling them.

The Structure of the AICPA Code (The “Pyramid”)

• Principles: Broad, philosophical goals (the “why”).
• Rules: Minimum standards of enforceable conduct (the “what”).
• Interpretations: Guidelines for applying rules in specific situations.

The Three Parts of the Code

Organized according to the member’s professional role:

• Part 1: Members in Public Practice (auditors, tax preparers).
• Part 2: Members in Business (CFOs, controllers, accountants in a company).
• Part 3: Other Members (retired or not currently working).

The Conceptual Framework: A 3-Step Process

The essential application when explicit rules do not cover a situation:

1. Identify Threats: Determine if the relationship poses a threat to compliance.
2. Evaluate Safeguards: Assess whether safeguards can mitigate the threat to an acceptable level.
3. Apply Safeguards or Exit: If safeguards reduce the risk, continue; if not, refuse or withdraw from service.

Core Idea

• The scenario should allow a