the role of the public accountant in the american economy chapter 01 mcgraw-hill/irwin copyright ©...

The Role of the Public Accountant in the American Economy

Chapter 01

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

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Assurance servicesAssurance 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.

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Types of ServicesTypes 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

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Attestation ServicesAttestation 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 agreed-upon procedures report on subject matter or an assertion about subject matter that is the responsibility of another party (e.g. management)

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The Attest FunctionThe Attest Function

Management

SubjectMatter

SuitableCriteria

The CPA

Gathers Evidence

SubjectMatter*

The AttestReport

IssuesReport

*May be management’s assertion about the subject matter.

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Suitable criteriaSuitable 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.”

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Forms of AttestationForms of Attestation

1-8*Applicable financial reporting framework

Audit of Financial StatementsAudit of Financial Statements

Management

PreparesFinancial

Statements

Criteria (e.g., GAAP)

The Auditors

Gathers Evidence

FinancialStatements

The Auditors’Report

IssuesReport

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Financial Statement AuditFinancial 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

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Audit EvidenceAudit 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

• Financial statement amounts Accurate, properly classified and summarized Notes are informative and complete

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What Creates the Demand for Audits?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

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History of the Attest FunctionPeriod Developments Audit Objective Nature of Audit

Ancient - 1850

Audits of city states, individuals & ventures

Detection of fraud Detailed; No reliance on controls

1850-1905 Industrial revolution resulted in the need for corporate audits

Detection of fraud & clerical errors

Some testing; No reliance on controls

1905-1940 Development of stock markets - increased emphasis on earnings

Determination of fairness; detection of fraud & errors

Increased emphasis on testing; Slight reliance on controls

1940-1975 Development of auditing standards

Determination of fairness

Substantial reliance on controls

1975-1985 Criticism by Congress; Increased self-regulation

Determination of fairness

Internal control determines scope of audit

1985-1995 Increased demands for reporting on compliance & internal control

Determination of fairness

Risk assessment determines audit scope; must assess risk of fraud

1995-Present Panel on Audit Effectiveness; Sarbanes-Oxley Act of 2002

Determination of fairness

Business risk approach to audits

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The Accounting Profession’s The Accounting Profession’s Credibility CrisisCredibility Crisis

2000—The Panel on Audit Effectiveness made a variety of suggestions to improve audits.

2001—Enron Bankruptcy 2002—WorldCom Fraud 2002—Sarbanes-Oxley Act 2003—Public Company Accounting

Oversight Board began operations

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Financial AuditsFinancial 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

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Other Types of AuditsOther Types of Audits

Compliance Audits Example: IRS audit of income tax return

Operational Audits Example: Effectiveness of operations of

receiving department of a manufacturing company

Integrated Audits Example: Assurance on both the financial

statements and effectiveness of internal control over financial reporting

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Other Types of AuditorsOther Types of Auditors

Internal Auditors Government Accountability Office Auditors Tax Auditors

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Internal Auditors 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.

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Government Accountability Office Government Accountability Office Auditors (GAO Auditors)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

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Tax AuditorsTax 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

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AICPA’s Traditional RoleAICPA’s 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.

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Establishes Standards--ExamplesEstablishes 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

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Research and PublicationResearch 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

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Continuing Professional Continuing Professional EducationEducation

Development of continuing professional education programs

Necessary for continuing education requirement for CPA certificate

Offered by AICPA State societies Other professional organizations

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Professional RegulationProfessional 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)

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The CPA ExaminationThe 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

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State Boards of AccountancyState 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)

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Other PartiesOther Parties

FASB Sets GAAP for entities other than federal,

state and local governments GASB

Standards of financial accounting for state and local government entities

FASAB Accounting standards for the US government

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PCAOB Role 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

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Securities and Exchange Securities and Exchange Commission (SEC)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

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Securities and Exchange Securities and Exchange Commission (SEC )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

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Types of Professional ServicesTypes of Professional Services Attestation and Assurance Tax Consulting Accounting Personal Financial Planning Litigation support Fraud Investigation Personal Financial Planning

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Organization of the Public Organization of the Public Accounting ProfessionAccounting Profession

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

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Categories of Categories of Public Accounting FirmsPublic Accounting Firms

Local Regional National Big 4 Alternative Practice Structures

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Industry SpecializationIndustry Specialization

Firms with detailed knowledge and understanding of a client’s industry

Helps firms Be more effective at collecting and evaluating

audit evidence Make valuable suggestions to improve client’s

operations Provide the client consulting services

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Typical Structure of a National Typical Structure of a National CPA FirmCPA Firm

Partners

Managers

Seniors

Staff Assistant

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Responsibilities on an EngagementResponsibilities on an Engagement

Partner—Overall responsibility is to assure that that audit is performed in accordance with professional standards.

Manager—Supervise overall engagement. Seniors—”In charge” auditor on a daily

basis. Staff assistants—Work under the

immediate supervision of the senior.

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Elements of Public Accounting Elements of Public Accounting WorkWork

Professional Developments Stay current on developments within the

profession Seasonal fluctuations

Busy season from December through April Relationships with clients

Need to maintain independence