Chapter 02

Professional Standards

McGraw-Hill/IrwinCopyright 2014 by The McGraw-Hill Companies, Inc. All rights reserved.

Three sets of auditing standardsAICPA (Auditing Standards Board) for nonpublic companies in US.PCAOB for public companies in USInternational Auditing Standards with differing authorities in various countriesThree Sets of Auditing Standards2-*

Public Company Accounting Oversight BoardAuditing, Attestation, Quality Control, Independence, Ethical Standards for audits of public companies American Institute of Certified Public AccountantsAuditing, Attestation, Quality Control, Independence Ethical, Accounting and Review Standards for engagements involving nonpublic companies

State Boards of AccountancyLicense CPAs and CPA firms to practice in jurisdictionsAuthority of Organizations2-*

Regulation of the Public Accounting Profession2-*

Principles Underling a GAAS Audit 1/6Purpose of an auditPremise of an auditPersonal responsibilities of the auditorAuditor actions in performing the auditReporting results of an audit

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Principles Underling a GAAS Audit 2/6Purpose 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 3/6Premise 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 4/6Personal responsibility of the auditorAppropriate 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.2-*

Principles Underling a GAAS Audit 5/6Auditor actions in performing the auditObtain 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.2-*

Principles Underling a GAAS Audit 6/6Reporting the results of an auditExpress 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.2-*

The 10 Generally Accepted Auditing StandardsGeneral StandardsStandards of Field WorkReporting 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.2-*

Generally Accepted Auditing Standards--General StandardsAdequate technical training and proficiencyIndependence in mental attitude is to be maintainedDue professional care is to be exercised2-*

Generally Accepted Auditing Standards--Standards of Field WorkAuditor must adequately plan and properly supervise workAuditor must obtain a sufficient understanding of entity, and its environment, including internal control to assess risk of material misstatement and to design further audit proceduresAuditor must obtain sufficient appropriate audit evidence to afford a reasonable basis for the opinion2-*

Generally Accepted Auditing Standards--Standards of ReportingState whether the financial statements are presented in accordance with GAAPIdentify circumstances in which such principles have not been consistently appliedInformative disclosures are adequate unless otherwise stated in the reportReport 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 therefor2-*

Terminology in Auditing Standards (Figure 2.3)2-*

ResponsibilityLevelMeaningWords Used to Indicate ResponsibilityUnconditionalResponsibilityAuditor must fulfill responsibilitiesMustShall (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 standardsShouldResponsibility to ConsiderAuditor should consider; whether the auditor complies with the requirements depends on the exercise of professional judgment in the circumstancesMayMightCouldOther phrases indicating a responsibilities to consider

The GAAS Hierarchy (Figure 2.3)2-*

Auditor Responsibility for the Detection of Errors and Fraud (1 of 2)Obtain information to assess the inherent risks and fraud risksInformation about the company and its environmentDiscussion among audit team members Inquiries of management and othersRisk assessment analytical procedures, including those involving revenueAssess the risk of errors and fraud that may cause the financial statements to contain a material misstatement.2-*

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 LawsNoncompliance 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 complianceInspect correspondence with licensing or regulatory authoritiesBe 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.2-*

The Standard Auditors Report for Nonpublic Companies

TitleAddresseeContent Sections (paragraphs)Introductory (We have audited)Managements responsibilityAuditors ResponsibilityOpinion ParagraphSignature (firm name)City and state of office issuing audit reportDate2-*

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.

The AICPA Standard Auditors Report--Introductory Paragraph2-*

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.

The AICPA Standard Auditors ReportManagements Responsibility Paragraph2-*

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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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.

The AICPA Standard Auditors Report--Opinion Paragraph2-*

GAAPFASB issues GAAP for nongovernmental entitiesAuthoritative: FASB Codification and Accounting Standards UpdatesNonauthoritative Pronouncements:Widely recognized practicesFASB concepts StatementsAICPA Issues PapersInternational Financial Reporting StandardsVarious othersOther sources of GAAPGASB--State and local governmentsFASAB--Federal government2-*

Other Types of Auditors ReportsStandard unmodified report (unqualified per PCAOB standards)Financial statements follow GAAP and auditor does not add additional commentary for any issue Other reportsUnmodified with emphasis of matter (or other emphasis)Example: A lack of consistency in application of accounting principlesQualified opinionScope limitation or departure from GAAPAdverse opinionDeparture from GAAP so significant that financial statements as a whole are misleadingDisclaimer of opinionUnable to arrive at an opinion due to a very significant scope limitation

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Public Company Audit ReportTitle 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.2-*

Applicability of SSAEs 2-*

Elements of Quality ControlLeadership responsibilities for quality within the firm (tone at the top)Relevant ethical requirementsAcceptance and continuance of clients and engagementsHuman ResourcesEngagement performanceMonitoring

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QC Element 1: Leadership responsibilities for quality within the firmFirms 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.2-*

QC Element 2: Relevant ethical requirementsFirm 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.2-*

QC Element 3: Acceptance and ContinuanceFirm 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.2-*

QC Element 4: Human ResourcesFirm 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.2-*

QC Element 5: Engagement PerformanceFirms engagements are consistently performed in accordance with professional standards and regulatory and legal requirements, with policies and procedures addressing:Engagement performance.Supervision responsibilities.Review responsibilities.Example: Design policies and procedures that address the tracking of progress of each engagement.2-*

QC Element 6: MonitoringFirms 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.2-*

Quality Control ProceduresDepend 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 ProfessionPublic CompaniesPublic Company Accounting Oversight BoardRegistration of public accounting firms that audit public companiesConduct inspections of public company practice of registered public accounting firmsNonpublic CompaniesAICPA & State Boards of AccountancyPeer review for nonpublic practice segments

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PCAOBComposed of 5 members only two may be CPAsMembers appointed by SEC and may serve no more than two five-year termsAll accounting firms that audit SEC registrants must register with PCAOBPledge to cooperate with PCAOB inquiriesPCAOB can impose monetary damages, suspend firms or make referrals to Justice Department2-*

Peer ReviewsMembers of AICPA Conducted by CPAs or other CPA firmsTwo types of peer reviewsSystem reviewStudy of CPA firms system of quality controlSelect sample of firms engagements and examine related working paper filesEngagement reviewSample of CPA work including reports to evaluate appropriatenessLess in scope than system reviewReport: pass, pass with deficiencies, or fail

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PCAOB InspectionsConducted by PCAOB staffFocusPrimarily evaluating performance of sample of individual audit and review engagements; a risk based approach to selection and inspection is used.Selected quality control and management issues only. This differs from a peer review.ReportWritten report to SEC, part of which is made public2-*

International Accounting StandardsInternational 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 ReportContains expanded description of managements responsibility and explanation of the audit process similar to the nonpublic company audit reportMay state present fairly, in all material respects or give a true and fair viewReport may indicate that the financial statements comply with the provisions of the countrys relevant statutes or lawsMay be signed using the personal name of the auditor or the audit firm or both2-*

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