Auditing
A systematic process or obtaining and evaluating evidence regarding assertions about economic actions and events in order to ascertain the degree of correspondence between the assertions and established criteria AND communicate the results to interested u
4 Different types of Audits
1. Financial Statement Audit
2. Operational Audit (Internal Controls)
3. Compliance Audit
4. Forensic Audit
Financial Statement Audit
-Auditor gathers evidence to form an opinion as to whether a company's FS's are prepared in uniformity with GAAP
-This opinion is shared w/ interested users through a written audit report.
Attest (ATTESTATION) Service:
-Financial Statement Audit is an exa
Operation Audit (Internal Controls)
Done to confirm / verify the efficiency and effectiveness of management's operating procedures
internal control audit
Compliance Audit
Done to determine if a company is following applicable laws and regulations
Forensic Audit
Done to uncover fraud
The Institute of Internal Auditors (IIA)
Is the primary organization supporting internal auditors
Internal Auditing
An independent, objective assurance and consulting activity designed to add value and improve an organization's operations. It helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effec
Internal Control Audits
Public companies are required to engage an external auditor to provide an opinion on the effectiveness of internal controls
An audit of internal control is available but not required for private entities
Compliance Audits
Determines the extent to which rules, policies, laws, covenants, or government regulations are followed by the entity being audited
Operational Audits
Involves a systematic review of part or all of an organization's activities to evaluate whether resources are being used effectively & efficiently
Tax Preparation and Planning Services
Assist clients w/ preparing and filing tax returns, provide advice on tax and estate planning, and represent clients on tax issues before the IRS or tax courts
Management Advisory Services
MAS involves providing advice and assistance concerning an entity's organization, HR, finances, operations, IT systems, or other activities
A model of Business Processes: 5 Componenets
1. The Financing Process
2. The Purchasing Process
3. The HR management process
4. The Inventory Management process
5. The Revenue process
Securities and Exchange Commission (SEC)
Administers the securities act of 1933, the securities act of 1934, and sarbanes-oxley of 2002
-Securities Act of 1933: regulates disclosure of material into in a registration statement for an IPO of securities. S FORMS: which are used for issuing securit
Public Company Accounting Oversight Board (PCAOB)
A nonprofit corporation established by congress to oversee the audits of public companies in order to protect the interests of investors and further its public interest in the prep. of informative, accurate and independent audit reports.
The PCAOB does NO
American Institute of CPA's (AICPA)
Private professional organization of over 400,000 CPAS in 145 countries
Most important function is the promulgation of rules and standards that guide audit and related services provided to nonpublic companies; gov. entities, school districts and others li
International Auditing and Assurance Standards (IAASB)
Sponsored and funded by the international federation of accountants (IFAC), which describes itself as "the global organization for the profession dedicated to serving the public interest by strengthening the profession and contributing to the development
Financial Accounting Standards Board (FASB)
Privately funded body whose mission is to establish standards for financial reporting and accounting
International Accounting Standards Board (IASB)
The IASB is the international counterpart of the FASB
The IASB's standards are the predominately recognized accounting standards outside the US
Responsible for development and publication of international financial reporting standards (IFAS) and for appro
Prior 2002 Audit
Audit firms has Peer Reviews every 3-5 years.
-One CPA firm reviewed the work of another firm to make sure audit standards followed
Auditing Standards Board (ASB)
Private professional organization sponsored by AICPA who established auditing standards
Sarbanes-Oxley
Established PCAOB who was given the authority to create and enforce audit standards for public company audits.
1947 ASB Creates 10 generally accepted audit standards (GAAS). Divided into 3 groups:
Guidelines and procedures for conducting qualified audits.
1. General Standards
2. Standards of field work
3. Standards of reporting
General Standards (GAAS)
*Relates to professional qualifications of auditor and the quality of work done by auditor.
1. Auditor must have adequate technical training and proficiency.
-Must be proficient in auditing and accounting
-This proficiency is obtained through education an
Standards of Field Work (GAAS)
*Guidelines and procedures for conducting the audit at the client's place of operations
1. Audit must be adequately planned and all assistants properly supervised.
-A unique audit program (lists procedures to be followed in the conduct of the audit) shoul
Standards of Reporting (GAAS)
Guidelines for creating the audit report
1. The audit report must indicate whether the financial statement are presented in conformity with GAAP
2. The audit report must indicate circumstances where GAAP have been applied inconsistently
-If it IS applied
Internal Controls
Policies and procedures created by the company to provide reasonable assurance of meeting its objectives
Audit Report
Letter communicating what was audited, the responsibilities of management & auditor, describes what an audit is, and gives the auditor's opinion
Standard Audit Report (For Public Company)
4 Paragraphs:
1. Introductory Paragraph
2. Scope Paragraph
3. Opinion Paragraph
4. Audit of Internal Controls Paragraph
Unqualified Opinion
Financial statements present, in all material aspects, the financial position and statement of operations & cash flows in conformity with GAAP.
Materiality
The smallest amount of error or misstatement that would cause a decision maker to make a different decision
Introductory Paragraph
Identify the Financial Statements being audited
Identify management's responsibility
Identify Auditor's responbility
Scope Paragraph
DESCRIBES AN AUDIT
State the audit was conducted in accordance with PCAOB standards.
An audit provides REASONABLE ASSURANCE that the financial statements do not contain material misstatements
An audit involves gathering evidence on a TEST BASIS
An audit i
Opinion Paragraph
Give auditor's opinion
4 Audit Opinions
1. Unqualified: Financial Statements conform to GAAP
2. Qualified: Called an 'except for' opinion. Except for something, the FS's do conform to GAAP.
3. Adverse: Financial Statements DO NOT conform to GAAP
4. Disclaimer of Opinion: Auditor is unable to gi
4 circumstances where an unqualified opinion is given, but additional explanatory language is added to the standard audit report
1. When the audit opinion is based, in part, on the report of another auditor.
2. When the auditor has substantial doubt about entity's ability to continue as a going concern.
3. There has been an inconsistent application of GAAP.
4. Emphasis of matter
Circumstance where an opinion is based, in part, on other auditor work
Principal Auditor Can:
1. Assume full responsibility: do not mention other auditor's. Simply issue the report.
2. Share responsibility with other auditors:
-Intro paragraph: Need to indicate the dollar amounts of assets and revenues audited by the other a
Circumstance Going Concern
The company will continue to exist into the future
When an auditor has substantial doubt about an entity continuing as a going concern:
-Issue the standard audit report and add an explanatory paragraph, after the opinion paragraph; the explanatory paragra
Circumstance inconsistent application of GAAP and Emphasis of a matter
Inconsistent application of GAAP: Company changed GAAP acceptable methods from one year to the next
Emphasis of a matter: The auditor wants to attention of user of audit report to something specific
These require no change to the intro, scope, or opinion
3 Situations where unqualified opinion is not given
1. There is a departure from GAAP
2. Scope limitations
3. Auditor Lacks Independence
Departure from GAAP (Situation 1 where unqualified opinion is not given)
Auditor must determine how material the departure is to the financial statements.
If material: Issue qualified opinion
If highly material: Issue adverse opinion
IF QUALIFIED:
-No change to the intro or scope paragraph
-Explanatory paragraph before opinion
Scope Limitation (Situation 2 where unqualified opinion is not given)
Auditor is unable to perform certain audit procedures and thus are unable to gather evidence needed.
Issue either a qualified or a disclaimer opinion depending on how material the scope limitation is.
if limitation is material: Qualified opinion
if limita
Auditor Lacks Independence (Situation 3 where unqualified opinion is not given)
Auditor must issue a disclaimer of opinion
AUDIT REPORT:
-Two sentence report disclaiming an opinion
-Indicate the auditor is not independent
-Do not state reasons why auditor is not independent.
Rules of Conduct
Guidelines for ethical behavior
created by the AICPA
5 categories of rules of conduct
1. Integrity and Objectivity
2. Independence
3. Professional Standards
4. Responsibilities to clients
5. Other responsibilities and practices
Integrity and Objectivity (rules of conduct category 1)
one rule
Rule Name: INTEGRITY AND OBJECTIVITY: In the performance of all services, a member shall maintain objectivity and integrity, be free of conflicts of interest, and not knowingly misrepresent facts
Independence (rules of conduct category 2)
one rule
Rule Name: INDEPENDENCE: A member in public practice shall be independent in performance of attest services.
Workers Within CPA firm - independence requirements
1. Staff: must be independent of all attest clients they provide attest services to.
2. Managers: Must be independent of all attest clients of the firm for whom they work on both attest and non attest
3. Partners: Must be independent of all attest clients
What impairs independence
1. Financial Relationship: Owning debt or equity securities in the client would impair independence. (Even owning ONE SHARE)
2. Family Relationship
A. Immediate Family (Spouse and Dependents):
-Financial Interests: financial interests of immediate family
Professional Standards (rules of conduct category 3)
3 rules
3 Rules of Conduct
1. Rule Name: GENERAL STANDARDS: In the performance of all services, a member will adhere to the following standards:
A. Professional Competence
B. Due professional care
C. Planning & Supervision
D. Sufficient, Appropriate Evidence
2. R
Responsibilities to Client (rules of conduct category 4)
2 rules
2 Rules of conduct:
1. Rule Name: CONFIDENTIAL CLIENT INFORMATION: A member may not disclose any confidential client information without the express consent of the client
2. Rule Name: CONTINGENT FEE (payment based on a particular outcome): A member may n
Other responsibilities and practices (rules of conduct category 5)
4 rules
1. Rule Name: ACTS DISCREDITABLE: A member will not engage in activities that discredit the profession.
-Solicitation and sharing of CPA exam questions
-Failure to return client documents (Usually while waiting for payment)
2. Rule Name: ADVERTISING & OTH
11 Rule Names
1. Integrity & objectivity (integrity & objectivity)
2. Independence (independence)
3. General Standards (professional standards)
4. Compliance with Standards (professional standards)
5. Accounting Principles (professional standards)
6. Confidential Clien
2 Sources of Law under which Auditor can be Sued
1. Common Law: Written opinions of prior courts within a state (legal precedents). Each state has it's own common law.
2. Statutory Law: Laws enacted by the legislative branch of federal or a state government
Under common law, the auditor can be sued by:
1. CLIENT
-Breach of contract
-Ordinary negligence
-Gross negligence
-Fraud
2. Third Parties (creditors & investors)
-Ordinary negligence
-Gross negligence
-Fraud
Breach of Contract
Auditor failed to provide the services that were agreed to.
ENGAGEMENT LETTER CONTAINS:
-Written contract between the client & the auditor
-Description of services that will be provided
-Responsibilities of both parties
-Deadlines for services to be provi
Ordinary Negligence
The CPA failed to exercise reasonable care in performing services. I.e. the auditor departed from one of the GAAS
To be successful in a negligence claim against an auditor, the plaintiff must prove:
1. The auditor had a duty to the plaintiff to exercise d
3 Classes of Third Parties in Common Law
1. Primary Beneficiaries: Third party creditors known by name by the auditor to be a user of the audit report.
2. Foreseen Third Parties: Third party creditors who rely on the audit report but were not known by the auditor to be a user of the report.
3. F
4 Common law standards that govern the ability of third parties to sue an auditor for negligence
1. Privity Standards
2. Near Privity Standards
3. Foreseen third party standard (restatement standard)
4. Reasonably foreseeable third party standard
Privity Standards (common law standard 1)
Only those parties in privity may sue an auditor for ordinary negligence (only the client is in privity i.e. no third part can sue for ordinary negligence).
COURT CASE:
-Ultramares v. Touche (1931)
Privity: A contractor specific agreement exists between t
Near Privity Standards (common law standard 2)
Allows third parties whose relationship with the auditor APPROACHES PRIVITY (primary beneficiaries) to sue for ordinary negligence
COURT CASE:
-Credit alliance corp vs. Arthur Anderson (1985)
Foreseen third party standard (restatement standard)
(common law standard 3)
Allows all third party creditors (both primary beneficiaries and foreseen third parties) to sue an auditor for ordinary negligence
COURT CASE:
-Rusch factors, inc. vs. levin (1968)
MOST (43) STATES FOLLOW THIS
Reasonably foreseeable third party standard (common law standard 4)
Allows all third parties who have a reasonable need to rely on the audit report to sue an auditor for ordinary negligence.
COURT CASE:
-Resenblum vs. adler (1981)
Gross Negligence
Reckless departure from professional standards
Fraud
Action taken with the intent to deceive
To sue for gross negligence or fraud, plaintiff must prove:
1. There was a false representation made by auditor
2. There was knowledge or belief by the auditor that the statement was false
3. Plaintiff relied on the false statement
4. Plaintiff suffered a loss due to this reliance
****only need to prove #5 for fra
Statutory Law
1. Securities Act of 1933
2. Securities Exchange Act of 1934
Securities Act of 1933
Regulates the sale of securities in an IPO
Requires companies to file a REGISTRATION STATEMENT with the SEC before the IPO.
-Registration statement: disclosures such as description of the securities, salaries paid to board members & officers, and a set of
Securities Exchange Act of 1934
Regulates the trading of securities after the IPO
Suing under section 10(b): Burden of proof plaintiff must prove 4 things
1. The financial statements were materially misstated
2. Plaintiff relied on the financial statements
3. Due to this reliance, plain