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Chapter 2 Notes

by: Victoria Andreski

Chapter 2 Notes ACCT 4150

Victoria Andreski

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Chapter 2: The Financial Statement Auditing Environment
Nancy Harp
Class Notes
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This 6 page Class Notes was uploaded by Victoria Andreski on Tuesday January 26, 2016. The Class Notes belongs to ACCT 4150 at Clemson University taught by Nancy Harp in Spring 2016. Since its upload, it has received 27 views. For similar materials see Auditing in Accounting at Clemson University.


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Date Created: 01/26/16
Chapter 2 —The Financial Statement Auditing Environment Types of Auditors • External Auditors (aka Independent Auditors) o 3 party; outside auditors o May practice as a sole proprietor or as a member of a CPA firm o Not a member of company being audited • Internal Auditors o Auditors employed at individual companies, partnerships, government agencies, & other agencies o Institute of Internal Auditors (IIA)—primary organization supporting internal auditors § Mission: “provide dynamic leadership for the global profession of internal auditing” o Ex: Cynthia Cooper • Government Auditors o Employed by federal, state, & local agencies o A type of internal auditor o 2 agencies at federal level use auditors: Government Accountability Office (GAO) & Internal Revenue Service (IRS) • Forensic Auditors o Fraud examiners—come in for special circumstances o Employed by government agencies, corporations, public accounting firms, & consulting & investigative services firms o Trained in detecting, investigating, & deterring fraud & white-collar crime Types of Services • Audit Services o Internal Control Audits § Available but not required for private entities § Public company auditing standards require an integrated audit of internal control & financial statements o Compliance Audits § Determines extent to which the company being audited follows the rules, policies, laws, covenants, or governmental regulations o Operational Audits § Systematic review of part/all of organization’s activities to evaluate if resources are being used effectively & efficiently § Assesses performance, identifies areas for improvement, & develops recommendations § aka performance audit or management audit § Requires auditor to identify/create objective, measurable criteria against which to assess effectiveness & efficiency o Forensic Audits § Detect or defer fraudulent activities • Attest Services o Report on nature & quantity of inventory stored in client’s warehouse so that client can obtain bank loan • Assurance Services o Auditing is a specialized form of assurance service • Non-Assurance Services o Tax Preparation & Planning Services § Assist clients w/ preparing & filing tax returns, providing advice on tax & estate planning, & representing clients on tax issues before the IRS or tax courts o Management Advisory Services § Provides advice & assistance concerning company’s organization, personnel, finances, operations, systems, & other activities o Compilation & Review Services § Bookkeeping, payroll processing, & preparing financial statements § Compilations—when accounting firms provide nonaudit accounting services relating directly to financial statements of companies • Less rigorous & provide no assurance • Usually at smaller firms § Review—performance of inquiry & analytical procedures to provide accountants w/ reasonable basis for expressing limited assurance that no material modifications should be made to the statements so that they conform to applicable financial reporting framework (GAAP) • Typically occurs quarterly (10Q) for public companies—no heavy testing Audit Teams • Partner (Shareholder) • Manager • Senior/In-Charge • Associate/Staff o In position for typically 2-3 years o Being told what to do o Manager typically not with you—senior helps you & teaches you Scandals • Brokerage firms • Mutual fund managers • Stock exchanges • Corporate giants o Enron/WorldCom • Public accounting firms Government Regulation • Congress passed Sarbanes-Oxley Public Company Accounting Reform & Investor Protection Act in 2002 • Congress passed Dodd-Frank Wall Street Reform & Consumer Protection Act in 2010 Society’s Expectations & Auditor’s Responsibilities • Auditor has a responsibility to plan & perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement (caused by error or fraud) • Auditor is able to obtain reasonable, NOT absolute, assurance that material misstatements are detected o Society expects auditors to be perfect & are quick to get mad when mistakes are made § Only provide reasonable assurance Context of Financial Statement Auditing • Industry/business of auditor’s audit client • Context provided by client’s business impacts auditor & audit Corporate Governance • “Process & structure used to direct & manage the business entity considering various stakeholder interests” • Why do we need it? o To achieve objectives & ensure accountability Model of Business • Business organizations exist to create value for their stakeholders o System of corporate governance is necessary o Managers are overseen & supervised • Board of Directorsà Audit Committee (subcommittee of Board—should be independent) • Processes—auditors need to know how a business works (each is different) o Objectives o Strategies o Transactions o Controls o Reports • Components-drive the tests that are done o Purchasing process § Acquire goods/services to support operations § Purchase electrical power, office supplies, custodial services, etc. to support activities o Revenue process § Generate revenue through sales of goods/services to customers • Collect proceeds through cash (immediately or AR) o Inventory management process § Accumulating/allocating costs to inventory & making adjustments to record inventory at lower of cost or market o Financing process § Obtain capital from borrowing/soliciting investments from owners & usually invest in assets (land, buildings, equipment) § Repay lenders & provide a return on owners’ investments o Human resource management process § Hire personnel to perform various functions in accordance with enterprise’s mission & strategy Organizations that affect the public accounting profession • Securities & Exchange Commission (SEC)—federal government agency o Administers Securities Act of 1933, Securities Exchange Act of 1934, & Sarbanes-Oxley Act of 2002 o Has responsibility & authority to oversee the establishment of accounting & auditing standards • Public Company Accounting Oversight Board (PCAOB) o Nonprofit o Quasi-governmental regulatory agency o Overseen by SEC o Authority to set standards, inspect, investigate, & enforce for public company audits o Require all public accounting firms that provide audits for public companies to register w/, pay fees to, & follow rules/standards of PCAOB o Conducts regular inspections o Broad investigative & disciplinary authority over registered audit firms • American Institute of Certified Public Accountants (AICPA) o Private professional association o Promulgation of rules/standards that guide audit & related services provided to nonpublic companies • Financial Accounting Standards Board (FASB) o Privately funded body o Mission: establish standards for financial accounting & reporting § Emerging Issues Task Force (EITF)—established to meet accountants’ needs for timely guidance on accounting practices/methods & to limit # of issues requiring formal pronouncements from FASB • International Auditing & Assurance Standards Board (IAASB) o Sponsored & funded by International Federation of Accountants (IFAC) o Independent standard-setting boards that develop international standards on ethics, education, & public accounting standards o Issues International Standards on Auditing (ISA) • International Accounting Standards Board (IASB) o International counterpart to FASB o Recognized accounting standards outside of US Auditing Standards • Guidelines for & measure of quality of auditor’s performance • Generally Accepted Auditing Standards (GAAS)—financial audits by external auditors • 10 Generally Accepted Auditing Standards (PCAOB) o General Standards § T: Adequate technical training & proficiency • Have correct accounting degree & CPA § I: Independence • In fact & opinion • Disclose any relationships you have with clients o Ex: banks—do you have any accounts/loans with them? § P: Due professional care • Can’t do a sloppy job preparing reports o Standards of Fieldwork § S: Adequate planning & supervised assistants § I: Obtain sufficient understanding of internal controls • Helps to plan the audit & determine the nature, timing, & extent of tests to be performed • Public companies are forced to test internal controls § E: Obtain sufficient appropriate evidential matter • Through inspection, observation, inquiries, & confirmations o Standards of Reporting § W: GAAP § A: Disclosures • Footnotes must also be audited § C: Consistency • Consistent observations from current period & previous period § E: Opinion • Report should contain an expression of opinion • Disclaimer o Express opinion or explain that you couldn’t form an opinion Principles Underlying an Audit (ASB) • Purpose o Express an opinion on financial statements prepared by management § Management has responsibility to prepare financial statements & provide auditor w/ necessary information to complete audit • Responsibilities o Competence & capability o Comply w/ ethical requirements o Maintain professional skepticism o Exercise professional judgment • Performance o Sufficient & appropriate audit evidence o Supports reasonable (NOT absolute) assurance that financial statements are free of material misstatement • Reporting o Express an opinion (written report) o Based on evaluation of audit evidence obtained o State opinion cannot be expressed Statements on Auditing Standards (SAS)—Interpretations of GAAS • SAS & GAAS= minimum standards of performance for auditors • Auditors don’t have as detailed guidance • SAS classified by SAS & AU numbers o SAS—order that standards are issued (chronological) o AU—organized by topical content Ethics, Independence, & Code of Professional Conduct • Ethics—system/code of conduct based on moral duties/obligations that indicate how we should act o Have transparent information that people can rely on • Professionalism—conduct, aims, or qualities that characterize a profession/professional person • Code of Professional Conduct o Principles o Rules of Conduct o Interpretations of the Rules  


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