McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter 02

Professional Standards

“In today’s regulatory environment, it’s virtually impossible to violate rules.”

– Bernard Madoff, money manager, on October 12, 2007, approximately one year prior to being arrested for embezzling $50

billion from investors in a Ponzi scheme.

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Auditing Standards for Public and Nonpublic Entities

Audits of Public Entities

Audits of Nonpublic Entities

AICPA Statements on Auditing Standards

Standards issued by the Auditing Standards Board prior to April 2003 not amended or superseded by PCAOB standards (Interim Standards)

All current standards issued by Auditing Standards Board

PCAOB Auditing Standards

All current standards issued by PCAOB

Not applicable

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Generally Accepted Auditing Standards

• Identify necessary qualifications and characteristics of auditors and guide the conduct of the audit

• Purpose of GAAS is to achieve the following objectives of an audit examination – Obtain reasonable assurance about whether

financial statements are free of material misstatement

– Report on the financial statements and communicate in accordance with auditor’s findings

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Comparison of AICPA GAAS to Principles: Responsibilities General Standards Responsibilities Principle

1. Training and proficiency 2. Independence in mental attitude 3. Due professional care

Auditors are responsible for:

•competence and capabilities

•ethical requirements (independence and due care)

•professional skepticism and professional judgment

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Responsibilities Principle

1. Competence and capabilities

– Experience and expertise

2. Independence

– Independence in fact vs. independence in appearance

– Financial and managerial relationships

3. Due care

– Level of performance by reasonable auditor in similar circumstances

4. Professional skepticism and judgment

– Skepticism: Appropriate questioning and critical assessment of evidence

– Judgment: Application of training, knowledge, and experience in making informed decisions during audit

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Comparison of AICPA GAAS to Principles: Performance Standards of Field Work Performance Principle

1. Planning and supervision 2. Understanding of entity and

environment to assess risk of material misstatement

3. Obtain sufficient appropriate

evidence

To obtain reasonable assurance:

•Plan work and supervise assistants

•Determine and apply appropriate materiality levels

•Identify and assess risks of material misstatement

•Obtain sufficient appropriate evidence

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Performance Principle

Goal is to provide reasonable assurance that financial statements do not contain material misstatements 1. Planning and supervision

– Preparation of audit plan 2. Materiality

– Influences decisions of financial statement users – Considered throughout the audit

3. Risk assessment – Understand entity and environment (including internal control) – Determine necessary effectiveness of substantive tests

4. Audit evidence – Sufficient = quantity (How many transactions or components?) – Appropriate = quality (What level of reliability needed? Source?)

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Overview of Evidence

Detection Risk

Sufficiency (Quantity of Evidence)

Relevance (What Does Evidence Tell the Auditor?)

Reliability (Can the Auditor Trust the Evidence?)

Appropriateness (Quality of Evidence)

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Sufficient evidence

• Related to quantity (number of transactions or components examined)

• Influenced by effectiveness of entity’s internal control

Effective internal control

Lower level of control risk

Evaluate less evidence

Ineffective internal control

Higher level of control risk

Evaluate more evidence

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Appropriate Evidence

• Relates to the quality of evidence

• Relevance: Does evidence address assertion(s) of interest?

• Reliability: Source of evidence – Auditors’ direct personal knowledge

– External documentary evidence

– External-internal evidence

– Internal documentary evidence

– Verbal evidence

High

Low

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Comparison of AICPA GAAS to Principles: Reporting Standards of Reporting Reporting Principle

1. Financial statements in accordance with GAAP

2. GAAP applied consistently (only report if not consistent)

3. Adequacy of disclosures (only report if not adequate)

4. Express or disclaim an opinion

• Express an opinion or state that an opinion cannot be expressed

• Opinion is based on conformity of financial statements with applicable financial reporting framework

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Reporting Principle

• Express an opinion (or indicate that an opinion cannot be expressed) on entity’s financial statements

• Assess financial statements against financial reporting framework

– Set of criteria used to determine the measurement, recognition, presentation, and disclosure of material items in the financial statements

– Examples include GAAP, IFRS, or special purpose framework

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Types of Audit Opinions

• Unqualified – F/S are in conformity with GAAP

• Qualified – Except for limited items, F/S are in conformity with GAAP

– Can issue for GAAP departure and scope limitation

• Adverse – F/S are not in conformity with GAAP

– Can issue for GAAP departure (more serious)

• Disclaimer – Auditors do not express an opinion

– Can issue for scope limitation (more serious) or situation in which auditor is not independent

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System of Quality Control

• Provides firm with reasonable assurance that the firm and its personnel

– Comply with professional standards and regulatory/legal requirements

– Issue reports that are appropriate in the circumstances

• Reviewed through either peer reviews (for firms auditing nonpublic entities) or PCAOB inspections (for firms auditing public entities)

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