Chapter 01 - The Role of the Public Accountant in the American Economy

CHAPTER 1

The Role of the Public Accountant in the American Economy

Review Questions 1-1 The crisis of credibility largely arose from the number of companies that restated their pre iously issued financial statements as a result of accounting irregularities and fraud! Especially responsible "ere the ery isible Enron and #orldCom fraud cases! $oth companies filed for ban%ruptcy and constituted the largest companies in American history to do so! The e&tent of the accounting irregularities and fraud being in estigated and disclosed brought into 'uestion the effecti eness of financial statement audits! (n addition) the criminal con iction of Arthur Andersen) **P) one of the then $ig + accounting firms) on charges of destroying documents related to the Enron case brought into 'uestion the ethical standards of the profession! Assurance ser ices are professional ser ices that enhance the 'uality of information) or its conte&t) for decision-ma%ing! The t"o types are- .a/ those that increase the reliability of information and .b/ those that in ol e putting information in a form or conte&t that facilitates decision-ma%ing! A financial statement audit is) by far) the most common type of attest engagement! The o erall assertion) made by management) most fre'uently is that the financial statements follo" generally accepted accounting principles! A large corporation "ith securities listed on a stoc% e&change is re'uired by the rules of the stoc% e&change and by the rules of the 2ecurities and E&change Commission to pro ide an audit report "ith the annual financial statements furnished to its stoc%holders! (t also is re'uired to engage the auditors to pro ide an opinion on its internal control! Apart from legal re'uirements) ho"e er) a large listed corporation recogni3es that it must maintain in estor confidence in the reliability of its financial statements and internal control o er financial reporting if it is to continue to be able to secure capital from the public! The report by a firm of certified public accountants adds credibility to the financial statements prepared by the corporation! #hen a small family-o"ned enterprise elects to ha e an audit) the purpose usually is to use the auditors4 report to support an application for a ban% loan!

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A report by an independent public accountant concerning the fairness of a company4s financial statements is commonly re'uired in the follo"ing situations.1/ .,/ .0/ .1/ .+/ .5/ .6/ Application for a ban% loan! Establishing credit for purchase of merchandise) e'uipment) or other assets! Reporting operating results) financial position) and cash flo"s to absentee o"ners .stoc%holders or partners/! (ssuance of securities by a corporation! Annual financial statements by a corporation "ith securities listed on a stoc% e&change or traded o er the counter! 2ale of an ongoing business! Termination of a partnership!

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To add credibility to financial statements is to increase the li%elihood that they ha e been prepared follo"ing the appropriate criteria) usually generally accepted accounting principles! As such) an increase in credibility results in financial statements that can be belie ed and relied upon by third parties! $usiness ris% is the ris% that the in estment "ill be impaired because a company in ested in is unable to meet its financial obligations due to economic conditions or poor management decisions! (nformation ris% is the ris% that the information used to assess business ris% is not accurate! Auditors can directly reduce information ris%) but ha e only limited effect on business ris%! At the beginning of the century) the principal ob8ecti e of auditing "as the pre ention and detection of fraud! Audit "or% centered on the balance sheet) because the income statement "as regarded as highly confidential and not for public disclosure! Today) the principal ob8ecti e of auditing is to form an opinion on the fairness of financial statements and their conformity "ith generally accepted accounting principles! $ut the professional standards also re'uire that an audit be designed to pro ide reasonable assurance of detecting material misstatements) due to errors or fraud! Particular emphasis is placed on the income statement "hich is of great importance to in estors! Auditing today also has the ob8ecti es of meeting the re'uirements of the 2ecurities and E&change Commission .2EC/ and the Public Company Accounting 9 ersight $oard for public companies! An operational audit attempts to measure the effecti eness and efficiency of a specific unit of an organi3ation! (t in ol es more sub8ecti e 8udgments than a compliance audit or an audit of financial statements because the criteria of effecti eness and efficiency of departmental performance are not as clearly established as are many la"s and regulations or generally accepted accounting principles! The report prepared after completion of an operational audit is usually directed to management of the organi3ation in "hich the audit "or% "as done!

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A compliance audit is an audit to determine "hether financial reports or other assertions are in compliance "ith established criteria! The necessary ingredients are erifiable data and the e&istence of standards established by an authoritati e body! An operational audit) on the other hand) is a re ie" of a department or other unit of a business or go ernmental organi3ation to measure the effecti eness and efficiency of operations! (nternal auditors often perform operational audits as do auditors employed by the ;o ernment Accountability 9ffice .;A9/ of the federal go ernment! (nternal auditors must be independent of the department heads and other line e&ecuti es "hose "or% they re ie"! <o"e er) internal auditors are not independent in the same sense as a public accounting firm! The public accounting firm ser es many clients and the re enue obtained from any one client is only a small part of the re enue of the firm! (nternal auditors) on the other hand) are employees of one company) and are sub8ect to the restraints inherent in the employer-employee relationship! (nternal auditors can achie e a great deal of independence by reporting to the audit committee of the board of directors) but they cannot achie e the same degree of independence as is possessed by the e&ternal public accounting firm! The internal auditors are employees of 2pacecraft) (nc!) and may be influenced by corporate management! The public accounting firm is independent of the company and is in a better position to ta%e positions opposed to those of company management! The "or% of the internal audit staff emphasi3es measurement of the efficiency and effecti eness of arious operating units of the company and compliance "ith all types of controls) "hereas the public accounting firm is primarily concerned "ith determining the fairness of 2pacecraft4s financial statements! The ;o ernment Accountability 9ffice .;A9/ is a staff of professional auditors "hich reports to Congress! (ts function is to determine that programs carried out by federal agencies conform to the financial authori3ation of the Congress! (t is also concerned "ith the cost-effecti eness of go ernment programs! The audit acti ities include in estigation of the costs and performance of corporations holding go ernment contracts! Among the many important contributions to auditing literature by the A(CPA are the series of 2tatements on Auditing 2tandards .2A2s/) 2tatements on 2tandards for Attestation Engagements .22AEs/) (ndustry Audit and Accounting ;uides) Audit ;uides) 2tatements on 2tandards for Accounting and Re ie" 2er ices .22AR2s/) Auditing Practice Releases .formally Auditing Procedure 2tudies/) (ndustry Ris% Alerts) and the Code of Professional Conduct .only t"o re'uired/! A peer re ie" is a critical re ie" of a public accounting firm4s practices by another public accounting firm .or other CPAs functioning as a peer re ie" team/! The purpose of a peer re ie" is to encourage adherence to 'uality control standards established by the accounting firm and the profession!

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Chapter 01 - The Role of the Public Accountant in the American Economy

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The 2ecurities and E&change Commission .2EC/ is an agency of the federal go ernment and is responsible for administering a number of acts) including the 2ecurities Act of 1:00 and the 2ecurities E&change Act of 1:01! (n meeting this responsibility) the 2EC re ie"s financial statements of companies offering securities for sale to the public! (t is particularly concerned "ith re'uiring full disclosure of financial information and "ith pre enting misrepresentation! Through the Public Company Accounting 9 ersight $oard) the 2EC no" o ersees public accounting firms that audit public companies! (ncluded in this o ersight process includes de elopment of auditing) independence) and 'uality control standards= inspection of performance= and enforcement of the standards! The A(CPA is the national organi3ation of certified public accountants! (t has long been a leader in accounting and auditing research) in publication of authoritati e accounting and auditing pronouncements and studies) and in promoting high professional standards of practice! 2er ices offered by public accounting firms in addition to auditing include other forms of attestation) ta& "or%) consulting ser ices) litigation support ser ices) fraud in estigation ser ices) personal financial planning and accounting ser ices! This last category includes preparation of financial statements for smaller companies that ha e limited accounting personnel and arious types of "rite-up "or%! Public accounting firms also perform a ariety of other ser ices! Consulting ser ices include aiding clients in the design of accounting systems) con ersion to (nformation Technology .(T/ systems) preparation of budgets) planning business combinations "ith other companies) e&ecuti e search) and numerous other pro8ects! Public accounting firms are restricted as to the consulting ser ices that they may pro ide to audit clients that are public companies! The partnership form of organi3ation for a public accounting firm offers se eral ad antages o er a sole proprietorship! A partnership offers the opportunity for speciali3ation by the partners in areas such as ta&ation) auditing) and consulting ser ices! Partners can discuss difficult technical problems among themsel es) and benefit from different perspecti es! Also) the partnership may be better able to attract and retain high 'uality professional staff) because they may be re"arded by acceptance into the partnership! The follo"ing characteristics of a professional corporation distinguish it from the traditional corporation.1/ .,/ .0/ .1/ All shareholders must be engaged in the practice of public accounting! To the e&tent possible) directors and officers should be certified public accountants! 2hares of a professional corporation may be transferred only to those engaged in public accounting or to the corporation itself! The corporation4s shareholders and employees ha e liability e'ui alent to other forms of organi3ations .i!e!) the corporate form of organi3ation does not reduce liability/! >ote) ho"e er) that CPAs may choose to purchase liability insurance to limit potential liability!

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Chapter 01 - The Role of the Public Accountant in the American Economy

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*ocal firms usually ha e only one or t"o offices) are headed by a single CPA or ha e a fe" CPAs as partners) and ser e clients in a single city or area! The ser ices pro ided are mostly income ta& "or%) consulting ser ices) and accounting ser ices! Auditing is often only a small part of the practice! Regional firms often arise from the merger and e&pansion of local firms! They typically maintain se eral offices in neighboring cities and states! Auditing is a more important function for regional firms than for the local firms) because larger businesses are included among the clients! >ational firms ha e offices in most ma8or cities in the ?nited 2tates and some operate in other countries as "ell! These firms offer a full range of ser ices) "ith auditing often representing the largest single portion of the practice! (nternational firms ha e offices in most of the "orld@s ma8or cities! These firms offer a full range of ser ices) "ith auditing often representing the largest single portion of the practice! The arious le els of accounting personnel in a large public accounting firm are staff assistants) senior auditors) managers or super isors) and partners .and principals/! The staff assistant performs audit procedures such as the obser ation of physical in entories and confirmation of recei ables under the super ision of a senior! The senior auditor plans and coordinates the audit and drafts the audit report! The senior also re ie"s "or%ing papers) controls the allocation of audit time) and trains assistants on the 8ob! The manager or super isor usually is responsible for super ising and re ie"ing se eral audit engagements concurrently) and resol ing significant problems "ith the client! The partners maintain contacts "ith clients) de elop ne" business) establish policies of the firm) re ie" the ade'uacy of audit "or%) and sign audit reports! The engagement partner is responsible for performance of the audit in accordance "ith professional standards! A partner also de otes time to the recruitment and de elopment of staff) to A(CPA and other professional group acti ities) to educational and other ci ic acti ities) and generally to promoting an en ironment in "hich the firm can prosper! The position of principal) "hich is often held by top-ran%ing consulting personnel "ho do not hold the CPA certificate) has responsibilities similar to those of a partner! The most significant responsibilities of a partner in a public accounting firm include .only three re'uired Assume ultimate responsibility for the audits assigned to him or her 2ign audit reports Re ie" the audit "or% for compliance "ith firm and professional standards Aaintain relations "ith audit clients Establishing firm policies 2taff recruitment and de elopment

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The (nternational Auditing and Assurance 2tandards $oard establishes International Standards on Auditing .ISAs/ International Standards on Quality Control .ISQC/ and standards for other assurance and related ser ices! (ts pronouncements are meant to foster the de elopment of consistent "orld"ide professional standards! (ts standards do not to o erride the national auditing standards of its members! Questions Requiring Analysis 1-,1 .a/ The 2arbanes-9&ley Act of ,00, made significant reforms in the regulation system for public accounting firms that audit public companies! (t contains pro isions toughening penalties for corporate fraud) restricting the types of consulting CPAs may perform for audit clients) and creating the Public Company Accounting 9 ersight $oard .PCA9$/ to o ersee the accounting profession! .b/ Primary regulation of public accounting firms that audit public companies is pro ided by the PCA9$ and the 2ecurities and E&change Commission .2EC/! #ith respect to the practices of these firms) the PCA9$ has the responsibility for.1/ .,/ .0/ .1/ .+/ Establishing or adopting auditing) 'uality control) and ethic standards) Registering public accounting firms) Performing inspections of the practices of registered) Conducting in estigations and disciplinary proceedings of registered firms) and 2anctioning registered firms!

The 2EC in estigates iolations of the securities la"s) including allegations of fraudulent financial reporting and public accounting firm audit deficiencies! (n addition) the state boards of accountancy may re o%e any public accounting firm@s license to practice! .c/ Primary regulation of public accounting firms that are not under the PCA9$@s inspection program rests "ith the A(CPA and the state boards of accountancy! Aembers of the A(CPA in public practice must practice "ith a firm that participates in a practice re ie" program! Birms can meet this re'uirement by enrolling the A(CPA Peer Re ie" Program) "hich re'uires the firm to ha e a peer re ie" e ery three years! Ethical iolations are in estigated and enforced by the A(CPA and the state boards of accountancy! .a/ Audits of financial statements of a corporation contemplating issuing debenture bonds may facilitate the transaction through reducing information ris%Cthe ris% that the information used to ma%e the in estment decision is materially misstated! Aisstatements of the financial statements may occur due to accidental errors) lac% of %no"ledge of accounting principles) unintentional bias) or by deliberate falsification of the statements! .b/ #hen financial statements ha e not been audited a Dcredibility gapD may e&ist in that management can hardly be e&pected to be impartial and unbiased in their preparation! This credibility gap may lead to a situation in "hich in estors find the information ris% too great and they decide not to in est in the bonds! (f they do decide to in est in the bonds) the in estors "ill li%ely demand a higher rate of return!

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Chapter 01 - The Role of the Public Accountant in the American Economy

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The Public Company Accounting 9 ersight $oard "as created because of the concerns about the credibility of the public accounting profession that occurred in the later part of ,001 and the early part of ,00,! The large number of public company restatements due to accounting irregularities and fraud caused the in esting public and Congress to 'uestion the effecti eness of audits! (n addition) the con iction of Arthur Andersen **P of destruction of e idence related to the Enron case caused Congress to 'uestion the profession@s ethical principles! The Public Company Accounting 9 ersight $oard has the responsibility to o ersee and discipline public accounting firms that audit public companies! 2pecifically) the PCA9$ has the responsibility for.1/ .,/ .0/ .1/ .+/ Establishing or adopting auditing) 'uality control) and ethic standards) Registering public accounting firms) Performing inspections of the practices of registered) Conducting in estigations and disciplinary proceedings of registered firms) and 2anctioning registered firms!

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.b/

.a/ An e&ample of possible bias on the part of the pro ider of financial information is the situation in "hich an indi idual or business entity applies for a ban% loan! (n such circumstances) there is an incenti e to o erstate assets) income) and o"ner4s e'uity) and to o erloo% or minimi3e liabilities! Eistortions of this type gi e the appearance of greater financial strength! A ban% loan officer may insist that a prospecti e borro"er pro ide audited financial statements! This pro ides assurance that the data in the financial statements ha e been e&amined by independent competent persons!

Ob ective Questions 1-,7 Aultiple Choice Fuestions .a/ .0/ $oth sets of standards re'uire independence!

.b/ .1/ The client4s management is primarily responsible for representations contained in the financial statements! The independent auditors are responsible for performing their audit in accordance "ith generally accepted auditing standards! .c/ .1/ The most important benefit of ha ing an annual audit by a public accounting firm is to pro ide assurance to in estors and other outsiders that the financial statements are dependable! The e&pansion of the securities mar%ets has tremendously increased the need for erification of financial statements performed by competent) independent persons! Ans"er .,/ is incorrect because management cannot a oid responsibility for the financial statements by retaining independent auditors! Ans"er .0/ gi es no recognition to the fact that many nonpublic corporations and other business entities ha e no obligation to file audited financial statements "ith go ernmental agencies! (t also disregards the fact that large corporations "hich secure capital from the general public "ould continue to pro ide audited statements e en though there "ere no such re'uirements by go ernmental agencies! Ans"er .1/ is unacceptable because it implies that an audit is designed to detect illegal acts "ithout regard to type or si3e!

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Chapter 01 - The Role of the Public Accountant in the American Economy

.d/

.,/ The PCA9$ ordinarily does not re ie" financial reports filed "ith the 2ecurities and E&change CommissionCalthough) if they so desire) they may re ie" such reports to accomplish their other responsibilities! The other three replies are all e&plicit responsibilities of the PCA9$! .1/ The Public Company Accounting 9 ersight $oard "as gi en the authority by the 2arbanes-9&ley Act of ,00, to establish or adopt auditing standards for audits of public companies! .1/ ;o ernmental auditing often e&tends to audits of efficiency) effecti eness) and compliance ."ith la"s) regulations) etc/! The other responses) ade'uacy) e aluation) and accuracy) are terms not typically used to summari3e the scope of go ernmental auditing! .0/ >ormally) the higher in an organi3ation an internal auditor reports) the greater the degree of independence! Accordingly) reporting to the audit committee of the board of directors increases the li%elihood that the internal auditor "ill be able to act independently of those being audited! Ans"ers .1/ and .,/ may lead to a lesser degree of independence because "hen an internal auditor reports to the financial ice-president or the controller they cannot ob8ecti ely re ie" their "or%! Ans"er .1/ is incorrect because it is generally not practical or effecti e for the internal auditor to report to stoc%holders on a timely basis! .1/ Ethical scandals at the A(CPA "as not one of the causes of the passage of the 2arbanes-9&ley Act of ,00,! All of the other responses contributed to passage of the Act! .i/ .0/ The Bederal Accounting 2tandards Ad isory $oard establishes accounting standards for ?nited 2tates go ernmental agencies! The ;o ernmental Accounting 2tandards $oard establishes accounting standards for state and local go ernment entities! .8/ .1/ Borensic audits are usually performed "hen fraud has been found or is suspected! Ans"er .1/ is incorrect because it o erstates the nature of most audits by suggesting that all audits are forensic in nature! Ans"er .,/ is "rong in that CPA firms .or la" firms/ may perform forensic audits! Ans"er .0/ is incorrect because "hile compliance audits may find fraud) they are not directed at fraud as are forensic audits!

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Chapter 01 - The Role of the Public Accountant in the American Economy

.%/ .1/ $ecause the auditors@ purposes for considering internal control are to .a/ plan the audit and .b/ to determine the nature) timing) and e&tent of the tests to be performed) ans"er .1/ is correct! .l/ .,/ A compliance audit measures the compliance of an organi3ation "ith established criteria such as la"s and regulations! Ans"er .,/ is correct because it addresses policies and procedures on en ironmental la"s and regulations! 1-,: .1/ .a/ .c/ .f/ .l/ .,/ Phrases more applicable to an audit performed in 1:00Complete re ie" of all transactions! Auditors4 attention concentrated on balance sheet! Auditing procedures to pre ent or detect fraud on the part of all employees and managers! $an%ers and short-term creditors as principal users of audit reports!

Phrases more applicable to an audit performed today.b/ .d/ .e/ .g/ .h/ .i/ .8/ .%/ .m/ .n/ Assessment of internal control! Emphasis upon use of sampling techni'ues! Eetermination of fairness of financial statements! Registration statement! Bairness of reported earnings per share! (nfluence of stoc% e&changes and the in esting public upon the use of independent auditors! Concern about fraudulent financial reporting! ;enerally accepted auditing standards! Pressure for more disclosure! Auditing for compliance "ith la"s and regulations!

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Chapter 01 - The Role of the Public Accountant in the American Economy

1-00 Publication
1! ,! 0! 1! +! 5! 6! 7! :! 10! 2tatements on Auditing 2tandards .2A2s/ The Gournal of Accountancy Regulation 2-H 2tatements on 2tandards for Accounting and Re ie" 2er ices .22AR2/ Binancial Reporting Releases .BRRs/ Accounting and Reporting 2tandards for Corporate Binancial 2tatements Accounting and Reporting 2tandards for ;o ernmental Entities (ndustry Accounting and Auditing ;uides Auditing Practice Releases The Ta& Ad isor c! c! b! c! b! d! g! c! c! c!

!"onsor
A(CPA A(CPA 2EC A(CPA 2EC BA2$ ;A2$ A(CPA A(CPA A(CPA

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Column One 1! ,! 0! 1! +! 5! Fuality control 9perational audit e! h! i! 8! c! d! a! f! b! g! Column Two Peer Re ie" Aeasurement of effecti eness and efficiency of a unit of an organi3ation $asis for sampling and testing Auditing staff reporting to Congress Aaterial information Credibility Regulation of auditors of public companies Registration statement 9pinion Accounting ser ice

(nternal control ;eneral Accountability 9ffice Eisclosure Critical characteristic that must be maintained by the accounting profession 6! Public Company Accounting 9 ersight $oard 7! 2ecurities and E&change Commission :! Audited financial 2tatements 10! Compilation of financial statements

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!tatement a! b! c! d! e! f! g! h! i! 8! #hen financial statements are in ol ed this is referred to as an audit! The term "e are not a"are of any material modifications that should be made is often included in the report! The report issued pro ides a summary of procedures follo"ed and findings! The report issued pro ides reasonable assurance! The procedures in ol ed are generally limited to in'uiry and analytical procedures! The report issued pro ides absolute assurance! The report pro ides limited assurance! The procedures follo"ed are agreed upon "ith the specified user or users! This type of engagement pro ides more assurance than a re ie"! The CPA need not be independent to perform this ser ice! Ty"e of Engagement E R A E R > R A E >

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Chapter 01 - The Role of the Public Accountant in the American Economy

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a! b! c! d! e! f! g! a! b! c! d! e! f! g! h!

1 : 0 1 6 , 5 7 , : 1 6 5 1 11 Topic 1 , 0 1 + 5 6 7 : 10 11 1,

Agreed-upon procedures engagement Re ie" Attest engagement Audit of financial statements (ntegrated audit Assurance ser ices E&amination 2ecurities and E&change Commission Assertion 2tatements on Auditing 2tandards Binancial reporting frame"or%! 2arbanes-9&ley Act of ,00, Public Company Accounting 9 ersight $oard American (nstitute of Certified Public Accountants 2uitable criteria! Type of Auditor CPA CPA (nternal auditor ;A9 $an% e&aminer CPA CPA (nternal auditor (R2 CPA ;A9 CPA Class of #or% Audit of financial statements Audit of financial statements 9perational audit 9perational audit Compliance audit Consulting ser ices Audit of financial statements 9perational audit Compliance audit Compliance audit Compliance audit Accounting ser ices

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Problems 1-05 29*?T(9>- Beller Company .estimated time- ,0 minutes/ .a/ Barber should e&plain to Beller that an independent audit is an e&amination of the financial statements in accordance "ith generally accepted auditing standards! The ob8ecti e of an audit is to render an opinion on the fairness "ith "hich the financial statements present financial position) results of operations) and cash flo"s in conformity "ith generally accepted accounting principles! The CPA) after an ob8ecti e e idence-gathering audit) e&presses an opinion on the fair presentation of financial statements! An independent e&pert is needed to lend credibility to the financial statements! (t "ould not be meaningful for a company to report on itself "ithout the attestation of an independent party because the company itself might not be ob8ecti e!

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.b/

Barber should inform Beller of the follo"ing "ays in "hich an independent audit can be beneficial to .only fi e re'uired/.1/ .,/ .0/ .1/ .+/ .5/ .6/ .7/ .:/ .10/ .11/ .1,/ .10/ .11/ .1+/ 2er e as a basis for the e&tension of credit! 2upply credit rating agencies "ith re'uired information! 2er e as a basis for preparation of ta& returns! Establish amounts of losses from fire) theft) burglary) and so forth! Eetermine amounts recei able or payable under arious agreements! Pro ide data for possible sale or merger! 2er e as a basis for action in ban%ruptcy and insol ency cases! Eetermine proper e&ecution of trust agreements! Burnish estates "ith information to obtain proper settlements and a oid costly litigation! (mpro e internal control! Pro ide aid in cases of ta& audits) court actions) and so forth! Eiscourage employees from perpetrating errors and fraud! Pro ide industry-"ide comparisons! Assist in analysis of ade'uacy of insurance co erage! Pro ide the professional %no"ledge of an e&ternal auditor) "hich may help company in a number of "ays!

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29*?T(9>- Peters I Berrel .Estimated time- ,0 minutes/ Peters is ta%ing a ery narro" ie" of the CPA4s role in the American economy! The reser ed) aloof attitude recommended by Peters "as perhaps 8ustified a half-century or more ago "hen the primary ob8ecti e of many audits "as the disco ery of errors) defalcations) and other forms of fraud! (n the current era) the auditors4 role has changed from that of a Ddetecti eD to that of accounting e&perts "hose breadth of e&perience in the audit of many companies enables them to offer clients constructi e ad ice "hich leads to compliance "ith accounting principles) impro ed accounting methods) better financial administration) and more profitable operation! To fulfill this broader role of ad isers as "ell as impartial re ie"ers) the auditors need the cooperation of client personnel at all le els! They need managers and employees to spea% freely of their problems and to e&plain fully "hy certain operating methods are follo"ed! The audit "ill be far more effecti e if client personnel are "illing to identify problem areas! This %ind of t"o-"ay communication bet"een the client and the auditors "ill be possible only if the client ie"s the auditors as approachable) cordial indi iduals "ith a sincere interest in helping the client! The auditors can be independent and ob8ecti e "ithout being cold and impersonal! They should ne er con ey the impression that they regard the client4s employees as potential embe33lers! >either should they ta%e o er office e'uipment or accounting records in a manner that suggests lac% of consideration for the con enience and status of the client4s staff! The de elopment of social relationships "ith the client outside the office) as ad ocated by Berrel) is helpful to the CPA partner as it is to the architect) the physician) the attorney) and members of other professions! The successful CPA "ill usually be an acti e community leader) "ell %no"n in ci ic organi3ations) social clubs) educational circles) and many other related areas! The CPA not only attracts ne" clients but contributes to the ad ancement of the total en ironment in "hich the CPA4s professional talents are employed!

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Chapter 01 - The Role of the Public Accountant in the American Economy

The most difficult issue posed by Peters and Berrel is "hether the de elopment of ery close friendships bet"een the CPA and staff on the one side and the client and staff on the other may cause the CPA to lose independence to some degree! This possibility cannot be easily dismissed! (n assessing relationships "ith the client) the CPA must not only consider the fact of being independent) but also the recognition of independence by the public! The CPA must as% the 'uestion- #ould an outsider ha ing full %no"ledge of the relationships bet"een the CPA and a client ha e doubts about the CPA4s independenceJ This hard-to-define narro" path bet"een cordial CPA-client relations on the one hand and the threat of loss of public confidence in the CPA4s independence on the other demands that the CPA e&ercise care and 8udgment in social relationships "ith clients! Partners) "ho by the ery nature of their responsibilities must meet "ith business e&ecuti es on their o"n ground) tend to de elop social contacts "ith clients! Presumably) partners in a public accounting firm ha e demonstrated the maturity) 8udgment) and breadth of ie" that "ill enable them to maintain a proper balance bet"een friendship "ith clients and professional independence! #hen the element of se& enters the picture) the formulation of precise rules of conduct becomes more difficult) if not impossible! Assume) for e&ample) that a female e&ecuti e and part o"ner of a client company and a male partner of the company4s public accounting firm are %no"n to be constant companions during off business hours! The public "ould probably find it difficult to belie e that the CPA "ould be truly independent in auditing the business in "hich his friend played such an important role! #n$Class Team Case 1-07 29*?T(9>- Types of 2er ices Pro ided by CPAs .Estimated time- 1+ minutes/ The follo"ing are typical replies relating to this ery general 'uestion! The purpose of this team e&ercise is to consider employment options "ithin the profession of accounting! 2tudents "ill typically ha e many concerns relating to this topic and an early discussion may pro ide them "ith helpful bac%ground information! .a/ Ta& ser ices performed by public accounting firms fall into the categories of compliance "or% and ta& planning! Compliance "or% in ol es preparing the federal) state) and local ta& returns of clients! Ta& planning in ol es consulting "ith clients on ho" to structure their business affairs to minimi3e the amount and postpone the payment of ta&es! Ta& "or% "hile "or%ing for a corporation is similar in that it deals "ith compliance and "ith planning! (t differs) ho"e er) in that the "or% "ill be performed for the one company) and not the broad range of clients typical of a public accounting firm! This ob iously has ad antages in terms of de eloping e&pertise related to the company! Ta&ation "or% for the ;eneral Accounting 9ffice "ill relate primarily to studies of general compliance "ith ta& la"s! (nternal Re enue 2er ice deals completely "ith compliance "ith arious federal ta& la"s! Public accounting firms ha e historically emphasi3ed the auditing of financial statements) although e&pansion of the attest function to a number of other areas is currently occurring! Auditing "or% "ith corporations generally in ol es "or%ing in the internal auditing department of that corporation! (n addition to auditing financial information) internal auditing staff members de ote a significant amount of time to operational and compliance audits!

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Chapter 01 - The Role of the Public Accountant in the American Economy

The auditing "or% "ith the ;eneral Accounting 9ffice includes both compliance and operational audits! (nternal Re enue 2er ice auditing "or% is) as indicated) related to compliance "ith arious federal ta& la"s! .c/ Public accounting firms become in ol ed "ith systems design both through audits and through consulting ser ices! (n audits) CPAs must analy3e their clients4 internal control) as "ell as ma%e recommendations for impro ements! <o"e er) public accounting firms that audit public companies may not perform systems consulting for those clients! 2imilarly) internal auditors for corporations) as "ell as information technology specialists become in ol ed in systems design! The ;eneral Accounting 9ffice and the (nternal Re enue do not typically become in ol ed in systems design beyond that needed to perform compliance audits) and in the case of the ;A9) operational audits!

Research an% &iscussion Case 1-0: 29*?T(9>- 2mith I Co! .Estimated time- 00 minutes/ .a/ The follo"ing arguments might be ad anced in fa or of allo"ing public accounting firms to sell o"nership interests to non-accountants through incorporation Access to capital is impro ed and "ill lead to an efficient allocation of resources "ithin the economy! $ecause public accounting firms compete against companies that are allo"ed to obtain capital in such a manner) they should not be constrained to capital a ailable from accountants and loans! The fact that in this case the CPAs o"n +1 percent of the stoc% limits any possible negati e effects on ser ice 'uality "hich might result from non-accountant in ol ement! Brom the perspecti e of the public accounting firm) the possibility of liability that is limited to the amount of corporate assets is appealing! CPAs compete internationally) and it does not ser e this country4s interests to limit their ability to obtain capital!

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Chapter 01 - The Role of the Public Accountant in the American Economy

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The follo"ing arguments might be ad anced in fa or of the restriction of firm o"nership The professional yet personal nature of the ser ice in ol ed may be affected negati ely as shareholders e&ert pressure on CPAs "hich negati ely affects the 'uality of their "or%! Any limits on personal liability may negati ely affect those harmed by negligent performance by the firm! *imiting public accounting firms to sole practitioner) partnership and professional corporation status has ser ed the public "ell o er the years and there appear to be only limited ad antages to allo"ing public o"nership!

.c/

There is no ob ious ans"er to this case! >ote that the situation today is ery much unsettled as fe" states currently allo" traditional incorporation under any circumstances! <o"e er) the traditional ability of CPAs to obtain ade'uate capital leads us to 'uestion "hether the possible ad antages of traditional incorporation are ade'uate to o ercome the fairly significant arguments against it!

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