McGraw-Hill/Irwin

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

Chapter 02
Professional Standards
In todays regulatory environment, its 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
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Statements on Auditing Standards Standards issued by the Auditing Standards Board prior to April 2003 not amended or superseded by PCAOB standards (Interim Standards) All current standards issued by PCAOB

Audits of Nonpublic Entities

All current standards issued by Auditing Standards Board

PCAOB Auditing Standards

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 auditors findings

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Comparison of AICPA GAAS to Principles: Responsibilities

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

Responsibilities Principle 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 1. Planning and supervision
2. Understanding of entity and environment to assess risk of material misstatement 3. Obtain sufficient appropriate evidence

Performance Principle 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

Appropriateness (Quality of Evidence)

Sufficiency (Quantity of Evidence)

Relevance (What Does Evidence Tell the Auditor?)

Reliability (Can the Auditor Trust the Evidence?)

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Sufficient evidence
Related to quantity (number of transactions or components examined) Influenced by effectiveness of entitys 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 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

Reporting Principle 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 entitys 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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