Solution manual auditing and services 2e by louwers chap002

Chapter 02 - Professional Standards CHAPTER Professional Standards LEARNING OBJECTIVES Review Checkpoints Name the various practice standards for internal, governmental, and independent auditors and accounting firms and identify their sources Explain the 10 AICPA generally accepted auditing standards (GAAS) and explain how GAAS was or was not followed in specific fact situations Describe how the audit examination is affected by auditors’ responsibility for the general standards and standards of field work 2, 3, 4, 5, 6, 7, 8, 9, 10, 11 55 List the standards of reporting and identify how these standards are reflected in the content of the auditors’ report 12, 13, 14, 15, 16 43, 47, 48, 56 Identify the need for attestation standards and explain how attestation standards differ from generally accepted auditing standards 17, 18 49 List and explain the important features of quality control standards for an accounting firm 19, 20, 21 52, 54 2-1 Exercises, Problems, and Simulations 46 40, 41, 42, 44, 45, 50, 51 Chapter 02 - Professional Standards SOLUTIONS FOR REVIEW CHECKPOINTS 2.1 For independent auditors of financial statements, practice standards are issued by the AICPA Auditing Standards Board (in the form of Statements on Auditing Standards) and the Public Company Accounting Oversight Board (in the form of Auditing Standards) Statements on Auditing Standards are appropriate for the audits of nonpublic entities, while Auditing Standards are appropriate for the audits of public entities For governmental auditors, the Government Accountability Office issues Government Auditing Standards (also known as the “Yellow Book”) For internal auditors, the Institute of Internal Auditors issues Statements of Internal Auditing Standards (also known as the “Red Book”) For fraud auditors, the Association of Certified Fraud Examiners issues Professional Standards and Practices for Certified Fraud Examiners For auditors in other countries, the IFAC International Auditing and Assurance Standards Board issues International Standards on Auditing and Assurance 2.2 Auditing procedures relate to acts to be performed during the engagement Auditing standards deal with measures of the quality of performance of those acts and the objectives to be attained Auditing standards are less subject to change and provide the criteria for rejecting, accepting, or modifying auditing procedures in a given circumstance An example of the relative stability of standards and procedures is found in the change from non-computerized information systems to computerized information systems New auditing procedures were required to evaluate computerized information systems, but auditing standards remained unchanged and were the criteria for determining the adequacy of the new auditing procedures 2.3 The standard for due professional care is the care that would be exercised by prudent auditors The prudent auditor is one who exercises reasonable judgment, who is not expected to be omniscient, who is presumed to have knowledge special to his or her profession, who is expected to be aware of his or her own ignorance, and who is expected to possess the skills of the profession whether a beginner or a veteran 2.4 Independence in fact represents auditors’ mental attitudes (do auditors truly act in an unbiased and impartial fashion with respect to the client and fairness of its financial statements?) Independence in appearance relates to financial statement users’ perceptions of auditors’ independence Auditors can be independent in fact but not perceived to be independent For example, ownership of a small interest in a publicly traded client would probably not influence auditors’ behavior with respect to the client However, it is likely that third-party users would not perceive auditors to be independent 2.5 Three elements of planning and supervision considered essential in audit practice are:  A written audit program  An understanding of the client’s (auditee’s) business  Policies to allow an audit team member to document disagreements with accounting or auditing conclusions and disassociate him or herself from the matter 2-2 Chapter 02 - Professional Standards 2.6 The timing of the auditors’ appointment is important because auditors need time to properly plan the audit and perform the necessary work without undue pressure from tight deadlines 2.7 Auditors obtain an understanding of a client, including its internal control, as a part of the control risk assessment process primarily in order to plan the nature, timing and extent of substantive audit procedures A secondary purpose is because of auditors’ responsibilities for reporting on client’s internal controls under Auditing Standard No 2.8 As the client’s internal control is more effective (a lower level of control risk), the necessary effectiveness of auditors’ substantive procedures is reduced (a higher level of detection risk) Conversely, when the client’s internal control is less effective (a higher level of control risk), the necessary effectiveness of auditors’ substantive procedures is increased (a lower level of detection risk) 2.9 Evidence is defined as the information used by auditors on which to base their opinion on the financial statements 2.10 External documentary evidence is audit evidence obtained from another party to an arm’s-length transaction or from outside independent agencies External evidence is received directly by auditors and is not processed through the client’s information processing system External-internal documentary evidence is documentary material that originates outside the bounds of the client’s information processing system but which has been received and processed by the client Internal documentary evidence consists of documentary material that is produced, circulates, and is finally stored within the client’s information processing system Such evidence is either not circulated to outside parties at all or is several steps removed from third-party attention 2.11 In general, evidence that is completely external in nature is most reliable, because the client has not influenced its processing In contrast, evidence that is completely internal in nature is least reliable, as it may represent a fictitious transaction created or modified by client personnel to enhance perceptions of the client’s financial statements 2.12 Financial Accounting Standards Board, Financial Accounting Standards Advisory Board, and Governmental Accounting Standards Board statements are the highest level of authoritative support for GAAP Textbooks, handbooks, and journal articles are the lowest level 2.13 Yes The unqualified opinion sentence in the auditors’ report implies, among other things, that the accounting principles used by the entity are appropriate in the circumstances 2.14 Two messages are usually implicit in the auditors’ standard report: (1) the extent and informativeness of disclosures are adequate, and (2) the accounting principles have been consistently applied By implicit, these matters are only mentioned in the auditors’ report if concerns are noted by auditors 2-3 Chapter 02 - Professional Standards 2.15 Four types of opinions and their messages: Type Unqualified opinion Message Financial statements are presented in conformity with GAAP Adverse opinion Financial statements are not presented in conformity with GAAP Qualified opinion Financial statements are presented in conformity with GAAP, except for one or more departures or issues of concern Disclaimer of opinion An opinion cannot be issued on the financial statements 2.16 Investors, creditors and other users tend to assume that financial statements are audited and “everything is OK” whenever they know a public accountant has been associated with the client’s financial statements If an audit examination has not been performed, accountants need to make the fact known so users will not be mislead (although through no fault of the accountant) If an audit examination has been performed, accountants must report their work and conclusions for users’ benefit 2.17 The purpose served by the attestation standards is to guide attestation work in areas other than audits of financial statements 2.18 The major differences between attestation standards and generally accepted auditing standards (GAAS) lie in the areas of practitioner competence, risk of material misstatement, and reporting Some other differences are minor ones GAAS presume knowledge of accounting and require training and proficiency as auditors (meaning auditors of financial statements) The attestation standards are more general, requiring training and proficiency in the “attest function” and knowledge of the “subject matter of the assertions.” The attestation standards have no requirement regarding an understanding of an entity’s overall environment, including internal control Some types of subject matter that serve as the basis for an attestation engagement may not be affected by the client’s internal control in the same sense as a financial accounting and reporting system Reporting is different because attestations on nonfinancial information not depend upon generally accepted accounting principles The attestation standards speak of “evaluation against reasonable criteria,” and “conformity with established or stated criteria” and provide flexibility for attestation engagements and services on a wide variety of informational assertions 2.19 While GAAS relate to the conduct of individual audit engagements, quality control standards govern the quality of an accounting firm’s accounting and audit practice as a whole Quality Control Standard No identifies five elements of quality control for an accounting firm When a peer review or quality review is conducted, the reviewers evaluate the firm’s statement of policies and procedures designed to ensure compliance with the five elements These statements vary in length and complexity, depending upon the size of the accounting firm 2.20 This is an example of a policy statement related to engagement performance as it relates to consultation for assistance with difficult accounting and auditing problems 2-4 Chapter 02 - Professional Standards 2.21 In addition to the standard setting role previously discussed, one of the primary roles of the Public Company Accounting Oversight Board (PCAOB) is to monitor firms that audit public entities The Board’s goal is to ensure that audit quality is not compromised and that auditors’ performance continues to meet public expectations Soon after it began operations in early 2003, the PCAOB began registering accounting firms providing auditing services to public entities Firms not registered are not allowed to conduct audits of public entities Other PCAOB monitoring activities include conducting inspections of registered accounting firms (similar to peer reviews), special investigations, and disciplinary proceedings SOLUTIONS FOR MULTIPLE-CHOICE QUESTIONS 2.22 a b c d Incorrect Correct Incorrect Incorrect Due professional care is a general standard, not a standard of reporting This standard is a standard of reporting Sufficiency of evidence is a standard of field work While the auditors’ report does reference the use of GAAS in the audit examination, this is not one of the standards of reporting 2.23 a Incorrect b c Incorrect Incorrect d Correct This practice relates to accountants’ competence and training, not due professional care This practice is a standard of reporting Sufficiency of evidence is a standard of field work and is not related to due professional care These practices are a part of due professional care 2.24 a b c d Incorrect Correct Incorrect Incorrect GAAS relates to the conduct of an audit engagement by auditors Quality Control Standards are firm- (rather than auditor-) related GAAP relates to accounting, rather than auditing practices International auditing standards govern the conduct of audits conducted across international borders 2.25 a Incorrect b Incorrect c Incorrect d Correct Auditors may lack training and proficiency in this case, but (d) is a better answer Auditors may lack planning and supervision in this case, but (d) is a better answer Auditors had enough investigative independence to identify the problem Auditors let some feelings for the client override their obligations to the users of the financial statements a b c Correct Incorrect Incorrect d Incorrect 2.26 According to the second standard of field work Consulting suggestions are secondary objectives in an audit Information about the entity’s internal control is, at best, indirect evidence about assertions in the financial statements Information about the entity’s internal control provides auditors with little opportunity to learn about changes in accounting principles 2-5 Chapter 02 - Professional Standards 2.27 a b Incorrect Correct c d Incorrect Incorrect a b Incorrect Incorrect c Incorrect d Correct a b Incorrect Incorrect c Incorrect d Correct 2.30 c Correct Initials of the preparer and reviewer provide evidence of due professional care and planning and supervision 2.31 a b Incorrect Correct c d Incorrect Incorrect Attestation standards require adequate knowledge of the subject matter An understanding of the client’s environment (including internal control) is not required under attestation standards, because internal control may not always be relevant to the subject matter of the attestation Attestation standards require sufficient evidence is required Attestation standards require independence in mental attitude a b c Incorrect Incorrect Correct d Incorrect a b c Incorrect Incorrect Incorrect d Correct 2.28 2.29 2.32 2.33 External evidence is quite reliable Representations from management should least affect auditors’ conclusions, as they have not been validated or corroborated by external parties Auditor-prepared evidence is highest on the scale of appropriateness Although a representation of a client employee, inquiry of the entity’s legal counsel is considered more reliable than that of entity management Inquiry of management should least affect auditors’ conclusions Although very persuasive, auditors’ personal knowledge (choice d) provides the most persuasive evidence Observation of a client’s procedures provides evidence on the effectiveness of the client’s internal control, but not the existence assertion for newly acquired computer equipment Auditors’ personal knowledge provides the most persuasive evidence Inquires of client personnel are the least reliable form of evidence While more reliable than inquiries (choice a), inspection of internal documents is a relatively unreliable form of evidence While sales invoices are documents created by external parties, the fact that these documents were received from client personnel decreases their reliability Because the bank statements were received directly from outside parties, this is a more reliable form of evidence than choice (c) EITF positions are in the third level of authoritative support AICPA industry guides are in the second level of authoritative support FASB statements on standards are in the first level of authoritative support FASB statements on concepts are in the fourth level of authoritative support Internal documents are a relatively low quality of evidence Written representations are the lowest quality of evidence While direct, external evidence is of reasonable quality, it is of lower quality than direct personal knowledge of the auditor (choice d) Direct, personal knowledge of auditors is the most appropriate form of evidence 2-6 Chapter 02 - Professional Standards 2.34 a Incorrect b Incorrect c Incorrect d Correct 2.35 b Correct Given the choices presented, the EITF position is ranked highest on the GAAP hierarchy (see Exhibit 2.3) 2.36 b Correct Government auditing standards are issued by the Government Accountability Office (GAO) Governmental accounting standards are issued by the Governmental Accounting Standards Board 2.37 a Correct b Incorrect c Incorrect d Incorrect Consultation with a specialist demonstrates due professional care if auditors not have expertise in the area in question Auditors are experts in financial matters, not areas of art (and other collectibles) valuation GAAS applies to all audit engagements, including audit engagements for not-for-profit organizations Since (a) is correct, (d) cannot be correct 2.38 2.39 While it may increase auditors’ knowledge about the client, obtaining an understanding of a client’s internal control does not directly influence auditors’ training and proficiency Obtaining an understanding of a client’s internal control does not directly influence auditors’ independence Obtaining an understanding of a client’s internal control does not directly help satisfy the quality control standard about audit staff professional development The primary purpose of obtaining an understanding of a client’s internal control is to plan the nature, timing, and extent of substantive audit procedures on an engagement NOTE TO INSTRUCTOR: Since this question asks students to identify the standard that has not been violated, the response labeled “correct” has not been violated and those labeled “incorrect” have been violated a Incorrect b Correct c Incorrect d Incorrect a Correct b c Incorrect Incorrect d Incorrect Due professional care has not been followed in this case; as a result, this standard has been violated The consistency standard relates to the consistent presentation of financial information, not the consistent presentation of the auditors’ report As a result, this standard has not been violated In this case, disclosures are not adequate; as a result, this standard has been violated Footnotes are considered an integral part of the financial statements Failure to include an important footnote would be considered a departure from generally accepted accounting principles, resulting in a violation of this standard Attestation standards differ from generally accepted auditing standards in that they apply to engagements other than those on the audited financial statements Attestation standards require that the practitioner be independent Attestation standards may apply to prospective “what if” financial statements Attestation standards include standards of field work 2-7 Chapter 02 - Professional Standards SOLUTIONS FOR EXERCISES AND PROBLEMS 2.40 Audit Engagement Independence a Auditors should not follow clients’ suggestions about the conduct of an audit unless the suggestions clearly not conflict with their professional competence, judgment, honesty, independence, or ethical standards Where there is no disagreement about the results to be accomplished and the client’s suggestions represent good ideas, auditors can consider these suggestions Within professional bounds, mutual agreement with the client is acceptable Auditors must never agree to any arrangement that violates generally accepted auditing standards or the AICPA’s Code of Professional Conduct b The reasons that would not support dividing the assignment of audit work solely according to assets, liabilities and income and expenses include the following: Work should be assigned to staff members by considering the degree of difficulty in relation to the technical competence and experience of individual staff members Sequence of work performed on an examination should be in accordance with an overall audit plan It is impossible to segregate work areas by major captions because often a close relationship exists among a number of accounts in more than one category For example, interest and dividend income are normally based on an asset (investments) and interest expense is normally based on a liability (long-term debt) Often a single form of audit documentation is desirable to provide evidence with respect to balances in accounts of various types, such as an insurance analysis supporting premium disbursements, the insurance expense portion, and the prepaid insurance balance Duplication of staff effort would be more likely to occur if assignments were made on such a basis Frequently, the scope of work regarding a single account requires simultaneous participation by the staff, such as in the observation of inventories Many audit operations are not susceptible to division by category, as for example investigating internal control, testing transactions, and preparing the report c The audit staff member whose uncle owns the advertising agency should not be assigned to examine the client’s advertising account The accounting firm is responsible for avoiding relationships which might suggest a conflict of interest Regardless of whether this staff member could be independent and unbiased in such a situation (independence in fact), external parties will likely be influenced in their thinking by the fact that the uncle is the owner of the advertising agency (the staff member would not have independence in appearance) Even if a problem of ethics were not involved, it would be unwise for the accounting firm to assign this staff member because the client’s attitude could change significantly and the firm’s position would be jeopardized if difficulties later arose in connection with the contract Any situation in which bias exists or might arise should be avoided 2-8 Chapter 02 - Professional Standards 2.41 Standards of Field Work The three generally accepted standards of field work and their relation to the illustration are as follows: The first standard of field work is that auditors must adequately plan the work and must properly supervise any assistants Fulfilling this standard would include the preparation of an audit program for accounts receivable and reviewing it with the assistant prior to beginning the examination These things were not done Also, the completed audit documentation should have been reviewed to determine whether an adequate examination was performed The illustration states that this procedure was followed The second standard of field work is that auditors must obtain a sufficient understanding of the entity and its environment, including its internal control, to assess the risk of material misstatement of the financial statements whether due to error or fraud, and to design the nature, timing, and extent of further audit procedures The case presented did not reference any work on the internal control Complete reliance upon prior-year audit documentation in lieu of an evaluation of the existing internal control is improper, because changes may have been implemented to the system and controls by the client The third standard of field work is that auditors must obtain sufficient appropriate audit evidence through audit procedures performed to afford a reasonable basis for an opinion regarding the financial statements under audit The assistant’s preparation of audit documentation, confirmation requests, and other procedures seem to fulfill the requirements of this standard if the audit work is properly performed and is of sufficient scope 2.42 Time of Appointment and Planning 2.43 From a theoretical viewpoint (and, in fact, from a practical viewpoint as well) such short notice of a request for an audit causes difficulties with planning the audit work, with establishing staffing requirements, and with reviewing the work; all of these features are important elements in the exercise of due audit care The December 26 - January 20 period is a serious time constraint for an initial audit engagement The greatest difficulties involve the third general standard (due professional care) and the three standards of field work In view of the short notice and the time constraint, there may be some question as to whether an audit could be completed with due professional care by January 20 Standards of Reporting 2-9 Chapter 02 - Professional Standards You must determine whether an unqualified opinion satisfies the standards of reporting, in particular: a Determine whether the financial statements are presented in conformity with generally accepted accounting principles (GAAP) Read the footnote description of accounting policies Use a GAAP checklist Review the audit documentation for any indication of accounting policies not described in the footnote or ones apparently not in conformity with GAAP Refer to SAS criteria concerning the “meaning of present fairly” (SAS 69) regarding determinations that: (i) The accounting principles are generally acceptable, having authoritative support (ii) The accounting principles are appropriate in the circumstances (iii) The financial statements are informative (iv) The information is reasonably summarized (v) Material adjustments have not been waived without appropriate justification b Determine whether any accounting changes have been made and whether accounting principles have been applied consistently c Determine whether the footnote disclosures are adequate to inform users of any material information evident in the audit documentation The fourth standard of reporting is not referenced above However, the fact that an opinion has been prepared would satisfy this standard 2.44 GAAS in a Computerized Environment The first general standard requires auditors to be properly trained and proficient In an audit of a computerized accounting system, adequate training and proficiency must be directly related to information technology and controls in a computerized environment In particular, auditors should be knowledgeable of what computer systems do, how to test the operations of a computerized accounting system, and how to use documentation unique to a computerized accounting system The second general standard relates to auditor independence The training and proficiency standard contributes to satisfaction of the independence standard by enabling auditors to make their decisions and judgments Otherwise, auditors might be inclined to subordinate their judgments to other persons, possibly to client personnel When auditors lack training and proficiency, it is virtually impossible to maintain an operational independence over audit decisions An independence of mental attitude is futile if actual decisions are subordinated to others The third general standard requires due professional care The exercise of due professional care requires a critical review of the work at every level of supervision and the decisions made by auditors Lacking the requisite skills and lacking independent decisions, the due professional care expected of auditors at operational, supervisor, and review levels cannot be delivered 2-10 Chapter 02 - Professional Standards The first standard of field work requires adequate planning and supervision of assistants Training and proficiency in computerized accounting systems auditing is necessary for planning access to computerized records and programs and conducting appropriate audit procedures The planning should provide for an early examination of the computerized accounting system so that further procedures involving non-computer controls and accounting features may be planned should they depend upon computer control procedures 2.44 GAAS in a Computerized Environment (Continued) The second standard of field work relates to assessing the risk of material misstatement, which includes assessing both inherent risk and control risk Training and proficiency are very important for being able to obtain an understanding of a computerized accounting system’s internal controls Client personnel will expect audit personnel to be capable of working with a computer system The third standard of field work requires auditors to obtain sufficient appropriate audit evidence to provide a basis for an opinion on financial statements Documentary evidence relating to a computerized accounting system includes program flowcharts, logic diagrams, and decision tables that are not normally used in non-computerized systems Since these types of documentation are a part of the evidence, they must be understood by auditors; this understanding comes through training and proficiency in their use 2.45 Authoritative Support SAS 69 (1992), amended by SAS 91 (1999), specifies the hierarchy of sources of authoritative support Refer to Exhibit 2.3 in Chapter 2-11 Chapter 02 - Professional Standards 2.46 Sources of Professional Standards: Description 2.47 Source a Definition of a financial statement audit for a private entity a AICPA Auditing Standards Board b Guidance for reporting on internal control for a public entity b PCAOB c Standards for the practice of internal auditing c Institute of Internal Auditors d Generally accepted government auditing standards d U.S Government Accountability Office e Standards of financial accounting e Financial Accounting Standards Board f Auditing standards for public entities f PCAOB (with AICPA Auditing Standards Board serving as Interim Standards) g Auditing standards for private entities g AICPA Auditing Standards Board h Guidance for lending credibility to nonfinancial information h AICPA Auditing Standards Board (attestation standards) i Auditing standards for foreign entities i IFAC International Auditing and Assurance Standards Board Auditors’ Reports a For scope limitations, the auditors’ report would be modified as follows:  The scope paragraph would be modified to indicate that “except for” the matter of the scope limitation, the audit was conducted in accordance with generally accepted auditing standards (for a qualified opinion) The scope paragraph would be omitted if auditors issued a disclaimer of opinion  An explanatory paragraph would be added to the auditors’ report to describe the nature of the scope limitation, including dollar effects  The opinion paragraph would be modified to either indicate that “except for” the effects of adjustments that might have been identified, the financial statements are prepared according to GAAP (qualified opinion) or to disclaim an opinion (disclaimer of opinion) Auditors can issue either a qualified opinion or a disclaimer of opinion when scope limitations exist (assuming these limitations are material) b For departures from GAAP, the auditors’ report would be modified as follows:  An explanatory paragraph would be added to describe the nature of the departure from GAAP, including dollar effects 2-12 Chapter 02 - Professional Standards  The opinion paragraph would be modified to indicate either that “except for” the effects of the departure from GAAP, the financial statements are prepared according to GAAP (qualified opinion) or that the financial statements are not prepared according to GAAP (adverse opinion) Auditors can issue either a qualified opinion or an adverse opinion when departures from GAAP are noted (assuming these departures have a material effect on the financial statements) 2.48 Association with Financial Statements The consequence of being associated with financial statements is that the fourth standard of reporting is invoked, which requires an indication of the nature of the examination and degree of responsibility auditors are assuming to be clearly indicated in the report a Associated Issue the auditors’ report b Not associated Tax returns are an exception c Associated Issue a disclaimer of opinion (public entity) Issue a compilation report (nonpublic entity) d Not associated CPA is associated with accounting records but not with financial statements e Associated Issue a disclaimer of opinion (public entity) f Associated Issue a disclaimer of opinion (auditors should have requested that the client not print the auditors’ name in this way.) g Not associated Nothing needs to be done so long as client doesn’t mention auditors in the interim statement document 2-13 Chapter 02 - Professional Standards 2.49 Investment Performance Attestation 1, Proficiency in the attest function and knowledge of the subject matter: Accountants must be persons who know and understand investment statistics, operations of mutual funds, and SEC rules regarding expenses Reasonable criteria: Accountants must determine whether standards exist for presentation of investment return statistics and expense ratios, or they must be able to assess the reasonableness of management’s presentation of criteria In addition, accountants must determine whether the statistics can be evaluated against reasonable criteria that are understandable by users of the advertisements Independence: Accountants must determine that they have independence in relation to Mystery Capital Management and its officers and directors 5, 6, 8,10 Due care, planning and supervision, sufficient evidence: Accountants must conduct the field work carefully to obtain the evidence necessary in the circumstances Report: The accountants’ report must identify the performance statistics and expense ratios and relate them to the criteria upon which they are based Reservations: If accountants have any misgivings about misrepresentation of the statistics and ratios management presents, these representations must be stated in the report 11 Limitation on use of report: In some cases, the report may be intended solely for the information and use of specified parties As a result, it may not be appropriate for this report to be presented in the entity’s advertisements 2-14 Chapter 02 - Professional Standards 2.50 Auditing Standards Case Study General Standards The auditor must have adequate technical training and proficiency to perform the audit It was inappropriate for Holmes to hire the two students to conduct the audit The examination must be conducted by persons with proper education and experience in the field of auditing Inexperienced persons can assist, if they are supervised The auditor must maintain independence in mental attitude in all matters relating to the audit To satisfy the second general standard, Holmes must be without bias with respect to the client under audit Because of the financial interest in the bank loan, Holmes is neither independent in fact nor appearance with respect to the assignment undertaken The auditor must exercise due professional care in the performance of the audit and the preparation of the report This standard requires performing the audit with due care, which imposes on everyone a responsibility to observe the standards of field work and reporting Exercise of due care requires critical review at every level of supervision of the work done and the judgments exercised Holmes did not review the work or the judgments of the assistants and clearly failed to adhere to this standard Standards of Field Work The auditor must adequately plan the work and must properly supervise any assistants This standard recognizes that early appointment of auditors has advantages for auditors and the client Holmes accepted the engagement without considering the availability of staff In addition, Holmes failed to supervise the assistants The work performed was not adequately planned The auditor must obtain a sufficient understanding of the entity and its environment, including its internal control, to assess the risk of material misstatement of the financial statements whether due to error or fraud, and to design the nature, timing, and extent of further audit procedures Holmes did not study the client’s internal control nor did the assistants There appears to have been no audit examination at all The work performed was more an accounting service than it was an auditing service The auditor must obtain sufficient appropriate audit evidence through audit procedures performed to afford a reasonable basis for an opinion regarding the financial statements under audit No evidence was acquired to support the financial statements The auditors merely checked the mathematical accuracy of the records and summarized the accounts Standard audit procedures and techniques were not performed 2-15 Chapter 02 - Professional Standards 2.50 Auditing Standards Case Study (Continued) Standards of Reporting The auditor must state in the auditor’s report whether the financial statements are presented in accordance with generally accepted accounting principles The report made no reference to generally accepted accounting principles Because a proper examination was not conducted, the report should state no opinion can be expressed as to the fair presentation of the financial statements in accordance with generally accepted accounting principles The auditor must identify in the auditor’s report those circumstances in which such principles have not been consistently observed in the current in relation to the preceding period The report makes no reference to the consistent application of accounting principles The improper audit would not enable auditors to know whether such implicit reporting was appropriate When the auditor determines that informative disclosures are not reasonably adequate, the auditor must so state in the auditor’s report Without footnotes, the financial statements cannot contain adequate disclosure Holmes’ report should have referenced the lack of appropriate footnote disclosures The auditor must either express an opinion regarding the financial statements taken as a whole, or state that an opinion cannot be expressed, in the auditor’s report When the auditor cannot express an overall opinion, the auditor should state the reasons therefor in the auditor’s report In all cases where an auditor’s name is associated with financial statements, the auditor should clearly indicate the character of the auditor’s work, if any, and the degree of responsibility the auditor is taking, in the auditor’s report Although the report contains an expression of opinion, such an opinion is not based on the results of a proper audit examination Holmes should disclaim an opinion for failure to conduct an examination in accordance with generally accepted auditing standards 2-16 Chapter 02 - Professional Standards 2.51 Generally Accepted Auditing Standards a This situation is related to the second standard of reporting, which addresses the consistent application of accounting principles Because the change in accounting standards is considered to be reasonable and has been properly accounted for and disclosed, this change does not represent a departure from GAAP However, the change in accounting principle should be mentioned in the auditors’ report, based on the second standard of reporting b This situation is related to the first general standard, which addresses the training and proficiency of auditors In this case, auditors can accept this engagement assuming that they take appropriate measures to obtain the knowledge necessary to perform the audit and understand important issues affecting this client It is important to note that the existence of industry-specific accounting issues will require auditors to obtain the knowledge necessary to complete the engagement c This situation is related to the first standard of reporting, which addresses the conformity of the financial statements with GAAP If the client elects to treat these leases as operating leases in violation of GAAP, auditors should issue either a qualified or adverse opinion, depending upon the materiality of the departure from GAAP d This situation is related to the first standard of field work, which indicates that the audit should be properly planned In this case, auditors should evaluate whether the client’s deadline will allow an audit to be properly planned and conducted according to generally accepted auditing standards The fact that this would be an initial audit makes this possibility even more questionable than usual e This situation is related to the third standard of field work, which requires auditors to obtain sufficient appropriate audit evidence Given the low level of control risk, auditors would then proceed to perform the necessary auditing procedures, which provide the basis for their opinion on the client’s financial statements f This situation is related to the second general standard, which requires auditors to be independent In this particular case, the fact that one of the partner’s husband is an officer of the prospective client would likely result in the firm declining this particular engagement because of a lack of independence g 2.51 This situation is related to the fourth standard of reporting, which requires auditors to provide an indication of their work when their name is associated with financial statements Auditors can allow the financial statements to be printed on their letterhead, assuming they prepare a report disclaiming an opinion on the fairness of these financial statements Generally Accepted Auditing Standards (Continued) h This situation is related to both the first standard of reporting (conformity of the financial statements with GAAP) and third standard of reporting (adequacy of disclosures) Auditors should insist upon disclosure of the potential litigation and, if the client refuses, issue either a qualified opinion or adverse opinion, depending upon the materiality of the omission of the disclosures In addition, the auditors’ report should provide information regarding the omitted disclosures 2-17 Chapter 02 - Professional Standards 2.52 i This situation is related to the second standard of field work, which requires auditors to obtain an understanding of their clients and internal controls Once this understanding has been obtained, auditors would then proceed to perform the necessary substantive audit procedures j This situation is related to the third general standard, which addresses due professional care An important element of due professional care is critical review of work performed by persons at various levels within the firm Because the supervisor’s review of the work performed by the assistant indicates that the work supports the opinion on the financial statements, no further actions are necessary Quality Control Standards a b c d e f g h i 2.53 Personnel management (advancement and performance) Engagement performance Engagement performance (consultation) Personnel management (assignments) Personnel management (hiring) Personnel management (professional development) Monitoring Independence, integrity and objectivity Acceptance and continuance of clients Relative Appropriateness of Evidence a Audit evidence obtained from independent sources outside the client provides greater assurance of reliability (competency) than that which is secured solely within the client b Accounting data and financial statements developed under satisfactory conditions of internal control are more reliable (competent) than those which are developed under unsatisfactory conditions of internal control c Direct personal knowledge obtained by the independent auditors through physical examination, observation, computation, and inspection is more persuasive than information obtained indirectly Public Company Accounting Oversight Board Inspection Reports (Internet Exercise) 2.54 a The major information contained in inspection reports include (1) a summary of audit deficiencies identified by the PCAOB’s inspection, (2) a description of the inspection process (Appendix B), and (3) the accounting firm’s response to the draft inspection report While the results of the PCAOB’s inspection of the firm’s quality control systems are not provided in the portion of the report available to the “public” (via the PCAOB’s website), these results will be made public by the PCAOB if the firm does not satisfactorily address deficiencies within one year of the date of the report 2-18 Chapter 02 - Professional Standards b c – f 2.55 The PCAOB’s inspection of firm’s quality control systems include practices, policies, and procedures in the following areas:  Tone at the top  Partner evaluation, compensation, admission, assignment of responsibilities, and disciplinary actions  Independence implications of nonaudit services; business ventures, alliances, and arrangements; personal financial interests; and commissions and contingent fees  Client acceptance and retention  Consultations on accounting, auditing, and SEC matters  The firm’s internal inspection program  Establishing and communicating audit policies, procedures, and methodologies  Supervision by U.S audit teams of the work performed by foreign affiliates on foreign operations of U.S issuer audit clients The answers here will depend up on the report selected by the student It is important to emphasize that event the largest and most sophisticated accounting firms have audit deficiencies One interesting exercise is to randomly assign your students to reports (ensuring that all Big Four firms are covered) and compare the types and magnitude of deficiencies identified In addition, having students evaluate whether the firm’s response is appropriate in the circumstances is an interesting classroom exercise Kaplan CPA Exam Simulation: Generally Accepted Auditing Standards To: Kelly, CPA From: Engagement Partner, CPA Planning Auditors must adequately plan the work and must properly supervise any assistants An audit program must be developed prior to substantive testing to ensure that adequate planning has occurred Also, all evidence is to be recorded within the audit documentation, and then the documentation is reviewed by qualified personnel (i.e., partner in charge of the engagement) to ensure proper supervision Internal Control Auditors must obtain sufficient appropriate audit evidence through audit procedures performed to afford a reasonable basis for an opinion regarding the financial statements under audit Auditors need to make an assessment of control risk If control risk is assessed as high, auditors will need to gather more evidence than anticipated or gather better quality evidence The opposite would be true if control risk is assessed as low 2-19 Chapter 02 - Professional Standards 2.56 Kaplan CPA Exam Simulation: GAAP Hierarchy Authoritative Body Pronouncements AICPA Practice Bulletins (cleared by FASB) FASB Statements and Interpretations Pronouncements of Bodies Composed of Expert Accountants Other Accounting Literature X X AICPA Issues Papers and Technical Practice Aids APB Opinions X X Consensus Positions of the FASB Emerging Issues Task Force AICPA Accounting Research Bulletins FASB Technical Bulletins X X X APB Statements X FASB Concepts Statements X 2-20 ... International Auditing and Assurance Standards Board issues International Standards on Auditing and Assurance 2.2 Auditing procedures relate to acts to be performed during the engagement Auditing standards... Accounting Standards Board f Auditing standards for public entities f PCAOB (with AICPA Auditing Standards Board serving as Interim Standards) g Auditing standards for private entities g AICPA Auditing. .. (in the form of Statements on Auditing Standards) and the Public Company Accounting Oversight Board (in the form of Auditing Standards) Statements on Auditing Standards are appropriate for the