414 ACTG Chapter 2 Lecture Notes (Messier 8e)
Question 1: What types of auditors provide professional services?
Answer 1: Four types of auditors provide professional services. They are:
1.
2.
3.
4.
External auditors [independent auditors or certified public accountants (CPAs)]
Internal auditors
Government auditors
Forensic auditors
Question 2: What types of audit, attest, and assurance services do auditors provide?
Answer 2: Audit services provided by auditors include:
1.
2.
3.
4.
5.
Financial statement audits
Internal control audits
Compliance audits
Operational audits
Forensic audits
Auditors also provide attest and assurance services. Other nonaudit services include:
1.
2.
3.
4.
Tax preparation and planning services
Management advisory services
Compilation (no assurance)
Review services (negative assurance)
Question 3: What is an internal control audit?
Answer 3: The Sarbanes-Oxley Act (2002) requires auditors of public companies to attest to the
effectiveness of the entitys internal control over financial reporting. An audit of internal control
is not required for private entities. For public companies, the audit of internal control and the
audit of the financial statements is called an integrated audit.
Question 4: What is a compliance audit?
Answer 4: A compliance audit determines the extent to which rules, policies, laws, covenants, or
government regulations are followed by the entity being audited. An example of a compliance
audit is the examination of tax returns of individuals and companies by the Internal Revenue
Service for compliance with the tax laws.
Question 5: What is an operational audit?
Answer 5: An operational audit involves a systematic review of part or all of an organizations
activities to evaluate whether resources are being used effectively and efficiently. The purpose of
an operational audit is to assess performance, identify areas for improvement, and develop
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recommendations. Sometimes this type of audit is referred to as a performance audit or
management audit.
Question 6: What is the purpose of a forensic audit?
Answer 6: The purpose of a forensic audit is the detection or deterrence of fraudulent activities.
Some examples where a forensic audit might be conducted include: business or employee fraud;
criminal investigations; shareholder and partnership disputes; business economic losses; and
matrimonial disputes.
Question 7: How are public accounting firms structured and categorized and what types of
services are offered by public accounting firms?
Answer 7: Accounting firms are organized based on the following structures:
(1) proprietorships, (2) general or limited liability partnerships, or (3) corporations.
Accounting firms are categorized by size: (1) Big-4 firms, (2) national firms, (3) regional firms,
and (4) local firms. Public accounting firms offer audit, tax, management advisory services, and
accounting and review services.
Question 8: What parties make up a typical audit team and what are their responsibilities?
Answer 8: A typical audit team is composed of, in order of authority, a partner, a manager, one
or two seniors, and several staff members.
The lead engagement partner has the authority and decision-making responsibility for auditing
matters, including the issuance of the audit report.
The manager ensures that the audit is properly planned, including scheduling of team members.
The senior (or in-charge) auditor assists in the development of the audit plan. In addition, he or
she prepares budgets, assigns audit tasks to associates and directs the day-to-day performance of
the audit, and supervises and reviews the work of associates.
Staff (or associate) members perform audit procedures assigned to them and prepare adequate
and appropriate documentation of completed work.
Question 9: Following the Enron and WorldCom debacles, what government regulation was
enacted to restore public confidence?
Answer 9: Under pressure to restore public confidence, Congress passed the Sarbanes-Oxley
Public Company Accounting Reform and Investor Protection Act (July 2002). Sarbanes-Oxley
effectively transferred authority to set and enforce auditing standards for public company audits
to the PCAOB.
More recently, the international financial crisis of 2007-2009 resulted in the passage of the
Dodd-Frank Wall Street Reform and Consumer Protection Act (2010).
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Question 10: What is the auditors responsibility for errors, fraud, and illegal acts?
Answer 10: Many individuals incorrectly believe that auditors have the responsibility to detect
all errors, fraud, and illegal acts. This is simply not true. The financial statements are the
responsibility of management and the auditors responsibility is to express an opinion that
provides reasonable assurance on the fairness of the financial statements. Due professional care
requires that the auditor exercise professional skepticism, which is an attitude that includes a
questioning mind and a critical assessment of audit evidence. If the auditor fails to exercise due
professional care, he or she can be held liable for civil damages and even criminal penalties.
While auditors must exercise due care in their work, the financial statements ultimately are the
responsibility of management. For public companies, the Sarbanes-Oxley Act requires that CEOs
and CFOs of public companies take explicit responsibility for their company's financial
statements by 'certifying,' among other things, that they are responsible for establishing and
maintaining internal control, and that the financial statements fairly present the entity's financial
conditions and operations. In short, management is primarily responsible for the fairness of the
company's financial statements. Nevertheless, the auditor's responsibility to provide reasonable
assurance with respect to errors, fraud, and illegal acts clearly shapes the auditor's environment
and the work that he or she performs.
Question 11: In what context is a financial statement audit conducted?
Answer 11: A financial statement audit is conducted within the clients business and industry
since that is the environment within which a particular business operates.
Question 12: What is the model of business processes used in auditing?
Answer 12: The model of business processes used in auditing includes five cycles. They are:
1.
2.
3.
4.
5.
Financing process
Purchasing process
Human resources management (Payroll) process
Inventory management process
Revenue process
Question 13: What are management assertions?
Answer 13: Management assertions are the implicit and explicit assertions made by management
about its financial statements. are There three categories of management assertions. They are:
1. Assertions about classes of transaction and events for the period under audit;
2. Assertions about account balances at the period end; and
3. Assertions about presentation and disclosure.
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Question 14: What is the basic role of the Public Company Accounting Oversight Board
(PCAOB or Board)?
Answer 14: The PCAOB is a quasi-governmental regulatory agency overseen by the SEC. The
Board sets auditing standards for audits of public companies (referred to as Big-GAAS). The
basic role of the PCAOB is to oversee the auditors of public companies in order to protect the
interest of investors. The PCAOB conducts inspections of audit firms to assess the degree of
compliance with auditing standards.
As of January 2012, the PCAOB has issued 15 auditing standards. They include:
AS No. 1: References in Auditors Reports to the Standards of the Public Company
Accounting Oversight Board
AS No. 3: Audit Documentation
AS No. 4: Reporting on Whether a Previously Reported Material Weakness
Continues to Exist
AS No. 5: An Audit of Internal Control Over Financial Reporting That Is Integrated
with An Audit of Financial Statements
AS No. 6: Evaluating Consistency of Financial Statements
AS No. 7: Engagement Quality Review
AS No. 8: Audit Risk
AS No. 9: Audit Planning
AS No. 10: Supervision of the Audit Engagement
AS No. 11: Consideration of Materiality in Planning and Performing an Audit
AS No. 12: Identifying and Assessing Risks of Material Misstatement
AS No. 13: The Auditor's Responses to the Risks of Material Misstatement
AS No. 14: Evaluating Audit Results
AS No. 15: Audit Evidence
Note that AS 2 was replaced by AS 5.
Auditing standards for audits of nonpublic companies are set by the AICPA's Auditing Standards Board
(ASB) (Little-GAAS). Until 2003, the ASB was responsible for establishing all auditing standards in the
US. When Congress passed Sarbanes-Oxley, it gave the PCAOB the authority to either set auditing
standards for US public company audits or to delegate that role to another party. The Board choose to
assume the standard-setting role. The Board adopted the ASB's standards that existed as of April 2003.
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Since that time, the ASB has converged its auditing standards with international standards, but many of
these changes have not been reflected in the PCAOB's standards.
Question 15: What are auditing standards? What are the ten generally accepted auditing
standards (GAAS)?
Answer 15: Auditing standards provide a systematic approach for conducting an audit.
Currently, there are two sets of auditing standards those standards for public companies
(PCAOB) and those standards for private companies [Auditing Standards Board (ASB)]. The
standards for audits of private companies are beginning to diverge from those applicable to
audits of public companies. There are ten generally accepted auditing standards (GAAS). The
ASBs Statements on Auditing Standards (SASs) are more detailed interpretations of the ten
GAAS. SASs are classified by two numbering categories SAS (chronological) and AU (topical
content) numbers. The GAAS and SAS are the minimum standards of performance for
auditors. Standards issued by the PCAOB are called Auditing Standards (AS). The ten GAAS
include three general standards, three field standards, and four reporting standards (applicable to
public and private companies). They are:
General standards
1. The auditor must have adequate technical training and proficiency to perform the
audit.
2. The auditor must maintain independence in mental attitude in all matters relating to
the audit.
3. The auditor must exercise due professional care in the performance of the audit and the
preparation of the report.
Fieldwork standards
1. The auditor must adequately plan the work and must properly supervise any assistants.
2. The auditor must obtain a sufficient understanding of the entity and its environment,
including its internal control, to assess the risk of material misstatements of the
financial statements whether due to error or fraud, and to design the nature, timing, and
extent of further audit procedures.
3. The auditor must obtain sufficient appropriate audit evidence by performing audit
procedures to afford a reasonable basis for an opinion regarding the financial statements
under audit.
Reporting standards
1. The auditor must state in the auditors report whether the financial statements are
presented in accordance with generally accepted accounting principles (GAAP).
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2. The auditor must identify in the auditors report those circumstances in which such
principles have not been consistently observed in the current period in relation to the
preceding period.
3. When the auditor determines that informative disclosures are not reasonably
adequate, the auditor must so state in the auditors report.
4. 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 auditors report. When the
auditor cannot express an overall opinion, the auditor should state the reasons therefore
in the auditors report. In all cases where an auditors name is associated with financial
statements, the auditor should clearly indicate the character of the auditors work, if
any, and the degree of responsibility the auditor is taking, in the auditors report .
Question 16: What does the term due care mean?
Answer 16: The term due care is the auditing standard that requires a critical review of the
work done and the judgment exercised by those assisting in an audit at every level of
supervision.
Question 17: What are ethics, professionalism, independence, and the Code of Professional
Conduct (AICPA)?
Answer 17: Ethics refers to a system or code of conduct based on moral duties and obligations
that indicate how we should behave. The term professionalism refers to the conduct, aims, or
qualities that characterize or mark a profession or professional person. The ten GAAS (AICPA
and PCAOB) and the AICPAs Code of Professional Conduct establish guidance for acceptable
behavior for auditors. The Code of Professional Conduct contains principles, rules of conduct,
and interpretations of the rules that clarify the intent of the ten GAAS. The Code of Professional
Conduct applies to all auditors, including those auditing public companies.
Question 18: Because of the risk of material misstatement, what attitude must the auditor always
maintain when conducting an audit?
Answer 18: Because of the risk of material misstatement, an auditor must plan and perform the
engagement with an attitude of professional skepticism.
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