2: Chapter The Public Accounting Profession
Chapter 2
The Public Accounting Profession
Audit Challenge 2-1: Top-Quality Service East and West
1.
They would be looking for members that are current in their field, have good quality
control practices, have a good reputation in their community, and are competent. The prospective
members would likely also need to be qualified PAs and professional accountants.
2.
They could ask about the nature of the quality control practices in place, as well as the
results of peer review from the local professional accounting association. They could also engage
in their own peer review, have members from one firm location assess the work of another
location.
Review Questions
2-1
A small practitioner may work with a broad diversity of small clients, getting to know her
customers well, perhaps doing detailed work such as tax planning. She would also be responsible
for administrative, continuing education, quality control and marketing for the practice. A larger
firm enables having different people doing the different tasks, such as marketing, administration,
human resources, and support for quality assurance. There would also be an opportunity for
working at diverse clients of different sizes.
2-2
The major characteristics of PA firms that permit them to fulfill their social function
competently and independently are:
1.
2.
3.
Organizational form A PA firm exists as a separate entity to avoid an employeremployee relationship with its clients. The PA firm employs a professional staff
of sufficient size to prevent one client from constituting a significant portion of
total income and thereby endangering the firm's independence.
Conduct A PA firm employs a professional staff of sufficient size to provide a
broad range of expertise, continuing education, and promotion of a professional
independent attitude and competence.
Peer review This practice evaluates the performance of PA firms in an attempt to
keep competence high.
2-3
The answer to the first question will vary by province. For example, in Ontario, LLPs are
permitted.
Differences between a partnership and an LLP: In a normal partnership, each partner normally
could be liable to the full extent of his or her personal assets in the event of partnership lawsuits,
and would share in profits based upon the partnership agreement. In a Limited Liability
Partnership (LLP), one or more partners have limited liability (normally limited to the extent of
their capital contribution), while one or more partners is designated as having unlimited liability.
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Instructor's Solutions Manual for Auditing, C11e (Arens/Elder/Beasley/Splettstoesser-Hogeterp)
The LLP could also be structured so that all partners have limited liability, based upon the
legislation where the LLP was established.
A firm would choose to organize as an LLP to protect the assets of its partners.
2-4
The PA firm could have a web site to illustrate the services provided by the firm, to gain
potential clients, and also to gain potential employees or partners. The internet could also be used
as a vehicle for internal communications, as employees can use the internet for email, to send
files back and forth, to hold teleconferences, or to facilitate the firms intranet. The firm could
also use application service providers (ASP) for its own accounting. It could also outsource
client work, for example some firms sent their client tax returns to other countries for processing.
2-5
The CICA Handbook provides guidance in general circumstances to service the largest
numbers of situations and users. Where there is no guidance in the Handbook, accountants rely
on their professional judgment to fairly present the economic reality of the situation. Leaving the
application open to judgment may result in general acceptance of a minimum level of auditing or
accounting practice.
The existence of standards is a means of transmitting wisdom and avoiding unintentional
error due to ignorance.
Standards may be a more efficient and desirable way of creating a body of GAAP or GAAS
than expensive lawsuits and the development of case law.
Compliance with a documented set of standards can provide a better defense against legal
liability.
If the CICA did not develop standards, then other groups or agencies would.
Standards instill confidence in the fairness and reliability of financial statements to users.
On the other hand, market research suggests that too many standards are ineffective in
assisting the operation of the market.
Standard setting is expensive for the profession; the costs may exceed the benefits.
Given the complexity of the economic reality that financial statements attempt to portray, no
set of standards can be theoretically correct or deal appropriately with all situations.
2-6
By setting standards, the CICA provides a framework that can be used for engaging in
public accounting.
The CICA/CGAAC/SMAC conduct research and publish materials on many different subjects
related to accounting, auditing, management advisory services, and taxes. These research
materials enable professional accountants to stay current in their profession, or to take continuing
education on the topics of their choice.
The organizations also prepare and grade the CA, CGA, and CMA accounting examinations,
respectively. This is a high cost service that helps to ensure standardization of knowledge at the
entry level of theses professions.
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Chapter 2: The Public Accounting Profession
2-7
The CICA Handbook codifies as recommendations, generally accepted accounting
principles (GAAP), and generally accepted auditing standards (GAAS). In addition, the
Handbook includes Accounting Guidelines and Assurance and Related Services Guidelines. The
Guidelines are either interpretations of the recommendations, or a statement on a matter of
concern. The Handbook is prepared by the CICA, which serves two main functions: 1) it is the
umbrella organization to which all CAs belong, and 2) it has been given the authority by the
Canada Business Corporations Act and the various provincial incorporating acts to set the
accounting and auditing standards that must be followed by public accountants doing audits of
companies chartered under one of the acts.
2-8
Generally accepted auditing standards are general guidelines to aid auditors in fulfilling
their professional responsibilities. These guidelines include standards concerned with adequate
technical training and proficiency in auditing, due care, and an objective state of mind;
examination standards including planning and supervision, understanding and evaluation of
internal control, and the gathering of sufficient appropriate evidential matter; and standards of
reporting including identification of the responsibilities of management and the responsibilities
of the auditor with respect to the financial statements, the scope of the examination, and an
opinion on the financial statements as to whether the financial statements present fairly the
financial position, results of operations and changes in financial position in accordance with an
appropriately disclosed basis of accounting, usually GAAP.
Generally accepted accounting principles are specific rules for accounting for transactions
occurring in a business enterprise.
Examples may be any of the Accounting Recommendations (GAAP) and Assurance
Recommendations or CASs (GAAS) of the CICA Handbook.
2-9
An objective state of mind helps the PA evaluate evidence without bias. Due care
embodies the concept that a PA does his or her best during the engagement, helping to provide
high quality field work and results.
2-10 The large-scale business failures of Enron and WorldCom affected public confidence in
auditors worldwide. In the U.S., this resulted in the Sarbanes-Oxley legislation in 2002, and in
Canada, in CSA rules that provided for an additional layer of quality control. In Canada, the
Canadian Public Accountability Board is now responsible for conducting peer review of audit
firms that audit public companies.
2-11 SOX (Sarbanes-Oxley) was passed in the U.S. in 2002. At that time, the PCOAB was
created, mandated to develop additional auditing standards for public companies in the U.S. The
requirements of SOX resulted in more stringent rules for boards of directors and audit
committees, and added certification by the CEO (chief executive officer) and other senior
management with respect to the financial statements. Section 404 of that act also implemented
management certification of internal controls for publicly listed corporations, which was to be
audited.
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Instructor's Solutions Manual for Auditing, C11e (Arens/Elder/Beasley/Splettstoesser-Hogeterp)
Canada initially mirrored this legislation by means of regulations passed by the CSA (Canadian
Securities Association). However, using industry and other feedback, Canadas securities
regulators implemented a revised MI (multilateral instrument) numbered 52-109 in 2008, which
has some key differences from the U.S. Two of these differences are that managements
certification over internal controls does not have to be audited, and the second is that there is an
exemption from the internal control certification for venturers small publicly listed companies
that are listed on the venture exchanges (often called penny stocks).
2-12 The CPAB provides quality assurance of the financial statement audit of public
companies, by assessing the work of PAs conducting such audits. Firms must register with the
CPAB and be subject to quality control assessment by the CPAB.
2-13 International Standards on Auditing (ISAs) are developed for broad use around the world,
and are the basis for international GAAS. Member countries from around the world contribute to
the development and assessment of standards. Firms who conduct an audit with local GAAS
(such as Canadian GAAS) may not be in compliance with ISAs, since local standards often
differ.
2-14 Quality controls are established by individual public accounting firms to help ensure that
their firm meets its professional responsibilities to clients. Quality controls are the procedures
used by a public accounting firm that help it meet generally accepted auditing standards
consistently on every engagement. Quality controls are therefore established for the entire public
accounting firm as opposed to individual engagements.
2-15 A practice inspection is a review, by practice inspectors employed by the provincial
institute or ordre, of a public accounting firms compliance with its quality control procedure
system for auditing and accounting engagements and its compliance with the CICA Handbook.
Practice inspection is mandatory in those provinces that have instituted it. The discussion in the
text pertains to CAs in public practice in Ontario or CGAs in public practice in B.C.
Practice inspection can be beneficial to the profession and to individual firms. By helping firms
meet quality control standards, the profession gains if inspections result in practitioners doing
higher quality audits. A firm having a practice inspection can also gain if it improves the firms
practices and thereby enhances its reputation and effectiveness, and reduces the likelihood of
lawsuits. Of course, practice inspections are costly. There is always a trade off between cost and
benefits. A PA firm also gives up some independence of activities when it is reviewed by the
practice inspectors. The consensus is that practice inspection has been successful in increasing
the quality of public practice.
Discussion Problems
2-16
a.
b.
c.
d.
Engagement performance
General human resource policies and Engagement performance
Engagement performance
Engagement performance
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Chapter 2: The Public Accounting Profession
e.
f.
g.
h.
i.
2-17
General ethical requirements and Independence
Engagement quality control review
Client acceptance or continuance
General human resource policies
General human resource policies
a.
PAs provide can the following information and web links on their firm websites:
Office locations or affiliations
Lines of service the firm provides (audit, tax, management consulting,
etc.)
Industry specialization information for the firm
Online software tools and databases
Latest tax law developments applicable to clients
Calculators for retirement account decisions
Online privacy management software
b.
c.
2-18
PA firms invest their resources to develop sophisticated websites largely because
of a desire to maintain a client-service approach. Increased competition motivates
PA firms to improve the traditional paths of providing information to their clients.
A PA firm can reach clients more quickly and efficiently with vital information
via the firms website than through more traditional forms of communication,
such as a monthly or quarterly newsletter. Also, as more clients become
sophisticated in the area of technology, they expect their PA firms to do the same
by providing a useful website that has links to other helpful tools and resources.
The Internet is a useful tool for a PA firms accounting and auditing practice in
many ways. A firms website can be used to market the firms accounting and
auditing practice. The Internet also connects the firms global professional staff,
making it easier for staff from all over the world to provide client service on a
timely basis without having to be physically present at the clients location. PAs
also use online resources and databases to remain current on emerging business
and standards-setting issues. Examples include Standard and Poors Net
Advantage Database and Goldman Sachs Research Database. These two
databases provide extensive industry-specific information and coverage of
companies that PAs use on a subscription basis to stay current on industry
developments and to obtain industry data useful for auditing and consulting.
Note the following supplemental information:
The comments in the problem do summarize the beliefs of some practitioners about quality
control and practice inspection. The arguments against quality control and practice inspection are
stated in the comments and can be summarized as five basic arguments.
(1)
Relative cost for smaller firms is excessively high.
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Instructor's Solutions Manual for Auditing, C11e (Arens/Elder/Beasley/Splettstoesser-Hogeterp)
(2)
Smaller firms have less need for quality control because of greater partner involvement.
(3)
It eliminates the major competitive advantage of smaller firms which is a simple and
efficient organizational structure.
(4)
Quality control standards are not needed because they have already been implemented by
quality firms.
(5)
Three other things already provide assurance of adequate quality: auditing standards,
legal liability, and a competitive economic environment.
To support these comments it can be argued that the profession has functioned well with
relatively little controversy and criticism. A major reason many practitioners choose the
profession is the relative freedom to operate their professional practice as they see fit.
Solution to text problem
a.
The arguments against these comments are primarily as follows:
It will not be costly for most smaller firms to implement quality control requirements because
the quality control standards required are not onerous unless the firm chooses to register with
the CPAB and conduct public company audits
There is no need to eliminate the simple organizational structure now enjoyed by many
smaller public accounting firms.
Certain critics of the public accounting profession have argued strongly against selfregulation of the profession. Many public accountants believe that only through selfregulation will it be possible to minimize government interference. Even if the elements of
quality control enunciated by the text are in existence, the quality control and practice
inspection requirements may be necessary to avoid government interference.
For those firms that already have the necessary elements of quality control in their practice,
the additional implementation costs should be minimal. Those lacking such elements will
incur more cost, but presumably are lacking in certain elements needed for a high quality
practice.
Partner involvement on engagements does not necessarily ensure that all quality control
requirements have been met. For some smaller firms, top partners may spend relatively little
time on audits and therefore not be as knowledgeable about auditing as may be necessary.
b.
There is no correct answer to this question. Different people reach different conclusions,
depending on the weights put on each of the arguments stated in Part a, for and against quality
controls and practice inspection. The authors believe that both quality control and practice
inspection are worth the cost.
The post-Enron (and other accounting problems such as Nortel in Canada) have resulted in an
increased emphasis on quality control and practice inspections.
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Chapter 2: The Public Accounting Profession
Professional Judgment Problem
2-19 a.
Rossi and Montgomerys primary consideration is their professional competence
to perform all of the audit work for filing with the OSC. In addition, if Rossi and Montgomery
have performed bookkeeping services or certain consulting services for Mobile Home, they will
not be independent under the independence requirements.
b.
The filing with the OSC, in addition to normal audited financial statements, will require
completion and registration with the OSC of specific forms by the client and by the auditor. The
auditor needs to have an understanding of the requirements of these documents in addition to the
completion of the audit. Additional documents must be filed by the client and the auditor within
a specific time period after every quarter (usually 45 days) and after the year end (usually 90
days). These documents must adequately disclose the results of financial operations and any
related party transactions.
The audit firm must be registered with the CPAB (Canadian Public Accountability Board), pay
the appropriate fees, and be subject to quality control review from the CPAB.
Case
2-20 Note that this suggested answer uses the format of the standards prior to the
implementation of the CASs. Although the CASs use different terminology, each of these
standards still apply, so this solution can still be used as an answer guide for taking up and
discussing this case.
Brief Description of Generally Accepted
Auditing Standards
General Standard
1. The examination should be performed and
the report prepared by a person or persons
having adequate technical training and
proficiency in auditing, with due care and with
an objective state of mind.
Holmes Action Resulting in Failure to
Comply with Generally Accepted Auditing
Standards
1. 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. Although a junior assistant
has not completed his/her formal education,
he/she may help in the conduct of the
examination as long as there is proper
supervision and review.
2. To satisfy the general standard, Holmes
must be without bias with respect to the client
under audit. Holmes has an obligation for
fairness to the owners, management, and
creditors who may rely on the report. Because
of the financial interest in whether the bank
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Instructor's Solutions Manual for Auditing, C11e (Arens/Elder/Beasley/Splettstoesser-Hogeterp)
loan is granted to Raymonde, Holmes is
independent in neither fact nor appearance with
respect to the assignment undertaken.
3. This standard requires Holmes to perform
the audit with due care which imposes on
Holmes and everyone in Holmes organization
a responsibility to observe the examination and
reporting standards. Exercise of due care
requires critical review at every level of
supervision of the work done and the
judgments exercised by those assisting in the
examination. Holmes did not review the work
or the judgments of the assistants and clearly
failed to adhere to this standard.
Examination Standards
1. The auditor should plan and perform the
audit to reduce audit risk to an acceptably low
level that is consistent with the objective of an
audit. If assistants are employed, they should
be properly supervised.
2. The auditor should obtain an understanding
of the entity and its environment, including
internal control, sufficient to identify and
assess the risks of material misstatement of the
financial statements whether due to fraud or
error, and sufficient to design and perform
further audit procedures.
3. The auditor should obtain sufficient
appropriate audit evidence to be able to draw
reasonable conclusions on which to base the
audit opinion.
Reporting Standards
1. The report should identify the financial
statements and distinguish between the
responsibilities of management and the
responsibilities of the auditor.
2. The report should describe the scope of the
auditors examination.
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1. This standard recognizes that early
appointment of the auditor has advantages for
the auditor and the client. Holmes accepted the
engagement without considering risks or the
availability of competent staff. In addition,
Holmes failed to supervise the assistants. The
work was not adequately planned.
2. Holmes did not obtain an understanding of
the entity, nor of internal control, nor did the
assistants obtain such an understanding. There
appears to have been no audit examination at
all. The work performed was more an
accounting service than it was an auditing
service. Materiality was not evaluated, nor
were risks of fraud considered.
3. Holmes acquired no evidence that would
support the financial statements. Holmes
merely checked the mathematical accuracy of
the records and summarized the accounts.
Standard audit procedures and techniques were
not performed.
1. Cannot tell from the question whether this
standard was observed.
2. The scope of the work was so limited as to
not constitute an audit. The scope paragraph
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Chapter 2: The Public Accounting Profession
3. The report should contain either an
expression of an opinion on the financial
statements or an assertion that an opinion
cannot be expressed. In the latter case, the
reasons therefore should be stated
4. Where an opinion is expressed, it should
indicate whether the financial statements
present fairly, in all material respects, the
financial position, results of operations and
cash flows in accordance with Canadian
generally accepted accounting principles
[except for certain specific exceptions, stated
in the standards].
should have indicated this.
3. Although Holmes report contains an
expression of opinion, such opinion is not
based on the results of a proper audit
examination. Holmes should deny an opinion
because he failed to conduct an examination in
accordance with generally accepted auditing
standards.
4. Holmes report made no reference to
Canadian generally accepted accounting
principles as an appropriate disclosed basis of
accounting. Because Holmes did not conduct a
proper examination, the report should state that
no opinion can be expressed as to the fair
presentation of the financial statements in
accordance with generally accepted accounting
principles.
Ongoing Small Business Case: Planning for CondoCleaners.com
2-21 All businesses need to accurately record the transactions that are processed, so this would
be similar for both the accounting and cleaning business. Similarly, they need to follow local,
provincial and national regulations during their operations. They would also need to file income
tax returns, and be profitable to stay in business.
Internet Research Problem
2-22 The answers to this question will vary, depending upon the organizations that are
compared and the resources used.
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