Handout #3 The Auditing Environment & GAAS PDF

Handout #3: The Auditing Environment & GAAS The Auditing Environment: An Overview Stakeholders are parties who are directly involved in, interested in, or influence an organization. – Key Stakeholders include: Shareholders/investors Fina...

Handout #3: The Auditing Environment & GAAS The Auditing Environment: An Overview Stakeholders are parties who are directly involved in, interested in, or influence an organization. – Key Stakeholders include: Shareholders/investors Financial institutions Employees Customers Vendors Market institutions (e.g., analysts and credit rating agencies) Regulatory agencies ACCY 401 Auditing 1 of 10 The Auditing Environment: SOX Sarbanes-Oxley Act of 2002: Timeline Enron problems came to light October 2001 Andersen indicted March 14, 2002; convicted June 15, 2002 WorldCom fraud exposed June 2002 Congress passed July 25, 2002; Pres. Bush signed July 30, 2002 Key Provisions of the Bill Purpose: “To protect investors by improving the accuracy and reliability of corporate disclosures…” Title I: Establishes the Public Company Accounting Oversight Board (PCAOB) Title II: New auditor independence rules Title III: Corporate responsibility Title IV: Enhanced financial disclosures SOX created the Public Company Accounting Oversight Board (PCAOB) Board must propose rules, adopt interim or transitional auditing rules and professional standards within 270 days Adopted ASBs standards for audit and attest engagements, quality control, ethics, and independence on interim basis Rules for Financial Statement Issuers: May not engage their auditor for 9 specific non-audit services o Internal audit o Financial Information Systems o “Expert” services Must make annual internal control effectiveness reports and auditors must attest to these (§404) Hiring and Employment: 1 year cooling off period before hiring former auditor as CEO, CFO, CAO Prohibited from employing suspended or barred auditors May not extend loans to directors or corporate officers Disclosure: Must disclose equity transactions with management and 10% stockholders within 2 days Must disclose whether they have adopted code of ethics for senior officers Must disclose information about “material changes” on real time basis Must disclose off-balance sheet transactions Must disclose existence of “financial expert” on audit committee ACCY 401 Auditing 2 of 10 Rules for Audit Committees: Members must be independent of issuer - this excludes: o family and employees of management o people with significant business relationships with company o some interlocking directors AC is responsible for oversight of auditor o Must pre-approve all audit and non-audit services Must receive regular updates from auditor on: o Accounting treatments o Alternative GAAP treatments and auditor’s preference Accounting disagreements btwn auditor and management Rules for Boards of Directors/Officers: New: CEO and CFO must certify financial reports (§302) CEO/CFO must forfeit bonuses and profits on stock sales if issuer is required to issue a restatement due to misconduct Prohibited from trading during pension “blackout” periods Not new, but now law: Prohibited from fraudulently misleading auditors SEC can bar “unfit” officers and directors ACCY 401 Auditing 3 of 10 Rules for External Auditors: Must: comply with PCAOB auditing and professional standards comply with quality control standards submit to PCAOB quality control inspections Must retain documents for 7 years 5 year felony imposed for failure to maintain “all audit or review work papers” New: Must comply with internal controls testing standards Must attest to management’s representations on internal controls (Sec. 404) Must obtain audit committee pre-approval for services Must be responsible to the audit committee Not new, but now law: Must use a second partner review Must rotate audit partners every 5 years ACCY 401 Auditing 4 of 10 Auditing Standards Standard Setting Organizations Auditing Standards Public Company Accounting Oversight Board (PCAOB) Auditing Standards Board (ASB) Government Accountability Office (GAO) International Auditing and Assurance Standards Board (IAASB) Accounting Standards Financial Accounting Standards Boards (FASB) Securities and Exchange Commission (SEC) International Accounting Standards Board (IASB) ACCY 401 Auditing 5 of 10 Generally Accepted Auditing Standards Organized by four categories of fundamental principles: Purpose of an audit. Responsibilities. Performance. Reporting. ACCY 401 Auditing 6 of 10 Fundamental Principle #1: Purpose of an audit. 1. To provide an opinion about the financial statements. Fundamental Principle #2: Responsibilities. 1. Possess appropriate competence and capabilities. a. The audit is to be performed by a person or persons having adequate technical training and proficiency as an auditor. b. Requires the auditor to have formal education in auditing and accounting, practical experience, and continuing professional education (CPE). 2. Comply with ethical requirements. a. In all matters relating to the assignment, an independence in mental attitude is to be maintained by the auditor or auditors. i. Independence is necessary to maintain the value of an audit. 3. Maintain professional skepticism and exercise professional judgment. a. Due professional care is to be exercised in the planning and performance of the audit and the preparation of the report. i. The auditor is a professional responsible to fulfill his or her duties diligently and carefully --- and avoid negligence and bad faith. b. Professional Skepticism i. Professional Skepticism is an attitude that includes a questioning mind and a critical assessment of the audit evidence. ii. Since evidence is gathered throughout the audit, professional skepticism should be exercised throughout the audit process. ACCY 401 Auditing 7 of 10 Fundamental Principle #3: Performance. 1. Obtain reasonable assurance about whether financial statements are free of material misstatement. a. Reasonable Assurance i. The exercise of due professional care allows the auditor to obtain reasonable assurance that the F/S are free from material misstatement, whether caused by error or fraud. ii. Absolute assurance is not attainable because of the nature of audit evidence and the characteristics of fraud. 2. Plan work and supervise assistants. a. The work is to be adequately planned and assistants, if any, are to be properly supervised. i. Sufficient planning to ensure an adequate audit. Proper supervision of assistants, especially since staff perform most of the detail work. 3. Determine and apply materiality level or levels. a. Consider what matters to a user of the information. 4. Identify and assess risks of material misstatement based on understanding of entity and its environment, including internal controls. a. A sufficient understanding of internal control is to be obtained to plan the audit and to determine the nature, timing, and extent of tests to be performed. ii. Widely accepted concept: the importance of a client’s internal control system in generating reliable financial information. 5. Obtain sufficient appropriate audit evidence. a. Sufficient appropriate evidence is to be obtained through inspection, observation, inquiries, and confirmations to afford a reasonable basis for an opinion regarding the financial statements under audit. b. Decision about quantities and types of evidence to accumulate is based on professional judgment. ACCY 401 Auditing 8 of 10 Fundamental Principle #4: Reporting. 1. Express opinion on financial statements in a written report (see below). 2. Whether financial statements are presented fairly in accordance with financial reporting framework. Old Reporting Standards 1. The report shall state whether the financial statements are presented in accordance with generally accepted accounting principles. 2. The report shall identify those circumstances in which such principles have not been consistently observed in the current period in relation to the preceding period. 3. Informative disclosures in the financial statements are to be regarded as reasonably adequate unless otherwise stated in the report. 4. The report shall either contain an expression of opinion regarding the financial statements, taken as a whole, or an assertion to the effect that an opinion cannot be expressed. When an overall opinion cannot be expressed, the reasons therefore should be stated. In all cases where an auditor’s name is associated with financial statements, the report should contain a clear-cut indication of the character of the auditor’s work, if any, and the degree of responsibility the auditor is taking. ACCY 401 Auditing 9 of 10 Audit Reports: Four Categories of Audit Reports on Financial Statements ACCY 401 Auditing 10 of 10