Chapter 01

The Role of the Public Accountant in the American Economy

Note: Certain slides in this presentation were created by McGraw Hill, the publisher of the textbook

McGraw-Hill/Irwin

CHAPTER 1

From Merriam Websters Dictionary

Definitions Definition of AUDIT 1 a : a formal examination of an organization's or individual's accounts or financial situation b : the final report of an audit 2 : a methodical examination and review
Would you accept a financial statement from management?
Note: Certain slides in this presentation were created by McGraw Hill, the publisher of the textbook.

APPLE, INC. Financial Statements pdf page 44 Auditors Report pdf page76

Audit of financial statementsAn examination designed to provide an opinion; the highest level of assurance that the financial statements follow generally accepted accounting principles or another acceptable basis of accounting.

Attest engagement (1)

<b>Def</b>: An engagement in which the CPAs issue an examination, a review, or an agreed-upon procedures report on subject matter or an assertion about subject matter that is the responsibility of another party (e.g., management).

Assurance Assurance services (1) <b>Def</b>: Professional services that enhance the quality of information, or its context, for decision makers. Many assurance services involve some form of attestation.

attest verb \-test\ Definition of ATTEST transitive verb 1 a : to affirm to be true or genuine; specifically : to authenticate by signing as a witness b : to authenticate officially

Independence Independence includes two categoriesindependence of mind and independence of appearance Term: Independence in appearance (73) Def: The avoidance of circumstances that would cause a reasonable and informed third party, having knowledge of all relevant information, including safeguards applied, to reasonably conclude that the integrity, objectivity, or professional skepticism of a firm or a member of the attest engagement team has been compromised.

Term: Independence of mind (73)

Def: The state of mind that permits the performance of an attest service without being affected by influences that compromise professional judgment, thereby allowing an individual to act with integrity and exercise objectivity and professional skepticism .

Internal Control The Committee of Sponsoring Organizations (COSO) commissioned a study to:

Establish a common definition of internal control to serve the needs of different parties. Provide a standard against which businesses and other entities can assess their control systems and determine how to improve them. The study, titled Internal ControlIntegrated Framework,2 defines internal control as [emphasis added]:
A process, effected by the entity's board of directors, management, and other personnel, designed to provide reasonable assurance regarding the achievement of objectives in the following categories: Reliability of financial reporting. Effectiveness and efficiency of operations. Compliance with applicable laws and regulations.

Material Per page 44 of text -Sufficiently important to influence decisions Made by reasonable users of financial statements.

Types of Professional Services

Attestation and Assurance (Includes auditing) Tax (compliance and tax planning) Consulting Accounting (and Review Services) Personal Financial Planning Litigation support Fraud Investigation
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Assurance services
The broad range of information enhancement services that are provided by certified public accountants (CPAs). Two types:
Increase reliability of information Putting information into a form or context that facilitates decision making.

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Which of the following has primary responsibility for the fairness of the representations made in financial statements?

(1) (2) (3) (4)

Client's management. Independent auditor. Audit committee. AICPA.

Types of Services
Assurance Services
Attestation Services
Example: Audits of Financial Statements, Examinations of Internal Control

Other Assurance Services

Example: CPA ElderCare Prime Plus Services

NonAssurance Services
Tax Services Management Consulting Services Other
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Attestation Services
To attest to information means to provide assurance as to its reliability Attest engagement:
A practitioner is engaged to issue or does issue an examination, a review, or an agreed-upon procedures report on subject matter or an assertion about subject matter that is the responsibility of another party (e.g. management)

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The Attest Function

Management Subject Matter Suitable Criteria

The CPA Gathers Evidence Issues Report Subject Matter* The Attest Report

*May be managements assertion about the subject matter.

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Suitable criteria
Standards established or developed by groups of experts. Example: Internal control audit standards established by a committee of experts on internal control Example: Financial statement audit standards are GAAP. For a financial statement audit suitable criteria are referred to as the applicable financial reporting framework.
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Forms of Attestation

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What are the required statements ?

Who might be the users ?

Audit of Financial Statements

Management Prepares Financial Statements Criteria (e.g., GAAP) The Auditors Gathers Evidence Issues Report Financial Statements The Auditors Report

*Applicable financial reporting framework

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Financial Statement Audit

Auditors gather evidence and provide a high level of assurance that the financial statements follow GAAP, or some other appropriate basis of accounting Audit involves searching and verifying accounting records and examining other documents Evidence necessary to issue an audit report that states auditors opinion

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Audit Evidence
Evidence focuses on whether financial statements are presented in accordance with GAAP; examples:
Balance sheet
Do assets really exist Are the assets valued correctly Are the liabilities complete? Are assets and liabilities properly classified

Income statement
Sales really occurred Sales have been recorded at appropriate amounts Recorded costs and expenses are applicable to period All expenses have been recognized

Financial statement amounts

Accurate, properly classified and summarized Notes are informative and complete

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What Creates the Demand for Audits?

Audits lend credibility to information by reducing information risk, the risk that information is materially misstated
assists userse.g. lenders, investors

Financial statement misstatements arise due to- Accidental errors Lack of knowledge of accounting principles Unintentional bias Deliberate falsification

Audits do not directly address business risk, the risk that a company will not be able to meet its financial obligations due to economic conditions or poor management decisions

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The most important benefit of having an annual audit by a public accounting firm is to: Provide assurance to investors and other outsiders that the financial statements are reliable. Enable officers and directors to avoid personal responsibility for any misstatements in the financial statements. Meet the requirements of government agencies.

Provide assurance that illegal acts, if any exist, will be brought to light

From Chapter 6

Corporate governance
Board of directors oversee corporations activities Public companies must establish audit committees of their boards of directors

Audit committees are charges with areas such as oversight of financial reporting, regulatory compliance, and risk management.
Note: instructor serves on audit committee of a not for profit entity.

Do not have to know

Period Ancient - 1850 1850-1905

History of the Attest Function

Developments Audits of city states, individuals & ventures Industrial revolution resulted in the need for corporate audits Development of stock markets - increased emphasis on earnings Development of auditing standards Criticism by Congress; Increased self-regulation Increased demands for reporting on compliance & internal control Panel on Audit Effectiveness; SarbanesOxley Act of 2002 Audit Objective Detection of fraud Detection of fraud & clerical errors Determination of fairness; detection of fraud & errors Determination of fairness Determination of fairness Determination of fairness Determination of fairness Nature of Audit Detailed; No reliance on controls Some testing; No reliance on controls Increased emphasis on testing; Slight reliance on controls Substantial reliance on controls Internal control determines scope of audit Risk assessment determines audit scope; must assess risk of fraud Business risk approach to audits 2002---audit procedures must address risk of fraud
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1905-1940

1940-1975 1975-1985

1985-1995

1995-Present

Do not have to know

The Accounting Professions Credibility Crisis

2000The Panel on Audit Effectiveness made a variety of suggestions to improve audits (including documentation of audit
2001Enron Bankruptcy 2002WorldCom Fraud 2002Sarbanes-Oxley Act (top management must individually certify 2003Public Company Accounting Oversight Board began operations 2008Dodd Frank act more regulations for broker dealers

evidence and judgments, risk assessments, and the linkage of audit procedures to audit risks)

the accuracy of financial information. In addition, penalties for fraudulent financial activity became more severe. Also, SOX increased the independence of the outside auditors who review the accuracy of corporate financial statements, and increased the oversight role of boards of directors.)

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Financial Audits
Audit of the financial statements of an entity
Covers the balance sheet and related statements of income, retained earnings and cash flows Goal is to determine if prepared in conformity with GAAP Performed by CPAs Users include management, investors, bankers, creditors, financial analysts, government agencies

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Other Types of Audits

Compliance Audits

Operational Audits

Examples: IRS audit of income tax return Not for Profit entities which receive federal fundsOMB Circular A-133 Example: Effectiveness of operations of receiving department of a manufacturing company Example: Assurance on both the financial statements and effectiveness of internal control over financial reporting
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Integrated Audits

Other Types of Auditors

Internal Auditorslarge part of work consists of operational audits Government Accountability Office Auditors includes audits of government agencies Tax Auditors

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Internal Auditors
Employed by a company as an employee They often
perform operational and compliance audits address internal control report to the audit committee of the board of directors and to the president

The Institute of Internal Auditors is the international organization of internal auditors.

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DNB

Government Accountability Office Auditors (GAO Auditors)

Headed by the comptroller general Responsibility of supporting Congress Perform

Compliance, operational and financial audits of government agencies Examinations of corporations holding government contracts to verify contract payments have been proper

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Tax Auditors
Responsible for enforcement of tax laws of various sorts (e.g., state and federal income taxes, property taxes, sales taxes) Internal revenue agents generally perform compliance audits of income tax returns

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AICPAs Traditional Role

Establish Standards Research and Publication Continuing Professional Education Self-Regulation

Note: Much of the standards setting and regulation roles relating to public companies (referred to as issuers) has been taken over by the SEC and the PCAOB.

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Establishes Standards--Examples AICPA Auditing Standards Board

Issues official pronouncements on auditing matters for nonpublic companies (nonissuers) Statements on Auditing Standards (SASs) Statements on Standards for Attestation Engagements (SSAEs) Guidance for attesting to information other than financial statements such as financial forecasts

Accounting and Review Services Committee

Statements on Standards for Accounting and Review Services (SSARS) Standards for compilations or reviews not audits of financial statements

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Research and Publication

Publications Journal of Accountancy (monthly) The Tax Advisor Audit publications Industry Audit and Accounting Guides Audit Risk Alerts Auditing Practice Releases Other publications Accounting Research Studies Statements of Position Accounting Trends & Techniques
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Continuing Professional Education

Development of continuing professional education programs Necessary for continuing education requirement for CPA certificate Offered by
AICPA State societies Other professional organizations

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Professional Regulation
Regulations of Individual CPAs
Code of Professional Conduct ethical rules for CPAs Requirements for regular membership in AICPA

Regulation of Public Accounting Firms

Division for Public Accounting Firms
Center for Public Company Audit Firms Private Companies Practice Section (PCPS)

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The CPA Examination

Uniform national examination prepared and graded by the AICPA Computerized exam includes multiple choice and simulations in four parts
Auditing and Attestation Financial Accounting & Reporting Regulation Business Environment & Concepts

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State Boards of Accountancy

Issue CPA certificates All boards require successful completion of CPA examination Education and experience requirements vary National Association of State Boards of Accounting (NASBA)

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Other Parties
FASB
Sets GAAP for entities other than federal, state and local governments

GASB
Standards of financial accounting for state and local government entities

FASAB
Accounting standards for the US government

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PCAOB Role
Adopt auditing, attestation, quality control, ethics and independence standards relating to the preparation of audit reports for SEC registrants Oversee and discipline CPAs and CPA firms that audit public companies, including
Register firms Perform inspections of firms Conduct investigations and disciplinary proceedings of firms Sanction registered firms

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Securities and Exchange Commission (SEC)

Agency of the US government Oversight responsibility for the PCAOB Objectives
Protect investors and public by requiring full disclosure of financial information by companies offering securities for sale to the public Prevent misrepresentation, deceit, or other fraud in the sale of securities

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Securities and Exchange Commission (SEC )

Registration statements
Qualify securities for sales Contains audited financial statements Makes SEC major user of financial statements

Protects investors Regulation S-X

Basic accounting regulation
Comment letters

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Do not have to know

Organization of the Public Accounting Profession

Sole proprietorship Partnerships Professional Corporation Limited Liability Partnership (LLP) Limited Liability Company (LLC)

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Categories of Public Accounting Firms

Local Regional National Big 4 Alternative Practice Structures

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Industry Specialization
Firms with detailed knowledge and understanding of a clients industry Helps firms
Be more effective at collecting and evaluating audit evidence Make valuable suggestions to improve clients operations Provide the client consulting services

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Typical Structure of a National CPA Firm

Partners Managers Seniors

Staff Assistant

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Responsibilities on an Engagement
PartnerOverall responsibility is to assure that that audit is performed in accordance with professional standards. ManagerSupervise overall engagement. SeniorsIn charge auditor on a daily basis. Staff assistantsWork under the immediate supervision of the senior.

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Elements of Public Accounting Work

Professional Developments
Stay current on developments within the profession

Seasonal fluctuations
Busy season from December through April

Relationships with clients

Need to maintain independence

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