Chapter 2

what is PCAOB and what do they do?

Public Company Accounting Oversight Board -sets US audit standards for public companies -run by gov

Operational auditing is oriented primarily toward a. Efficiency and future improvements to accomplish the goals of management b. the accuracy of data reflected in management's financial reports c. verification that an entity's financial statements are fairly presented d. past protection provided by existing internal control

a. Efficiency and future improvements to accomplish the goals of management

How does the SEC relate to auditing?

oversees establishment of accounting and auditing standards for public companies in the US

What the auditor's and management's responsibilities?

-management is responsible for financial statements -auditors provide reasonable assurance that the statements are not materially misstated

What is managements responsiblities?

-objectives and strategies -risk management -accounting information systems -internal controls

What is the AICPA?

-American Institute of Certified Public Accountants -sets audit standards for nonpublic companies in the US

What is IASB?

-International Accounting Standards Board -establishes IFRS

What is corporate governance?

-board of directors: oversight of management -audit committee, required to have one person who is a financial expert

What is included in the business process?

-financing -purchasing -human resource management -inventory management -revenue

What are other services that auditors provide?

1. Attest services 2. Assurance services 3. Tax 4. Advisory 5. Compilation: take info. and put it into financial stmts (not certified) 6. Review

what are the four types of auditors?

1. External: audit being performed by the outside 2. Internal: auditors performed by employee, make sure organization is following procedures 3. Government: audit agencies within gov. Forensic: fraud, divorce settlements

What are the types of audits?

1. Financial statement audit (external auditors) 2. Internal control audit (external auditors) 3. Compliance audit (internal auditors) 4. Operational audit (internal auditors) 5. Forensic audit (external auditors)

Which of the following best describes the general character of the three generally accepted auditing standards classified as standards of field work? A. Criteria for audit planning and evidence gathering. B. The competence, independence, and professional care of persons performing the audit. C. The need to maintain an independence of mental attitude in all matters relating to the audit. D. Criteria for the content of the auditor's report on financial statements and related footnote disclosures.

A. Criteria for audit planning and evidence gathering.

Operational auditing is oriented primarily toward... A. Future improvements to accomplish the goals of management. B. The accuracy of data reflected in management's financial records. C. Past protection provided by existing internal control. D. Verification that an entity's financial statements are fairly presented.

A. Future improvements to accomplish the goals of management.

Which of the following best describes the relationship between business objectives, strategies, processes, controls, and transactions? A. To achieve its business processes, a business formulates objectives, which are carried out through the entity's strategies. The entity's information and internal control systems must be designed to ensure that the entity's strategies are properly executed, captured, and processed. B. To achieve its objectives, a business formulates strategies to implement its transactions, which are carried out through business processes. The entity's information and internal control systems must be designed to ensure that the processes are properly executed, captured, and processed. C. To achieve its objectives, a business formulates strategies and implements processes, which are carried out through business transactions. The entity's information and internal control systems must be designed to ensure that the transactions are properly executed, captured, and processed. D. To achieve its strategies, a business formulates objectives and implements processes, which are carried out through the entity's information and internal control systems. Transactions are conducted to ensure that the processes are properly executed, captured, and processed.

A. To achieve its business processes, a business formulates objectives, which are carried out through the entity's strategies. The entity's information and internal control systems must be designed to ensure that the entity's strategies are properly executed, captured, and processed.

What is ASB?

Auditing Standards Board -part of AICPA -principles underlying and audit conducted in accordance with GAAP -statements of auditing standards (SAS)

The Public Company Accounting Oversight Board... A. Is a quasi-governmental organization that has a policy to ignore public comment and input in the process of setting auditing standards. B. Is a quasi-governmental organization that has legal authority to set auditing standards for audits of public companies. C. Is a quasi-governmental organization that has legal authority to set accounting standards for public companies. D. Is a quasi-governmental organization that is independent of the SEC in setting auditing standards.

B. Is a quasi-governmental organization that has legal authority to set auditing standards for audits of public companies.

Which of the following is NOT a part of the role of internal auditors? A. Assisting external auditors. B. Providing reports on the reliability of financial statements to investors and creditors. C. Consulting activities. D. Operational audits.

B. Providing reports on the reliability of financial statements to investors and creditors.

Which of the following is correct regarding the types of audits over which the ASB and the PCAOB, respectively, have standard-setting authority in the United States? A. Public company audits (ASB) Nonpublic company audits (PCAOB) B. Nonpublic co. audits (ASB) Nonpublic co. audits(PCAOB) C. Nonpublic company audits (ASB) Public company audits (PCAOB) D. Public company audits (ASB) NonPublic company audits (PCAOB)

C. Nonpublic company audits Public company audits

Which of the following best places the events of the last decade in proper sequence? A. Increased consulting services to auditees, Sarbanes-Oxley Act, Enron and other scandals, prohibition of most consulting work for auditees, establishment of PCAOB. B. Enron and other scandals, Sarbanes-Oxley Act, increased consulting services to auditees, prohibition of most consulting work for auditees, establishment of PCAOB. C. Sarbanes-Oxley Act, increased consulting services to auditees, Enron and other scandals, prohibition of most consulting work for auditees, establishment of PCAOB. D. Increased consulting services to auditees, Enron and other scandals, Sarbanes-Oxley Act, prohibition of most consulting work for auditees, establishment of PCAOB.

D. Increased consulting services to auditees, Enron and other scandals, Sarbanes-Oxley Act, prohibition of most consulting work for auditees, establishment of PCAOB.

Which of the following statements best describes management's and the external auditor's respective levels of responsibility for a public company's financial statements? A. Management and the external auditor share equal responsibility for the fairness of the entity's financial statements in accordance with GAAP. B. Neither management nor the external auditor has significant responsibility for the fairness of the entity's financial statements in accordance with GAAP. C. Management has the primary responsibility to ensure that the company's financial statements are prepared in accordance with GAAP, and the auditor provides a guarantee that the statements are free of material misstatement. D. Management has the primary responsibility to ensure that the company's financial statements are prepared in accordance with GAAP, and the auditor provides reasonable assurance that the statements are free of material misstatement.

D. Management has the primary responsibility to ensure that the company's financial statements are prepared in accordance with GAAP, and the auditor provides reasonable assurance that the statements are free of material misstatement.

What is FASB?

Financial Accounting Standards Board -establishes US financial accounting standards

What is the IAASB?

International Auditing and Assurance Standards Board -issues international audit standards

Briefly discuss the key events that led up to the Sarbanes-Oxley Act of 2002

· Most of the auditing firms execute various non-audit services to their clients with a very high price. · The members of the audit committees were not fully and truly independent to the client's management system · The consulting fee of some of the largest public accounting firms far exceeded external audit fees. · It allowed auditors to execute various other services such as information system design and implementation, and internal audit services.

List the three categories of GAAS. Discuss why the GAAS and the SAS are considered minimum standards of performance for auditors.

· 1.) General Standards addresses the qualification and minimum standards of work. · 2.) Standards of Fieldwork addresses how work has to be performed. · 3.) Standards of reporting addresses the information required and other consideration before the report is issued. · The standards prescribe the framework within which an audit is to be performed to obtain the required results. o Standards prescribe who can perform an audit and how it should be performed.

List the four categories of Principles Underlying an Audit Conducted in Accordance with GAAS. How do the Principles relate to the 10 GAAS, and how are they different?

· 1.) Purpose of the audit is to provide an opinion on the fairness of the financial statements and the premises that the management is responsible for the preparation of financial statements and implementation of control and other prescribed aspects. · 2.) Responsibility auditors are responsible for having competence, knowledge, and professional skepticism and for the compliance of ethical standards. · 3.) Performance The auditor would provide a reasonable assurance on financial statements. · 4.) Reporting Based on the audit a report containing the opinion would be issued.

Identify three of the documents by the Securities Exchange Act of 1934 that are commonly encountered by auditors. Briefly describe the purpose of each of these documents.

· 10K = provide a detailed analysis to the users regarding the company's operations. · 10Q = provide the current status and the future plans of the company. · 8K = provide details of any specific and significant events that have occurred in the company and that may be required by the investors.

The AICPA performs a number of functions that directly bear on independent auditors of nonpublic entities, including promulgation of rules and standards. List four types of rules or standards issued by the AICPA.

· American Institute of Certified Public Accountants is a private professional association of over 400k CPAs o Functions to produce rules and standards that guide audit and related services provided to nonpublic companies, governments, school districts, etc. · 1.) The Code of professional conduct · 2.) Quality control and peer review standards · 3.) Attestation standards · 4.) Compilation and review standards

Give one example each of compliance, operational, forensic audits.

· Compliance: the extent to which rules, policies, laws, covenants, or government regulations are followed by the entity being audited. o A university may ask auditors to determine whether applicable rules and policies are being followed with respect to the granting of student loans. · Operational: systematic review of part or all of an organization's activities to evaluate whether resources are being used effectively and efficiently. o When an entity employs auditors to assess the efficiency and effectiveness of its use of information technology recourses. · Forensic: detect or deter fraudulent activities. o Business or employee fraud.

Why is independence such an important standard for auditors? How does auditor independence relate to the agency relationship between owners and mangers discussed in Chapter 1?

· Independence enables the auditor to work without any significant conflict of interest. · The agency relationship between owners and managers involves information asymmetry or conflict of interest.

Compare and contrast management's responsibility for the entity's financial statements with the auditor's responsibilities for detecting errors and fraud in the financial statements.

· Management is primarily responsible for the preparation of fair company's financial statements. · The Sarbanes-Oxley Act of 2002 requires that CEOs and CFOs of public companies take explicit responsibility for their company's financial statements by "certifying" that they are responsible for establishing and maintaining internal control, and that the financial statements fairly present the entity's financial conditions and operations. · The auditors are responsible for providing reasonable assurance with respect to errors, fraud, and illegal acts.

What kind of organization is the PCAOB, why was it formed, and what does it do?

· Public Company Accounting Oversight Board is a "nonprofit corporation established by Congress to oversee the audits of public companies in order to protect the interests of investors and further the public interest in the preparation of informative, accurate, and independent audit reports." · Overseen by the SEC. · Formed because the Sarbanes-Oxley Act of 2002. · Conducts a program of regular inspections to assess the degree of compliance of registered public accounting firms. · Can impose sanctions on registered firms to deter possible recurrence of rule violations and to enhance the quality and reliability of future audits.

What role does the SEC play in the establishment of accounting and auditing standards for public companies?

· Securities and Exchange Commission regulates ongoing reporting that are listed and traded on a stock exchange. · Has responsibility and authority to oversee the establishment of accounting and auditing standards.

Briefly discuss each of the components of the high-level model of business presented in the chapter. Why might understanding the characteristics of an entity's business in each of these areas be important for a financial statement auditor?

· The essential components of the high-level model of business offered in the chapter are: corporate governance, objectives, strategies, processes, controls, transactions, and financial statements. o Corporate governance is carried out by management and the board of directors in order to ensure that business objectives are carried out and that company assets are safeguarded. o To achieve its objectives, management must formulate strategies and implement various processes which are in turn carried out through business transactions. o The entity's information and internal control systems must be designed to ensure that these transactions are properly executed, captured, and processed in order to produce accurate financial statements. o It is important that the auditor obtain a firm understanding of these components in order to understand relevant risks and to plan the nature, timing, and extent of the audit so that it is efficient and effective.

What roles do information systems and stems of internal control play in the high-level model of business discussed in the chapter, and why might it be important for an auditor to understand these roles?

· The information system must maintain a record of all businesses transactions. · It should be capable of producing accurate financial reports to summarize the effects of the entity's transactions. · Among other things, internal control is required to ensure that a proper environment is established and that transactions are appropriately conducted and recorded by the information system and company employees. · Effective internal control provides safeguards to ensure the (1) reliability of financial reporting, (2) compliance with laws and regulations, and (3) the effectiveness and efficiency of operations. · Auditing standards require that the auditor obtain an understanding of the client's environment, including its internal control, in planning the nature, timing, and extent of testing.

Discuss how the events that have so dramatically affected auditors and the public accounting profession since the Enron scandal may in some sense be "healthy" for the profession.

· The public accounting profession had been shifted to Government regulation from their self-regulation. · Many of the large accounting firms are forbidden from performing the non-audit services for their clients, which they were privileged to so far. · Most of the audit firms sold their consulting divisions, and focused on their original services alone.