Advanced Auditing Chapter 3, Section E, Module A MC, Section B, Section D, Module A Other Public Accounting Services, Chapter 2: Professional Standards, Section C, MOdule C - Legal Liability, Module B - Professional Ethics, Advanced Auditing Ch 1
Types of Audit Opinions
- Unmodified (unqualified): F/S are fairly stated in conformity with GAAP -Qualified: Except for limited items, F/S are in conformity with GAAP -Adverse: F/S are NOT in conformity with GAAP -Disclaimer: -Auditors DO NOT express an opinion
forseen users
Cases Rusch Factrors v Levin 3rd Party Definition Reasonably limited and identifiable group of users who have relied on the auditor's work Example Bank or Trade creditors when the auditor is aware that the client is providing F/S to such users
Primary beneficiary / known user
Cases Ultramares Corp vs Touche Credit Allaince v Arthur Andersen 3rd Party Definition Auditor knows that a specific user will use the audit report Example Auditor is aware of bank loan agreement that required audited financial statements.
Sources of Auditor Liability
Common Law Uses legal precedent to identify responsibility -Clients -Non-shareholder third parties Statutory Law Based on Violations of written statutes -Shareholders
the International Standards on Auditing are issued by what board?
IAASB
International Auditing standards are referred to as what?
ISA's
Special-purpose frameworks
a coherent accounting framework in which substantially all important financial meaurements are governed by criteria other than GAAP or IFRS
Prospective financial information
financial information representing the financial position, results of operations, and cash flows for some period of time in the future
auditors defense to securities exchange act
good faith Didn't know about the scheme to defraud or material misstatements
GAAS
guidelines used in place for conducting an audit to make sure the financial statements comply with GAAP
auditors civil liability under securities act
have liability because auditors are "experts" and must perform a "reasonable investigation (burden of proof on auditors)
what does the opinion state?
if financial statements are presented fairly via applicable financial reporting framework
Accountants must be ___________ in order to perform review services
independent
assurance services
independent professional services that improve the quality of information, or its context, for decision makers
priviledged communication
information held confidential within a protected relationship Limitations -Required by Professional standards -Subpoena or Summons -Ethics division of AICPA inquiry -Peer Review Additional Limitations Intent a the time of the communication was for the information to remain confidential -state granted privilege does NOT extend to the Federal court
Scienter
intent to deceive
fraud
intentional misstatements
fraud financial report
intentional misstatements that entail cooking the books (making financial statements look better than they really are), like fictitious sales
Burden of proof for securities exchange act
investors must show: Economic loss F/S contained a material misstatement Loss caused by reliance on F/S Auditors were aware that the F/S contained a material misstatement (has been interpreted as gross negligence)
Comfort Letter
is prepared for underwriters in conjunction with a public registration of securities. A comfort letter is a document prepared by an accounting firm assuring the financial soundness or back of a company.
primary beneficiiares
known by name to auditor
Primary Beneficiary
known by name to the auditor
defenses of auditors to third parties
lack of appropriate relationship to auditor to bring suit third party did to rely on FS but something else (causation defense) audit conducted per GAAS
unmodified opinion
lack of consistency in applying accounting principles
gross negligence
lack of even slight care, indicative of a reckless disregard for one's professional responsibilities
gross negligence
lack of minimal care
ordinary negligence
lack of reasonable care
common law liability to third parties
liable to all parties for tort liability, gross negligence and fraud
ultramares
liable to third party for gross negligence and fraud
Both financial projections and financial forecast can be presented for __________ use but only financial forecasts can be used for __________ use
limited (single user), general (large number of users)
presentation and disclosure
management assertion that all transactions and events have been presented correctly and that all relevant information has been disclosed to financial statement users, usually in the footnotes to the financial statements
fraud
misery of fact an individual knows to be false
auditors criminal liability under securities act
must have "willfully" violated --> fraud or gross negligence (selling unregistered securities)
can auditors obtain absolute assurance that the financial statements are free from material misstatements?
no
what does the AICPA do?
no legislative body created for establishing standards
AICPA
nonpublic company in the United States that issues Statements on Auditing Standards
comfort letters
not required by securities act, but by underwriters (investment banks) Assurance provided by auditors regarding: audited & unaudited FS and items that have changes since audited FS
tort liability
obligation based on failure to exercise appropriate level of professional care
Representation Letter
obtained by the auditor from management to confirm oral responses given by management to specific inquiries -Such letters reduce the possibility of misunderstandings concerning the matters that are the subject of the representations. -End of Fieldwork - Required
in the auditor report of a non-public company, where is the opinion stated?
on the bottom of the report
in the auditor report of a public company, where is the opinion stated?
on the top of the report
liability for auditor under 1933 act
ordinary, gross, negligence + fraud
foreseen third parties
parties who could be reasonably expected to rely on auditors work
Foreseen users
parties who could reasonably expected to rely on the auditors work
foreseeable third parties
parties whose decision normally rely on audits FS and opinion on FS
PCAOB inspections entail what?
performance audits of greater than 100 public companies inspected annually
analytical procedures
procedures that allow auditors to evaluate financial information by studying relationships among both financial and non-financial data. When used near the end of the audit, analytical procedures allow auditors to assess the conclusions reached during the audit and evaluate the overall financial statement presenatation
the opinion conditions with the PCAOB is included in the report for what company?
public
PCAOB
public company in the United States issuing other auditing standards
what words are included in the audit report title of a public company?
registered and independent
State Boards of Accountancy
regulates CPA firms and who can hold the license
Securities exchange act of 1934
regulates subsequent trading of securities established SEC Requires periodic reporting (10k 10q and 8K)] Governs national securities exchanges and brokers rtrading Regulates proxy solicitations--guarding investors' right to an informed vote Regulates takeovers--tender offers have to be registered Empowers the Fed's Board of Governors to regulate margins in trading
plaintiff do NOT need to show in securities act of 1933
reliance on FS FS caused the loss Auditor negligence
Detection Risk
risk that auditors and their audit procedures will fail to detect a material error or misstatement
Examination
similar to an audit but limited in terms of the focus of the engagement. Renders opinions that represent a high level of assurance
what are the auditing standards applied to audits of nonpublic companies?
standards established by AICPA
who can revoke the right to practice as a CPA?
state boards of accountancy
SAS
statements issued via the AICPA
Strict Liability
strictly liable without regard to intent, knowledge or falsity
materiality
sufficiently important to influence decisions made by reasonable users of financial statements
what does the AICPA auditing standards hierarchy imply?
that standards must be applied via SAS application recommendations for public interpretation
Form 8-K
the "current events" report filed periodically at the occurrence of major events, such as earnings releases, major asset sales, acquisitions, and auditor changes
continuing audit files (or permanent files)
the audit documentation containing information of continuing audit significance for current and past audits of the same client
audit trail
the chain of evidence provided through coding, cross-references, and documentation connecting account balances and other summary results with the original transaction source documents
Deep Pockets Theory
the concept that lawsuits may be brought against auditors not because they are necessarily at fault but because they are the only party with resources against which recovery can be made.
Expectation Gap
the difference between the actual work and assurance required by GAAS and the expectation of that work by the general public
termination letters
the documentation provided to former clients dealing with the subject of future services, in particular (1) access to audit documentation by new auditors (2) resissuance of the auditors' report when required for SEC reporting or comparative financial reporting, and (3) fee arrangements for such future services. The termination (e.g., disagreements about accounting principles and audit procedures, fees, or other conflicts)
independence in appearance
the extent to which others (particularly financial statement users) perceive auditors to be independent
Interim Financial reporting
the financial informatin or statements covering a period less than a full year or for 12 month period ending on a date other that he entity's fiscal year end
assurance
the lending of credibility to information
responsible party
the person or persons, either as individuals or representatives of the entity, responsible for the subject matter of an attestation engagement
audit engagement partner
the person with the final responsibility for the audit, and usually an industry specialist
the discussion scenario entails what?
the person working in the company is responsible for preparing their own audits, or else, a conflict of interest exists in the company
specialist
the persons skilled in fields other than accounting and auditing- actuaries, appraisers, attorneys, engineers, and geologists- who are not members of the public accounting firm
information risk
the probability that the information circulated by an entity will be false or misleading
interim audit work
the procedures performed several weeks or months before the balance sheet due date
substantial equivalency
the process through which CPAs licensed in one state can practice in another state
Financial Projections
the prospective financial information reflecting a transaction or event that my (hypothetically) occur in the future
attestation engagement
the provision of an opinion on subject matter or an assertion about the subject matter that is the responsibility of another party
auditing
the systematic process of objectively obtaining and evaluating evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between the assertions and established criteria and communicating the results to interested users
audit documentation
the written basis for the auditor's conclusions that provides the necessary support for the auditor's assertions and representations made in the auditor's report
misappropriation of assets
theft of assets via misstating financial statements, like company credit card used for personal use
financial statements
they prepare GAAP via accounting standards
engagement letter
this letter sets for the understanding with the client, including in particular (1) the objectives of the engagement (2) management's responsibilities (3) the auditors' responsibilities, and (4) any limitations of the engagement
business risks
those factors, events, and conditions that could prevent the organization from achieving its business objectives
a higher level of responsibility for detecting illegal acts is found where?
through materials that have a direct effect on the financial statements
how do auditors detect misstatements?
through obtaining reasonable assurance
What is the purpose of an audit?
to provide financial statement users on auditors if the financial statements are presented fairly, via IMMATERIAL RESPECTS
SOC 3
trust services report. used in marketing organizations' control effectiveness.
errors
unintentional misstatements
common law
uses legal precedent to identify power and responsibility (clients and non shareholder third parties)
SEC pronouncements
various pronouncements affected via CPA's
liability under statutory law
violations specie laws or statutes (Securities act)
auditing standards
when a public auditor gathers evidence
unconditional responsibility
when an auditor must comply with responsibilities were requirements are relevant, like "must"
Presumptively Mandatory Responsibility
when an auditor must comply with responsibilities where it is relevant, except in rare circumstances when exceptions are included, like "should"
responsibility to consider
when an auditor must consider whether ore not to do it, like may
International Auditing Standards
when different authorities are leveraged through countries
private company
when ownership is closely held. E.g. QT, Staples
public company (or SEC issuers)
when ownership is widely held. E.g. Apple
Agreed-Upon Procedures
The methods used in an engagement in which users participate in determining the scope of procedures performed by the accountants. The level of assurance provided varies depending on the procedures requested
Financial forecast
The prospective financial information reflecting an entity's estimates of what is likely to occur in a future period.
predecessor auditor
The public accounting firm that has been terminated or has voluntarily withdrawn from an audit engagement (whether the audit has been completed or not)
quality assurance partner
The second audit partner on the audit team as required for audits of financial statements filed with the SEC who reviews the audit team's work in critical audit areas (those areas with the highest potential audit risk)
Adverse interest threat
This threat to an auditor's independence arises when CPAs act in opposition to clients (i.e. litigation).
Financial self-interest threat
This threat to an auditor's independence arises when CPAs have a financial relationship with a client.
Advocacy threat
This threat to an auditor's independence arises when CPAs promote a client's interest or Position.
Self-review threat
This threat to an auditor's independence arises when CPAs review their own work.
Management Participation Threat
This threat to an auditor's independence arises when CPAs take the role of client management or provide management functions.
Undue influence threat.
This threat to an auditor's independence arises when attempts to coerce or influence the CPA member (i.e. significant gifts or threats to replace an auditor)
Familiarity threat
This threat to an auditor's independence arises when the CPAs have a close or longstanding relationship with a client.
Independence in appearance
This type of independence depends on whether a reasonable investor, with knowledge of all relevant facts and circumstances can conclude that the auditor is not capable of exercising objective and impartial judgment.
Independence In fact
This type of independence is a mental state of objectivity and lack of bias.
Decision Problems, Moral Principles & Consequences
The 3 key elements for ethics
Interpretations
The AICPA Code of Professional Conducts interpretations of the rules.
Rules of Conduct
The AICPA Code of Professional Conducts's minimum standards of ethical conduct stated as specific rules.
Principles
The AICPAs code of Professional Conducts's ideal standards of ethical conduct.
who's auditor liable to?
client, shareholders, non related third parties
Prudent person concept
Auditor is expected to conduct the audit with due care and it is not expected to be perfect
True. under specific circumstance.
(T/F) An Auditor can take loans from a financial institution.
False. Only when non-attest, if disclosed.
(T/F) CPAs are allowed to receive commission fees for recommending the products or services for clients of third parties when conducting an attestation engagement?
True. (Independence rule 1.200)
(T/F) Financial interest in a non-client may impair independence when the non-client has a financial interest in the client.
False.
(T/F) Lawsuits from 3rd parties impair independence?
Liability Under the 1933 Act
- Auditors responsible for material misrepresentations or omissions - Defenses * Due diligence (auditors performed a GAAS audit) * Causation (loss resulted from other factors)
"Fair Share" Proportionate Liability
Allocates damages across liable parties when plaintiffs cannot collect full amount Three questions 1)Violated securities laws? 2)For how much is the party responsible? -Could include parties who have already settled or are not named in the suit 3)Knowing violation?
Foreign Corrupt Practices Act of 1977
Amends 1934 Act Prohibits these bribes to foreign gvt for all companies (not just public companies) Requirements for public companies to keep accurate accounting records & adequate internal controls
Compilation
An accounting service in which the practitioner assists in assembling information that is the representation of management but provides no assurance.
attestation
An accounting service resulting in a report on subject matter or an assertion about subject matter that is the responsibility of another party
materiality
An amount or event that is likely to influence financial statement users' decisions. Thus, material information is a synonym for important information. The emphasis is on the financial statement users' point of view, not on the auditors' or managers' points of view
Liability to Clients
Breach of Contract Tort Liablity for ON, GN,CF, F
Quality controls standards issued by ASB
CPA firm level
burden of proof for plaintiff in securities act of 1933
Damage or loss, FS were materially misleading
valuation or allocation
Management assertion that all assets, liabilities, and equity interests of the entity have been valued in accordance with the relevant financial reporting standards (e.g., GAAP) and are listed in the financial statements at the proper amount, and any resulting valuation adjustments have been appropriately recorded in the financial statements
Joint and Several Liability
The assessment of a full loss suffered by a plaintiff irrespective of shared wrongdoing.
permanent files (or continuing audit fies)
The audit documentation containing information or continuing audit significance for current and past audits of the same client
Governance Audits
The board of directors and senior management must have reliable and relevant information to meet their responsibilities -Management policies are in effect -Strategy decisions are made with the best information -Adequate progress toward goals -Operating performance is measured and communicated -Risk assessment is performed and communicated -Effectiveness of proactive risk management
year-end audit work
The procedures performed shortly before and after the balance-sheet date.
New Requirement for Fraud Detection
Three requirements: Audits must include procedures designed 1)To provide reasonable assurance of detecting material direct effect illegal acts 2)To identify material related-party transactions 3)To evaluate client's ability as a going concern
the report issued provides a summary of procedures performed (determined by the user) and findings is called what?
an agreed upon procedure
Review
an engagement in which a practitioner provides limited assurance about financial information
Common law types
breach of contract and tort liability
Sufficient Evidence
enough evidence to support a convincing argument
liability unser Securities exchange act
gross negligence or fraud
Liability for the acts of others
Auditor is liable for those under their direct supervision - employees - other CPA firms - specialists
independence in fact
Auditors' mental attitude and impartiality with respect to the client
common law proof - clients
clients MUST show an economic loss CAUSED BY auditors breached contract or failed to excercersie due care
sources of auditor liability
common + statutory law
Common Law Liability: Clients
- The most common source of lawsuits against CPAs is from clients. - Breach of contract: Failure to perform the audit in accordance with engagement letter - What client must prove depends on action brought
Statutory Liability: Securities Act of 1933
- regulates the initial issuance of securities by registrants to investing public -required to file registration statement with the SEC that includes F/S -Under Section 11 of the securities Act of 1933 plaintiff must prove: 1) Material Misrepresentation or omission in the registration statement. 2) Suffered a loss (purchased the securities) -No need to show reliance on F/S or that loss was caused by misstatement -Burden of proof shifts to the auditor
What are two primary differences of the examination over compliance under AT 1 and AS 2201?
-AT 1 only covers controls over compliance with the SEC regulations. BD is not required to perform a full audit of ICFR under AS 2201 -AT 1 covers controls as a fiscal year end and through out the fiscal period
Communication between Predecessor and Successor Auditors
-Attempt to communicate is required -If client permits, issues to discuss: 1) Disagreement with Management 2) Fraud, Illegals acts and internal control 3) Reason for the change in auditors 4) Management Integrity issues
Examples of Attestation Engagements
-Audit of Financial Statements -Audit of Internal control over financial reporting -Reviews of financial statements -Attestation services on Information Technology
Developments in Auditor Liability
-Auditors not subject to RICO (and treble damages) unless involved in management of corrupt organization (Reves vs. EY) -Limitations on aiding and abetting—Central Bank vs. First Interstate Bank -Organization of firms as limited liability partnerships -Auditor liability caps discussion has lost momentum.
Sarbanes-Oxley Act of 2002
-CEO and CFO sign-off on financial statements -White Collar Crime Penalty Enhancement Act of 2002 -Extends statute of limitations for bringing suit under the Securities Exchange Act -Higher potential liability in civil cases -New laws regarding ---Destruction, alteration, or falsification of documents ---Record retention issues (increased requirements) -Independence restrictions on audit services
Private Securities Litigation Reform Act of 1995
-Joint and several liability vs. "fair share" proportionate liability" rule -Conditions that trigger joint and several liability -Damage caps -New requirement for fraud detection
Conditions That Trigger Joint and Several Liability
-Knowing violation of securities laws -Plaintiffs meet certain wealth and loss conditions ---If plaintiff's net worth < $200,000 and the damages are > 10% of plaintiff's net worth, all parties are jointly and severally liable for the uncollectible share. ----Otherwise, uncollectible share is divided among solvent defendants proportionately (maximum is 150% of original proportion).
damage caps
-Knowing violators are responsible for all uncollectible amounts, while other liable parties pay only their proportion -Damages cannot exceed the difference between ----Purchase/sale price and -----Mean trading price during the 90-day period beginning with the date of the information correction
Common Law Tort Liability to Clients - Defenses
-Lack of Duty No Express or implied contract (lack of privity) (best for negligence) - Non-negligent Performance Followed GAAS - Causation Something else caused client loss - Contributory negligence client were partially responsible for loss.
Liability to third Parties
-Only tort liability, unless they contract with auditors -Liability to all GN or CF and F -Liability for ON depends upon relationship and jurisdiction
Securities acts of 1933
-Regulate securities trading, including IPOS, in the U.S. -Require disclosure of important financial and nonfinancial information using GAAP Required to file registration statement with SEC that includes FS (and prospectus) -Require audited F/S Goal is full and fair disclosure for informed choices
Regulation FD (2000)
-Requires public disclosure of material non-public information simultaneously when it is revealed to securities analysts and institutional investors. ---To prevent selective "inside" disclosure and provide a level playing field -SEC felt that securities analysts were reluctant to say bad things about companies that provided this information to them for fear of being cut off from future early disclosures. -Concern was that it would reduce disclosure by issuers; early research says it didn't.
Unique elements to successful internal audits
-Value-added versus compliance -Proactive - look for future problems and opportunities -Creative - find new ways to do things -Customer-focused -Understand management process, including how decisions are made, and communicate effectively -Issue identification -Talk to departments and managers about their issues -Utilizes all business perspectives -understand the business and roles outside accounting
attestation engagements include those related to
-agreed upon procedures -financial forecasts and projections -pro forma financial information -an entity's internal control over financial reporting -compliance attestation -management's discussion and analysis -service organizations
what are two things auditors are responsible for?
-appropriate competence -capabilities to perform the audit
What are 3 types of engagements?
-examination -review -agreed-upon procedures
What are some differences between attestation standards and fundamental auditing principles?
-general standards concern the practitioner's knowledge about the subject matter of the engagement and having suitable criteria by which to measure the subject matter -attestation standards do not require evaluation of internal control(may be necessary for examinatins
The following conditions must be met before accountants can conduct an examination on an entity's internal control:
-management accepts responsibility for the effectiveness of its internal control -management's evaluation of control is based on suitable and available criteria -management's evaluation of control is supported by sufficient evidence -management presents its assertion about the effectiveness of its internal control in a written report that accompanies the accountants report
name four different responsibilities auditors hold for detecting misstatements?
-obtain info -assess risk of error and fraud -plan and perform audit based on that assessment -exercise due care in degree of professional skepticism used to achieve reasonable assurance
BD who clear investment transactions or carry customer assets are required to file a report with the SEC addressing:
-their compliance with net capital requirements -reserves and custody of securities -quarterly security counts -compliance with rules on customer statements
Major steps in a compliance examination:
-understand the specific compliance requirements and assess planning materiality -plan the engagement and assess inherent risk -understand relevant controls over compliance, assess control risk, and design tests of compliance with detection risk in mind -obtain sufficient evidence of compliance with specific requirements , including a written letter of management representations -consider subsequent events -form an opinon and prepare the report
Liability to primary Beneficiaries for Ordinary Negligence (ON)
1 Auditors were aware entity intended on reliance on opinion 2 3rd party was specially identified 3 auditors acknowledged (by action) intent to rely on opinion
Name the four sources of legal liability for auditors
1) Civil Liability to Clients under Common Law 2) Civil Liability to 3rd parties under common Law 3) Civil Liability under statutory law 4) Criminal Liability
Responsibility Principles
1) Competence and capabilities - experience, expertise 2) Relevant Ethical Requirements: -Independence -Due Care -Objectivity 3) Professional Skepticism and judgement
List and discuss the steps a CPA should follow with regard to dealing with a predecessor auditor and a new client before accepting engagement.
1) Request permission to make such inquiries of the predecessor 2) Ask Lancaster to authorize Smith & Smith to respond fully to all inquires because Smith and Smith would be prohibited from disclosing confidential information without client permission. 3) Advise Smith and Smith of Lancaster's decision to change auditors. - This would be a good business judgment as well as an act of professional courtesy 4) Make Reasonable inquiries of Smith and Smith regarding matters that will aid in deciding whether to accept the engagement -integrity of management -disagreements with management about accounting and auditing matters. -Smith & Smith understand of the reason(s) for the change in auditors -fraud, illegal acts, internal control issues 5) If Smith and Smith does not respond fully to AOW's questions, consider the implications of the limited response in deciding whether to accept the engagement. 6) After weighing all information from Smith & Smith, inform Lancaster that the first time audit is more time consuming than a recurring audit because the new audit team is generally unfamiliar with the client's operations and does not have the benefit of past knowledge of company affairs to use as a guide. 7) Discuss with Lancaster the estimated required audit time and fee arrangement with a clear explanation of the purpose & scope of the audit 8) Coordinate any work that can be done by client personnel so that excess audit time might be eliminated and proposed report deadlines can be reasonably met. 9)To Satisfy AOW's quality control objective, use procedures such as review Apollo's financial statements inquiring of third parties such as Apollo's banks, legal counsel, investment bankers and others in the business community as to Apollo's reputation. 10) Evaluate AOW's ability to serve Lancaster and Apollo property with reference to industry expertise, size of engagement and available staff. 11) Accept the engagement and confirm the understandings in an engagement letter if AOW has no reservations and after all significant factors have been considered, discuss and agreed to.
accountants may accept engagements to attest to:
1) an entity's compliance with the requirement of laws, regulations, rules, and so forth and 2) the effectiveness of an entity's internal controls that ensure compliance with the requirements
Three conditions must be met for a compliance attestation:
1) management accepts responsibility for compliance 2) compliance or the controls over compliance is/are capable of evaluation and measurement against reasonable criteria 3) sufficient evidence must be available to support management's evaluation
To perform an attestation engagement on prospective information or pro forma information, accountants must
1) obtain knowledge about the entity's business, accounting principles, and factors affecting the events and transactions in question 2) obtain an understanding of the process through which the information was developed 3)evaluate the assumptions used to prepare the information 4) identify the key factors affecting the information 5) evaluate the preparation and presentation of the financial information
Common Law Negligence
1. Duty of Care Existed 2. Breach of Duty 3. Proximate Cause (was breach) 4. Injury
Performance Principle
1. Planning and Supervision -Preparation of Audit Plan 2. Materiality - Influences decisions of F/S users - Considered throughout the audit. 3. Risk Assessment - Understand the entity and environment (including internal control) -Determine necessary effectiveness of substantive tests. 4. Audit Evidence - Sufficient = quantity (how many transactions or components?) - Appropriate = quality (What level of reliability needed? Source?)
How does the Securities Act of 1933, which imposes civil liability on auditors for misrepresentations or omissions of material facts in a registration statement, expand auditors' liability to purchasers of securities beyond that of common law?
1. Privity is not a necessary element of proof 2. There are potentially millions of plaintiffs 3. Reliance is not a necessary element of proof. 4. Burden of Proof shifts to the auditor
COSO categories of objectives within a organization
1. Reliable financial reporting 2. Efficiency and effectiveness of operations 3. Compliance with laws and regulations
audit plan
A comprehensive list of the specific audit procedures that the audit team members need to perform to gather sufficient appropriate evidence on which to base their opinion on the financial statements. The professional standards require that the auditor plan each audit engagement, including the establishment of an overall strategy for each audit engagement
Internal Audit
A periodic assessment of a company's own planning, organizing, leading, and controlling processes.
Institute of Internal Auditors (IIA)
A professional accounting organization that is dedicated to the promotion and development of the practice of internal auditing.
Management's Discussion and Analysis
A required section of financial reports of public companies in which management analyzes the results of operations and cash flows for the periods presented
modified cash basis framework
A special purpose framework that provides limited accruals for items such as fixed assets and/or inventories and long-term debt
lead schedule
A summary of the accounts in or components of an account group
Auditing
A systematic process of objectively obtaining and evaluating evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between those assertions and established criteria and communicating the results to interested users.
third party beneficiary
A third party who does NOT have privity of contract but is known to the contracting parties and is intended to have certain rights and benefits under the contract.
22. When accountants are not independent, which of the following reports can nevertheless be issued? a. Compilation Report b. Standard unqualified audit report c. Examination report on a forecast d. Examination of internal control over financial reporting
A. Compilation Report
39. If the auditor expresses an adverse or disclaimer of opinion on the complete set of financial statements, she or he is not permitted to a. Express an unmodified opinion on a single financial statement b. Express an unmodified opinion on an element of the financial statements c. Express a similar opinion on a single financial information d. Perform any of the above
A. Express an unmodified opinion on a single financial statement
25. Which of the following conditions must be met before an accountant can conduct an examination of an entity's internal control? a. Management presents its assertion about the effectiveness of its internal control in a written report b. Management represents that there are no internal control deficiencies c. The accountant represents that he or she has not conducted an audit of the financial statements d. The accountant has designed a significant portion of the internal controls
A. Management presents its assertion about the effectiveness of its internal control in a written report
26. When interim financial information is presented in a footnote to annual financial statements, the standard audit report on the annual financial statements should a. Not mention the interim information unless there is an exception that the auditors need to include in the report b. Contain an audit opinion paragraph that specifically mentions the interim financial information if it is not in conformity with GAAP c. Contain an extra paragraph that gives negative assurance on the interim information if it has been reviewed d. Contain an extra explanatory paragraph if the interim information note is labeled "unaudited"
A. Not mention the interim information unless there is an exception that the auditors need to include in the report
31. The AICPA Special Committee on Assurance Services identified five global "mega trends" that can affect a CPA's business. Which of the following is NOT one of those mega trends? a. The decreasing supply of natural resources b. Information Technology c. New Social structures d. Demands for transparency
A. The decreasing supply of natural resources
33. B. Harper is surfing the internet and finds a great pair of rollerblades at a really low price. He has never heard of the company and is concerned with the product he ordered may not be the product he receives. Harper may be more willing to place an order with this company if a. The website displays the WebTrust seal b. The company provides its annual report and the report of the independent auditors on its website c. The company provides a money-back guarantee d. Only a partial payment is required prior to receiving the product
A. The website displays the WebTrust seal
the statements on auditing standards (AU-C) issued by what board?
AICPA
which board conducts peer reviews?
AICPA
which board establishes standards for nonpublic companies?
AICPA
Ethical Rulings
AICPA Code of Professional Conduct's published explanations and answers to questions about rules of conduct.
ordinary negligence
Absence of reasonable care that can be expected of a person in a set of circumstances. For auditors, it is in terms of what other competent auditors would have done in the same situation.
- Participants in an engagements - Individuals in a position to influence the engagement - a partner or manager who provides not-attest services to an attest client - a partner in the office where the engagement partner practices - the firms benefit plan - an entity that can be controlled by any person considered a member
According to AICPA who are covered members?
vouching
An audit procedure in which an auditor selects an item of financial information, usually from a journal or ledger, and follows its path back through the processing steps to its origin i.e., the source documentation that supports the item selected)
tracing
An audit procedure in which the auditor selects a basic source document and follows its processing path forward to find its final recording in a summary journal or ledger. In practice, however, this term may be used to describe following the path in either direction
Attestation
An engagement in which a practitioner is engaged to issue or does issue a written communication that expresses a conclusion about the reliability of a written assertion that is the responsibility of another party.
operational auditing
An examination designed to evaluate the processes and procedures of an organization or an area within an organization to ensure the process or area is operating efficiently and effectively
internal auditing
An examination service provided to a company to assist the company to meet its corporate goals and objectives by evaluating and recommending risk management, control, and governance processes.
Broker-dealer
An individual or company involved in the business of buying and selling investment securities either for its own account or on behalf of customers.
service organization
An organization or segment of an organization that provides services to user entities that are relevant to the user entities' internal control over financial reporting.
Judgement
Application of training, knowledge and experience in making informed decisions during audit
Skepticism
Appropriate questing and critical assessment of evidence
Assurance Services
Assurance services are independent professional services that improve the quality of information, or its context, for decision makers. - Valued because the assurance provider is independent and perceived as being unbiased with respect to the information examined. Examples: - Consumer reports - Compliance with entertainment royalty agreements - CPA WebTrust - Process/System assessment - Quality control standards compliance
PCAOB Auditing Standards
Auditing Standards (AS) Audits of Public Entities All current standards issued by PCAOB Audits of Nonpublic Entities Not Applicable
20. If a nonissuer wants an accountant to perform an examination of its internal controls, the accountant should follow a. PCAOB AS5, "An Audit of Internal Control over Financial Reporting That Is Integrated with an Audit of Financial Statements." b. AICPA AT 501, "An Examination of an entity's internal control over financial reporting that is integrated with an audit of its financial statements." c. AICPA AU 315, "Understanding the entity and its environment and assessing the risks of material misstatement." d. FASB Concepts Statement No. 1, "Objectives of Financial Reporting by business enterprises."
B. AICPA AT 501, "An Examination of an entity's internal control over financial reporting that is integrated with an audit of its financial statements."
37. Which of the following is a generally accepted attestation standard but is NOT a fundamental auditing principle a. Appropriate competence and capability b. Adequate knowledge of the subject matter c. Independence D. Due care
B. Adequate knowledge of the subject matter
34. Which of the following is NOT a principle of Trust Services a. Security b. Authentication c. Privacy d. Confidentiality
B. Authentication
27. During a review of a nonissuer's financial statements, accountants are required to make certain inquiries of management. Which of the following inquiries is NOT required by SSARS? a. The basis for the preparation of financial statements b. Internal control deficiencies c. Significant transactions occurring near the end of the reporting period d. Material subsequent events
B. Internal control deficiencies
21. A review service engagement involving unaudited financial statements involves a. More work than a compilation and an audit b. Less work than an audit but more work than a compilation c. Less work than a compilation but more work than an audit d. More work than an audit but less work than a compilation
B. Less work than an audit but more work than a compilation
30. In providing assurance services to clients, public accounting firms are building on their reputations for a. Knowledge and integrity b. Objectivity and integrity c. Independence and due professional care d. Professionalism and Trust
B. Objectivity and Integrity
29. To be useful, an audit of a service organization's controls should cover a minimum of a. Three months b. Six months c. A year d. The user entity's fiscal period
B. Six months
19. To perform an attestation engagement on prospective information or pro forma information, accountants must do all of the following EXCEPT a. obtain knowledge about the entities's business and accounting principles b. Understand the internal controls used in the processes that generated the information c. Obtain an understanding of the process through which the information was developed d. Evaluate the assumptions used to prepare the information
B. Understand the internal controls used in the processes that generated the information
Auditors are interested in having independence in appearance because a. they want to impress the public with their independence in fact b. they want the public at large to have confidence in the profession c. they need to comply with fundamental principles of GAAS d. Audits should be planned and properly supervised
B. they want the public at large to have confidence in the profession Rationale: Since appearances influence the public, this is important. Independence in fact refers to the facts, not appearances. Fundamental principles do not mention independence in appearance. Planning and supervision has nothing to do with independence in appearance.
Securities Act of 1933
Burden of Proof Auditors Offense ON, GN, F Auditors' Defenses -Due Diligence (GAAS audit) -Causation
Common Law - Clients
Burden of Proof Client Offense Breach of Contract ON, GN, F Auditors' Defenses -Lack of Duty -No breach or inappropriate performance (GAAS audit) -Causation -Contributory Negligence
Securities Act of 1934
Burden of Proof Investors Offense GN, F Auditors' Defenses -Good Faith -No knowledge of material misstatements ("scienter")
Common Law - Third Parties
Burden of Proof Third Parties Offense ON depends upon party and jurisdiction GN, F Auditors' Defenses -Lack of Duty -No breach or inappropriate performance (GAAS audit) -Causation
35. Which of the following statements should be included in a practitioner's repot on the application of agreed-upon procedures a. A statement that the practitioner performed an examination of prospective financial statements b. A statement of scope limitation that will qualify the practitioner's opinion c. A statement referring to standards established by the AICPA d. A statement of negative assurance based on procedures performed
C. A statement referring to standards established by the AICPA
40. An accountant may allow general distribution of reports based on a. An agreed upon procedures engagement b. An examination of prospective financial information c. An examination of forecasted financial information d. None of the Above
C. An examination of forecasted financial information
32. An Assurance service is one that is defined as a service that a. Provides auditing services to non-financial information b. Reviews unaudited financial information c. Improves the quality of information for decision makers d. Reduces the risk in management decision making
C. Improves the quality of information for decision makers
24. Accountants are permitted to express "negative assurance" in which of the following reports? a. Standard unqualified audit report on audited financial statements. b. Compilation report on unaudited financial statements c. Review report on audited financial statements d. Adverse opinion report on audited financial statements
C. Review report on audited financial statements
Attestation Engagement
a practitioner assesses and reports on "subject matter or an assertion about the subject matter that is the responsibility of another party"
36. The official *statements on standards for accounting and review services* are applicable to practice with a. Audited financial statements of public companies b. Unaudited financial statements of public companies c. Unaudited financial statements of nonissuers d. Audited financial statements of nonissuers
C. Unaudited financial statements of nonissuers
Criminal Liability
CPAs can be found criminally guilty for knowingly being involved with false or misleading financial statements State Law -Uniform Securities Acts Federal Law -Securities Act of 1933 (Section 24) -Securities Act of 1934 (Section 32) -Sarbanes-Oxley -Foreign Corrupt Practices Act of 1977
Foreseeable User
Cases Rosenblum Inc vs Adler 3rd Party Definition An unlimited class of users that the auditor should have reasonably been able to foresee as being likely users of the F/S Example A trade creditor that has not previously conducted business with the client and the client has not furnished F/S to trade creditors in the past.
Professional Skepticism
a state of mind that is characterized by appropriate questioning and a critical assessment of audit evidence
28. According to auditing standards, financial statements presented on a special purpose should NOT a. Contain a note describing the special purpose framework b. Describe in general how the special purpose framework differs from generally accepted accounting principles c. Be accompanied by an audit report that gives an unqualified opinion with reference to the special purpose framework d. Contain a note with a quantified dollar reconciliation of the assets based on the special purpose framework with the assets based on generally accepted accounting principles
D. Contain a note with a quantified dollar reconciliation of the assets based on the special purpose framework with the assets based on generally accepted accounting principles
38. The performance of an attestation engagement on prospective financial information does NOT require which of the following a. If the basis of the prospective financial information is different than the financial statements, a reconciliation of the two must be provided b. Management must disclose all significant assumptions used in generating the prospective financial information c. Management must disclose significant assumptions used in generating the prospective financial information d. Management must disclose the probability of obtaining the results included int the prospective financial information
D. Management must disclose the probability of obtaining the results included int the prospective financial information
23. For a compliance engagement, three conditions must be met. Which of the following is NOT one of the three conditions? a. Management accepts responsibility for compliance b. Management's evaluation of compliance is capable of evaluation and is measured against reasonable criteria c. Sufficient evidence is available to support management's evaluation d. Management provides a report attesting to the satisfactory compliance
D. Management provides a report attesting to the satisfactory compliance
inherent limitations of an audit include what?
a tradeoff between cost and benefit of auditing
adverse opinion
Departure from GAAP so significant that financial statements as a whole are misleading
criminal liability under securities exchange act
Did auditors act "willfully and knowingly"? Fines of up to $5 million and imprisonment for up to 20 years
Defense to securities act of 1933
Due dilliigence or blame someone else
Non-Financial Attestation Engagements
Effectiveness of internal control systems, compliance with environmental regulations, sustainability reporting engagements. Examples: •Compliance with contractual requirements •Effectiveness of internal control systems •Inventory quantities and locations
Compliance Audit
Evaluate conformity of existing conditions to specific requirements -Policy and procedures -Professional standards -Laws, regulations or contracts
Financial Audits
Examine and evaluate -Areas of management concern (e.g. new payment process) -Financial information used by internal decision makers (e.g. monthly sales reports) -Financial information being sent to outside agencies or stakeholders (e.g. IRS, SEC, shareholders)
Operational Audits
Examine and evaluate -Quality, effectiveness and efficiency of operations -Current risks that need to be managed -Possible future risks -Internal control Term is sometimes used synonymously with internal audit.
Constructive Fraud
Existence of extreme or unusual negligence even though there was no intent to deceive or do harm. Constructive fraud is also termed recklessness. Recklessness in the case of an audit is present if the auditor knew an adequate audit was not done, but still issued an opinion, even though there was no intention of deceiving statement users.
Breech of Contract
Failure of one or both parties in a contract to fulfill the requirements of the contact. Parties who have a relationship that is established by a contract are said to have privity of contract
Disclosure Requirements
If the auditor acquires information regarding a potential illegal act, determine its likelihood and its effect on financials -Unless clearly inconsequential, notify management and audit committee --If insufficient action by client warrants modified opinion or resignation, notify board of directors, which must notify SEC ---If board fails to report within one day, auditor should report to SEC (and may resign).
common law defense - auditor
Innocence - they did not breach contract or performed with appropriate level of care Casuation - something ELSE caused loss contributory negligente - client partially responsible for loss
Statutory Law
Law passed by the U.S. Congress or state legislatures
existence
Management assertion that all assets, liabilities, and equity interests do actually exist
occurence
Management assertion that all of the transactions and events that have been recorded are valid, pertain to the entity, and have actually taken place.
completeness
Management assertion that all of the transactions, events, assets, liabilities, equity interests, and other disclosures that should have been recorded in the financial statements have been recorded
cutoff
Management assertion that refers to accounting for revenue, expense, and other transactions in the proper period. The cutoff date generally refers to the audit client's year-end balance sheet date
Class Action Fairness Act (2005)
Moves class action cases from state courts to federal courts
Common Law Constructive Fraud
Mr Ri 1. Material misrepresentation or omission 2. Recklessness 3. Reliance 4. Injury
Common Law Fraud
Ms Ri 1. Material misrepresentation or omission 2. Scienter 3. Reliance 4. Injury
Proof - third parties
Must show that: economic loss caused by reliance on misstated FS Auditors failed to excercise due care F/S materially misstated
Accountants are _____required to be independent for compilation engagements
NOT
tort liablity
Obligation based on Failure to exercise appropriate level of professional care - Ordinary negligence is lack of reasonable care -Gross Negligence is lack of minimal care (similar to constructive fraud) -Fraud is a misrepresentation of fact an individual knows to be false.
Fruad
Occurs when a misstatement is made and there is BOTH the knowledge of its falsity and the intent to deceive
PCAOB Standards by topic (AS) issued by what board?
PCAOB
which board establishes standards for public companies?
PCAOB
Privity
Parties who share a contractual relationship
foreseeable
Parties whose decisions normally rely on audited F/S and opinions on those F/S
civil liability under securities exchange act
Plaintiffs have burden of proof Auditors cannot be held liable for ordinary negligence
financial reporting
Process of providing statements of financial position (balance sheets), results of operations (income statements, statements of shareholders' equity, and statements of comprehensive income), changes in cash flows (statements of cash flows), and accompanying disclosure to outside decision makers who do not have access to management's internal sources of information; a company's accountants, under the direction of its management, perform this function
Appropriate Evidence
Relates to the quality of evidence - Relevance: Does evidence address assertion(s) of interest? - Reliability: Source of evidence
SOC 1
Report for controls over financial reporting
SOC 2
Report on Controls at a Service Organization Relevant to Security, Availability, Processing Integrity, Confidentiality, or Privacy which may be requested by a user but does not apply directly to the user's financial statements
qualified opinion
Scope limitation or a departure from GAAP
Engagement letter includes
Should include: -Billing and Fees -Objectives of the engagement -Management's responsibilities Client cooperation should be specified in the engagement letter, this is a key purpose of the letter -Auditors' responsibilities The engagement letter would typically include items relating to the use of specialists -Any limitations of the scope of the engagement Accept an engagement after the close of the fiscal year -confirmations -inventory observation Mgmt. must permit auditors to inquire with the entity's legal counsel
what additional information is included in the audit of a public company?
critical audit matters
AICPA Statements on Auditing Standards
Statements on Auditing Standards (SASs) Audits of Public Entities Standards issued by the Auditing Standards Board (ASB) prior to April 2003 not amended or superseded by PCAOB standards (Interim Standards) Audits of Nonpublic Entities All current standards issued by Auditing Standards Board (ASB)
Professional standards for performing attest engagements are provided by
Statements on standards for attestation engagements in the AT section of the AICPA's professional standards
SEC powers
Suspend trading in a stock--10 days Delist a stock Suspend trading on an exchange--up to 90 days Suspend or expel a broker Sanction accountants
Pro forma
The description of financial information reflecting historical data as if a certain transaction had occurred.
planning memorandum
The document summarizing the preliminary analytical procedures and the materiality assessment with specific directions about the effect on the audit
rights and obligations
The entity is entitled to all rights of the assets, the liabilities are the legal responsibility of the entity, and all of the disclosed events and transactions pertain to the entity
Review evidence
The evidence required to provide limited assurance obtained by (1) inquiring of management, (2) conducting analytical procedures, and (3) obtaining written representations from management.
appropriate financial reporting framework
The financial reporting treatment (i.e. GAAP, IFRS, etc.) adopted by management and, when appropriate, those charged with governance in the preparation of the financial statements that is acceptable in view of the nature of the entity and the objective of the financial statements, or that is required by law or regulation
Proportionate Liability
The legal doctrine that payment of a share of the court's damage award be based on the extent (or proportion) of fault exhibited by a convicted defendant
Joint and Several Liability
The legal doctrine that when multiple defendants are named, the full amount of a damage award may be collected from any of the defendants named in the lawsuit even though they may be only partially at fault
International Standards for the Professional Practice of Internal Auditing
Three major categories: 1. Attribute Standards: -characteristics of internal auditors (e.g., objectivity and independence) 2. Performance Standards: -Relate to conducting internal audits and evaluating quality of work 3. Implementation standards: -Specific implementation of attribute and performance standards to specific engagements (e.g., assurance or consulting)
Common Law Liability: Tort Liability to Clients
Tort Liability Obligation base on failure of auditors to exercise appropriate level of professional care - Ordinary negligence: lack of reasonable care -Gross Negligence or constructive fraud: recklessness -Fraud: intentional misrepresentation of fact
insider trading penalties
Treble gains or $1MM, whichever is greater Jail sentences up to 10 years
With each category, there are two types of SOC reports which are:
Type 1: describes the SO internal controls placed in operation at a specific point in time but does not report on the effectiveness of the controls Type 2 report not only includes a description of the controls but also reports on the service organization's auditors testing of the controls over a minimum six month period
1. Remain in compliance with standards 2. If subpoenaed by the court 3. PCAOB peer or quality review of practice 4. Ethics violation for state board of accountancy investigation
What are the exceptions to disclosing confidential client information without client consent?
1. Define facts and circumstance 2. Identify stakeholders 3. Identify stakeholders' rights and obligations 4. identify alternatives and consequences 5. choose superior alternative
What is the Ethical Decision Process?
- Direct financial interest - Material indirect financial interest - Material Joint ventures - Loads outside normal lending practices (Collateral required)
What types of financial relationships are prohibited according to the AICPA Independence rule 1.200?
Principles; Rules of Conduct
While ______ are aspriational goals of behavior, the ______ are enforceable ethical regulations that CPAs must follow.
breach of contract
a failure to fulfill the requirements of a contract
what is the end product of an auditor report?
a piece of paper saying the same thing every year through a report issuing an opinion
Which of the following ownership situations is permissible for a public accounting firm? a. A partner of the firm is responsible for fraud issues related to audits and audit clients. He owns 20 percent of the firm and is not a CPA. b. Because the firm now specializes in fraud auditing and fraud investigation, the managing partner of the firm has a background in law enforcement and fraud investigation but is not a CPA. c. A partner of the firm who owns 50 shares of stock in an audit client of the firm is responsible for fraud issues related to audits and audit clients. d. A partner of the firm who has 20 years of experience in law enforcement and fraud investigation is responsible for fraud issues related to audits and audit clients. The partner's career began as a police officer after receiving a law enforcement degree from a local community college.
a. A partner of the firm is responsible for fraud issues related to audits and audit clients. He owns 20 percent of the firm and is not a CPA. Rationale: A non-CPA who does not have a majority interest and does not have an ultimate responsibility for the firm's services can be a partner. A CPA must have ultimate responsibility for the firm services, a non-CPA cannot be the managing partner. A majority owner and partner in the firm cannot own stock in an audit client. Non-CPA owners of the firm must hold a bachelor's degree.
An accountant recommends a local computer company to a client that is trying to upgrade its computerized sales records. The client purchases $25,000 worth of equipment and sends a check to the accountant for 5 percent of the total sales. This is an example of a a. Commission. b. Contingent fee. c. Referral fee. d. Nonaudit fee.
a. Commission. Rationale: This is a commission—a percentage paid in connection with a business activity. This is not an example of a contingent fee, referral fee or a nonaudit fee.
If a public accounting firm says it always follows the rule that requires adherence to FASB pronouncements in order to give a standard unmodified auditor's report, it is following a philosophy characterized by a. the imperative principle b. the utilitarian principle c. virtue ethics d. reliance on members collective conscience
a. Imperative principle Rationale: Imperative means that a rule is always followed. Utilitarian means that some exceptions based on a calculation of good and bad outcomes is sometimes used.Strict adherence to rules might be consider a virtue, but is the second best answer. The firm is following a rule, not listening to members' collective conscience.
Which of the following would probably not be considered an "act discreditable to the profession"? a. Numerous moving traffic violations. b. Failing to file the CPA's own tax return. c. Filing a fraudulent tax return for a client in a severe financial difficulty. d. Refusing to hire Asian Americans in an accounting practice.
a. Numerous moving traffic violations. Rationale: Traffic violations are generally considered outside the reach of professional conduct rules. Failing to file one's own tax return is discreditable. Filing a fraudulent tax return, even for a client in financial difficulty, is discreditable under AICPA interpretation. Employment discrimination is discreditable.
An auditor's independence would not be considered impaired if she or he had a. Owned common stock of the audit client but sold it before the company became a client. b. Sold short the common stock of an audit client while working on the audit engagement. c. Served as the company's treasurer for six months during the year covered by the audit but resigned before the company became a client. d. Performed the bookkeeping and financial statement preparation for the company, which had no accounting personnel and for which the president had no understanding of accounting principles.
a. Owned common stock of the audit client but sold it before the company became a client. Rationale: A direct financial interest disposed before the auditor client relationship arises does not impair independence. A short sale creates the commitment to acquire the client's stock and impairs independence. Service in the capacity of management during the period covered by the financial statements impairs independence. Performing accounting services and preparing financial statements when the client cannot take responsibility for them impairs independence.
Phil Greb has a thriving practice in which he assists attorneys in preparing litigation dealing with accounting and auditing matters. He is "practicing public accounting" if he a. Uses his CPA designation on his letterhead and business card. b. Is in partnership with another CPA. c. Practices in a professional corporation with other CPAs. d. Never lets his clients know that he is a CPA.
a. Uses his CPA designation on his letterhead and business card. Rationale: By using his CPA designation on his letterhead and business card, he is "holding out" as a CPA and does work that other CPAs perform. Mere partnership with another CPA is not enough if the other CPA does not "hold out." Working in a professional corporation with another CPA is not enough if the other CPA does not "hold out." If he never lets his clients know that he is a CPA and does not "hold out" as a CPA, he is not in public accounting, according to the AICPA.
peer review
assessing firm compliance with quality control standards every three years
Performance principle
assessing the risk of material misstatement and obtaining sufficient appropriate evidence for an opinion
reasonable assurance
audit risk at acceptable low level
what does the PCAOB issue?
auditing standards codified by topic
audit
conducts GAAS, or PCAOB via auditing standards
A public accounting firm's independence is not impaired when members of the audit engagement team does which of the following for a public company audit client? a. Prepares special purchase orders for active plutonium in secure national defense installations. b. Completes operational internal audit assignments under the directions of the client's director of internal auditing. c. Prepares outsourced internal audit work on the client's financial accounting control monitoring. d. Prepares actuarial assumptions used by the client's actuaries for life insurance actuarial liability determination. e. All of the above would impair the public accounting firm's independence. b. Correct Independence is not impaired for nonfinancial statement-related internal audit services when the client has its own director of internal auditing in charge
b. Completes operational internal audit assignments under the directions of the client's director of internal auditing. Rationale: Independence is not impaired for nonfinancial statement-related internal audit services when the client has its own director of internal auditing in charge. Preparing special purchase orders for active plutonium in secure national defense installations is a type of bookkeeping service that impairs independence. Independence is impaired when the audit firm performs more than 40% of financial-related internal audit work (i.e., outsourced internal audit work) for all clients with more than $200 million assets. So, preparing outsourced internal audit work on the client's financial accounting control monitoring is an incorrect response. Independence is impaired when auditors perform important actuarial work and then audit their own work product (the client's actuarial calculations based on the audit team-prepared assumptions).
The audit committee's responsibility for auditor independence concerns a. Ensuring that partners of the public accounting firm are not stockholders in the company. b. Ensuring that nonaudit services provided by the auditor do not impair independence. c. Reporting on auditor independence to the PCAOB. d. Ensuring that all nonaudit services are provided by auditors who do not perform the financial statement audit.
b. Ensuring that nonaudit services provided by the auditor do not impair independence. Rationale: Sarbanes-Oxley and the PCAOB have placed the responsibility for auditors' independence on the audit committee. Primary in this responsibility is the monitoring of all engagements contracted with the external auditors to ensure that the auditors are not performing any assignments that are prohibited by PCAOB standards or otherwise impair the auditors' independence. It would be difficult to monitor whether individual public accounting firm employees are independent. Firm quality control practices monitor this. While Sarbanes-Oxley and the PCAOB have placed the responsibility for auditors' independence on the audit committee, the audit committee does not have to report to the PCAOB.
Which of the following "bodies designated by Council" have been authorized to promulgate accounting principles enforceable under Rule 203 of the AICPA Code of Professional Conduct? a. Auditing Standards Board. b. Federal Accounting Standards Advisory Board. c. Consulting Services Executive Committee. d. Accounting and Review Services Committee.
b. Federal Accounting Standards Advisory Board. Rationale: The Federal Accounting Standards Advisory Board has been so authorized.
When a CPA knows that a tax client has skimmed cash receipts and not reported the income in the federal income tax return but signs the return as a CPA who prepared the return, the CPA has violated which of the following AICPA rules of conduct? a. Rule 301—Confidential Client Information. b. Rule 102—Integrity and Objectivity. c. Rule 101—Independence. d. Rule 203—Accounting Principles.
b. Rule 102—Integrity and Objectivity. Rationale: Rule 102—Integrity and Objectivity is relevant because the CPA knowingly misrepresented facts. Rule 301—Confidential Client Information is not relevant because the CPA did not tell anyone else about the omission. Rule 101—Independence is not required in tax practice. Rule 203—Accounting Principles is not relevant because the CPA is not giving an opinion on financial statements' conformity with GAAP.
AICPA members who work in industry and government must always uphold which two of the following AICPA rules of conduct? a. Rule 101—Independence. b. Rule 102—Integrity and Objectivity. c. Rule 301—Confidential Client Information. d. Rule 501—Acts Discreditable.
b. Rule 102—Integrity and Objectivity. d. Rule 501—Acts Discreditable. Rationale: Integrity and objectivity are required of all members. Prohibition of discreditable acts applies to all members. The Independence Rule (101) is focused on members in public practice, not members serving in industry or government. The Confidential Client Information Rule (301) is focused on members in public practice, not members serving in industry or government.
When a client's financial statements contain a material departure from an FASB Statement on Accounting Standards and the public accounting firm believes the departure is necessary to ensure that the statements are not misleading, a. The public accounting firm must qualify the auditors' report for a departure from GAAP. b. The public accounting firm can explain why the departure is necessary and then give an unmodified opinion paragraph in the auditors' report. c. The public accounting firm must give an adverse auditors' report. d. The public accounting firm can give the standard unmodified auditors' report with an unmodified opinion paragraph.
b. The public accounting firm can explain why the departure is necessary and then give an unmodified opinion paragraph in the auditors' report. Rationale: Rule 203 permits the explanation and the unqualified opinion when the public accounting firm can explain why the departure is necessary and then give an unmodified opinion paragraph in the auditors' report. "Must" is wrong. The public accounting firm can explain why the departure is necessary and then give an unqualified opinion paragraph in the auditors' report. The opinion paragraph can be unqualified, but with the explanation, the report is not "standard."
Audit independence in fact is most clearly lost when a. a public accounting firm audits competitor companies in the same industry (eg. coke and pepsi) b. an auditor agrees to the argument made by the client's financial vice president that deferring losses on debt refinancing is in accordance with generally accepted accounting principles c. an audit team fails to discover the client's misleading omission of disclosure about permanent impairment of asset values d. A public accounting firm issues a standard unmodified report, but the reviewing partner fails to notice that the assistant's observation of inventory was woefully incomplete
b. an auditor agrees to the argument made by the client's financial vice president that deferring losses on debt refinancing is in accordance with generally accepted accounting principles Rationale: The statement "An auditor agrees to the argument made by the client's financial vice president that deferring losses on debt refinancing is in accordance with generally accepted accounting principles" implies that the auditor subordinated judgment to the client's officer. Merely auditing competitors does not impair independence. Lack of competence itself is not an impairment of independence. The facts may have been misrepresented, but the auditors didn't know it. "A public accounting firm issues a standard unmodified report, but the reviewing partner fails to notice that the assistant's observation of inventory was woefully incomplete" is another example of a lack of competence. In this case, the auditors misrepresented facts (giving the unqualified report when the audit was not entirely in conformity with GAAS), but they did not knowingly do so.
statutory law
based on violations of written statutes (shareholders)
common law liability - clients
breach of contract - failure to perform audit in accordance with engagement letter Tort liability for ordinary, gross negligence + fraud
When a public accounting firm audits FUND-A in a mutual fund complex that has sister funds FUND-B and FUND-C, independence for the audit of FUND-A is not impaired when a. Managerial-level professionals located in the office where the engagement audit partner is located but who are not on the engagement team own shares in FUND-B, which is not an audit client. b. The wife of the FUND-A audit engagement partner owns shares in FUND-C (an audit client of another of the firm's offices) and these shares are held through the wife's employee benefit plan funded by her employer, the AllSteelFence Company. c. Both (a) and (b). d. Neither (a) nor (b).
c. Both (a) and (b). Rationale: Managers not on the engagement can own shares in nonclient sister funds. Independence is not impaired when close family members of audit partners own shares in audit client sister funds not audited by the close family member's relatives, so long as the shares are held through the family member's employee benefit plan.
According to the AICPA Code of Conduct, which of the following acts is generally forbidden to CPAs in public practice? a. Purchasing bookkeeping software from a high-tech development company and reselling it to tax clients. b. Being the author of a "TaxAid" newsletter promoted and sold by a publishing company. c. Having a commission arrangement with an accounting software developer to receive 4 percent of the price of programs recommended and sold to audit clients. d. Engaging a marketing firm to obtain new financial planning clients for a fixed fee of $1,000 for each successful contact.
c. Having a commission arrangement with an accounting software developer to receive 4 percent of the price of programs recommended and sold to audit clients. Rationale: Rule 503 prohibits commission compensation for referring products or services to clients for which the CPA performs attest services. No rule forbids reselling products for profit. Authorship itself is not forbidden. Rule 503 permits CPAs to pay fees to obtain clients. (This answer is "close" to correct—forbidden—because the CPA must disclose the fee payment to the new client.)
The AICPA removed its general prohibition of CPAs taking commissions and contingent fees because a. CPAs prefer more price competition to less. b. Commissions and contingent fees enhance audit independence. c. Nothing is inherently wrong about the form of fees charged to nonaudit clients. d. Objectivity is not always necessary in accounting and auditing services. c. Correct The FTC dragged the AICPA kicking and screaming into the agreement.
c. Nothing is inherently wrong about the form of fees charged to nonaudit clients. Rationale: The AICPA removed its general prohibition of CPAs taking commissions and contingent fees because "nothing is inherently wrong about the form of fees charged to nonaudit clients." However, it should be noted that the FTC dragged the AICPA kicking and screaming into the agreement. CPAs generally prefer to compete on the basis of quality of service rather than price. The conventional wisdom is the opposite of the statement, "commissions and contingent fees enhance audit independence." The AICPA "principles" statements assert that objectivity is always necessary.
Which of the following agencies issues independence rules for the auditors of public companies a. FASB b. GAO c. PCAOB d. ARSC
c. PCAOB Rationale: The PCAOB (in cooperation with SEC) makes independence rules for auditors of public companies. FASB makes accounting principles (not independence rules).GAO makes auditing standards for government audits. ARSC makes practice standards for accountants' work on unaudited financial statements.
Which of the following is considered a close relative (but not an immediate family member) as defined by the AICPA? a. Spouse. b. Spousal equivalent. c. Parent. d. Uncle.
c. Parent. Rationale: A parent is defined as a close relative but not an immediate family member. A spouse is defined as an immediate family member. A spousal equivalent is defined as an immediate family member. An uncle is neither an immediate family member nor a close relative.
Under SOX and PCAOB rules, ensuring that the auditor is independent in appearance is the responsibility of a. The public accounting firm b. senior management c. the audit committee d. the PCAOB
c. the audit committee Rationale: Sarbanes-Oxley and PCAOB have placed the responsibility for ensuring that the external auditors are independent on those charged with governance (including the audit committee). An external auditor is not able to "assure" that they are independent. Sarbanes-Oxley and PCAOB have placed the responsibility for ensuring that the external auditors are independent on those charged with governance (including the audit committee). Management is not responsible for the auditor's independence. The PCAOB sets standards for the auditing profession and serves at the regulator for audit firms. The PCAOB is not responsible for the auditor's independence.
disclaimer of opinion
can't arrive at an opinion due to a very significant scope limit
1998 Securities Litigation Uniform Standards Act
caused plaintiffs to switch actions to state courts to insure joint and several liability. Requires class action lawsuits with > 50 parties to be filed in federal courts class actions alleging fraud regarding publicly traded securities, since they are traded across state lines, must be heard in federal courts.
For agreed upon procedures
clearly worded engagement letters specifically delineating the desired procedures to be performed are of upmost importance. -identify the specified users -describes the specific findings related to each procedure
Which of the following "bodies designated by Council" have been authorized to promulgate general standards enforceable under the General Standards Rule of the AICPA Code of Professional Conduct? a. AICPA Division of Professional Ethics. b. Financial Accounting Standards Board. c. Government Accounting Standards Board. d. Accounting and Review Services Committee.
d. Accounting and Review Services Committee. Rationale: The Accounting and Review Services Committee has been so authorized.
According to Rule 501, which of the following is not a "discreditable act"? a. Withholding a client's sales records. b. Failing to file or remit tax payments. c. Failing to follow requirements of the PCAOB during the audit of an SEC client. d. Advertising that indicated the firm can reduce IRS penalties.
d. Advertising that indicated the firm can reduce IRS penalties. Rationale: Advertising that indicates the firm can reduce IRS penalties is the type of advertising violates rule 502, not rule 501 regarding "acts discreditable." Withholding client records is an "act discreditable." Failing to file or remit tax payments is a felony and as such is an "act discreditable." Failure to follow standards during an SEC audit is an "act discreditable."
Which of the following would not be considered confidential information obtained in the course of an engagement for which the client's consent would be needed for disclosure? a. Information about whether a consulting client has paid the CPA's fees on time. b. The actuarial assumptions used by a tax client in calculating pension expense. c. Management's strategic plan for next year's labor negotiations. d. Information about material contingent liabilities relevant for audited financial statements.
d. Information about material contingent liabilities relevant for audited financial statements. Rationale: Client permission is not needed for information required by GAAP, such as material contingent liabilities in audited financial statements. An audit team member cannot even tell a credit agency about the client's payment record. The actuarial assumptions are not required to be disclosed by GAAP or GAAS in tax engagements. Strategic plans of this nature are not required by GAAP or GAAS.
CPA Kara Rambo is the auditor of Ajax Corporation. Her audit independence will not be considered impaired if she a. Owns $1,000 worth of Ajax stock. b. Has a husband who owns $1,000 worth of Ajax stock. c. Has a sister who is the financial vice president of Ajax. d. Owns $1,000 worth of the stock of Pericles Corporation, which is controlled by Ajax as a result of Ajax's ownership of 40 percent of Pericles' stock, and Pericles contributes 3 percent of its total assets and income in Ajax's financial statements.
d. Owns $1,000 worth of the stock of Pericles Corporation, which is controlled by Ajax as a result of Ajax's ownership of 40 percent of Pericles' stock, and Pericles contributes 3 percent of its total assets and income in Ajax's financial statements. Rationale: Ownership of $1,000 worth of the stock of Pericles Corporation, which is controlled by Ajax as a result of Ajax's ownership of 40 percent of Pericles' stock, and Pericles contributes 3 percent of its total assets and income in Ajax's financial statements is a situation of having an immaterial financial interest in a nonclient investee that is immaterial to the client's financial statements. Ownership of $1,000 worth of Ajax stock, impairs independence by a direct financial interest in the client. If a husband who owns $1,000 worth of Ajax stock, then independence is impaired by the attribution of the financial interest of the spouse. Having a nondependent close relative (sister) in an audit sensitive position with the client impairs independence.
A CPA's legal license to practice public accounting can be revoked by the a. American Institute of Certified Public Accountants. b. State society of CPAs. c. Auditing Standard Board. d. State board of accountancy.
d. State board of accountancy. Rationale: The state board is the regulatory agency that grants a license to practice and can revoke one. The AICPA does not grant licenses to practice. The state CPA societies do not grant licenses. The ASB does not grant licenses.
Which of the following is true? a. Members of an audit engagement team cannot speak with audit client officers about matters outside the scope of the audit while the audit engagement is in progress. b. Audit team members who leave the public accounting firm for employment with audit clients can provide audit efficiencies (next year) because they are very familiar with the firm's audit plans. c. Audit team partners who leave the public accounting firm for employment with audit clients can retain variable annuity retirement accounts established in the person's former firm retirement plan. d. The public accounting firm must discuss with the audit client's board or its audit committee the independence implications of the client's having hired the audit engagement team manager as its financial vice president.
d. The public accounting firm must discuss with the audit client's board or its audit committee the independence implications of the client's having hired the audit engagement team manager as its financial vice president. Rationale: The public accounting firm must discuss with the audit client's board or its audit committee the independence implications of the client's hiring the audit engagement team manager as its financial vice president. The statement "Members of an audit engagement team cannot speak with audit client officers about matters outside the scope of the audit while the audit engagement is in progress" is not true. For example, an auditor's freedom to talk with clients about employment is not denied. The audit firm simply must take actions to mitigate any possible threat to the quality audit work. "Audit team members who leave the public accounting firm for employment with audit clients can provide audit efficiencies (next year) because they are very familiar with the firm's audit plans" may be a second-best answer, but the "efficiencies" are offset by the extra review the audit firm is obligated to perform. Former audit partners can retain material retirement accounts only if they are fixed as to amount and timing. (The "variable" word in the question negates the "fixed" requirement.)
Which of the following is true if an auditor performs nonaudit services for a government entity? a. The scope of the audit must be reduced so that the auditor does not audit the area for which the nonaudit work was performed. b. The auditor is prohibited from providing nonaudit work in areas directly related to the production of accounting information. c. The senior members of the government entity must document their review of the nonaudit service and indicate why it is appropriate for the auditors to perform this service. d. The scope of the audit cannot be reduced because the nonaudit work was performed by the public accounting firm.
d. The scope of the audit cannot be reduced because the nonaudit work was performed by the public accounting firm. Rationale: The scope of the audit work cannot be reduced because a public accounting firm performed nonaudit work. The audit organization may not reduce the scope of its audit. There are restrictions (not strict prohibition) concerning where in the organization the nonaudit work can be performed. The audit organization, not the government organization, must document why the nonaudit service does not affect independence.
substantive audit plan
document that contains a list of audit procedures for gathering evidence related to the relevant assertions identified for the significant financial statement accounts and disclosures on an audit client
why are unmodified opinions good?
ensures financial statements are performed fairly in conformity with GAAP
what does the PCAOB do?
establishes standards for public company- legislative body here
Accountants can perform __________ and __________ regarding compliance, but not __________
examinations and agreed upon procedures, but not reviews
standard unmodified opinion
financial statements for GAAP and additional commentary not added there
Management Letter
formal report to the client in which the auditor provides commentary and suggestions on a variety of matters including internal control brought to light during the course of the audit -Profit possibilities, business strategy, operational efficiency, etc. -Value-added service -End of the audit NOT REQUIRED
the accountant should obtain __________________ or other evidence of the party's responsibility for the subject matter or the written assertion
written acknowledgement
Liability under the Securities Exchange act of 1934
•Defenses -Auditors acted in good faith -Auditors were not aware of material misstatements •Ernst & Ernst v. Hochfelder -Relieved auditors from liability for ordinary negligence -Did provide liability for "reckless behavior" in the absence of scienter
Internal Audit Reports
•Effective internal audit reports must be accurate, concise, clear, and timely -greater emphasis on effective communication for internal auditing in comparison with external auditing •Include both favorable or unfavorable findings •Unfavorable findings should include -Condition - what was found -Criteria - basis for determining that the condition was improper -Cause - why did this happen? -Effect - why is this bad? -Recommendation - what do you think should be done about this? -Objections - Any reasons for management disagreement with audit report •IIA standards require follow-up to ensure compliance with recommendations
Reporting Principle
•Express an opinion or state that an opinion cannot be expressed •Opinion is based on conformity of financial statements with applicable financial reporting framework
Termination Letters
•Many accounting firms have policies regarding the use of termination letters •Issues addressed may include: 1. Access to audit documentation 2. Reissuance of the auditor's report for comparative F/S 3. Fee issues 4. Circumstances for Termination •Good idea because: 1. Accountant's litigation risk, makes it clear when concluded 2. Helps avoid misunderstandings with client 3. Make it easier to respond to successor inquiries
Statutory Liability: Securities Act of 1934
•Regulates daily trading of securities and requires periodic financial statements and information to be filed with the SEC •Auditors liable for gross negligence and fraud •To bring suit under Rule 10-(b) and 10b-5 of the Securities Act of 1934 investors must show: 1. Material misrepresentation or omission 2. Scienter or Recklessness 3. Reliance 4. Injury •Loss caused by reliance on F/S -burden of proof shifted to investor
Financial Attestation Engagements (Other than Audits)
•Supplementary financial statistics •Pro forma financial information •Financial forecasts and projections