audit ch. 3-4
4-19 a. The following questions concern possible violations of the AICPA Code of Professional Conduct. Choose the best response. In which one of the following situations would a CPA be in violation of the AICPA Code of Professional Conduct in determining the audit fee? 1. A fee based on whether the CPA's report on the client's financial statements results in the approval of a bank loan. 2. A fee based on the outcome of a bankruptcy proceeding. 3. A fee based on the nature of the service rendered and the CPA's expertise instead of the actual time spent on the engagement. 4. A fee based on the fee charged by the prior auditor.
(1) A fee based on whether the CPA's report on the client's financial statements results in the approval of a bank loa
3-21a. the following questions concern unmodified opinion audit reports with an emphasis-of-matter explanatory paragraph or nonstandard wording in report paragraphs. Choose the best response. An entity changed from the straight-line method to the declining-balance method of depreciation for all newly acquired assets. This change has no material effect on the current year's financial statements but is reasonably certain to have a substantial effect in later years. If the change is disclosed in the notes to the financial statements, the auditor should issue a report with a(n) 1. unmodified opinion. 2. qualified opinion. 3. unmodified opinion with explanatory paragraph. 4. qualified opinion with explanatory paragraph regarding consistency.
(1) unmodified opinion
3-20b. the date of the CPA's opinion on the financial statements of the client should be the date of the 1. completion of all important audit procedures. 2. closing of the client's books. 3. finalization of the terms of the audit engagement. 4. submission of the report to the client.
(1)completion of all important audit procedures.
4-20c. Which of the following is not a provision of the Sarbanes-Oxley Act of 2002? 1. The auditor of an issuer may not provide internal audit outsourcing services for the issuer. 2. Audit documentation must be maintained for five years. 3. The lead and reviewing partners must rotate off the audit after five years. 4. Tax services must be preapproved by the audit committee.
(2) Audit documentation must be maintained for five years.
3-22 b. An auditor who qualified an opinion because of an insufficiency of audit evidence should refer to the scope limitation in the Auditor's Responsibility Section Opinion Section Note to the Financial Statements (1) Yes No Yes (2) No Yes No (3) Yes Yes No (4) Yes Yes Yes
(2) No Yes No
3-22 c. An adverse opinion and a disclaimer of opinion 1.may be used interchangeably. 2. both require modification of the opinion section. 3. result in the auditor's withdrawal from the engagement. 4. indicate situations in which there are material GAAP departures.
(2) both require modification of the opinion section.
4-20 a. The following questions concern auditor professional responsibilities. Choose the best response. a. The concept of materiality would be least important to an auditor when considering the 1. adequacy of disclosure of a client's illegal act. 2. effects of a direct financial interest in the client on the CPA's independence. 3. discovery of weaknesses in a client's internal control structure. 4. types of evidence to use in testing accounts receivable.
(2) effects of a direct financial interest in the client on the CPA's independence.
3-21c. The auditor's report contains the following: "We did not audit the financial statements of EZ, Inc., a wholly owned subsidiary, which statements reflect total assets and revenues constituting 27 percent and 29 percent, respectively, of the consolidated totals. Those statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for EZ, Inc., is based solely on the report of the other auditors." These sentences 1. assume responsibility for the other auditor. 2. indicate a division of responsibility. 3. require a departure from an unmodified opinion. 4. are an improper form of reporting.
(2) indicate a division of responsibility.
4-18 b. Which of the following services can be offered to public company audit clients under SEC requirements and the Sarbanes-Oxley Act? 1. Tax services for executives involved in financial reporting 2. Tax planning not involving tax shelters 3. Internal audit outsourcing 4. Bookkeeping and other accounting services
(2)Tax planning not involving tax shelters
4-19 b. The AICPA Code of Professional Conduct states that a CPA shall not disclose any confidential client information obtained in the course of a professional engagement except with the consent of the client. In which one of the following situations would disclosure by a CPA be in violation of the Code? 1. Disclosing confidential information in compliance with a subpoena issued by a court. 2. Disclosing confidential information in order to properly discharge the CPA's responsibilities in accordance with the profession's standards. 3. Disclosing confidential information to another accountant interested in purchasing the CPA's practice. 4. Disclosing confidential information during an AICPA-authorized peer review.
(3) Disclosing confidential information to another accountant interested in purchasing the CPA's practice.
4-20b. According to the profession's ethical standards, which of the following events may justify a departure from GAAP? 1. New legislation 2. Conflicting industry practices 3. Evolution of a new form of business transaction 1. I and II 2. II and III 3. I and III 4. I, II, and III
(3) I and III
4-18 c. An auditor strives to achieve independence in appearance to 1. comply with auditing standards related to audit performance. 2. become independent in fact. 3.maintain public confidence in the profession. 4. maintain an unbiased mental attitude.
(3)maintain public confidence in the profession.
4-19 c. A CPA's retention of client records as a means of enforcing payment of an overdue audit fee is an action that is 1. not addressed by the AICPA Code of Professional Conduct. 2. acceptable if sanctioned by the state laws. 3. prohibited under the AICPA rules of conduct. 4. a violation of generally accepted auditing standards.
(3)prohibited under the AICPA rules of conduct.
4-18 a. (Objectives 4-5, 4-6) The following questions concern auditor independence. Choose the best response. What is the meaning of the rule that requires the auditor be independent? 1. The auditor must adopt a critical attitude during the audit. 2. The auditor's sole obligation is to third parties. 3. The auditor may have a direct ownership interest in the client's business if it is not material. 4. The auditor must be without bias with respect to the client under audit.
(4) The auditor must be without bias with respect to the client under audit.
3-20 a. Objectives 3-1, 3-2, 3-3, 3-4, 3-8) The following questions concern unmodified opinion audit reports. Choose the best response. Which of the following is not a required element of a standard unmodified opinion audit report issued in accordance with AICPA auditing standards? 1. A title that emphasizes the report is from an independent auditor 2. The city and state of the audit firm issuing the report 3. A statement explaining management's responsibilities for the financial statements 4. The name of the engagement partner
(4) The name of the engagement partner
3-22 a. The following questions concern audit reports other than unmodified opinion audit reports with standard wording. Choose the best response. As compared to an unmodified opinion, an opinion qualified due to a material departure from generally accepted accounting principles would 1. include an extra paragraph in the opinion section. 2. include a slight modification to the auditor's responsibility section. 3. include a slight modification to the introductory paragraph in the opinion section. 4. indicate that, except for the problem noted, the financial statements are presented fairly
(4) indicate that, except for the problem noted, the financial statements are presented fairly
3-20c. If a principal auditor decides to refer in his or her report to the audit of another auditor, he or she is required to disclose the 1. name of the other auditor. 2. nature of the inquiry into the other auditor's professional standing and extent of the review of the other auditor's work. 3. reasons for being unwilling to assume responsibility for the other auditor's work. 4. portion of the financial statements audited by the other auditor.
(4) portion of the financial statements audited by the other auditor.
3-21b. When the financial statements are fairly stated but the auditor concludes there is substantial doubt whether the client can continue in existence, the auditor should issue a(n) 1. adverse opinion. 2.qualified opinion only. 3. unmodified opinion. 4. unmodified opinion with explanatory paragraph.
(4)unmodified opinion with explanatory paragraph.
Parts of AICPA Code of Professional Conduct
(Look at Table 4-1.......pg. 89 ) Preface to all Members (Principles) Part I - Members in Practice Part II - Members in Business Part III - Other Members
3-25 (Objectives 3-4, 3-5, 3-6, 3-7, 3-8) The following are independent situations for which you will recommend an appropriate audit report: 1. Subsequent to the date of the financial statements as part of his post-balance sheet date audit procedures, a CPA learned that a recent fire caused heavy damage to one of a client's two plants; the loss will not be reimbursed by insurance. The newspapers described the event in detail. The financial statements and footnotes as prepared by the client did not disclose the loss caused by the fire. 2. During the course of his audit of the financial statements of a corporation for the purpose of expressing an opinion on the statements, a CPA is refused permission to inspect the minutes of board of directors' meetings that document significant decisions of the board. The corporation secretary instead offers to give the CPA a certified copy of all resolutions and actions involving accounting matters. 3. A CPA is engaged in the audit of the financial statements of a large manufacturing company with branch offices in many widely separated cities. The CPA was not able to count the substantial undeposited cash receipts at the close of business on the last day of the fiscal year at all branch offices. As an alternative to this auditing procedure used to verify the accurate cutoff of cash receipts, the CPA observed that deposits in transit as shown on the year-end bank reconciliation appeared as credits on the bank statement on the first business day of the new year. He was satisfied as to the cutoff of cash receipts by the use of the alternative procedure. 4. On January 2, 2020, the Retail Auto Parts Company received a notice from its primary supplier that effective immediately, all wholesale prices will be increased by 10 percent. On the basis of the notice, Retail Auto Parts revalued its December 31, 2019, inventory to reflect the higher costs. The inventory constituted a material proportion of total assets; however, the effect of the revaluation was material to current assets but not to total assets or net income. The increase in valuation is adequately disclosed in the footnotes. 5. A CPA has completed her audit of the financial statements of a bus company for the year ended December 31, 2019. Prior to 2019, the company depreciated its buses over a 10-year period. During 2019, the company determined that a more realistic estimated life for its buses was 12 years and computed the 2019 depreciation on the basis of the revised estimate. The CPA has satisfied herself that the 12-year life is reasonable. The company has adequately disclosed the change in estimated useful lives of its buses and the effect of the change on 2019 income in a note to the financial statements. 6. E-Lotions.com, Inc., is an online retailer of body lotions and other bath and body supplies. The company records revenues at the time customer orders are placed on the website, rather than when the goods are shipped, which is usually two days after the order is placed. The auditor determined that the amount of orders placed but not shipped as of the balance sheet date is not material. For each situation, do the following: Required a. Identify which of the conditions requiring a deviation from a standard unmodified opinion audit report is applicable, if any. b. State the level of materiality as immaterial, material, or highly material. If you cannot decide the level of materiality, state the additional information needed to make a decision. c. Given your answers in parts a. and b., state the appropriate audit report from the following alternatives (if you have not decided on one level of materiality in part b., state the appropriate report for each alternative materiality level): 1. Unmodified opinion—standard wording 2. Unmodified opinion—explanatory paragraph 3.Unmodified opinion—nonstandard report wording 4.Qualified opinion—GAAP departure 5. Qualified opinion—scope limitation 6. Disclaimer 7. Adverse*
(a)CONDITION (b)MATERIALITY LEVEL (c)TYPE OF REPORT COMMENTS 1. Failure to follow GAAP. Highly material or material, depending upon the amount of the loss and the auditor's preliminary judgment about materiality (7) Adverse (if highly material) or (4) Qualified opinion — GAAP departure (if material) Disclosure of this information is required in a footnote. Failure to do so is a violation of GAAP and is likely to result in a qualified opinion, or it could be so material that it requires an adverse opinion. 2. Scope of the audit has been restricted. Highly material (6) Disclaimer Failure of the client to allow the auditor to inspect the board minutes would be a material client-imposed restriction. Due to the importance of the minutes, a disclaimer would be necessary. The certified copy of all resolutions and actions would not be a satisfactory alternative procedure. 3. Scope of the audit has been restricted. Not applicable (1) Unmodified opinion—standard wording Because the auditor was able to obtain alternative evidence, no scope qualification is necessary. If there were such a qualification, the opinion would be qualified or a disclaimer, depending on materiality. 3-25 (continued) (a)CONDITION (b)MATERIALITY LEVEL (c)TYPE OF REPORT COMMENTS 4. Failure to follow GAAP. Material (4) Qualified opinion only—GAAP departure Retail Auto Parts has used replacement cost inventory rather than lower of cost or market. It is not sufficiently material to require an adverse opinion. 5. None Not applicable (1) Unmodified opinion—standard wording The change of estimated life is a change of condition and not a change in accounting principles. Therefore, an unmodified opinion is appropriate since there is adequate disclosure. 6. Failure to follow GAAP. Immaterial (1) Unmodified opinion—standard wording The amount is immaterial.
Objectives 3-4, 3-5, 3-6, 3-7, 3-8) For the following independent situations, assume that you are the audit partner on the engagement: 1. A number of frozen yogurt stores have opened in the last few years and your client, YogurtLand, has experienced a noticeable decline in customer traffic over the past several months that has caused you to have substantial doubt about YogurtLand's ability to continue as a going concern. 2. Intelligis Electronics is a manufacturer of advanced electrical components. During the year, changes in the market resulted in a significant decrease in the demand for their products, which are now being sold significantly below cost. Management refuses to write off the products or to increase the reserve for obsolescence. 3. In the last 3 months of the current year, Oil Refining Company decided to change direction and go significantly into the oil drilling business. Management recognizes that this business is exceptionally risky and could jeopardize the success of its existing refining business, but there are significant potential rewards. During the short period of operation in drilling, the company has had three dry wells and no successes. The facts are adequately disclosed in footnotes. 4. Your client, Harrison Automotive, has changed from straight-line to sum-of-the-years' digits depreciation. The effect on this year's income is immaterial, but the effect in future years may be highly material. The change is not disclosed in the footnotes. 5. Circumstances prevent you from being able to observe the counting of inventory at Brentwood Industries. The inventory amount is material in relation to Brentwood Industries' financial statements. But, you were able to perform alternative procedures to support the existence and valuation of the inventory at year-end. 6. Approximately 20 percent of the audit of Lumberton Farms, Inc., was performed by a different CPA firm, selected by you. You have reviewed their audit files and believe they did an excellent job on their portion of the audit. Nevertheless, you are unwilling to take complete responsibility for their work. Required For each situation, do the following: a. Identify which of the conditions requiring a deviation from a standard unmodified opinion audit report is applicable, if any. b. State the level of materiality as immaterial, material, or highly material. If you cannot decide the level of materiality, state the additional information needed to make a decision. c. Given your answers in parts a. and b., state the appropriate audit report from the following alternatives (if you have not decided on one level of materiality in part b., state the appropriate report for each alternative materiality level): 1. Unmodified opinion—standard wording 2. Unmodified opinion—explanatory paragraph 3. Unmodified opinion—nonstandard report wording 4. Qualified opinion only—GAAP departure 5. Qualified opinion—scope limitation 6. Disclaimer 7. Adverse*
(a)CONDITION (b)MATERIALITY LEVEL (c)TYPE OF REPORT COMMENTS 1. Substantial doubt about going concern Material (2) Unmodified ─ Emphasis-of-matter explanatory paragraph Because the auditor has substantial doubt about the client's ability to continue as a going concern, the auditor should add an explanatory paragraph to the unmodified opinion. 2. Failure to follow GAAP Material or Highly material (more information is needed about the size of the misstatement) (4) Qualified opinion only—GAAP departure (7) Adverse The failure to reduce the value of the inventory for a decline in value is a departure from GAAP. 3-26 (continued) 3. None Not applicable (1) Unmodified— standard wording There is no indication questioning the ability of the business to continue operations. The auditor does not add an explanatory paragraph simply because there is a risky business, but the auditor could choose to emphasize this matter in an explanatory paragraph. 4. Change in accounting principle Immaterial (1) Unmodified— standard wording The change in accounting principle is immaterial and thus disclosure is not required. 5. Scope of the audit has been restricted Material or Highly material (1) Unmodified—standard wording The scope of the audit was initially restricted, but the auditor was able to satisfy himself or herself by alternative procedures. 6. Report involving other auditors Material (3) Unmodified— nonstandard report wording This is a shared audit report in which the auditor will identify the portion of work done by the other auditor in the auditor's responsibility paragraph and still issue an unmodified opinion. The absolute dollar amounts of assets and revenues or percentages must be stated.
Direct vs. Indirect ownership in respect. to independence
1. Direct Ownership - Partner or spouse or immediate family member - materiality is irrelevant Indirect Ownership - Partner has stock in a mutual fund (example) close but not direct. Materiality should be considered!
Principles of Professional Conduct (Table 4-2......pg. 90) Must know all six
1. Responsibilities In carrying out their responsibilities as professionals, members should exercise sensitive professional and moral judgments in all their activities. 2. The Public Interest Members should accept the obligation to act in a way that will serve the public interest, honor the public trust, and demonstrate a commitment to professionalism. 3. Integrity To maintain and broaden public confidence, members should perform all professional responsibilities with the highest sense of integrity. 4. Objectivity and Independence A member should maintain objectivity and be free of conflicts of interest in discharging professional responsibilities. A member in public practice should be independent in fact and appearance when providing auditing and other attestation services. 5. Due Care A member should observe the profession's technical and ethical standards, strive continually to improve competence and quality of services, and discharge professional responsibility to the best of the member's ability. 6. Scope and Nature of Services A member in public practice should observe the principles of the Code of Professional Conduct in determining the scope and nature of services to be provided.
Rules of Conduct
100- Integrity and objectivity ( Members in public practice & Members i n business) In the performance of any professional service, a member shall maintain objectivity and integrity, shall be free of conflicts of interest, and shall not knowingly misrepresent facts or subordinate his or her judgment to others. 200 ( Members in public practice) Independence A member in public practice shall be independent in the performance of professional services as required by standards promulgated by bodies designated by the Council. 300 ( Members in public practice & Members in business) General standards A member shall comply with the following standards and with any interpretations thereof by bodies designated by the Council: (1) undertake only those professional services that the member or member's firm can reasonably expect to be completed with professional competence, (2) exercise due professional care, (3) adequately plan and supervise all engagements, and (4) obtain sufficient relevant data to afford a reasonable basis for all conclusions or recommendations. 310 Compliance with standards ( Members in public practice & Members i n business) A member who performs auditing, review, compilation, preparation, management consulting, tax, or other professional services shall comply with standards promulgated by bodies designated by Council. 320 Accounting principles ( Members in public practice & Members i n business) A member shall follow the professional audit reporting standards promulgated by bodies designated by Council in issuing reports about entities' compliance with generally accepted accounting principles. 400 Acts discreditable ( Members in public practice, Members i n business, other members) A member shall not commit an act discreditable to the profession. 510 Contingent fees ( Members in public practice) A member in public practice shall not perform for a contingent fee any professional service if the member also performs for the client an audit, review, or certain compilations of financial statements, or an examination of prospective financial statements. A member in public practice also shall not prepare an original or amended tax return or claim for a tax refund for a contingent fee for any client. 520 Commissions and referral fees ( Members in public practice) A member in public practice shall not receive or pay a commission or referral fee for any client if the member also performs for the client an audit, review, or certain compilations of financial statements, or an examination of prospective financial statements. For nonprohibited commissions or referral fees, a member must disclose the existence of such fees to the client. 600 Advertising and other forms of solicitation X A member in public practice shall not seek to obtain clients by advertising or other forms of solicitation in a manner that is false, misleading, or deceptive. Solicitation by the use of coercion, overreaching, or harassing conduct is prohibited. 700 Confidential client information ( Members in public practice) A member in public practice shall not disclose any confidential client information without the specific consent of the client, except for the four specific situations included in the rule. 800 Form of organization and name ( Members in public practice) A member may practice public accounting only in a form of organization permitted by state law or regulation whose characteristics conform to resolutions of the Council and shall not practice public accounting under a firm name that is misleading.
Each of the following situations involves a possible violation of the AICPA Code of Professional Conduct. For each situation, state the applicable rule of conduct and whether it is a violation. a. Stefan, CPA, provides tax services, management advisory services, and bookkeeping services and also conducts audits for the same nonpublic client. Because the firm is small, the same person often provides all the services. b.Roberta Marteens is a CPA, but not a partner, with three years of professional experience with Johnson and Batchelor, CPAs. She owns 25 shares of stock in an audit client of the firm, but she does not take part in the audit of the client, and the amount of stock is not material in relation to her total wealth. c. A nonaudit client requests assistance of Taylor Bordeaux, CPA, in the installation of a local area network. Bordeaux has no experience in this type of work and no knowledge of the client's computer system, so she obtains assistance from a computer consultant. The consultant is not in the practice of public accounting, but Bordeaux is confident of her professional skills. Because of the highly technical nature of the work, Bordeaux is not able to review the consultant's work. d. In preparing the personal tax returns for a client, Sarah Milsaps, CPA, observed that the deductions for contributions and interest were unusually large. When she asked the client for backup information to support the deductions, she was told, "Ask me no questions, and I will tell you no lies." Milsaps completed the return on the basis of the information acquired from the client. e. Silvia Panster, CPA, set up a casualty and fire insurance agency to complement her auditing and tax services. She does not use her own name on anything pertaining to the insurance agency and has a highly competent manager, Meg Emrich, who runs it. Panster often requests Emrich to review the adequacy of a client's insurance with management if it seems underinsured. She believes that she provides a valuable service to clients by informing them when they are underinsured. f. Seven small Austin, Texas, CPA firms have become involved in an information project by taking part in an interfirm working paper review program. Under the program, each firm designates two partners to review the audit files, including the tax returns and the financial statements, of another CPA firm taking part in the program. At the end of each review, the auditors who prepared the working papers and the reviewers have a conference to discuss the strengths and weaknesses of the audit. They do not obtain authorization from the audit client before the review takes place. g. Francisco Hernandez, CPA, serves as controller of a U.S.-based company that has a significant portion of its operations in several South American countries. Certain government provisions in selected countries require the company to file financial statements based on international standards. Francisco oversees the issuance of the company's financial statements and asserts that the statements are based on international financial accounting standards; however, the standards he uses are not those issued by the International Accounting Standards Board.
4-23 a. Independence Rule - no violation, assuming Stefan has evaluated the threats and client management assumes appropriate responsibility for the services, including providing strategic direction for the advisory services and preparing source documents for the bookkeeping services. b.Independence - no violation. Marteens is not a partner nor is she assigned to the engagement team for the audit client. c. General Standards rule - violation. A member who accepts a professional engagement implies that he or she has the necessary competence to complete the engagement according to professional standards. Bordeaux has violated the rule since she does not have the expertise to review the work of the consultant hired by Bordeaux. Bordeaux should have suggested that the company hire the consultant directly. d. Integrity and Objectivity - violation. This rule states that in tax practice, a member may resolve doubt in favor of his or her client as long as there is reasonable support for his or her position. In the example case, the client has provided no support for the unusual deductions. Milsaps has violated the rule on integrity and objectivity by not requiring reasonable support for the deductions. e. Independence and Integrity and Objectivity - violation. Appearance of independence has been impaired by Panster's agency's financial dealing with her audit clients and participation in a business, which impairs her objectivity. It is also a conflict of duties to recommend her own firm to review the adequacy of the insurance coverage of existing clients. f. Confidential Client Information - violation. The client should have been notified that the review was to take place, and an attempt made to obtain the client's permission for such review since the review was not a part of an AICPA, state CPA society, or Board of Accountancy review program. The firms violated the rule on confidential client information by not obtaining consent from the client for the review. g. Accounting Principles - violation. This rule designates that the International Accounting Standards Board (IASB) is the established body for issuing international financial accounting standards. Hernandez's assertion that the financial statements are based on international financial accounting standards would be in violation of the accounting principles rule because he did not use standards issued by the IASB.
Unmodified Opinion with Explanatory Paragraph or Modified Wording 5 common causes for this type of report
5 common causes
Materiality
A misstatement in the financial statements can be considered material if knowledge of the misstatement would affect a decision of a reasonable user of the financial statements. (Look at Table 3-1........pg. 65 )
Audit Report
Actually the final step in the audit process - Why study it now? It is used to explain the "character" of the auditor's work and "degree" of responsibility taken for the financial statements.
Focus on Rule 200 Independence
Applies to auditors only - other professionals do not need to be independent Independence in Fact/of Mind and Independence in Appearance · A CPA must be independent (unbiased) when performing professional services that are attestation services (audits & review, for example) They need not be independent for tax & mgmt. services, for the most part. They need an Unbiased Viewpoint and need to be Competent
Reports over Internal Controls over Financial Reporting
Auditors of larger public companies must also issue an opinion on internal control over financial reporting. This can be done as a separate or a combined report. (See Figure 3-4 pg. 56 ,for the separate report.) Larger public companies are known as "accelerated filers". Non- accelerated filers (smaller companies) do not need this report on internal controls over financial reporting.
Rule 200 Applies to partners & shareholders and Covered Members - they cannot hold direct ownership (materiality is irrelevant) or indirect ownership in an audit client (if material). See key list of covered members on page 95 of text.
Covered Members The prohibition on direct financial interests applies to covered members in a position to influence an attest engagement. Covered members include the following: 1. Individuals on the attest engagement team 2. An individual in a position to influence the attest engagement, such as individuals who supervise or evaluate the engagement partner 3. A partner or manager who provides more than 10 hours of nonattest services to the client in a fiscal year 4. A partner in the office of the partner responsible for the attest engagement 5. The firm and its employee benefit plans 6. An entity that can be controlled by any of the covered members listed above or by two or more of the covered individuals or entities operating together
6-8 In respect to independence
Director, Officer or Management of a company is not allowed. Honorary directors for not-for-profit is o.k. Lawsuit or intent to sue between CPA firm & client Can they remain objective?? Litigation either way affects current year audit...... but tax and allowable consulting are usually Not impacted if amounts are immaterial and if both CPA firm and client are sued together by a third party independence is not impaired. Bookkeeping and Auditing Cannot do both bookkeeping and audit for public companies but for private companies you can. The CPA firm must be careful not to be performing any management duties in the process, however. Unpaid Fees Independence is impaired if fees go back 1 year before the report date - this would be considered a Loan!
Code of Professional Conduct
Establishes right and wrong behavior for CPA's Why is it needed? To contr ol actions, behaviors of members for good of society What makes a CPA a professional? Holding self to higher standard than society requires So, once again, why is it needed? Most financial statement users do not fully understand professional services due to their complexity, so they rely on professionals (CPA's) to ensure everything is operating properly. "Not everyone can analyze financial statements, but they can look at an unqualified opinion report and assume the auditor could"
Next of Kin ( related to independence)
Immediate - spouse, spousal equivalent, dependent children Close Family - non-dependent children, in laws, siblings - here materiality matters: knowledge of ownership matters If immediate or close family member holds a key financial employee role at the client independence is considered impaired
KAM's -
Key Audit Matters, can be used but are NOT required. They go below the Basis for Opinion Section if utilized.
Public Company Reports - (Figure 3-3, p. 54)
Let's focus on some differences. Use of Unqualified vs Unmodified The overall Standard report is actually different Internal control over financial reporting report is required for large companies. CAM's required, vs. KAM's allowed
Financial Institutions (in respect. to independence )
Loans in general are not allowed....new loans are never allowed. But there are exceptions: car loans, credit cards less than $10,000, fully collateralized loans, immaterial loans, mortgage loans These are the types of loans that keep an economy moving.
CAM's - Critical Audit Matters - Required for PCAOB audits
PCAOB expects at least one, but this sparks an interesting conversation. Each Critical Audit matter requires: Identification of the matter Description of why the matter/issue was considered critical Description of how the CAM was addressed during audit Description of what accounts/disclosures were impacted
Standard Unmodified
Pg. 51 lists 4 requirements that must be met before an unqualified opinion can be issued 1. All statements—balance sheet, income statement, statement of changes in stockholders' equity, and statement of cash flows—as well as required disclosures, are included in the financial statements. 2. Sufficient appropriate evidence has been accumulated, and the auditor has conducted the engagement in a manner that enables him or her to conclude that the audit was performed in accordance with the applicable auditing standards. 3. The financial statements are presented fairly in all material respects in accordance with U.S. generally accepted accounting principles or other appropriate accounting framework. This also means that adequate disclosures have been included in the footnotes and other parts of the financial statements. 4. There are no circumstances requiring the addition of an emphasis-of-matter paragraph or modification of the wording or auditor's opinion in the report.
8 basic parts to a standard unmodified audit report for Non-Public Companies
Report Title - Word independent must be used Address - To the board of directors/stockholders Opinion Section - Goes first, due to importance. Opinion, not guarantee. Basis for Opinion - According to GAAS, Independent and Ethical Management's Responsibility - Management and those in charge of governance Auditor's Responsibility - Auditor's responsibility as defined in three paragraphs. 1. Reasonable Assurance/not a guarantee. 2. Scope/Evidence/Risk. 3. Communicates with those in charge of governance. Name(Signature) and Address of CPA Firm- CPA firm name, City/State Audit Report Date- last date of audit procedures
4-22 The following situations involve the provision of nonaudit services. Indicate whether providing the service is a violation of AICPA rules or SEC rules including Sarbanes-Oxley requirements on independence. Explain your answer as necessary. a. Providing advice to a private company client on accounting for a merger with another private company. b. Providing bookkeeping services to a private company. The source documents were prepared and authorized by the client. c. Providing internal audit services to a public company that is not an audit client. d. Implementing a financial information system designed by management for a private company. e. Recommending a tax shelter to a client that is publicly held. The services were preapproved by the audit committee. f. Providing bookkeeping services to a public company. The services were preapproved by the audit committee of the company. g. Providing internal audit services to a public company audit client with the preapproval of the audit committee.
Service Violation? a. Providing advice to a private company client on accounting for a merger with another private company No b. Providing bookkeeping services to a private company. The source documents were prepared and authorized by the client. No c. Providing internal audit services to a public company that is not an audit client. No d. Implementing a financial information system designed by management for a private company. No e. Recommending a tax shelter to a client that is publicly held. The services were pre-approved by the audit committee. No * f. Providing bookkeeping services to a public company. The services were preapproved by the audit committee of the company. Yes g. Providing internal audit services to a public company client with the preapproval of the audit committee. Yes Recommending tax shelters is not prohibited as long as the service does not meet the characteristics of an abusive tax avoidance strategy and does not have the potential to impair independence.
Signature, Tenure, Address of Audit Firm for Public Companies
Signature - CPA firm (engagement partner name is allowed, not required) Tenure - Year audit firm began serving the client is required Address - City/State
International Accounting & Auditing Standards Now & Future Study Objective 3-9 from text pg. 73
The increasing globalization of the world's capital markets and the expanding presence of business operations in multiple countries are leading to calls for the establishment of a single set of accounting standards to be used around the world. IFRS is increasingly accepted worldwide as the basis of accounting used to prepare financial statements in other countries. U.S. public companies are required to prepare financial statements that are filed with the SEC in accordance with generally accepted accounting principles in the United States, but foreign companies listed on U.S. exchanges are allowed to report under IFRS. It is uncertain whether or when the SEC will allow U.S. companies to report using IFRS or provide IFRS financial statements as supplemental information. An auditor may be engaged to report on financial statements prepared in accordance with IFRS. When the auditor reports on financial statements prepared in conformity with IFRS, the auditor refers to those standards rather than U.S. generally accepted accounting principles as follows: In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Carlos Incorporated as of December 31, 2019 and 2018, and the results of its operations, comprehensive income, changes in equity, and its cash flows for the years then ended in conformity with International Financial Reporting Standards as issued by the International Accounting Standards Board.
Must Know the Basic Threats to Compliance of the Code of Professional Conduct. (Table 4-3.....p. 91) Must know all seven
Threat\Definition\ Example of a Threat 1. Adverse interest The threat that a member will not act with objectivity because the member's interests are opposed to the attest client's interests. An officer, director, or significant shareholder participates in litigation against the firm. 2. Advocacy The threat that a member will promote an attest client's interest or position to the point that his or her objectivity or independence is compromised. A member endorses an attest client's services or products. 3. Familiarity The threat that, due to a long or close relationship with an attest client, a member will become too sympathetic to the client's interest or too accepting of the client's work or product. A member's close friend is employed by the client. 4. Management participation The threat that a member will take on the role of an attest client management or otherwise assume management responsibilities, such as may occur during an engagement to provide nonattest services. Due to a loss of client personnel, the attest client asks a member firm to assist with accounting activities, including the authorization of transactions. 5. Self-interest The threat that a member could benefit, financially or otherwise, from an interest in, or relationship with, an attest client or persons associated with the client. The member has a financial interest in an attest client, and the outcome of a professional services engagement may affect the fair value of the financial interest. 6. Self-review The threat that a member will not appropriately evaluate the results of a previous judgment or service performed or supervised by the member or an individual in the member's firm and that the member will rely on that service in forming a judgment as part of another service. The member performs bookkeeping services for the attest client and then performs an audit of those financial statements. 7. Undue influence The threat that a member will subordinate his or her judgment to an individual associated with a client or any relevant third party due to that individual's reputation or expertise, aggressive or dominant personality, or attempts to coerce or exercise excessive influence over the member. The client indicates that it will not award additional engagements to the firm if the firm continues to disagree with the client on an accounting or tax matter.
Rule 200 Independence - Specific to Sarbanes Oxley / Publicly traded clients
· 9 prohibited services: If you are auditing a public company you cannot audit and do 9 specific services! The list is on pg. 98 · Audit Committees - help auditors stay independent of management. (3,5,7, etc.). They must approve all audit and non-audit work. · Cooling off period - A CPA firm cannot continue with a client if an auditor of the CPA firm takes CEO, CFO, controller type job if that auditor worked on an audit at all one year prior to the start of the audit. (Assistants are o.k.) · A former partner or shareholder cannot be an employee of a client if the partner/shareholder is still "claimed" as an associate of the CPA firm or if there is participation in key firm events or involvement in key decision making processes. · Partners - 5 years on ....5 years off! Lead and Concurring Partner (concurring does review at end). Sub partner is 7 years on ....2 years off. Audit firms need not rotate, just the partner, but the European Union is now requiring firm rotation as well. · Those who can influence an audit are not permitted to have financial ownership in a client. a) Members of audit engagement team b) Those in position to influence engagement due to chain of command c) Any partner or manager who does 10 or more hours of non-audit service for the client d) Partners in the office of the partner mainly in charge of the engagement · A new CPA firm ( a firm that replaced and existing firm) needs to be cautious not to be considered aiding "opinion shopping". Meaning, no saying the CPA firm will take a certain stance on an accounting topic in order to get the work, but changing its stance after solidifying the client.
Organizations that Enforce these rules of conduct:
· AICPA · State Board of Accountancy · PCAOB