Chapter 1 AUDIT

Generally accepted accounting principles (GAAP)

Concepts or standards established by such authoritative bodies as the FASB and the GASB and accepted by the accounting profession as essential to proper financial reporting.

Fraud

Intentional misstatement of financial statements by management (fraudulent financial reporting), or theft of assets by employees (employee fraud). Fraud also is referred to as irregularities.

Applicable financial reporting framework

The financial reporting framework adopted by management and, where 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 objectives of the financial statements, or that is required by law or regulation.

Public Company Accounting Oversight Board (PCAOB)

The five-member board established in 2002 to oversee the audit of public (issuer) companies that are subject to the securities laws. The board has authority to establish or adopt, or both, rules for auditing, quality control, ethics, independence, and other standards relating to the preparation of audit reports.

American Institute of Certified Public Accountants (AICPA)

The national professional organization of CPAs engaged in promoting high professional standards to ensure that CPAs serve the public interest.

Audit committee

A committee of a corporation's board of directors that engages, compensates, and oversees the work of the independent auditors, monitors activities of the internal auditing staff, and intervenes in any disputes between management and the independent auditors. Members of the audit committee must be independent directors, that is, members of the board of directors who do not also serve as corporate officers or have other relationships that might impair independence.

Financial reporting framework

A set of criteria used to determine measurement, recognition, presentation, and disclosure of all material items appearing in the financial statements: For example, accounting principles generally accepted in the United States of America, or International Financial Reporting Standards (IFRS) issued by the International Accounting Standards Board (IASB).

Sarbanes-Oxley Act of 2002

A set of reforms that toughened penalties for corporate fraud, restricted the kinds of consulting CPAs can perform for audit clients, and created the Public Company Accounting Oversight Board to oversee CPAs and public accounting firms.

Many people confuse the responsibilities of the independent auditors and the client's management with respect to audited financial statements. a. Describe management's responsibility regarding audited financial statements. b. Describe the independent auditors' responsibility regarding audited financial statements. c. Evaluate the following statement: "If the auditors disagree with management regarding an accounting principle used in the financial statements, the auditors should express their views in the notes to the financial statements."

a. Management has primary responsibility for the fairness of the financial statements and internal control. b. The auditors are responsible for performing an independent audit of the financial statements and issuing a report on them in accordance with generally accepted auditing standards. c. The statement if false. The notes to the financial statements should contain only representations of management. The auditors should express their reservations in their report.

The Sarbanes-Oxley Act of 2002 made significant reforms for public companies and their auditors. a. Describe the events that led up to the passage of the Act. b. Describe the major changes made by the Act.

a. The events leading up to the passage of the Sarbanes-Oxley Act include: • A large number of misstatements of financial statements, many of which resulted from fraudulent financial reporting. Notably including WorldCom and Enron. • The conviction of the Big 5 accounting firm of Arthur Andersen on charges of destroying evidence. b. The major reforms made the Act include: • Tougher penalties for fraud. • Restrictions on the types of consulting services that may be provided by auditors to their public audit clients. • The creation of the Public Company Accounting Oversight Board to establish auditing standards and oversee accounting firms that audit public companies. • Requirements for management to make a assertion about the effectiveness of internal control. • Requirements for auditors of public companies to audit and report on internal control