56 terms

Auditing Chapter 2

Purpose of Generally Accepted Auditing Standards (GAAS)
to obtain reasonable assurance about whether the financial statements as a whole are free of material misstatement, whether due to fraud or error, thereby enabling auditors to express an opinion on whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework; to report on the financial statements, and communicate as required by GAAS, in accordance with the auditor's findings
in a sense, auditors must conduct a GAAS audit to determine whether the company's financial statements are prepared according to GAAP
3 broad categories of standards and respective fundamental principles
general standards--responsibilities principle; standards of field work--performance principle; standards of reporting--reporting principle
general standards
(1) the auditor must have adequate technical training and proficiency to perform the audit; collectively as an audit team (2) the auditor must maintain independence (in fact and appearance) in mental attitude in all matters relating to the audit (3) the auditor must exercise due professional care in the performance of the audit and the preparation of the report
standards of field work
(1) the auditor must adequately plan the work and must properly supervise and assistants (2) the auditor must obtain sufficient understanding of the entity and its environment, including its internal control, to assess the risk of material misstatement of the financial statements whether due to error or fraud, and to design the nature, timing, and extent of further audit procedures (3) the auditor must maintain sufficient appropriate evidence by performing audit procedures to afford a reasonable basis for an opinion regarding he financial statements under audit
standards of reporting
(1) Must state in auditor's report whether financial statements are presented in accordance with GAAP (2) Auditor must identify in auditor's report those circumstances in which such principles have not been consistently observed in the current period in relation to preceding period (3) When auditor determines that informative disclosures are not reasonably adequate, auditor must state so in the auditor's report (4) Auditor must either express an opinion regarding the financial statements, taken as a whole, or state an opinion cannot be expressed, in the auditor's report. When auditor cannot express opinion, auditor should state reasons therefore in the auditor's report. In all cases where an auditor's name is associated with financial statements, auditor should clearly indicate the character of the auditor's work, if any, and the degree of responsibility the auditor is taking.
audit procedures
the particular and specialized actions that auditors take to obtain evidence in a specific audit engagement
auditing standards
audit quality guides that remain the same through time and for all audits
What is meant by GAAS
measures of the quality of the auditor's performance
responsibilities principle
relates to the personal integrity and professional qualifications of auditors; auditors are responsible for: -having appropriate competence and capabilities to perform the audit -complying with relevant ethical requirements (independence and due care) -maintaining professional skepticism and exercising professional judgement, throughout the planning and performance of the audit
competence and capabilities
begins with education at a university-level and are required to participate in continuing professional education throughout their careers, and finally experience
independence and due care
must maintain independence in mental attitude (state of mind), which is referred to as possessing independence in fact; also must maintain independence in appearance, which is how others perceive auditor's independence; due care reflects a level of performance that would be exercised by reasonable auditors in similar circumstances (this standard is often referred to as the prudent auditor)
professional skepticism
a state of mind that is characterized by appropriate questioning and a critical assessment of audit evidence; auditors don't assume anything, they evaluate and consider evidence and reliability of documents and information obtained from management
professional judgement
the application of relevant training, knowledge, and experience in making informed decisions about appropriate courses of action during the audit engagement
performance principle
contains five elements (1) reasonable assurance (2) planning and supervision (3) materiality (4) risk assessment (5) audit evidence
reasonable assurance concept
recognizes that a GAAS audit may not detect all material misstatements and auditors are not "insurers" or "guarantors" regarding the fairness of the company's financial statements; however, auditors should provide a high level of assurance (or confidence) regarding their work
Stages of an Audit
Obtain (or Retain) Engagement --> Engagement Planning --> Risk Assessment --> Audit Evidence --> Reporting
Planning and supervision considerations
concerned with (1) preparing an audit plan and supervising the audit work (2) obtaining knowledge of the client's business and (3) dealing with differences of opinion among the accounting firm's personnel
written Audit Plan
(formerly referred to as an audit program) and is a list of the audit procedures auditors need to perform to gather sufficient appropriate evidence on which to base their opinion on the financial statements; should be stated in enough detail to instruct the assistants about the work to be done
recognizes that auditors should focus on matters that are important to financial statement users; considered by the audit team in planning the audit, performing the audit, and evaluating the effect of misstatements on the entity's F/Ss
qualitative materiality
while the concept of materiality appears to be straightforward, the implementation of it requires high levels of professional judgement; ex. suppose a small dollar amount misstatement (in absolute terms) resulted in the company meeting its earnings expectations or resulted in a company reporting higher earnings than in the previous year, such impacts would likely influence investment decisions and thus should be considered material even though are small dollar amounts
risk assessment
important part of the performance principle and requires auditors to identify important concerns (or risks) that they face in the audit; requires an understanding of the client and its operating environment and includes internal controls operating within the client's accounting info systems that ultimately produce the F/Ss
internal control
defined simply as a system's capability to prevent or detect material accounting frauds or errors and provide for their correction on a timely basis
risk of material misstatement
a combination of inherent risk (the probability that a material misstatement, either an error or fraud, will occur) and control risk (the probability that a material misstatement, either an error or fraud, will not be prevented or detected on a timely basis by the entity's internal controls)
timing of auditor's appointment
important because auditor's need time to properly plan the audit and perform the necessary work without undue pressure from tight deadlines
Audit evidence
final element of the performance principle and is defined as all of the information used by auditors in arriving at the conclusions on which the audit is based (Ex., minutes of meetings, confirmations with independent third parties, invoices, analyst reports, and all other information that permits auditors to reach valid, logical conclusions)
"Appropriate" Evidence
must be relevant and reliable; relevance refers to the nature of information provided by the audit evidence; reliability refers to the extent of trust that auditors can place in evidence
more reliable evidence
when (1) it is obtained directly by auditors (rather than indirectly from other sources) (2) it is obtained from sources outside the entity rather than internal to the entity (3) the entity's internal controls are more effective rather than less effecctive
Evidence quality hierarchy (strongest to weakest)
(1) auditor's direct, personal knowledge, obtained through physical observation and auditor's own mathematical computations (2) documentary evidence obtained directly from external sources (external evidence) (3) documentary evidence that has originated outside the client's information processing system but has been received and processed by the client (external-internal evidence); considered reliable when internal control is strong (4) Internal evidence consisting of documents that are produced, circulated, and finally stored within the client's information system (considered low in reliability) (5) verbal evidence provided by the client's officers, directors, owners, and employees are generally considered the least reliable
verbal evidence
although considered to be weak, GAAS require that auditors obtain written corroboration from the client to emphasize management's responsibility for the fairness of the F/Ss (this is known as "management representation" or "written representation")
evidence sufficiency
relates to the quantity of evidence; no official standard, is a professional judgement call; real test is whether auditors can persuade others that their evidence is strong enough to reach the same conclusions they have reached
detection risk
represents the risk that the audit team's procedures will fail to detect a material misstatement; directly affects the sufficiency and appropriateness of evidence
Fundamental Reporting Principle
the ultimate objective of independent auditors - the report on the audit - is guided by this principle, which states: "based on evaluation of the evidence obtained, the auditor expresses an opinion in accordance with the auditor's findings, or states that an opinion cannot be expressed, in the form of a written report. The opinion states whether the F/Ss are prepared, in all material respects, in accordance with the applicable financial reporting framework."
financial reporting framework
set of criteria used to determine the measurement, recognition, presentation, and disclosure of material items inf the F/Ss; 3 examples of financial reporting frameworks are GAAP, IFRS, or a special purpose framework (such as cash or tax bases)
Unqualified report (or clean opinion)
expresses an unqualified opinion on the company's F/Ss; means "good" in the sense that auditors are not calling attention to anything wrong with the F/Ss; a company can have inadequate disclosure and still receive this opinion if it is immaterial
departures from GAAP
situations in which the entity's F/Ss (or elements within them) are materially misstated and do not present the entity's financial condition, results of operations, and cash flows in conformity with GAAP
adverse report
the opposite of an unqualified opinion and concludes that the company's F/Ss ARE NOT presented in conformity with GAAP (or DO NOT PRESENT FAIRLY)
qualified report
concludes that EXCEPT FOR a relatively isolated (usually limited) departure, the company's F/Ss are presented in conformity with GAAP; these can also be issued for auditor's inability to conduct a GAAS audit, which is a scope limitation
disclaimer of opinion
when auditor's do not express an opinion, can be because the auditor lacks independence or if a scope limitation is highly significant
elements of the auditor report
(1) report title (2) addressee (3) introductory paragraph (4) scope paragraph (5) opinion paragraph (6) explanatory paragraph; optional (7) internal control paragraph for public companies
date of report
last day of field work, referred to as the audit completion date
introductory paragraph
identifies the role of the auditors and of management in the financial reporting process
scope paragraph
indicates that the audits were conducted in accordance with PCAOB standards, which represent GAAS for public companies; describes the audit and suggests a sampling approach; includes the words reasonable basis and reasonable assurance
opinion paragraph
"...in all material respects..." the concept of materiality communicates that the audit team is unaware of any material misstatements in the F/Ss, choice of report depends on the nature and materiality of the effect of the GAAP departure
explanatory paragraph
identifies new accounting standards that were implemented by the company during the period covered by the report; may add additional information to inform users of other matters
internal control paragraph
expresses the auditors' opinion on the effectiveness of internal control over financial reporting
scope limitation (departure from GAAS)
auditors must modify language to identify nature of scope limitation and modify language to identify information for which responsibility is not assumed; types of opinions issued: either a qualified opinion or a disclaimer of opinion (no opinion)
departure from GAAP
no modifications necessary to the work done by the auditors or the responsibilities assumed by the auditor; types of opinions issued: qualified opinion or adverse opinion
purpose of a 'system of quality control'
to provide the firm with reasonable assurance that the firm and its personnel: comply with professional standards and applicable regulatory and legal requirements, and issue reports that are appropriate in the circumstances
SQCS 7 six elements
(1) leadership ("tone at the top") (2) relevant ethical requirements (3) acceptance and continuance of clients (4) human resources (5) engagement performance (6) monitoring
leadership responsibilities for quality within the firm ("tone at the top")
to promote an internal culture that quality is essential in performing engagements, firms should: (a) assign management responsibilities in such a manner that commercial considerations do not override the quality of work performed (b) base performance evaluation, compensation, and promotion opportunities for personnel on the quality of work performed (c) devote sufficient resources for developing, communicating, and supporting the firm's quality control policies and procedures
relevant ethical requirements
(a) communicate independence requirements to personnel (b) identify circumstances and relationships that create threats to independence and take appropriate action to eliminate or reduce those threats to an acceptable level (c) obtain written confirmation from all firm personnel with respect to their compliance with appropriate independence requirements
acceptance and continuance of clients
(a) consider the integrity of the client and the identity and business reputation of its owners, key management, related parties, and those charged with governance (b) ascertain whether the firm possesses the competency, capability, and resources to perform the engagement (c) determine whether the firm can comply with necessary legal and ethical requirements
human resource policies and procedures
should address how firms: (a) recruit and hire (b) determine and enhance the capabilities and competencies of personnel (c) assign personnel to engagements (d) provide appropriate professional development opportunities for personnel (e) develop effective performance evaluation, compensation, and advancement procedures
engagement performance
firms should develop policies and procedures related to the performance of the engagement, supervision of personnel, and review of work performed; these processes also addresses how firms: (a) maintain confidentiality, safe custody, and retrievability of engagement documentation (b) retain engagement documentation for a sufficient period of time (c) engage in consultation with other offices of the firm when dealing with complex, unusual, or contentious issues (d) establish policies and procedures for resolving differences of opinion within the engagement team (e) establish quality control review that is done at all levels
purpose is to provide the firm with reasonable assurance that policies and procedures comprising the system of quality control are operating effectively and complied with in practice