Ch. 2 - The Financial Statement Auditing Environment

Question 1

Independence

Answer 1

A state of objectivity in fact and in appearance, including the absence of any significant conflicts of interest.

Question 2

What are the ____ main types of auditors?

Answer 2

1. External auditors
2. Internal auditors
3. Fraud auditors
4. Government auditors

Question 3

True or false: any auditor can sign an audit opinion on a public company’s financial statements in the US.

Answer 3

False; only a CPA can do so.

Question 4

What are the “the Es” of state requirements for CPAs?

Answer 4

Examination, Education, and Experience

Question 5

Where do government auditors typically work?

Answer 5

for the Government Accountability Office (GAO) and IRS

But they can also work for the DCAA (the Defense Contract Audit Agency), the Army Audit Agency, and the FBI

Question 6

What are types of audits performed by external, internal, fraud, and governement auditors?

Answer 6

1. Internal control audits
2. Compliance audits
3. Operational audits
4. Fraud audits

Question 7

True or false: an auditor may not express an opinion on the entity’s system of internal controls as part of a financial statement audit.

Answer 7

False–in fact, it is required for public companies to retain an external auditor to provide an opinion on the effectiveness of their internal controls (under the Sarbanes-Oxley Act of 2002).

Called an integrated audit

Question 8

What is an integrated audit?

Answer 8

An audit of both financial statements and internal control over financial reporting, provided by the external auditor. Required for public companies.

Question 9

Besides the four main types of financial/accounting audits, what other services do auditors provide?

Answer 9

–Attest services: these can be about anything; for example, an auditor could attest to hthe nature and quantity of inventory stored in an entity’s warehouse, or attest to the appropriate handling of hazardous waste.

–Assurance services: Examples include assuring family members that elderly members are being cared for properly, including their finances and assets.

–Tax prep and planning

–Management Advisory Services (MAS): Advice and assistance concerning an entity’s organization, HR, finances, operations, IT systems, and other activities. Also can include helping to implement internal controls in preparation for a financial statement audit by another public accounting firm.

–Bookkeeping and compilation services

Question 10

Public accounting firm

Answer 10

An organization created to provide professional accounting-related services, including auditing. Usually formed as a proprietorship or as a form of partnership.

Question 11

What are the options for business organization for CPA firms?

Answer 11

They can be organized as proprietorships, general or limited liability companies, or corporations

Question 12

True or false: structuring public accounting firms as proprietorships and ordinary general partnerships provides limited liability for the owners (aka partners).

Answer 12

False–it does NOT

In such cases, aggrieved parties can seek recourse not only again the CPA firm’s assets but also against the personal assets of individual partners.

Question 13

True or false: CPA firms typically try to organize as corporations when possible. Explain.

Answer 13

true, because of the risk of litigation when structured as a proprietorships, LLC, or LLP. However, some states do not allow CPA firms to be set up as corporations, which is why large national and international firms are usually set up as LLPs.

Question 14

True or false: under an LLP, partners are not personally responsible for liabilities arising from other partners and employees negligent acts.

Answer 14

True!

Question 15

What does SOX refer to?

Answer 15

The Sarbanes-Oxley Public Company Accounting Reform and Investor Protection Act
(passed by Congress in July 2002)

Question 16

What did/does SOX do/what is it resposible for?

Answer 16

SOX (Sarbanes-Oxley Act of 2002) started a process of broad reform in corporate governance processes.

With respect for the accounting profession, SOX effectively transferred authority to set an enforce auditing standing for public company audits to the Public Company Accounting Oversight Board (PCAOB)

It also mandated that:
-SEC impose strict independence rules prohibiting auditors from providing many types of non-auditing services to public company auditees
-Audit firms must rotate audit partners on audit engagements every 5 years
-Public companies must obtain an integrated audit
-Audit firms must undergo inspection by the PCAOB

Question 17

What does the Dodd-Frank Act do?

Answer 17

It amends SOX by granting authority to the PCAOB to inspect foreign audit firms that practice in the US or that have US auditees by exempting public companies with under $75 million market capitalization from the requirement to submit to an audit of internal control over financial reporting

Question 18

What is the technical definition of professional skepticism?

Answer 18

It is an attitude that includes a questioning mind and a critical assessment of audit evidence

Question 19

Corporate governance

Answer 19

The oversight mechanisms in place to help ensure the proper stewardship over an entity’s assets. Management and the board of directors play primary roles, and the independent auditor plays a key facilitating role.

Question 20

Board of directors

Answer 20

Persons elected by the stockholders of a corporation to oversee management and to direct the affairs of the corporation.

Question 21

Audit committee

Answer 21

A committee consisting of members of the board of directors, charged with overseeing the entity’s system of internal control over financial reporting, internal and external auditors, and the financial reporting process. Members typically must be independent of management.

Question 22

How many business process categories are there, and what are they?

Answer 22

5

1. The financing process
2. The purchasing process
3. The HR management process
4. The inventory management process
5. The revenue process

Question 23

Business processes

Answer 23

Processes implemented by management to achieve entity objectives. Business processes are typically organized into the following categories: financing processes, purchasing, human resource management, inventory management, and revenue.

Question 24

Explain in detail what SEC is and what it does

Answer 24

SEC stands for the Securities and Exchange Commission

It is a federal government agency that administers the Securities Act of 1933, the Securities Exchange Act of 1934, and the Sarbanes-Oxley Act of 2002, among others.

The SEC has overall responsibility to oversee the establishment of accounting and auditing standards in the US. The SEC recognizes the Financial Accounting Standards Board (FASB) as the accounting standard setter in the US and issues Staff Accounting Bulletins (SABs) to augment the FASB’s standards.

The SEC also oversees the Public Company Accounting Oversight Board (PCAOB)

Question 25

What does the Securities Act of 1933 do?

Answer 25

It regulates disclosure of material information in a registration statement for initial public offering of securities.

Question 26

What does the Securities Exchange Act of 1934 do?

Answer 26

It regulates ongoing reporting by companies whose securities are listed and traded on a stock exchange or companies that possess assets greater than 10milllion and whose equity securities are held by 500 or more persons. It mandates the use of 10K, 10Q, and 8K reports.

Question 27

What is an 8K?

Answer 27

It is filed whenever a “material corporate event” occurs, such as the sale of a division or a change in auditors.

Question 28

What is the PCAOB?

Answer 28

Public Company Accounting Oversight Board

It describes itself as “a nonprofit corporation established by Congress to oversee the audits of public companies in order to protect the interests of investors and further the public interest in the preparation of informative, accurate, and independent audit reports.”

In reality, it is a quasi-governmental agency overseen by the SEC

SOX transferred authority for standard se4tting for public company audits from the profession (as represented by the AICPA) to the PCAOB.. All public accounting firms providing audits for public companies are required to register with, ay fees to, and follow the rules and standards of the PCAOB.

Question 29

What is the AICPA?

Answer 29

American Institute of CPAs

The AICPA is a private professional association with over 431,000 members in over 130 different countries.

The most important of its functions is to the promulgation of rules and standards that guide audit and related services provided to non-public companies, government agencies such as states, counties, municipalities, and school districts, and other entities such as universities and not-for-profit organizations.

The AICPA also houses standing committees that issue professional rules and standards relevant to assurance providers. These include:
-The Code of Professional Conduct
-Quality control and peer review standards
-Attestation standards
-Compilation and review standards

**Responsible for preparing and grading the Uniform CPA exam

Question 30

What is the IAASB?

Answer 30

International Auditing and Assurance Standards Board

It issued the International Standards on Auditing (ISA) and is the predominantly recognized auditing standard setter outside the US, with its standards being used in over 130 international jurisdictions.

The AICPAs Auditing Standards Board converges its auditing standards with the IAASB’s standards to the extent possible, so these two sets of standards are largely similar.

Question 31

What is the FASB?

Answer 31

Financial Accounting Standards Board

The FASB is a privately funded body whose mission is to establish standards for financial accounting and reporting. The FASB’s Accounting Standards Codification (or ASC) is recognized by the SEC, the PCAOB, and the AICPA as the source of US GAAP.

Question 32

International Standards on Auditing (ISA)

Answer 32

Statements issued by IFAC’s International Auditing and Assurance Standards Board.

Question 33

Generally accepted accounting principles (GAAP)

Answer 33

Accounting principles that are generally accepted for the preparation of financial statements in the United States. GAAP standards are currently issued primarily by the FASB, with oversight and influence by the SEC. International Financial Reporting Standards (IFRS) are set by the International Accounting Standards Board.

Question 34

What is the IASB?

Answer 34

International Accounting Standards Board

The IASB is the international counterpart to the FASB. The IASB’s standards are the predominately recognized accounting standards outside the US.

The IASB is responsible for the development and publication of International Financial Reporting Standards (IFRS), and for approving interpretations of IFRS.

Question 35

What are the organizations that are responsible for setting auditing standards that are relevant for financial statement auditors in the US and internationally?

Answer 35

-the PCAOB
-the AICPA’s ASB
-the IFAC’s IAASB

Question 36

Smaller US accounting firms that focus on audits of nonpublic company entities (including private businesses, universities, not-for-profits, and other entities) adhere to _______ standards

Answer 36

Smaller US accounting firms that focus on audits of nonpublic company entities (including private businesses, universities, not-for-profits, and other entities) adhere to ASB standards

Question 37

Larger accounting firms in the US that audit both nonpublic entities and public entities must ensure they follow what standards?

Answer 37

Larger accounting firms in the US that audit both nonpublic entities and public entities must ensure they follow both ASB and PCAOB standards.

Question 38

What is the purpose of an audit according to GAAP?

Answer 38

The purpose of an audit is to provide financial statement users with an opinion by the auditor on whether the financial statements are presented fairly, in all material resects, in accordance with the applicable financial reporting framework (aka financial reporting framework set out by FASB, GASB, or IASB). An auditors opinion enhances the degree of confidence that the intended users can place in the financial statements.

Question 39

What are the responsibilities of the auditor according to GAAP?

Answer 39

Auditors are responsible for having appropriate competence and capabilities to perform the audit, complying with relevant ethical requirements, and maintaining professional skepticism, and exercising professional judgment, throughout the planning and performance of the audit.

Question 40

What is the value of an independent audit?

Answer 40

The value of an independent auditor’s opinion is that it can reduce information risk and thereby “enhance the degree of confidence that intended users can place in the financial statements.

Question 41

What does the “appropriateness” of evidence refer to audit evidence?

Answer 41

“Appropriateness” refers to the relevance and reliability of the evidence.

Question 42

Statements on Auditing Standards (SAS)

Answer 42

Statements issued by the AICPA’s Auditing Standards Board.

Question 43

Statements issued by the PCAOB are called…

Answer 43

Statements issued by the PCAOB are called Auditing Standards (AS).

Question 44

Statements issued by the IAASB are called…

Answer 44

Statements issued by the IAASB are called International Standards on Auditing (ISA)

Question 45

Principles Underlying an Audit Performed in Accordance with GAAS

Answer 45

The ASB replaced the 10 Generally Accepted Auditing Standards with these Principles, organized into four parts: Purpose of an Audit and Premise upon which an Audit is Conducted, Auditor Responsibilities, Audit Performance, and Audit Reporting.

Question 46

Code of Professional Conduct

Answer 46

A set of principles, rules, and interpretations that establish guidance for acceptable behavior for accountants and auditors.

Issued by the AICPA. Technically it only applies to AICPA members, but in reality, the Code applies to all auditors, including those auditing public companies.