Exam 1 (1-4) Flashcards
Most defining case of corporate fraud in US history
Enron
Industries Enron was a part of
Oil and gas
Auditor of Enron
Arthur Anderson & Company
Two things Enron is a great example of
What happens when companies cannot govern themselves, what happens when the independent auditor is not independent
5 burdensome legislations created because of Enron
- Sarbanes-Oxley Act of 2002
- Creation of the PCAOB
- New rules by the DOJ on criminal misconduct by corporations
- SEC whistleblower protection/reward program
- New rules on auditor independence - prohibited services
PCAOB
The auditor of the auditors
7 services prohibited to assure auditor independence due to Enron
Bookkeeping, appraisal/valuation, legal services, tax services, financial system design/implementation, internal audit outsourcing, management functions / HR / broker services
Things a business integrity (BI) office and chief compliance officer help do
Set the tone for ethical behavior, provides avenue for folks to report their concerns, needs to be well publicized, 3rd party handled, added to annual audit plan
Balance sheet approach
A particularly straight-forward and user-friendly way to address the risk-assessment based approach to auditing required by both US and international auditing standards
International auditing standards require an in-depth understanding of
The audited company and its environment, a rigorous assessment of the risks of where and how the financial statements could be materially misstated and an improved linkage between the auditors’ assessed risks and the particulars of audit procedures performed in response to those risks
Least level of effort
Assurance
Medium level of effort
Attestation
Highest level of effort
Audit
Assurance
Risk advisory, IT system reliability, web site security
Attestation
Agreed upon procedures review, reporting on financial forecasts
Audit
Financial statements, internal controls over financial reporting, compliance, forensic
2 examples of non-assurance services
Tax services and management consulting services
A CPA does what with tax and management consulting services
Creates documentation on behalf of the company
An assurance service
CPA is taking company data or looking at established procedures/policies and performing analytical procedures to offer an opinion on the adequacy of such items
Attest engagement
A practitioner (CPA) is engaged to issue an examination report, a review report or an agreed-upon procedures report on subject matter or an assertion about subject matter that is the responsibility of another party (e.g. management)
Level of assurance provided in an examination
High (“reasonable”)
Level of assurance provided in a review
Limited
Level of assurance provided in agreed-upon procedures
Summary of findings
Risk of material misstatement in an examination
Low
Risk of material misstatement in a review
Not defined in stabdards
Risk of material misstatement in agreed-upon procedures
Varies by specific engagement
Nature of assurance in an examination
“In our opinion…”
Nature of assurance in a review
“We are not aware of any material modifications that should be made…”
Nature of assurance in agreed-upon procedures
Includes a summary of procedures followed and findings
Examination
Referred to as an audit when the subject matter is historical financial statements
Procedures for an examination
Select from all available procedures any combination that can limit Attestation risk to a low level
Procedures for a review
Generally limited to inquiry and analytical procedures
Procedures for agreed-upon procedures
Procedures agreed upon with the specified user or users
Suitable criteria
Standards established or developed by groups of experts
Examples of suitable criteria
Internal control audit - standards established by a committee of experts on internal control, financial statement audit - standards are GAAP
Financial statement audit suitable criteria
Applicable financial reporting framework
Financial statement audit
Auditors gather evidence and provide a high level of assurance that these follow GAAP or some other appropriate basis or accounting
Financial statement audit involves
Searching and verifying accounting records and examining other documents
Audit evidence
This focuses on whether financial statements are presented in accordance with GAAP
Examples of audit evidence
Balance sheet contains all liabilities, sales really occurred, sales have been recorded at appropriate amounts, recorded costs and expenses are applicable to period, all expenses have been recognized, financial statement amount are accurate, properly classified and summarized, notes are informative and complete
History of the attest function
Went from detection of fraud to determination of fairness
What creates the demand for audits
Lend credibility to information by reducing information risk; the risk that information is materially misstated
Financial statement misstatements arise due to
Accidental errors, lack of knowledge of accounting principles, unintentional bias, deliberate falsification
Audits do not directly address
Business risk
Financial statement users
Management, investors, bankers, creditors, financial analysts, government agencies (external)
Compliance audits
IRS audit of income tax return
Operational audits
Effectiveness of operations of receiving department of a manufacturing company
Integrated audits (SOX)
Assurance on both the financial statements and effectiveness of internal control over financial reporting (ICFR)
Audit type of most publicly traded companies
Integrated audit
Other types of auditors
Internal, government accountability office, state and other government, tax (IRS)
Internal auditors
Employee by a company as an employee
Internal auditors often
Perform operational and compliance audits, address internal control, report directly to the audit committee of the board of directors and indirectly to the president, ceo, or cfo
Organization of internal auditors
The institute of internal auditors
Government accountability office auditors (GAO auditors)
Headed by the comptroller general, responsibility for supporting congress
Government accountability office auditors perform
Compliance, operational and financial audits of government agencies, examinations of corporations holding government contracts to verify contract payments have been appropriate
Tax auditors
Responsible for enforcement of tax laws of various sorts (e.g., state and federal income taxes, property taxes, sales taxes), perform compliance audits of income tax returns
AICPA’s traditional role
Establish standards, research and publication, continuing professional education, self-regulation (mostly for private companies)
AICPA Auditing Standards Board (ASB)
Issues official pronouncements on auditing matters for non public companies (“non-issuers), statements on auditing standards (SASs), statements on standards for Attestation engagements (SSAEs)
Statements on standards for Attestation engagements (SSAEs)
Guidance for attesting to information other than financial statements such as financial forecasts
Accounting and review services committee
Statements on data data for accounting and review services (SSARS), standards for compilations or reviews not audits of financial statements
Regulations of individual CPAs
Code of professional conduct - ethical rules for CPAs, requirements for regular membership in AICPA
Regulation of public accounting firms
Peer review just follows AICPA peer review program
CPA examination
Uniform national examination prepared and graded by the AICPA, computerized exam includes multiple choice and simulations in four parts (changing significantly in 2024)
4 parts of CPA exam
Auditing and Attestation, financial accounting and regulation (aka “FAR”), regulation, business environment & concepts
FASB (financial accounting standards board)
Sets GAAP for entities other than federal state and local governments
GASB (governmental accounting standards board)
Standards of financial accounting for state and local government entities
FASAB (federal accounting standards advisory board)
Accounting standards for the US government
IFAC (international federation of accountants)
Sets international accounting standards
PCAOB role
Adopt auditing, Attestation, quality control, ethics and independence standards relating to the preparation of audit reports for SEC registrants, oversee and discipline CPAs and CPA firms that audit public companies
Securities and exchange commission (SEC)
Agency of the US government, oversight responsibility for the PCAOB
Objectives of the SEC
Protect investors and public by requiring full disclosure of financial statement information by companies offering securities for sale to the public, prevent misrepresentation, deceit or other fraud in the sale of securities
Form S-1
Qualify securities for sales, contains audited financial statements, makes SEC major user of financial statements
Regulation S-X
Lays out the form and content for publisher financial statements, covers non GAAP disclosures
Types of professional services
Attestation and assurance - traditional auditing, tax, consulting - significant part of a CPA firms revenue, accounting, personal financial planning, litigation support, fraud investigation
Categories of public accounting firms
Local, regional, national, big 4, alternative practice structures
Purpose of an audit
Provide an opinion on financial statements are in accordance with the applicable financial reporting framework
Premise of an audit
Management and those charged with governance has the responsibility to prepare financial statements in accordance with applicable financial reporting framework and provide auditor with needed information and unrestricted access to those in the entity
Personal responsibility of the auditor
Appropriate competence and capabilities to perform audit in accordance with standards, including maintaining professional skepticism and exercising professional judgment throughout the audit
Professional skepticism
A questioning mind and a critical assessment of audit evidence. Key to success as an auditor (internal or external)
Auditor actions in performing the audit
Obtain reasonable assurance about whether financial statements are free from error or fraud
Auditor is unable to obtain absolute assurance due to
Nature of financial reporting, nature of audit procedures, need to conduct audit within a reasonable period of time, cost involved to obtain absolute assurance
Reporting the results of an audit
Express in a written report an opinion on findings (or statements that opinion cannot be expressed)
3 GAAS General Standards (public)
- Adequate technical training and proficiency
- Independence in mental attitude is to be maintained
- Due professional care is to be exercised
3 GAAS standards of field work (public)
- Auditor must adequately plan and properly supervise work
- Auditor must obtain a sufficient understanding of entity, and it’s environment, including internal control to assess risk of material misstatements and to design further audit procedures
- Auditor must obtain sufficient appropriate audit evidence to afford a reasonable basis for the opinion
4 GAAS Standards of reporting (public)
- State whether the financial statements are presented in accordance with GAAP
- Identify circumstances in which such principles have not been consistently applied
- Informative disclosures are adequate unless otherwise stated in the report
- Report should clearly state the degree of responsibility assumed by the auditors by expressing an opinion or stating that one cannot be expressed & the reason therefore
The 10 PCAOB generally accepted auditing standards
General standards:
- Technical training
- Independence
- Exercise due professional care
Standards of field work:
- Planned and properly supervised
- Internal control must be sufficiently understood
- Evidential matter must be obtained
Reporting standards
- Presented in accordance with GAAP
- Disclosures adequate unless otherwise stated
- Identify gaps in GAAP consistency
- Degree of auditor responsibility re opinion or contrary
Unconditional responsibility
Auditor must comply with requirement in all cases where the requirement is relevant
Words used to indicate unconditional responsibility
Must, shall, is required
Presumptively mandatory responsibility
Auditor must comply with requirement in all cases in which the requirement is relevant, except in rare circumstances when the auditor makes a judgment that it is necessary to depart from the standard
Words used to indicate presumptively mandatory responsibility
Should
Responsibility to consider
Auditor should consider; whether the auditor follows depends on exercise or professional judgment in the circumstances
Words used to indicate responsibility to consider
May, might, could
Standard Auditors Report paragraph 1
Defines the auditor’s responsibility
Standard auditors’ report paragraph 2
Defines how the auditor arrived at their opinikn
Major differences between AICPA and PCAOB audit
PCAOB audits must provide an opinion on internal control
Standard auditors report paragraph 3
Provides the auditor’s overall opinion on the financial statements
Addressee of auditors reports
The board of directors and stockholders or the audit committee of the board
5 types of auditors reports
Standard unmodified report, unmodified with emphasis of matter, qualified opinion, adverse opinion, disclaimer or opinion
Standards unmodified report
Unqualified per PCAOB standards, financial statements follow GAAP and auditor does not add additional commentary for any issue
Unmodified with emphasis of matter
Example: a lack of consistency in application of accounting principles such as a switch from FIFO to LIFO
Qualified opinion
The “yes, but” opinion, everything was fine excerpt the auditor did not agree with the application of a particular accounting principle
Adverse opinion
Total disaster, departure from GAAP so significant that financial statements as a whole are misleading
Disclaimer of opinion
Disaster, unable to arrive at an opinion due to a very significant scope limitation (I.e. auditors have no opinion) since they either could not get access to the data or the data was so incomplete no opinion could be provided
Six elements of quality control
- Leadership responsibilities for quality within the firm
- Relevant ethical requirements
- Acceptance and continuance of clients and engagements
- Human Resources
- Engagement performance
- Monitoring
Leadership responsibilities for quality within the firm
Assigns staff with appropriate experience, ability and authority to oversee the QC efforts of the firm
Relevant ethical requirements
Employees verify in writing at least annually that they are in compliance with the firms policies and procedures regarding independence
Acceptance and continuance of clients and engagements
Will only accept clients for which the form knows they have the technical expertise to audit and will only accept firms after considering the integrity of the client
Human Resources
Firm has procedures in place to recruit qualified individuals meeting the firms requirements for education, maturity, ethics and leadership
Engagement performance
Procedures are in place to monitor the progress on each engagement
Monitoring
Assure that the firms policies and procedures are being followed on each audit and results of those reviews communicated regularly to senior partners in the firm (quality, independence, rules and regulations)
Audit of IFRS or GAAP financials more risky
IFRS because of a learning curve
5 steps in resolving an ethical dilemma
Identify the problem, identify possible courses of action, identify any constraints relating to the decision, analyze the likely effects of the possible courses of action, select the best course of action
Ethics
Refers to a system or code of conduct based on moral duties and obligations that indicate how an individual should interact with others in society
Code of professional conduct
Designed to provide a framework for expanding professional services and responding to changes in the profession
Three sections for code of professional conduct
Principles, rules, interpretations
Principles
Goal oriented positively stated statements on the professions responsibilities to the public, clients and fellow practitioners
Rules
The requirements that are enforceable under the AICPA bylaws
Interpretations
Provide guidelines for the scope and application of the rules
3 conceptual frameworks
For CPAs in public practice
1. Threats to code compliance
2. Threats to independence
CPAs in business
3. Threats to code compliance
11 rules of the AICPA code of professional conduct
- Independence
- Integrity and objectivity
- General standards
- Compliance with standards
- Accounting principles
- Acted discreditable
- Contingent fees
- Commissions and referral fees
- Advertising and other forms of solicitation
- Confidential client information
- Form of organization and name
2 types of independence
Independence of mind (actual independence) and independence of appearance
7 threats to independence
- Adverse interest
- Advocacy of client
- Familiarity
- Financial self-interest of CPA
- Management participation
- Self-review
- Undue influence
Adverse interest
Litigation between client and CPA firm
Advocacy of client
CPA promotes client securities as part of an initial public offering
Familiarity
Spouse holds a key position with client
Financial self-interest of CPA
CPA owns stock in the client
Management participation
CPA serves as officer of clirnt
Self-review
CPA firm has provided consulting services that relate to audit
Undue influence
Pressure from client to reduce audit procedures
Must be independent within the firm
Covered members
Covered members
Staff working on the attest engagement, individual may influence attest engagement, a partner in the office in which the partner in charge of the attest engagement primarily practices, partners or managers that provides more than 10 hours of non-attest services to client, the public accounting firm and it’s employees benefit plan, any entity controlled by one or more of the above
5 independence requirements for all partners
No partner or professional employee may own more than 5% of arrest client’s outstanding equity securities
No partner or professional employee may be a director, officer, employee, promoter, trustee, etc of a client
All direct financial interests are prohibited, regardless of amount
Material indirect financial interests are prohibited
Gifts from clients or management may impair independence
Key position
Primary responsibility for significant accounting accounting functions that support material components of the financial statements, has primary responsibility for the preparation of the financial statements or has the ability to exercise influence over the contents of the financial statements including being a member of the board, chief executive officer, president, chief financial officer, chief operating officer, general counsel, chief accounting officer, controller, director of internal audit, director of financial reporting, treasurer etc
8 consulting services prohibited by SOX
- Bookkeeping
- Financial systems design and implementation
- Appraisal, valuation or actuarial services
- Internal audit outsourcing
- Management functions or human resource services
- Investment services
- Legal services and expert services
- Certain tax services
Integrity and objectivity rule
Applies to all members of the AICPA and to all services provided by CPAs
3 violations to the integrity and objectivity rule
Makes or permits or directs another to make materially incorrect entries in a clients financial statements or records
Fails to correct financial statements that are materially false or misleading when a member has such authority
Signs or permits or directs another to sign a document containing materially false and misleading information
4 general standards
- Professional competence
- Due professional care
- Planning and supervision
- Sufficient relevant data
Acts discreditable rule
Client prepared records should always be returned to the client, client records prepared by the CPA (eg payroll records) should be provided to client except that they may be withheld if they are incomplete or fees are due for them, supporting records (eg adjusting entries) should be provided to client but maybe be withheld if fees are due for them, Cpa working papers (eg audit programs) are CPAs property and need not be provided to client unless required by law
Contingent fees rule
Allowable for clients for which the cpa provides none of the following services: an audit or review of financial statements, a compilation of financial statements expected to be used by a third party and does not disclose a lack of independence, an examination of prospective financial information
Commissions/referral fees
Only allowed for a non attest client
The four pillars of auditing
- Role in the economy
- Professional standards
- Professional ethics
- Legal liability
Common law
case law, develops through case decisions, generally arising due to breach of contract, negligence and fraud
statutory liability
written law, develops when governmental unit enacts laws and regulations
breach of contract
occurs when the client or auditor fails to meet the terms and obligations established in the contract (engagement letter)
Privity
A contract / agreement between two parties
Criminal law
Statutory law that defined the duties citizens owe to society and prescribed penalties for violations
Fraud
Actions taken with the knowdkef and intent to deceive
Gross negligence
An extreme, flagrant or reckless departure from professional standards of dude care or constructive fraud
Ordinary negligence
An absence of reasonable or due care in the conduct of an engagement
Class action
Lawsuit filed by one or more individuals on behalf of all persons who may have invested on the basis of the same false and misleading information
Scienter
Acting with intent to deceive, defraud or with knowledge of a false representation
Tort
Unlawful acts committed against another business entity that result in a monetary loss
Ultramares corporation v touché (1931)
A landmark case under common law in that it established that auditors could be held liable to third party beneficiaries for ordinary negligence and to other third parties for gross negligence
Credit alliance corp v Arthur Andersen and co (1985)
A common law decision establishing that auditors must demonstrate knowledge of reliance on the financial statement by a third party for a particular purpose to be held liable for ordinary negligence to that party
Rusch factors Inc v levin (1986)
A common law decision in which the auditors were found liable for ordinary negligence to a third party not specifically identified to the auditors although the auditors were aware of the intended use of the financial statements
Rosenblum v Adler (1983)
Established that the auditors could be held liable for ordinary negligence to all third parties that the CPAs could reasonably foresee as users of the financial statements for routine business purposes
Ultramares (privity, near privity, foreseen third parties, reasonably foreseeable)
Yes
No
No
No
Credit alliance (privity, near privity, foreseen third parties, reasonably foreseeable)
Yes
Yes
No
No
Rusch factors (privity, near privity, foreseen third parties, reasonably foreseeable third parties)
Yes
Yes
Yes
No
Rosenblum (privity, near privity, foreseen third parties, reasonably foreseeable third parties)
Yes
Yes
Yes
Yes
9 ways to prevent litigation
- Place emphasis within the firm on complying with GAAS and professional ethics
- Retain legal counsel that is familiar with CPA’s legal liability
- Maintain adequate professional liability insurance
- Investigate prospective clients thoroughly
- Obtain a thorough knowledge of the client’s business
- Use engagement letters to prevent misunderstandings with clients
- Carefully assess the risk of errors and irregularities including those indicated by weaknesses in internal control
- Exercise extreme care in audits of clients that have a high degree of business risk as indicated by such factors as financial difficulties
- Carefully prepare and review working papers
4 key Covid 19 audit risks
- Internal controls
- Fraud risk
- Non compliance with laws and regs
- Auditing accounting estimates
Three components of fraud risk
Pressure
Opportunity
Rationalization
Auditing accounting estimates
Allowance for doubtful accounts - are customers still financially solvent
Goodwill- still economic value in acquisition or need to be impaired
