Final Flashcards
6 Principles of Professional Ethics
Responsibilities The Public Interest Integrity Objectivity and Independence Due Care Scope and Nature of Services- auditors cannot do any other type of work besides audit
Examples of covered members
An individual on the attest engagement team- Can be rotated
Individual who may influence engagement (e.g., boss of engagement partner).
Other partners in engagement office- Can be rotated,
Certain partners and managers who provide nonattest services to the client
An accounting firm should not do these inappropriate things
Audit its’ own work.
Function as part of management or as an employee of the audit client.
Act as an advocate for the client.- Auditor should not defend the client or promote them
Bookkeeping services an auditor should not do
Prepare or originate source data underlying the financial statements.
Maintain or prepare client’s accounting records.
Prepare financial statements.
Limited Liability Partnerships (LLP)
Single layer of taxation, personal assets are safe unless partner was on the engagement
Most common form of organization
CPAs in Business- Applicable Rules
Integrity and Objectivity. General Standards Compliance with Standards Accounting Principles Acts Discreditable
CPAs in Business- Non applicable rules
Rules ordinarily not applicable: Independence Contingent fees Commissions and Referral Fees Advertising and Solicitation Confidential Client Information Form of Organization and Name
Statutory Law
Codified law written by a formal law making body- Congress
Common Law
Law created by judges during court cases- opinions written by judges because statutory is unclear. Law they make has precedence over future cases
Auditor legal strategies
Improve the quality of auditing.
Increasing insurance coverage
Reporting more conservatively-happens most often
Lobbying legislators for legal reform.
Being more selective in obtaining and retaining clients.
Get out of audit practices altogether to reduce liability exposure.
Many mid-sized firms stopped auditing publicly traded companies because they would not be able to handle a lawsuit.
Common Law- Liability to clients
Most frequent lawsuits against CPA’s
Lawsuits by the legal entity, not the shareholders
$ amount is generally small
Little publicity
Burden of proof- plaintiff, above 50%, more likely than not guilty
What does the plaintiff have to prove in a common law lawsuit? (By client or third parties)
.Duty—the CPA accepted a duty of care to exercise skill, prudence, and diligence. This is ordinarily easy to prove since by accepting an engagement a CPA assumes a responsibility to exercise due care.
Breach of duty—auditor violated contract
Loss—the client suffered a loss.
Proximate Cause— client must proved that they were harmed, and their loss was caused by auditors breach of duty
Ultramares Approach
Auditor not liable for ordinary negligence to a third party who was not in contractual privity, unless the third party was a third party beneficiary.
Audit must have been done for the third party to be liable for ordinary negligence, ex. For a bank to get a loan, and identity of 3rd party must be known
Restatement of Torts Approach
Audit must have been done for a third party, but identity of third party does not have to be known, Forseen Third Party
Rosenblum Approach
Auditor has duty to anyone they would have expected to use the financial statements, Forseeable third party
Right of Subrogation
This is a situation in which the third party “steps into the shoes of the client” recovery wise and can recover for ordinary negligence.
Statutory Law (1933)- Liability to Third Parties
Outlined situations where auditors would have to pay damages in court. Auditors can be sued for ordinary negligence
Purchasers of new securities may sue, auditors have burden of proof
Statutory Law (1934)- Liability to Third Parties
All buying and selling of securities
Third party investors may sue, plaintiff has burden of proof
Statutory Law (1934) burden of proof
Plaintiff must prove they had a loss, they relied on the financial statements, and the financial statements were misstated
Proportionate Liability versus Joint and Several Liability
Proportionate—20% liable, only pay 20% of damages.
Joint and several—20% liable can pay up to 100% if other defendants don’t have money. Everyone is liable for up to 100% of damages
Management representation letter and management letter
Management Representation Letter- written letter of representations summarizing the most important oral representations made during the year to auditor.
Management Letter- From the auditor to the client, makes recommendations. Not required but a professional courtesy
Engagement completion document
Formal document at the end of the audit, documents, disagreements with management
Date of audit report
Most important milestone
Rule: Cannot date the audit report sooner than obtained sufficient evidence to justify opinion. Last day of fieldwork
Phases of the audit
Interim Period
Subsequent Period- balance sheet date through date of audit report
Report Preparation Period- responsibility only covers subsequent events that come to their attention; client tells auditor or news story they see. They do not need to look for any events. Between date of the audit report and report release date
After Report-After report release date
Audit procedures to determine subsequent events.
Obtain understanding of management’s procedures to ensure that subsequent events are identified.
Management inquiry.
Read minutes- Shareholder board meeting minutes
Read interim financial statements.
Type I and Type II events
Type I - events that provide additional evidence as to conditions that existed at the date of the balance sheet
Type II - events that provide evidence with respect to conditions that arose subsequent to that date.
Audit findings to report to the audit committee
Qualitative aspects of the entity’s significant accounting policies.
Significant difficulties encountered during the audit.
Uncorrected misstatements.
Disagreements with management (over accounting, or auditing issues)
Management’s consultation with other accountants.
Significant issues discussed, or subject to correspondence with management.
Quantitative and Qualitative audit findings
Quantitative: Income, EPS, Total assets, Owners’ equity
Qualitative: Changes loss to income, Effect on compliance with loan covenants and contracts, Increases management’s compensation
2 ways of accounting for misstatements from previous years
Iron Curtain Method- cumulative effect of all misstatements from this year and prior years. Only one of these methods needs to come up material. Helps to find misstatements that offset each other.
Rollover method- misstatements from current year
3 types of misstatements
Factual Misstatements — Specific misstatements identified during the course of the audit for which there is no doubt.
Judgmental Misstatements — Differences arising from judgments of management that the auditor consider incorrect.
Projected Misstatements — Arise from sample results projection to population
Types of unmodified opinions
Unmodified standard
Unmodified with an emphasis of matter paragraph-auditor highlights something
Unmodified with an other matter paragraph
Unmodified on group financial statements
Reasons for an Emphasis of matter paragraph
Substantial Doubt about a Company’s Going-Concern Status
GAAP Not Consistently Applied
Uncertainties
Group Financial Statements
Reasons for a Basis of Modification paragraph
Departures from GAAP
Scope Limitations
Critical Audit Matter
Related to things in the account, geared more toward how the audit was performed and what made it difficult.
Arises from the audit and communicated or required to be communicated to the audit committee.
Relates to accounts or disclosures that are material to the financial statements.
Involved especially challenging, subjective, or complex auditor judgment.
Emphasis of matter, group financial statements, other matter paragraphs
Emphasis of matter-Auditors just want to highlight something in the financial statements
Other matter- Highlights something NOT in the financial statements
Group Financial Statements- 2 or more CPA firms auditing parent/ subsidiaries
Core opinion does not change with either
Adverse opinion vs. Disclaimer of opinion
Adverse opinion—An adverse opinion states that the financial statements are NOT pre¬sented fairly in conformity with GAAP
Disclaimer of opinion—Due to a significant scope limitation, or going concern issue, the auditor was unable to obtain sufficient appropriate audit evidence, expresses no opinion
Both are material and pervasive, a non pervasive would result in a qualified opinion
Uncertainties
Auditor has option of adding emphasis of matter paragraph, unless it is a going concern issue or lack of consistency
Ex. Lawsuit against the company or government actions
3 circumstances that lead to scope limitation
Circumstances beyond the control of the client (e.g., important accounting records were destroyed). Circumstances relating to the nature and timing of the auditors’ work (e.g., the auditors are hired too late to observe the client’s beginning inventory). The client (for example, the client refused to allow the auditors to send confirmations to customers).
6 main parts of a company audit report
What the auditors did Opinion of auditor Mention of internal controls Managements responsibility Auditors responsibility Standards used
Reasons shareholders value audit reports
To lower:
Business risk- success of business
Information risk- Risk that financial statements are not accurate
Agency costs- consequences that an agent my follow their own best interests
Sampling risk
The possibility that a properly drawn sample may not be representative of the underlying population. The auditor may thus form a different conclusion
3 criteria to use negative confirmations
Risk of misstatement is low
Low numbers of accounts
High response rate on last year’s confirmations
Purpose of an audit
To provide reasonable assurance that the financial statements are free from material misstatements arising from noncompliance
Bank balance 8/31- Book balance 8/31 reconciliation
Balance 8/31 \+ Deposits in transit 8/31 - Outstanding checks 8/31 \+ Bank service charge August -Interest earned August =Book balance 8/31
