Review Flashcards
Section 105
As set forth by Section 105 (Title I) of the Sarbanes-Oxley Act, the Public Company Accounting Oversight Board (PCAOB) may investigate any act or practice, or omission to act, by a registered public accounting firm that may violate any provision of the Sarbanes-Oxley Act, PCAOB rules, securities laws, and professional standards.
Possible disciplinary actions include temporary suspension or permanent revocation of registration; temporary or permanent suspension of persons; temporary or permanent limitation on activities, functions, or operations of the firm; civil monetary penalties; censure; additional professional education or training; and any other sanction provided for in the PCAOB rules. Additionally, the PCAOB will strictly sanction intentional or knowing conduct, including reckless conduct, that results in violations and repeat violations.
Independence
Independence is the cornerstone on which the audit, or attest, function of the accounting profession is based. It is the independence of the auditor that assures the public of the fair presentation of the audited financial statements. The audit opinion is the “Independent Auditor’s Report” (AU-C 600.A98 requires that the word “independent” appear in the title of the report).
The auditor’s independence recognizes the need for fairness—fairness to the owners and managers of the company and also to creditors and those who may rely wholly or in part on the auditor’s report.
Independence is the ability to act with integrity and objectivity and not to compromise one’s judgment or conceal or modify an honest opinion. Auditors (both external and internal) must be capable of acting in an honest, unbiased fashion, maintaining the ability to use judgment free from influence by or subordination to the will, opinion, and judgment of others.
The CPA must be independent not only in fact but also in appearance. This means both that a true conflict must not exist (the fact of independence) and that the appearance, or impression, of conflict must not exist (the appearance of independence). Hence, there must not be a compromise to the perception of the independence of the CPA in the mind of a reasonable observer, no matter how innocent the questionable circumstances may truly be. Any appearance of the lack of independence would erode the public’s confidence in the profession as quickly as the fact of a lack of independence.
The “reasonable person” concept is applicable, i.e., whether or not a reasonable person, having all the facts and the normal strength of character, concludes that a specific relationship is lacking in independence, represents a conflict of interest, or is a threat to a CPA’s integrity or objectivity.
GAO Conceptual Framework for Independence
The Government Accountability Office’s conceptual framework for independence involves identifying, evaluating, and applying safeguards to threats. The GAO has identified seven types of circumstances that could lead to threats of independence:
Self-interest Self-review Bias Familiarity Undue influence Management participation Structural threats
Improper influence
It is prohibited for any issuer’s officer or director to take any action to fraudulently influence, coerce, manipulate, or mislead any independent public or certified accountant engaged in the performance of an audit of the financial statements of that issuer for the purpose of rendering such financial statements materially misleading.
Code of ethics
The International Ethics Standards Board for Accountants (IESBA) Code of Ethics for Professional Accountants includes five principles to apply the conceptual framework:
Integrity Objectivity Professional competence and due care Confidentiality Professional behavior
The Government Accountability Office (GAO) has identified seven types of circumstances that could lead to threats of independence.
The Government Accountability Office (GAO) has identified seven types of circumstances that could lead to threats of independence:
Self-interest Self-review Bias Familiarity Undue influence Management participation Structural threats
Yellow Book
The Government Auditing Standards are issued by the comptroller general of the United States, Government Accountability Office (GAO). They are often called the “Yellow Book.” These are audit standards that must be followed for audits of federal organizations, programs, activities, functions, and funds received by contractors, nonprofit organizations, and other external organizations. These standards are recommended for use in audits of state and local government organizations, programs, activities, and functions.
GAO standards incorporate AICPA GAAS but go further, requiring:
a review for compliance with applicable laws and regulations,
external reporting of instances or indication of fraud, and
reports on the entity’s internal control structure.
These standards also contain guidelines for economy, efficiency, and program results audits.
Authoritative Body
In the preface to the AT section for the Statements on Standards for Attestation Engagements is a notation that indicates, “These statements are issued by the Auditing Standards Board, the Accounting and Review Services Committee, and the Management Consulting Services Executive Committee.” These are units of the American Institute of CPAs.
The FASB and GASB are independent authoritative bodies designated to promulgate financial accounting and reporting standards for business (for-profit) and governmental (and not-for-profit) entities.
The Government Accountability Office (GAO) is the accounting, auditing, and investigating agency of the U.S. Congress. This agency has promulgated “Standards for Audit of Governmental Organizations, Programs, Activities, and Functions” (the “Yellow Book”).
GAS
According to GAS (Government Auditing Standards) 1.14, the ethical principles that guide the work of auditors who conduct audits in accordance with Generally Accepted Government Auditing Standards (GAGAS) are the public interest; integrity; objectivity; proper use of government information, resources and positions; and professional behavior.
The “public interest” is defined in the government standards as “the collective well-being of the community of people and the entities the auditors serve” (GAS 1.15). Integrity includes “auditors conducting their work with an attitude that is objective, fact-based, nonpartisan, and nonideological with regard to audited entities and users of the auditors’ reports” (GAS 1.17). Government information is “to be used for official purposes and not inappropriately for the auditor’s personal gain or in a manner contrary to law or detrimental to the legitimate interests of the audited entity or the audit organization” (GAS 1.20).
Materiality in GAGAS financial audits is considered an “additional consideration” in GAGAS audits (GAS 4.46).
Section 104
Section 104 of the Sarbanes-Oxley Act (SOX) dictates that the Public Company Accounting Oversight Board (PCAOB) has the mandate and authority to conduct compliance inspections of each registered public accounting firm. Firms that audit more than 100 issuers are inspected annually. Firms that audit 100 or fewer issuers are inspected every three years.
This section gives the PCAOB the mandate and authority to conduct compliance inspections of each registered public accounting firm.
a. Those firms that audit more than 100 issuers are inspected annually.
b. Those firms that audit 100 or fewer issuers are inspected every three years.
Members of the AICPA designation
Based on the AICPA’s Code of Professional Conduct, a firm may only designate itself as “Members of the AICPA” when all CPA owners are members.
Services allowed by AICPA but not SEC
The AICPA does not prohibit auditors from assisting in the preparation of financial statements, whereas the SEC does. Both the AICPA and SEC prohibit auditors from preparing source documents and recording transactions.
A CPA should take the following steps when retained to review financial statements of a nonissuer:
Establish an understanding with the entity regarding the review service (an engagement letter).
Determine if the CPA is independent. If not, do not continue.
Acquire the necessary knowledge of the client’s industry accounting principles and practices.
Acquire a general understanding of the nature of the client’s business, including (a) its operating characteristics and (b) the nature of its assets, liabilities, revenues, and expenses (including its products and services).
Apply appropriate inquiry and analytical procedures to obtain a basis for communicating whether the CPA is aware of any material modifications that should be made to the financial statements for them to be in conformity with generally accepted accounting principles.
A review does not involve obtaining an understanding of internal control, assessing control risk (assessing the operating efficiency of the entity’s internal control activities), assessing fraud risks (assessing the risk of material misstatement arising from fraudulent financial reporting and the misappropriation of assets), making preliminary judgments about risk and materiality to determine the scope and nature of the procedures to be performed, or testing accounting records to obtain corroborating evidence. These procedures are performed in an audit.
Analytical procedures
Analytical procedures should be applied at two distinct phases in all audits.
- At the initial planning stages of the audit to assist the auditor in planning the nature, extent, and timing of other auditing procedures
- As an overall review of the financial information in the final review stage of the audit
Analytical procedures may also be used by the auditor as substantive procedures to obtain audit evidence about particular assertions.
Analytical procedures
Analytical procedures used in planning the audit should focus on the following:
a. Enhancing the auditor’s understanding of the client’s business and the transactions and events that have occurred since the last audit data
b. Identifying areas that may represent specific risks relevant to the audit
Analytical procedures
Analytical procedures involve comparisons of recorded amounts, or ratios developed from recorded amounts, to expectations developed by the auditor. Examples of sources of information for developing expectations include the following:
a. Financial information for comparable prior period(s) giving consideration to known changes
b. Anticipated results (e.g., budgets or forecasts including extrapolations from interim or annual data)
c. Relationships among elements of financial information within the period
d. Information regarding the industry in which the client operates (e.g., gross margin information)
e. Relationships of financial information with relevant nonfinancial information
Audit strategy
The audit strategy involves consideration of the expected conduct, organization, and staffing of the audit. It is important to establish the audit strategy prior to developing a detailed audit plan. The audit strategy should involve:
defining the scope of the audit (such as the basis of reporting, any industry-specific reporting requirements, and the locations of the entity);
determining reporting deadlines and key dates for expected communications with those charged with governance (this information helps to determine the timing of the audit); and
considering factors that direct the audit team efforts (such as materiality levels, preliminary identification of risks of material misstatement and material account balances, and recent industry or financial developments affecting the client).
The audit strategy assists the auditor in making decisions regarding resources for the audit (how many team members, to which areas they should be assigned, if work should begin at an interim date, and if specialists or other auditors’ work will be used) and how these resources will be managed.
The answer choice “the coordination of the assistance of the client’s personnel in data preparation” describes an issue that will directly affect the auditor’s decisions regarding resources in the audit, and this subject would be part of the overall audit strategy.
Evaluating the entity’s plans to handle adverse economic conditions would be part of understanding the entity and its environment, including its internal control (risk assessment). While an important part of the auditor’s work, this procedure would not be part of the overall audit strategy.
The auditor would not discuss the determination of fraud risk factors or which control weaknesses to include in the audit committee communication with management.
Assertions
This situation is concerned with assertions about account balances at the period-end. Those assertions consist of the following:
Existence: Assets, liabilities, and equity interests exist.
Rights and obligations: The entity holds or controls the rights to assets, and liabilities are the obligations of the entity.
Completeness: All assets, liabilities, and equity interests that should have been recorded have been recorded.
Valuation and allocation: Assets, liabilities, and equity interests are included in the financial statements at appropriate amounts.
By tracing test counts to the client’s inventory listing, you are asserting that all inventory items have been recorded in the inventory listing (completeness assertion).
Work of a specialist
Using the work of a specialist is an important decision, because the auditor is relying on this person to provide audit evidence on complex matters in which the auditor may not be an expert. When the auditor expresses an unmodified opinion on the financial statements, he does not mention the work of the specialist in the audit report.
The auditor should be concerned with the professional credentials, reputation, and experience of the specialist. Knowing that the specialist may have a tendency to produce information in the client’s favor may cause the auditor to apply additional procedures to the specialist’s findings or assumptions. In other words, the auditor should assess the risk that the actuary’s objectivity might be impaired.
The specialist does not need to be independent of the client, and the hiring of a specialist, even one with an existing relationship with the client, is not a significant deficiency. (Remember that a significant deficiency is a deficiency that is considered significant to the design and operation of the internal control structure.)
IT poses many specific risks to an entity’s internal control, including the following:
Reliance on systems or programs that are inaccurately processing data, processing inaccurate data, or both
Unauthorized access to data that may result in destruction of data or improper changes to data
The possibility of IT personnel gaining access privileges beyond those necessary to perform their assigned duties
Unauthorized changes to data in master files
Unauthorized changes to systems or programs
Failure to make necessary changes to systems or programs
Potential loss of data or inability to access data as required
Of the answer choices given, only access controls pose specific risks to the internal controls of an entity. Thus, the auditor would be more concerned with those controls.
Hash totals
Hash totals are an input control. They are a nonsense total; for example, the sum of the digits of an invoice number. A hash total is similar to a control total and is used to verify processing (or output) compared to input.
In this example, the hash total is the sum of the invoice numbers (201 + 202 + 203 + 204).
Code of Ethics Framework
Under the framework of the Code of Ethics for Professional Accountants, all professional accountants are required to identify threats to the fundamental principles and, if there are threats, apply safeguards to ensure that the principles are not compromised. Compliance with the fundamental principles may potentially be threatened by a broad range of circumstances. Many threats fall into the following categories:
a. Self-interest threats, which may occur as a result of financial or other interests that will inappropriately influence the professional accountant’s judgment or behavior
b. Self-review threats, which may occur when a previous judgment needs to be reevaluated by the professional accountant responsible for that judgment
c. Advocacy threats, which may occur when a professional accountant promotes a client’s or employer’s position or opinion to the point that subsequent objectivity may be compromised
d. Familiarity threats, which may occur when, because of a close relationship, a professional accountant becomes too sympathetic to the interests of others
e. Intimidation threats, which may occur when a professional accountant may be deterred from acting objectively by actual or perceived pressures, including attempts to exercise undue influence over the professional accountant
Loans impairment
According to the AICPA Code of Professional Conduct, an automobile loan or lease collateralized by the automobile does not impair the independence rule (ET 1.200.001).
Home mortgage loans, student loans, and personal loans from the client would each be considered an impairment of independence.
The Government Accountability Office (GAO) specifies four interrelated sections with respect to independence:
A conceptual framework
Guidance for audit organizations that are structurally located within the entities they audit
Requirements when performing nonaudit services
Guidance on documentation
Departure from FASB
According to the profession’s ethical standards, in unusual situations a departure from a FASB Accounting Standard may be necessary to keep the financial statements from being misleading. The Code specifically recognizes that accounting principles cannot anticipate all of the circumstances to which the principles may be applied. Examples of such cases include both the passage of new legislation and the evolution of a new form of business transaction. Thus, both of these situations justify such a departure.
Operating effectiveness of internal controls
The evaluation of the operating effectiveness of an internal control is concerned with how the control was applied (whether manual or automated), the consistency with which it was applied, and by whom it was applied. Inspection of documents and reports, and observation and inquiry of client personnel would assist with evaluating operating effectiveness.
Preparation of system flowcharts, however, assists the auditor with understanding the design of the internal control, not the operating effectiveness. Flowcharts would provide the least assurance about the operating effectiveness of an internal control.
Management representation letter
Management, not the accountant, acknowledges its responsibility for the fair presentation in the financial statements of financial position, results of operations, and cash flows in conformity with generally accepted accounting principles.
The accountant need not be in physical receipt of the management representation letter as of the date of the accountant’s review report, provided that management has acknowledged that they will sign the representation letter without modification and it is received prior to the release of the report (which could be after the date of the accountant’s review report). The management representation letter should be addressed to the accountant. The letter should be signed by those members of management whom the accountant believes are responsible for and knowledgeable about (directly or through others in the organization) the matters covered in the representation letter. Normally, the chief executive officer and chief financial officer or others with equivalent positions in the entity should sign the representation letter (AR 90.24).
If current management was not present during all periods covered by the accountant’s report, the accountant should nevertheless obtain written representations from current management for all such periods (AR 90.22).
Regarding significant findings from the audit, the auditor should communicate with those charged with governance the following matters:
a. The auditor’s views about qualitative aspects of the entity’s significant accounting practices, including accounting policies, accounting estimates, and financial statement disclosures
b. Significant difficulties, if any, encountered during the audit
c. Uncorrected misstatements, other than those the auditor believes are trivial, if any
d. Disagreements with management, if any
e. Other findings or issues, if any, arising from the audit that are, in the auditor’s professional judgment, significant and relevant to those charged with governance regarding their oversight of the financial reporting process
Independence in a compilation
AR-C 80.22 states, “When the accountant is not independent with respect to the entity, the accountant should indicate the accountant’s lack of independence in a final paragraph of the accountant’s compilation report.”
A compilation expresses no assurance on the financial statements, so a compilation report with negative assurance would not be issued. The accountant must be independent to perform a review engagement; therefore, the engagement would not be upgraded to a review if the accountant were not independent with respect to the entity.
Specialist
If, as a result of the work performed by the specialist, the auditor decides to add explanatory language, the auditor may refer to the specialist in the auditor’s report. The only time the auditor should refer to the work or findings of a specialist in the audit report would be if reference to the specialist’s findings clarifies an emphasis-of-matter or other-matter paragraph (such as for an unusually important subsequent event) or facilitates an understanding of a departure from an unmodified opinion.
The auditor should not imply that a more thorough audit was performed.
Evidence
Analytical procedures have the highest level of evidence when they use direct predictable relationships within financial statements. The amount of interest expense is directly related to balances and rates of interest bearing accounts and notes payable. Many factors affect the balances of accounts receivable, accounts payable, and travel and entertainment expense, which cannot be predicted with complete accuracy.
Misstatements
Misstatements can result from errors or fraud and may consist of any of the following:
a. An inaccuracy in gathering or processing data from which financial statements are prepared
b. A difference between the amount, classification, or presentation of a reported financial statement element, account, or item and the amount, classification, or presentation that would have been reported under the applicable reporting framework
c. The omission of a financial statement element, account, or item
d. A financial statement disclosure that is not presented in conformity with the applicable financial reporting framework
e. The omission of information required to be disclosed in conformity with the applicable reporting framework
f. An incorrect accounting estimate arising, for example, from an oversight or misinterpretation of facts
g. Differences between management’s and the auditor’s judgments concerning accounting estimates, or the selection and application of accounting policies that the auditor considers inappropriate
Management representation letter
In addition to requesting management to confirm that it has fulfilled its responsibilities, the auditor also may ask management to reconfirm its acknowledgment and understanding of those responsibilities in written representations. This is common but, in any event, may be particularly appropriate when:
those who signed the terms of the audit engagement on behalf of the entity no longer have the relevant responsibilities,
the terms of the audit engagement were prepared in a previous year,
any indication exists that management misunderstands those responsibilities, or
changes in circumstances make it appropriate to do so.
Consistent with the requirement of section 210, Terms of Engagement, such reconfirmation of management’s acknowledgment and understanding of its responsibilities is unconditional and is not made subject to the best of management’s knowledge and belief (as discussed in paragraph .A6 of this section).
The Public Company Accounting Oversight Board (PCAOB) was established by the Sarbanes-Oxley Act of 2002. Section 101(a) of the Sarbanes-Oxley Act states:
There is established the Public Company Accounting Oversight Board, to oversee the audit of public companies that are subject to the securities laws, and related matters, in order to protect the interests of investors and further the public interest in the preparation of informative, accurate, and independent audit reports for companies the securities of which are sold to, and held by and for, public investors.
SOX Section 204: Auditor Reports to Audit Committees
Section 204 of SOX Title II amends Section 10A of the Securities Exchange Act of 1934 by requiring that each registered public accounting firm that performs an audit of issuer financial statements timely report to the issuer’s audit committee:
a. all critical accounting policies and practices to be used;
b. all alternative treatments of financial information within GAAP that have been discussed with management officials of the issuer, ramifications of the use of such alternative disclosures and treatments, and the treatment preferred by the registered public accounting firm; and
c. other material written communications between the registered public accounting firm and the management of the issuer, such as any management letter or schedule of unadjusted differences.
Attribute sampling
Attribute sampling measures how many times an attribute (e.g., the absence of a required signature on a receiving report) occurs in a sample. Variable sampling measures the variance of dollar amounts in the sample items (e.g., that the extended dollar amount on a receiving report is correctly calculated). Attribute sampling would be used to inspect employee timecards for proper approval by supervisors. Attribute sampling is not appropriate to examine account balances, such as accounts receivable, inventory, or fixed assets; that would require the use of variable sampling.
The successor should inquire of the predecessor regarding the following:
a. Information that might bear on the integrity of management
b. Disagreements with management as to accounting principles, auditing procedures, or other similarly significant matters
c. Communications to those charged with governance regarding fraud and noncompliance with laws or regulations by the entity
d. Communications to management and those charged with governance regarding significant deficiencies and material weaknesses in internal control
e. The predecessor’s understanding as to the reasons for the change of auditors
AICPA Quality Control Standard (QC) 10.27 states:
“The firm should establish policies and procedures for the acceptance and continuance of client relationships and specific engagements, designed to provide the firm with reasonable assurance that it will undertake or continue relationships and engagements only when the firm:
a. is competent to perform the engagement and has the capabilities, including time and resources, to do so;
b. can comply with legal and relevant ethical requirements; and
c. has considered the integrity of the client, and does not have information that would lead it to conclude that the client lacks integrity.”
The accountant should not accept an engagement to be performed in accordance with SSARS if :
a. the accountant has reason to believe that relevant ethical requirements will not be satisfied;
b. the accountant’s preliminary understanding of the engagement circumstances indicate that information needed to perform the engagement is likely to be unavailable or unreliable; or
c. the accountant has cause to doubt management’s integrity such that it is likely to affect the performance of the engagement. (AR-C 60.24).
As a condition for accepting an engagement to be performed in accordance with SSARSs, the accountant should:
a. determine whether preliminary knowledge of the engagement circumstances indicate that ethical requirements regarding professional competence will be satisfied.
b. determine whether the financial reporting framework selected by management to be applied in the preparation of the financial statements is acceptable.
c. obtain the agreement of management that it acknowledges and understands its responsibility.
I. for the selection of the financial reporting framework to be applied in the preparation of financial statements.
II. for the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of the financial statements that are free from material misstatement, whether due to fraud or error.
III. for preventing and detecting fraud.
IV. for ensuring that the entity complies with laws and regulations applicable to its activities.
V. for the accuracy and completeness of the records, documents, explanations, and other information, including significant judgments provided by management for the preparation of financial statements.
VI. to provide the accountant with:
i. access to all information of which management is aware that is relevant to the preparation and fair presentation of the financial statements, such as records, documentation, and other matters.
ii. additional information that the accountant may request from management for the purpose of the engagement.
iii. unrestricted access to persons within the entity of whom the accountant determines it necessary to make inquiries. (AR-C 60.25)
Misstatements can result from errors or fraud and may consist of any of the following:
a. An inaccuracy in gathering or processing data from which financial statements are prepared
b. A difference between the amount, classification, or presentation of a reported financial statement element, account, or item and the amount, classification, or presentation that would have been reported under the applicable reporting framework
c. The omission of a financial statement element, account, or item
d. A financial statement disclosure that is not presented in conformity with the applicable financial reporting framework
e. The omission of information required to be disclosed in conformity with the applicable reporting framework
f. An incorrect accounting estimate arising, for example, from an oversight or misinterpretation of facts
g. Differences between management’s and the auditor’s judgments concerning accounting estimates, or the selection and application of accounting policies that the auditor considers inappropriate
According to AU-C 240.A19, the auditor should use professional judgment to determine those others within the entity to whom inquiries should be directed and the extent of such inquiries. In making this determination, the auditor should consider whether others within the entity may be able to provide information that will be helpful to the auditor in identifying risks of material misstatement due to fraud.
Examples of individuals within the entity to whom the auditor may wish to direct fraud related inquiries include the following:
Employees with varying levels of authority within the entity, including, for example, entity personnel with whom the auditor comes into contact during the course of the audit in obtaining (a) an understanding of the entity’s systems and internal control, (b) in observing inventory or performing cutoff procedures, or (c) in obtaining explanations for fluctuations noted as a result of analytical procedures
Operating personnel not directly involved in the financial reporting process
Employees involved in initiating, recording, or processing complex or unusual transactions—for example, a sales transaction with multiple elements, or a significant related party transaction
In-house legal counsel
Completion of the audit file
Completion of the audit file under auditing standards generally accepted in the United States of America is required within 60 days following the report release date. Completion of the audit file under PCAOB standards is required within 45 days following the report release date.
Control activities
Control activities are the policies and procedures that help ensure that management directives are carried out and necessary actions are taken to address risks that threaten the achievement of the entity’s objectives. Examples of specific control activities include the following:
a. Authorization
b. Segregation of duties
c. Safeguarding
d. Asset accountability
e. Performance reviews
SOX Section 208: Commission Authority
It is unlawful under Section 208 of SOX Title II for any registered public accounting firm to prepare or issue any audit report with respect to any issuer, if the firm or associated person engages in any activity with respect to that issuer that is prohibited by Section 10A of the Securities Exchange Act of 1934, or any rule or regulation of the SEC or PCAOB.
Audit Committee
Section 10A(m) of the Securities Exchange Act of 1934 prohibits the receipt of “any” consulting, advisory, or compensatory fees from the registrant for services other than as a member of the board.
Members of an issuer’s audit committee:
may establish procedures for employees to anonymously report fraud.
are typically responsible for the compensation of the public accounting firm employed by the registrant to provide an audit report.
may engage independent counsel as deemed necessary to carry out their duties.
Letters of inquiry sent to client’s attorneys
Letters of inquiry are sent to the client’s attorneys to provide the auditor with corroboration of the information furnished by management about litigation, claims, and assessments. The identification, description, and evaluation of asserted claims, assessments, and litigation (pending or threatened) and of probable outcomes are the responsibility of management. The attorney merely confirms this information according to his or her knowledge.
The client’s historical experiences in recent similar litigation are irrelevant; the outcome and the effects for every case must be evaluated independently
The auditor should obtain a sufficient understanding by performing risk assessment procedures to evaluate the design of controls relevant to an audit of financial statements and to determine whether they have been implemented. The auditor should use such knowledge to:
a. identify types of potential misstatements.
b. consider factors that affect the risks of material misstatement.
c. design tests of controls, when applicable, and substantive procedures.
While a successor accountant is not required to communicate with the predecessor accountant in connection with acceptance of a compilation or review engagement of a nonissuer, under some circumstances it may be beneficial to obtain information from the predecessor that will assist in determining whether to accept the engagement:
a. The information obtained about the prospective client is limited or appears to require special attention.
b. The change in accountants takes place substantially after the end of the accounting period for which statements are to be compiled or reviewed.
c. Frequent changes in accountants have occurred.
In evaluating whether management has identified all accounting estimates that could be material to the financial statements, the auditor considers the circumstances of the industry or industries in which the entity operates, its methods of conducting business, new accounting pronouncements, and other external factors. The auditor should consider performing the following procedures:
Consider assertions embodied in the financial statements to determine the need for estimates.
Evaluate information obtained in performing other procedures, such as the following:
Information about changes made or planned in the entity’s business, including changes in operating strategy, and the industry in which the entity operates that may indicate the need to make an accounting estimate
Changes in the methods of accumulating information
Information concerning identified litigation, claims, and assessments, and other contingencies
Information from reading available minutes of meetings of stockholders, directors, and appropriate committees
Information contained in regulatory or examination reports, supervisory correspondence, and similar materials from applicable regulatory agencies
Inquire of management about the existence of circumstances that may indicate the need to make an accounting estimate.
When financial statements that the accountant has compiled omit substantially all disclosures but are otherwise in conformity with the applicable financial reporting framework, the accountant should include a separate paragraph in the accountant’s compilation report that includes the following elements: (AR-C 80.25)
a. A statement that management has elected to omit substantially all the disclosures (and the statement of cash flows, if applicable) required by the applicable financial reporting framework (or ordinarily included in the financial statements if the financial statements are prepared in accordance with a special purpose framework)
b. A statement that if the omitted disclosures (and the statement of cash flows, if applicable) were included in the financial statements, they might influence the user’s conclusions about the entity’s financial position, results of operations, and cash flows (or the equivalent for presentations other than GAAP)
c. A statement that, accordingly, the financial statements are not designed for those who are not informed about such matters.
Prior period financials audited by predecessor auditor
If the prior-period financials have been audited by a predecessor auditor whose report is not presented, the successor auditor should indicate that fact in the introductory paragraph of the audit report, along with the date and type (qualified, unmodified, etc.) of the predecessor auditor’s report.
Any financial statements presented with the audit report must be mentioned in the audit report for the comparative statements. The auditor does not have the option to ignore the prior year’s financials, even if they were audited by someone else. Any amount of assurance (even limited assurance) expressed by the current auditor regarding the prior year’s statements would require that audit procedures be performed in order to support that opinion. The current auditor is not required to obtain any representations from the predecessor auditor concerning the prior year’s statements.
The internal auditor’s objectivity would evidence if she is impartial and operates free of conflicts of interest. Understanding the organizational status of the director of internal audit would assist the auditor with assessing the internal auditor’s objectivity. To do this, the auditor would look at various factors:
Does the internal auditor report to a person who has the ability to consider and act on the internal auditor’s findings?
Can the internal auditor report directly to those charged with governance, and does he do so regularly?
Do those charged with governance oversee employment decisions regarding the internal auditor?
The professional certifications of the internal audit staff would assist the auditor with assessing the competence of the internal auditors.
The consistency of the internal audit reports with the results of work performed and the appropriateness of internal audit conclusions would assist the auditor with assessing the quality and effectiveness of the internal auditor’s work.
GAAP
Generally accepted accounting principles (GAAP) are not broad guidelines, but the conventions, rules, and procedures (methods of applying the principles and practices) that govern how financial statements are prepared and presented. The principles are dynamic, and updates are regularly published.
GAAP is not just set forth in AICPA rules; GAAP comes from many different sources (including, but not limited to, FASB Statements of Financial Accounting Standards, FASB Interpretations, FASB Staff Positions, AICPA Accounting Research Bulletins, and AICPA Accounting Principles Board Opinions), all of which can be researched through the FASB Codification. Rules and interpretive releases of the Securities and Exchange Commission (SEC) are also sources of authoritative GAAP for SEC registrants.
GAAP represents the established criteria upon which management’s assertions are evaluated by the auditor. The objective of an audit is to state whether the financial statements are presented fairly in conformity with GAAP. The first standard of reporting (for generally accepted auditing standards) requires that the auditor state in the report whether the financial statements are presented in accordance with GAAP. However, the mention of GAAP in the report does not indicate that the audit has been conducted in accordance with GAAS.
