Test 1 (Ch. 1-5) Flashcards
What is External Auditing
Performing an audit in accordance to to principles and standards (GAAP and GAAS). It is independent of the entity being audited and is primarily interested in the reliability of financial reporting.
What does a Financial Statement Audit provide?
assurance on the reliability of the financial statement; they are free from material misstatement
What does an Integrated Audit provide?
assurance on internal control effectiveness
In auditing, what does ‘independence’ require?
objectivity and freedom from bias
Who are the users of audited financial statements? What are their jobs?
- Management: review performance, make operational decisions, and report results to capital markets
- Stockholders: buy or sell stock
- Bondholders: buy or sell bonds
- Financial Institutions: evaluate loan decisions considering interest rates, terms and risks
What is a financial statement audit?
examination of an entity’s financial statements and accompanying disclosures to add credibility to the reported financial position and performance of a business
What is a risk with financial statement auditing?
there are limitations and an auditor will not be able to go through all documents in their entirety
What are some skills of an external auditor?
- understand accounting and auditing literature
- develop industry and client-specific knowledge
- evaluate internal controls
- assess and respond to fraud risks
Why do auditors obtain a CPA license?
to let the public know that they have the appropriate knowledge and skills to conduct an audit
What does AICPA stand for?
American Institution of Certified Public Accountants
What is the job of the AICPA?
- develop standards for audits for nonpublic companies
- prepares and administers the CPA exam
What authoritative audit body is the Code of Professional Conduct under?
AICPA
What does the Code of Professional Conduct do?
aids auditors in conducting a quality audit
What PRINCIPLES of professional conduct does the Code of Professional Conduct consist of?
- Responsibilities: members exercise sensitive professional judgements in all their activities
- Public Interests: members accept the obligation to act in a way that will serve the public interest
- Integrity: members perform all professional responsibilities with he highest sense of integrity
- Objectivity and Independence: members maintain objectivity and be free of conflicts in discharging professional responsibilities
- Due Care: members observe the profession’s technical and ethical standards
- Scope and Nature of Services: members observe the principals of the code in deterring the scope and nature of services being provided
What RULES of professional conduct does the Code of Professional Conduct consist of?
- Integrity and Objectivity
- Independence
- General Standards
- Member shall comply with:
- Professional Competence
- Due Professionals Care
- Planning and Supervision
- Sufficient Relevant Data - Compliance with Standards
- Accounting Principles
- Acts Discreditable
- Contingent Fees
- Commissions and Referral Fees
- Advertising and Other Forms of Solicitation
- Form of Organization and Name
What does SEC stand for?
Securities and Exchange Commissions
What is the job of SEC?
- regulate the capital market system
- oversee responsibilities for the PCAOB and all public companies that are traded on US stock exchanges
- establish GAAP for companies whose stock is publicly traded
- prosecute public companies and their auditors for violating SEC laws (including fraud)
What does PCAOB stand for?
Public Company Accounting Oversight Board
What is the job of PCAOB?
- oversee auditors of public companies
- protect the interests of investors
- further the public interest in the preparation of informative, fair, and independent audit reports
Firms that provide audits of US public companies must register with….
the PCAOB
How many board members is PCAOB comprised of? How many of those members may be CPAs, why?
- comprised of 5 members
- no more than 2 members can be a CPA
- it helps to ensure members of the external auditing profession do not dominate the board
Why might management want an independent audit of its financial statements?
- to prove reliability of their statements
- show that they are following GAAP
- show that there is no internal influence
What must a company consider when determining if they want an audit from a large audit firm or a local firm?
- experience of the firm
- fees of the auditing firm
- how fast the audit is needed
What is fraud?
intentional act involving the use of deception that results in a misstatement of the financial statements
What are the 2 types of misstatements?
Misstatements arising from:
- misappropriation of assets - fraudulent financial reporting
What distinguishes fraud from errors?
intent to deceive
Is it the auditor’s job to find fraud?
NO
What happens if the auditor detects fraud?
- auditor reports detection to the client
- the client takes necessary steps to address the issue
- in no action is taken by the client, the auditor must withdraw from the audit
What is the Fraud Triangle?
model that recognizes that incentives, opportunities, and rationalization are elements typically associated with fraud
What are the 3 elements of the Fraud Triangle?
- incentive to commit the fraud
- opportunity to commit and conceal the fraud
- rationalization to justify committing the fraud
Fraud Triangle - Explain Incentive; give examples
- the reason for a fraudster to commit fraud
- compensation schemes
- financial pressures of improved earnings in firm
- debt covenants
Fraud Triangle - Explain Opportunity; give examples
- internal control weaknesses that enable the fraudster to commit and conceal the fraud
- industry position
- management’s inconsistency involving assets
Fraud Triangle - Explain Rationalization; give examples
- the mindset of the fraudster; mental process that fraudsters employ to ‘live with themselves’ as they try to convince themselves what they are doing is justifiable
- “I will lose everything if I don’t take the money”
- “this is a one time thing”
What are red flags?
risk factors suggesting an increased risk of fraud
What happens if there are a lot of red flags?
the auditor may have to increase their fees
What happened in the Enron Fraud?
- energy trades went bad
- management covered up financial problems by:
- shifting debt to off-balance sheet special entities
- sold assets to special purpose entities that they controlled to recognize revenue
- engaged in round trip trades where assets were recognized as sales and ended back up at Enron
How do auditors begin an audit?
a brainstorming session focusing on how and where fraud can occur at the client
What did the Sarbanes-Oxley Act of 2002 bring about?
- new standard setting for audits of public companies
- new standards for corporate governance
What was the Sarbanes-Oxley Act of 2002 a response to?
the bankruptcy of Enron and the subsequent collapse of its auditing firm
Who does the Sarbanes-Oxley Act of 2002 apply to?
publicly traded companies
Audit committees must….
- be responsible for the appointment, compensation, and oversight of the work of audit firms
- be independent
- provide adequate funding for audit committees
Responsibilities of audit committees….
- obtain an annual report by the external auditor that addresses:
- company’s internal control procedures
- quality-control of regulatory problems
- relationships that might threaten the independence of the external auditor
Audit committees have the authority to….
- hire and fire the head of the internal audit function
- set the budget for internal audit activity
- review the internal audit plan
- discuss all internal audit results