Written By:
Roger Philipp, CPA
Roger CPA Review
2261 Market St. #333
San Francisco, California 94114
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(877) ROG-4CPA
(415) 346-4272
Section 2 - Audit Standards & Engagement
Planning
Corresponding Videos
Watch the following course video lectures with this section:
2.01a Basic types of audits
2.01b Clarity Standards
2.01c Generally Accepted Auditing Standards
2.01d Responsibilities of the Auditor under Clarity Standards
2.02 GAAS and Responsibility of Auditor Homework Problems
3:24
2.03 Steps in the Audit Process TIPPICANOE 22:56
2.04 Planning Procedures 15:56
2.05 Audit Risk 41:39
2.06 Quality Control 6:32
2.07 Research Task Format- Audit 7:22
2.08 Audit Standards & Engagement Planning
Homework problems 23:31
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Section 2
(Lecture 2.01.1)
Basic types of Audits:
1) Compliance Audits
Are they following laws & regulations?
o IRS audits
o Governmental units to determine compliance with laws and regulations
o CPA to determine compliance with provisions of a bond or note agreement.
2) Operational Audits
Effectiveness/Efficiency/Economy done by Internal Auditors, Governmental auditors or
CPAs.
o Audit a department or division of a corporation to see if meeting organizational
goals.
o Review by governmental auditors to determine the effectiveness and benefit of
specific gov. funded programs.
3) Financial Statement Audits
Examination for purpose of giving an objective opinion as to the fairness of financial
statement presentations, in all material respects, in conformity with an Applicable
Financial Reporting Framework, such as U.S. Generally Accepted Accounting Principles
(GAAP).
The applicable financial reporting framework refers to the system of accounting under which
the financial statements have been prepared, and determines the form and content of the
financial statements. Accounting principles generally accepted in the United States of
America (GAAP) is considered a general purpose framework. General purpose
frameworks include:
GAAP, issued by the Financial Accounting Standards Board (FASB)
International Financial Reporting Standards (IFRS), issued by the International
Accounting Standards Board (IASB)
Statements of Federal Financial Accounting Standards issued by the Federal Accounting
Standards Advisory Board for U.S. federal governmental entities
Statements of Governmental Accounting Standards issued by the Governmental
Accounting Standards Board (GASB) for U.S. state and local governmental entities
The auditor:
o Possesses the appropriate qualifications to perform the audit.
o Applies professional skepticism, an attitude that includes a questioning mind
and a critical assessment of audit evidence.
o Complies with relevant ethical requirements.
o Exercises professional judgment throughout the engagement.
To express an opinion on the financial statements, the auditor obtains reasonable assurance
as to whether the financial statements are free from material misstatement.
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Reasonable Assurance** - a high level of assurance, although not equivalent to absolute
assurance
o The scope of the audit is limited to items that are considered material.
o The auditor cannot look at evidence supporting all information in the financial
statements.
To obtain reasonable assurance, the auditor:
Plans the work
Properly supervises assistants
Determine and apply appropriate materiality levels
Identify and assess risks of material misstatement
o May be due to error or fraud
o
Obtain sufficient appropriate audit evidence
100
Scope
Materiality
The Steps in an Audit
Prepare for
The audit
Obtain Understanding
of Client, its Environment,
including Internal Control
Assess Risks of Material
Perform Tests
Misstatement and Determine of Controls
Nature, Timing & Extent
of Further Procedures
Perform
Formulate
Substantive an Opinion
Procedures
Issue
Audit
Report
(Lecture 2.01.2)
CLARITY STANDARDS
In 2009, the Auditing Standards Board (ASB) began issuing a series of standards referred to as
effective for audits of financial statements for periods ending on or after December 15, 2012, are
organized in a uniform manner. These standards were designed to do just that, clarify the
auditing standards, make them easier to follow and easier to understand. These standards
apply to audits of non-issuers governed by the AICPA.
In anticipation of issuing the clarity standards, the ASB issued a pronouncement that described
two levels of requirements, unconditional requirements and presumptively mandatory
requirements, that apply to an audit performed in accordance with GAAS.
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Section 2
n Statements on Auditing
An unconditional requirement must be complied with in order for the auditor to
complete an engagement in accordance with GAAS. An auditor is required to comply
or the
, in every circumstance to which it applies.
A presumptively mandatory requirement is one that the auditor is also expected to
comply with in every circumstance to which it applies. In rare circumstances, however,
the auditor may depart from a presumptively mandatory requirement but must document
how an alternate procedure was sufficient to achieve the objective of the standard. A
.
The clarity project made several changes by introducing some new terminology and definitions
(Applicable Financial Reporting Framework, Emphasis-of-matter, Other-matter paragraphs),
new requirements (evaluate Applicable Financial Reporting Framework, apply Quality Control
procedures at the engagement level) that the auditor must fulfill and some significant changes to
the audit report. The clarity project also changed the format of each standard to include the
introduction, objective, definition, requirements and its application and other explanatory
materials.
Each standard begins with an Introduction, which includes the purpose and scope of each
standard. This tells us when the individual standards do or do not apply.
Each standard next follows with an indication of the objective of that standard, which the
auditor uses in planning and performing the audit, considering the interrelationships within
GAAS, to achieve the overall objectives of the auditor. This assists the auditor:
In determining if audit procedures in addition to those required are necessary, which will be
achieve the objective
In evaluating whether the auditor has obtained sufficient appropriate audit evidence
If audit evidence is not considered sufficient and appropriate, the auditor will determine if it is
achievable to do so. If not, the auditor will consider the effect on the audit report. In making the
determination, however, the auditor will evaluate whether sufficient appropriate audit evidence
can be obtained by some combination of:
Considering evidence obtained in achieving other objectives
Extending work performed to comply with a requirement, such as by increasing a sample
size
Performing procedures in addition to those required.
The auditor may determine that the objective of a relevant objective may not be achievable.
This may prevent the auditor from achieving the overall objective of the engagement, which will
lead the auditor to either modify the audit report or withdraw from the engagement when allowed
under applicable law or regulation.
The auditor will fail to meet an objective when:
The auditor is prevented from complying with relevant requirements
The auditor is unable to apply additional audit procedures considered necessary to achieve
the objective
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The inability to achieve an objective is considered a significant finding, which the auditor is
required to document. The auditor is not required to individually document the achievement of
each objective, documenting the failure to achieve an objective assists the auditor in evaluating
whether or not the overall objectives of the audit have been achieved.
Each clarified standard next provides definitions of terms that are particular to that standard.
Each clarified standard then identifies requirements in a section that includes all unconditional
or presumptively mandatory requirements. As indicated, the auditor is expected to comply with
every requirement. The only exceptions will apply when:
An entire section of GAAS does not apply, such as the section on reliance on the work of
internal auditors not being applicable when the client does not have an internal audit
department
A specific requirement does not apply because the condition it is intended to provide audit
evidence in relation to does not exist, such as the requirement to communicate significant
deficiencies and material weaknesses in internal control when no such weaknesses exist
The requirements may refer to application guidance or other explanatory material included
in a final section. This provides suggestions as to how to go about complying with those
standards.
The clarity standard also introduced some new terminology and new definitions such as the
Applicable Financial Reporting Framework, audit report terminology (Emphasis-of-matter vs
other-matter paragraph) and Group financial audits (division of responsibility), just to mention a
few.
Although the clarified standards were predominately intended to make the existing standards
easier to understand and apply, they do impose some new requirements that the auditor will
need to fulfill.
The auditor is required for example, to evaluate the acceptability of the applicable
financial reporting framework. The auditor needs to:
o Evaluate the NEEDS of Users
o Evaluate whether the applicable framework MEETS those needs
o Evaluates whether it is the MOST APPROPRIATE FRAMEWORK under the
circumstances.
Management also now has 2 major responsibilities added to the audit report (discussed
in detail in the Audit Reports section).
The auditor is also now required to apply Quality Control procedures at the engagement
level.
There were also significant changes made to both the form and content of the audit report,
discussed in detail in the Audit Report section.
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Section 2
(Lecture 2.01.3)
10 Generally Accepted Auditing Standards (10 GAAS)
Prior to the issuance of the clarity standards auditors were required to apply 10 generally
accepted audited standards. Under the clarity standards, the 10 GAAS were re-positioned into
the objectives, mentioned above. The PCAOB, which has based its auditing standards on
GAAS, has not adopted the clarity standards and, as a result, the 10 GAAS still apply to PCAOB
(Issuer) audits. In addition, the general concepts still relate to all audits, therefore, they are still
important for you to understand in preparing for the CPA Exam.
A financial audit is an examination whose purpose is to express an opinion on the financial
statements of a client. In performing such an engagement, the auditor is expected to follow
generally accepted auditing standards (GAAS). These 10 standards are used as overall
measures of the quality of the auditor's performance. The specific procedures needed to fulfill
these standards will vary for each engagement, but the standards themselves are always the
same. The GAAS standards are divided into three categories:
1. General standards - These apply to all aspects of the engagement from acceptance
to completion.
2. Fieldwork standards - These apply only to the portion of the engagement devoted to
the gathering of evidence.
3. Reporting standards - These apply only to the manner in which the audit report is to
be written.
10 GAAS (Measure of Quality
, versus Audit procedures which are
Acts to be performed by the auditor. (TIPPICANOE)
3 General Standards
Qualification of auditor and quality of work.
The first General standard states:
1. Training & Proficiency
must be performed by a person or persons having adequate technical
training and proficiency
Proper Education in accounting
Knowledge of industry & business
Practical experience (CPE)
The Second General standard states:
2. Independence
independence in mental attitude must be
Ability to act with integrity and objectivity. Independence means you, your
spouse, dependent kids or dependent relatives
The third General standard states:
3. Due Professional Care
must be exercised in the performance of the audit
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o
o
Critical review of judgement used at every level.
Skill and care of a prudent CPA.
o Preparation of complete workpapers.
o Operating without negligence/Due diligence.
o Professional Skepticism Maintaining an objective attitude
during the audit.
o Acting with Competency and Diligence.
3 Standards of Fieldwork
How audit is planned and how audit evidence is accumulated and evaluated.
The first standard of Fieldwork states:
1. Planning and Supervision
must adequately plan the work and must properly supervise any
The second standard of Fieldwork states:
2. Internal Controls - Rely
The auditor must obtain a sufficient understanding of the entity and the
environment, including its internal control, to assess the risk of material
misstatement (RMM) of the financial statements whether due to error or fraud,
and to design the nature, timing, and extent
Inverse
The third standard of Fieldwork states:
Relationship
3. Corroborative Audit Evidence - Substantive Testing
must obtain Sufficient Appropriate (Corroborative) audit
Evidence by performing audit procedures to afford a reasonable basis for an
4 Standards of Reporting
Preparation and content of the audit report
GAAS audit to check for GAAP.
The first standard of Reporting states:
1. Accounting Principles in Conformity with U.S. GAAP
must state whether the financial statements are presented in confirmity
o Explicitly stated in report.
The second standard of Reporting states:
2. No new Accounting Principles applied
Consistency
must indentify those circumstances in which such principles have not
been consistently observed in the current period in relation to the preceding
o Implicit
The third standard of Reporting states:
3. Omitted Informative Disclosures
adequate
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None
Implicit
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Section 2
The fourth standard of Reporting states:
4. Expression of an Opinion
must contain either an expression of opinion regarding the financial
statements, taken as a whole, or an assertion to the effect that an opinion cannot be
expressed. When an overall opinion cannot be expressed, the reasons therefore
statements, the report should contain a clear-cut indication of the character of the
Explicit
In summary, the 10 Generally Accepted Auditing Standards include (TIPPICANOE):
General Standards
Training and Proficiency
Independence
Professional Care
Standards of Fieldwork
Planning and supervision
Internal Controls
Corroborative Appropriate Audit Evidence
Reporting Standards
Accounting Principles in Accordance with GAAP
No New Principles - Consistency
Omitted Disclosures - None
Express an Opinion
(Lecture 2.01.4)
Responsibilities of the Auditor (AU-C Preface)
A financial audit is an examination whose purpose is to express an opinion on the financial
statements of a client. In performing such an engagement, the auditor is expected to follow
generally accepted auditing standards (GAAS). These professional attestation standards are
promulgated by the Auditing Standards Board (ASB), the Accounting and Review Services and
the Management Advisory Services Executive Committee of the AICPA. These standards are
used as overall measures of the quality of the auditor's performance. The specific procedures
needed to fulfill these standards will vary for each engagement, but the standards themselves
are always the same. Statements on Auditing Standards (SAS) are interpretations of GAAS
issued by the Auditing Standards Board of the AICPA.
Qualification of auditor and quality of work.
To perform an audit, the auditor is responsible for:
Having appropriate competence and capabilities in the form of adequate technical
training and proficiency as an auditor.
Complying with relevant ethical requirements, including remaining independent from the
audit client.
Maintaining professional skepticism and exercising professional judgment.
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Competence and Capabilities
Auditors are responsible for having appropriate competence and capabilities to perform
the audit. This is obtained through: Proper Education in accounting
Knowledge of industry & business
Practical experience
Continuing education (CPE)
While education in accounting is an important component of this requirement, it is also required
that the independent auditor have practical and technical experience. Junior auditors with the
appropriate education are to be adequately supervised and their work sufficiently reviewed by
senior auditors with experience in the field until they have gained the technical experience to
work unsupervised.
Relevant Ethical Requirements
While an auditor, presumably, will comply with all of the requirements of the AICPA Code of
Profess
perform an audit despite a lack of independence:
If GAAS provides for circumstances that allow the auditor to accept the engagement
The auditor is required by law or regulation to accept the engagement
independence in mental attitude in all matters relating to
Ability to act with integrity and objectivity. Independence means you, your
spouse, dependent kids or dependent relatives.
The Auditor must maintain independence for attestation engagements (CARES / ERAS)
o Compilations (unless a lack of independence is indicated)
o Agreed-upon procedure engagements leading to findings
o Reviews
o Examinations (Audits)
o Special reports
Need not be independent for:
o Compilations (when a lack of independence is indicated)
o Taxes
o Consultations
Attest Function = Must be Independent
Audit Yes
Review Yes
o Compilation No
o Taxes No
o Consultation No
Independence should be maintained in both:
o Fact State of mind
o Appearance How it appears to the public.
No Direct financial interest (material or immaterial, such as a share of stock in
client) held by auditor or immediate family
o Immediate family includes: spouse, cohabitant and dependents.
No Material Indirect financial interest (such as money in mutual fund with an
investment in client) held by auditor, family or close family members.
o Close family members include: Spouse, spousal equivalent, parents
(includes adoptive and step parent), dependents, nondependent children
(step), brothers and sisters.
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o
Section 2
Not independent if:
o More than 1 year of audit fees outstanding. Must be paid before issuing current
year report.
o Material loan unless from client in lending business and fully secured.
o Material litigation involving credibility of accountant or management (but not mere
monetary disputes over bills for earlier services).
o Accepting more than just a token gift.
o Entering into a Capital lease with the client.
o
o Final responsibility for journal entries (preparation of adjustments or depreciation
entries not a problem as long as client reviews and accepts final responsibility).
Any Direct financial interest
Client
CPA
Auditor
Mutual Fund
Material Indirect financial interest
Skepticism and Professional Judgment
The auditor plans and performs the audit exercising a degree of professional skepticism,
indicating that the auditor is aware of the possibility that the financial statements are materially
misstated and will be alert to indications, including:
Some audit evidence may contradict other audit evidence
Information may raise questions as to the reliability of documentary evidence
and responses to auditor inquiries
Conditions may indicate the possibility of fraud
There may be a need to apply audit procedures in addition to those required
by GAAS
Professional judgment is applied throughout the audit and should be adequately documented
such that an experienced auditor will understand significant judgments made in reaching
conclusions.
The auditor must exercise due professional care in the performance of the audit and the
preparation of the report.
Critical review of judgement used at every level.
Skill and care of a prudent CPA.
o Preparation of complete workpapers.
o Operating without negligence/Due diligence.
o Professional Skepticism Maintaining an objective attitude during the
audit.
o Acting with Competency and Diligence.
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Auditing Standards versus Audit Procedures
Auditing standards differ from auditing procedures in that procedures relate to acts to be
performed, whereas standards deal with measures of the quality
those acts. Materiality and relative risk underlie the application of all the standards.
Statements on Auditing Standards (SAS)
responsibility for following a particular SAS requirement. They are:
An unconditional requirement must be complied with in order for the auditor to
complete an engagement in accordance with GAAS. An auditor is required to comply
or the
with an
, in every circumstance to which it applies.
A presumptively mandatory requirement is one that the auditor is also expected to
comply with in every circumstance to which it applies. In rare circumstances, however,
the auditor may depart from a presumptively mandatory requirement but must document
how an alternate procedure was sufficient to achieve the objective of the standard. A
.
o On some occasions, a standard will include a requirement to consider a
procedure. This establishes a presumptively mandatory requirement to consider
the procedure or item being referenced, but does not establish a requirement to
perform the procedure.
These terms apply for both Public and Non-Public audits.
Assurance services as more broadly defined by the AICPA Special Committee on
Assurance Services (also referred to as the Elliott Committee) refers to
Another definition which we will cover in another section says; an engagement in which an
accountant issues a report designed to enhance the degree of confidence of third parties and
management about the outcome of an evaluation or measurement of financial statements
(subject matter) against an applicable financial reporting framework (criteria). Assurance
services include all attestation (including audit/review) services, plus a variety of other services
which will be developed in the future. Tax, compilations and consulting services are not
considered assurance services.
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Section 3
Professional Responsibilities & Ethics
(Lecture 3.01)
There are a variety of services that a member of the AICPA may provide their clients. This
section deals with the principles, rules and standards that govern those services. The CPA
profession has
commitment to protecting the public interest.
AICPA Code of professional conduct (ET), the State Board of
Accountancy in his or her state may s
member that commits a felony or files a fraudulent tax return for himself or herself, or for a
client.
10 Generally Accepted Auditing Standards (10 GAAS)
Prior to the issuance of the clarity standards auditors were required to apply 10 generally
accepted audited standards. Under the clarity standards, the 10 GAAS were re-positioned into
the objectives. The PCAOB, which has based its auditing standards on GAAS, has not adopted
the clarity standards and, as a result, the 10 GAAS still apply to PCAOB (Issuer) audits. In
addition, the general concepts still relate to all audits, therefore, they are still important for you to
understand in preparing for the CPA Exam.
A financial audit is an examination whose purpose is to express an opinion on the financial
statements of a client. In performing such an engagement, the auditor is expected to follow
generally accepted auditing standards (GAAS). These 10 standards are used as overall
measures of the quality of the auditor's performance. The specific procedures needed to fulfill
these standards will vary for each engagement, but the standards themselves are always the
same.
ET
AICPA Code of Professional Conduct Rules:
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