Chapter 02
Professional
Standards
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Authority of Organizations

Public Company Accounting Oversight Board


American Institute of Certified Public
Accountants


Auditing, Attestation, Quality Control, Independence,
Ethical Standards for audits of public companies
Auditing, Attestation, Quality Control, Independence
Ethical, Accounting and Review Standards for
engagements involving nonpublic companies
State Boards of Accountancy

License CPAs and CPA firms to practice in jurisdictions
2-2
Regulation of the Public Accounting Profession
2-3
Principles Underlying a GAAS
Audit 1/6
 Purpose
of an audit
 Premise of an audit
 Personal responsibilities of the auditor
 Auditor actions in performing the audit
 Reporting results of an audit
2-4
Principles Underlying a GAAS
Audit 2/6
 Purpose
of an audit—Provide an opinion
on financial statements are in accordance
with the applicable financial reporting
framework.


The framework is ordinarily GAAP.
The applicable framework corresponds to the
“suitable criteria” of an attest engagement.
2-5
Principles Underlying a GAAS
Audit 3/6
 Premise
of an audit—Management (and
those charged with governance) have
responsibility to:


Prepare financial statements in accordance
with applicable financial reporting framework.
Provide auditor with needed information and
unrestricted access to those in the entity.
2-6
Principles Underlying a GAAS
Audit 4/6
 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.
2-7
Principles Underlying a GAAS
Audit 5/6
 Auditor


actions in performing the audit
Obtain reasonable assurance about whether
financial statements are free from error or
fraud.
The 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.
2-8
Principles Underlying a GAAS
Audit 6/6
 Reporting
the results of an audit—
Express in a written report an opinion on
findings (or statement that opinion cannot
be expressed).

The opinion is on whether the financial
statements are in accordance, in all material
respects, with the applicable financial
reporting framework.
2-9
The 10 Generally Accepted
Auditing Standards
 General
Standards
 Standards of Field Work
 Reporting Standards
NOTE: These standards only apply to audits
conducted according to PCAOB
standards. The preceding “Principles”
replaced the 10 GAAS standards for
nonpublic company audits.
2-10
Generally Accepted Auditing
Standards--General Standards
 Adequate
technical training and
proficiency
 Independence
in mental attitude is to be
maintained
 Due
professional care is to be exercised
2-11
Generally Accepted Auditing
Standards--Standards of Field Work

Auditor must adequately plan and
properly supervise work
 Auditor must obtain a sufficient
understanding of entity, and its
environment, including internal control
to assess risk of material misstatement
and to design further audit procedures
 Auditor must obtain sufficient
appropriate audit evidence to afford a
reasonable basis for the opinion
2-12
Generally Accepted Auditing
Standards--Standards of Reporting




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 being assumed by the auditors by
expressing an opinion or stating that one cannot
be expressed, and the reason therefor
2-13
Terminology in Auditing Standards
(Figure 2.3)
Responsibility
Level
Meaning
Words Used to
Indicate Responsibility
Unconditional
Responsibility
Auditor must fulfill responsibilities
“Must”
“Shall” (PCAOB only)
“Is required” (PCAOB only)
Presumptively
Mandatory
Auditor must comply with requirements unless
auditor demonstrates and documents that
alternative actions were sufficient to achieve the
objectives of the standards
“Should”
Responsibility to
Consider
Auditor should consider; whether the auditor
complies with the requirements depends on the
exercise of professional judgment in the
circumstances
“May”
“Might”
“Could”
Other phrases indicating a
responsibilities to consider
2-14
The GAAS Hierarchy (Figure 2.3)
2-15
Auditor Responsibility for the
Detection of Errors and Fraud (1 of 2)


Obtain information to assess the inherent risks and
fraud risks
 Information about the company and its
environment
 Discussion among audit team members
 Inquiries of management and others
 Risk assessment analytical procedures, including
those involving revenue
Assess the risk of errors and fraud that may cause the
financial statements to contain a material
misstatement.
2-16
Auditor Responsibility for the
Detection of Errors and Fraud (2 of 2)

Based on that assessment, plan and perform the
audit to obtain reasonable assurance that
material misstatements, whether caused by
errors or fraud, will be detected.
 Exercise due care in planning, performing and
evaluating the results of audit procedures, and
the proper degree of professional skepticism to
achieve reasonable assurance that material
misstatements due to error or fraud will be
detected.
2-17
Auditor Responsibility for Client
Identifying Noncompliance with Laws

Noncompliance with laws that could have a direct
and material effect on financial statement amounts
and disclosures--same as for errors and fraud. An
audit obtains reasonable assurance of detecting
noncompliance with these laws.
 Other Laws (no direct effect on financial statement
amounts):

Specific procedures:
• Inquire of management as to compliance
• Inspect correspondence with licensing or regulatory authorities


Be aware of possible occurrence.
If information comes to the auditor’s attention, apply audit
procedures directed at determining whether
noncompliance with a law has occurred. An audit does
not provide assurance that noncompliance with these
laws will be detected.
2-18
The Standard Auditors’ Report for
Nonpublic Companies


Title
Addressee
 Content Sections (paragraphs)




Introductory (“We have audited”)
Management’s responsibility
Auditor’s Responsibility
Opinion Paragraph


Signature (firm name)
City and state of office issuing audit report
 Date
2-19
The AICPA Standard Auditors’
Report--Introductory Paragraph
We have audited the accompanying consolidated
balance sheets of ABC Company and its
subsidiaries, as of December 31, 20X1 and 20X0,
and the related consolidated statements of income,
retained earnings, and cash flows for the years
then ended.
2-20
The AICPA Standard Auditors’ Report—
Management’s Responsibility Paragraph
Management is responsible for the preparation and
fair presentation of these consolidated financial
statements in accordance with accounting principles
generally accepted in the United States of America;
this includes the design, implementation, and
maintenance of internal control relevant to the
preparation and fair presentation of consolidated
financial statements that are free from material
misstatement, whether due to fraud or error.
2-21
The AICPA Standard Auditors’ Report:
Auditors’ Responsibility Paragraphs
Our responsibility is to express an opinion on these consolidated financial statements
based on our audits. We conducted our audits in accordance with auditing standards
generally accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the consolidated
financial statements are free of material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and
disclosures in the consolidated financial statements. The procedures selected depend on
the auditor's judgment, including the assessment of the risks of material misstatement of
the consolidated financial statements, whether due to fraud or error. In making those risk
assessments, the auditor considers internal control relevant to the entity's preparation and
fair presentation of the consolidated financial statements in order to design audit
procedures that are appropriate in the circumstances, but not for the purpose of expressing
an opinion on the effectiveness of the entity's internal control An audit also includes
evaluating the appropriateness of accounting policies used and the reasonableness of
significant accounting estimates made by management, as well as evaluating the overall
presentation of the consolidated financial statements.
We believe that the audit evidence we have obtained is sufficient and appropriate to
provide a basis for our audit opinion.
2-22
The AICPA Standard Auditors’
Report--Opinion Paragraph
In our opinion, the consolidated financial
statements referred to above present fairly, in
all material respects, the financial position of
ABC Company and its subsidiaries as of
December 31, 20X1 and 20X0, and the
results of their operations and their cash flows
for the years then ended in accordance with
accounting principles generally accepted in
the United States of America.
2-23
GAAP

FASB issues GAAP for nongovernmental entities


Authoritative: FASB Codification and Accounting
Standards Updates
Nonauthoritative Pronouncements:
•
•
•
•
•

Widely recognized practices
FASB concepts Statements
AICPA Issues Papers
International Financial Reporting Standards
Various others
Other sources of GAAP


GASB--State and local governments
FASAB--Federal government
2-24
Other Types of Auditors’ Reports

Standard unmodified report (unqualified per PCAOB standards)


Financial statements follow GAAP and auditor does not add additional
commentary for any issue
Other reports

Unmodified with emphasis of matter (or other emphasis)
• Example: A lack of consistency in application of accounting
principles

Qualified opinion
• Scope limitation or departure from GAAP

Adverse opinion
• Departure from GAAP so significant that financial statements as a
whole are misleading

Disclaimer of opinion
• Unable to arrive at an opinion due to a very significant scope
limitation
2-25
Public Company Audit Report
 Title
is “Report of Registered Independent
Public Accounting Firm.”
 Refers to standards of the PCAOB rather
than GAAS.
 Includes a paragraph that refers to report
on internal control.
 Somewhat more brief than the nonpublic
company report.
2-26
Applicability of SSAEs
2-27
Elements of Quality Control
 Leadership
responsibilities for quality
within the firm (“tone at the top”)
 Relevant ethical requirements
 Acceptance and continuance of clients
and engagements
 Human Resources
 Engagement performance
 Monitoring
2-28
QC Element 1: Leadership responsibilities
for quality within the firm

Firm’s internal culture recognizes that quality is
essential in performing engagements and
recognizes the need to



perform work that complies with professional
standards and regulatory and legal requirements and
issue reports that are appropriate in the
circumstances.
Example: Assign management responsibilities
so that commercial considerations do not
override the quality of work performed.
2-29
QC Element 2: Relevant ethical
requirements
 Firm
and its personnel comply with
relevant ethical requirements.
 Example: At least annually, the firm should
obtain written confirmation of compliance
with its independence policies and
procedures from all firm personnel who
are required to be independent.
2-30
QC Element 3: Acceptance and
Continuance

Firm will undertake to continue relationships and
engagements only where the firm:
1. Has considered client integrity.
2. Is competent to perform the engagement.
3. Can comply with legal and ethical requirements.

Example: Background information is gathered on all
prospective audit clients, including the attitude of
principal owners, key management, and those charged
with governance on matters such as aggressive
accounting and internal control over financial reporting.
2-31
QC Element 4: Human Resources

Firm has personnel with the capabilities, competence,
and commitment to ethical principles to:
1. Perform engagements in accordance with professional standards
and regulatory and legal requirements.
2. Enable the firm to issue reports that are appropriate in the
circumstances.

Example: Design effective recruitment processes and
procedures to help the firm select individuals meeting
minimum academic requirements established by the
firm, and maturity, integrity and leadership.
2-32
QC Element 5: Engagement
Performance

Firm’s engagements are consistently performed in
accordance with professional standards and regulatory
and legal requirements, with policies and procedures
addressing:
1.
2.
3.

Engagement performance.
Supervision responsibilities.
Review responsibilities.
Example: Design policies and procedures that address
the tracking of progress of each engagement.
2-33
QC Element 6: Monitoring
 Firm’s
policies and procedures established
for each of the elements are suitably
designed and effectively applied.
 Example: Working papers, reports, and
client financial statements are reviewed to
assess compliance with the firm’s quality
control policies and procedures.
2-34
Quality Control Procedures
 Depend
on size of firm, number of offices
and nature of firm’s practices.
 Every CPA firm should have quality control
procedures applicable to every aspect of
its practice.
 Establish controls to provide assurance
that the CPA firm meets its responsibilities
to clients and public.
2-35
Regulation of the Public Accounting
Profession

Public Companies

Public Company Accounting Oversight Board
• Registration of public accounting firms that audit public
companies
• Conduct inspections of public company practice of
registered public accounting firms

Nonpublic Companies

AICPA & State Boards of Accountancy
• Peer review for nonpublic practice segments
2-36
PCAOB
 Composed
of 5 members – only two may
be CPAs
 Members appointed by SEC and may
serve no more than two five-year terms
 All accounting firms that audit SEC
registrants must register with PCAOB


Pledge to cooperate with PCAOB inquiries
PCAOB can impose monetary damages, suspend
firms or make referrals to Justice Department
2-37
Peer Reviews

Members of AICPA
 Conducted by CPAs or other CPA firms
 Two types of peer reviews
 System review
• Study of CPA firms’ system of quality control
• Select sample of firms’ engagements and examine related
working paper files

Engagement review
• Sample of CPA work including reports to evaluate
appropriateness
• Less in scope than system review

Report: pass, pass with deficiencies, or fail
2-38
PCAOB Inspections
 Conducted
by PCAOB staff
 Focus


Primarily evaluating performance of sample of
individual audit and review engagements; a
risk based approach to selection and
inspection is used.
Selected quality control and management
issues only. This differs from a peer review.
 Report

Written report to SEC, part of which is made
public
2-39
International Accounting
Standards
 International
Financial Reporting
Standards (IFRS)


Developed by International Accounting
Standards Board (IASB)
SEC accepts IFRS for foreign companies that
issue securities in US markets
2-40
International Audit Report
Contains expanded description of management’s
responsibility and explanation of the audit process
similar to the nonpublic company audit report
 May state “present fairly, in all material respects” or
“give a true and fair view”
 Report may indicate that the financial statements
comply with the provisions of the country’s relevant
statutes or laws
 May be signed using the personal name of the
auditor or the audit firm or both

2-41