BA 427 – Assurance and
Attestation Services
Lecture 1
Introduction
Lecture 1 – Introduction

Syllabus

Course Requirements

Course Materials and Resources

Corporate Governance
Lecture 1 – Grading
Final
Exam
30%
quizzes,
cases,
participation
15%
Three
Exams
55%
Lecture 1 – course materials




Gleim’s 2006 CPA Review Guide:
Auditing & Attestation, available from the
OSU bookstore and from the publisher’s
website.
Course Readings Packet, available from
the OSU bookstore.
Additional required readings will be
distributed in class and others are available
on the web.
Optional: Auditing and Assurance Services by
Arens, Elder & Beasley, 11th edition
Lecture 1 – course objectives

Help you succeed in your first weeks
on the job

Help you pass the CPA exam

Help you in your first two promotions
Lecture 1 – course objectives

These objectives have driven the following
choices for the course:

Gleim as our “textbook”

Extensive use of source documents

Coverage of topics that will help you advance in
your career, but that are not included in the firm’s
continuing education training

Six outside speakers from the accounting
profession
Lecture 1 – course objectives

The great issues of our day

The detection of fraud

The independence of the independent
public accountant

Corporate governance and aggressive
financial reporting

Self-regulation by the public accounting
profession
Lecture 1 – how to succeed

Do not fall behind on the readings.

Understand how to learn from Gleim.


Understand how to skim materials in
the readings packet.
Participate in class discussions,
particularly when outside speakers are
here.
Lecture 1 – Introduction

Syllabus

Course Requirements

Course Materials and Resources

Corporate Governance
Overview of the Course
The Public
Audit
Regulatory
Oversight
Corporate
Governance &
Reporting
Internal
Controls
The Audit
Committee
Internal
Auditing
A Framework for everything
we do:

Ask five questions:





Who
When
What
Why
How
A Framework for everything
we do:

Ask five questions:





Who: the private sector, a regulator, a selfregulatory body?
When: the sequence of events is
important.
What: is this a study, a recommendation, a
rule, and what is its impact?
Why: Motives; what is the economic, legal
and political context?
How: what provided this entity or person
the resources or clout to have an impact?
The Players
The Private Sector
Regulators
Investors
The SEC
Companies doing
business in the U.S.
Public Accounting Firms
The PCAOB
American Institute of
Certified Public Accountants
Wall Street
The GAO
U.S. Congress
Financial Accounting
Standards Board
The New York Stock Exchange
Auditing Standards Board
Ethics Division of the AICPA
Public Oversight Board
Self-regulatory Bodies
State Boards
The Courts
An example:

“Audit Committees: A Call to Action”:

Who


When


A public speech delivered in New York
Why


October 5, 2000 (before the bubble burst; see next slide)
What


Lynn Turner, SEC Chief Accountant from about 1997 to
2001, under SEC Chairman Arthur Levitt
To encourage self-regulation and regulatory reform
How

The SEC Chief Accountant is a high-profile position
An example:

“Audit Committees: A Call to Action”

Yet investors and the business community learned
a very valuable lesson 70 years ago—that the trust
and confidence in markets can be shaken and lost.
We learned that liquidity can disappear and capital
quickly dry up. Fair and orderly markets can
dissolve much more quickly than they are built.
An economy that is seemingly the Emerald City of
Oz with roads of gold can turn to a bowl of dust
overnight.
An example:

“Audit Committees: A Call to Action”:

Here are all (or most) of the sources that Turner
references and quotes in his speech:
 The Blue Ribbon Committee on Improving the
Effectiveness of Corporate Audit Committees
 The Committee of Sponsoring Organizations
(COSO) 1999 report “Fraudulent Financial
Reporting: 1987 – 1997”
 The Panel on Audit Effectiveness
 SAS 89 and SAS 90, issued by the APB
 Warren Buffett
 “New Responsibilities and Requirements for
Audit Committees,” by Arthur Andersen
Corporate Governance

Key regulatory and self-regulatory
events



The Foreign Corrupt Practices Act
The Treadway Report
The Blue Ribbon Committee on Improving
the Effectiveness of Corporate Audit
Committees
The FCPA

The Foreign Corrupt Practices Act

In 1976, bribes originating from Lockheed
Aircraft led to the arrest of a former Prime
Minister of Japan.
The FCPA

The Foreign Corrupt Practices Act


Signed by President Carter in 1977
Best known for its prohibition against U.S.
companies bribing foreign officials


This prohibition is sometimes incorrectly
characterized as prohibiting “grease payments”
to foreign government bureaucrats. It does not
do that.
The FCPA also imposes on U.S. public
companies internal accounting control and
bookkeeping requirements.
The FCPA

The Foreign Corrupt Practices Act

The increased bookkeeping and internal
accounting controls requirements were
intended to supplement the anti-bribery
provisions, by
 increasing corporate accountability;
 decreasing the likelihood that illegal
payments can be concealed.
The FCPA

The Foreign Corrupt Practices Act

The bookkeeping requirements:

Every public company shall make and keep
books, records, and accounts which, in
reasonable detail, accurately and fairly reflect
the transactions and dispositions of the assets of
the issuer.
The FCPA

The Foreign Corrupt Practices Act

The Act requires companies to devise and maintain
a system of internal accounting controls
sufficient to provide reasonable assurances that:




Transactions are executed in accordance with
management’s general or specific authorization.
Transactions are recorded as necessary to permit
preparation of financial statements in conformity with
GAAP, and to maintain accountability for assets.
Access to assets is permitted only in accordance with
management’s general or specific authorization.
The recorded accountability for assets is compared with
the existing assets at reasonable intervals and appropriate
action is taken with respect to any differences.
The FCPA

The Foreign Corrupt Practices Act




The Act codified existing concepts and “best
practices”
The Act is concerned with accounting
controls only, not all internal controls.
The Act acknowledges that all controls are
subject to a cost/benefit test.
For the first time, weak internal controls can
subject public companies, their officers and
employees to civil liability and criminal
prosecution under federal law.
Corporate Governance

Key regulatory and self-regulatory
events



The Foreign Corrupt Practices Act
The Treadway Report
The Blue Ribbon Committee on Improving
the Effectiveness of Corporate Audit
Committees
Treadway



Formally, The Report of the National
Commission on Fraudulent Financial
Reporting.
Chaired by James Treadway, Jr.,
Executive V.P. and General Counsel of Paine
Webber (and former SEC Commissioner).
The Commission conducted a two-year
study of the financial reporting system in
the U.S., and issued its report in October,
1987.
Treadway

The Commission was sponsored and
funded by:






The AICPA
The American Accounting Association
The Institute of Internal Auditors
The National Association of Accountants (now the
Institute of Management Accountants)
The Financial Executives Institute (now Financial
Executives International)
These organizations constitute “COSO”, the
Committee of Sponsoring Organizations
Treadway

Key conclusion:


“Fraudulent financial reporting is indeed a
serious problem. Infrequent though its
occurrence arguably may be, its
consequences can be widespread and
significant.
The Treadway Report consists primarily
of a series of recommendations
Treadway

Recommendations to Public Companies:

The Tone at the Top: the tone set by top
management—the corporate environment
or culture within which financial reporting
occurs—is the most important factor
contributing to the integrity of the financial
reporting process.
Treadway

Recommendations to Public Companies:



Top management must identify, understand, and
assess the factors that may cause the company’s
financial statements to be fraudulently misstated.
Public companies should maintain internal controls
that provide reasonable assurance that fraudulent
financial reporting will be prevented or subject to
early detection.
Public companies should develop and enforce
written codes of conduct that foster a strong ethical
climate and open channels of communication. The
Audit Committee should review annually the
program that management establishes to monitor
compliance with the code.
Treadway

Recommendations to Public Companies:




Public companies should maintain accounting
functions that are designed to meet their financial
reporting obligations.
Public companies should maintain an effective
internal audit function staffed with an adequate
number of qualified personnel.
Public companies should ensure that their internal
audit functions are objective.
Internal auditors should consider the implications of
their nonfinancial audit findings for the company’s
financial statements.
Treadway

Recommendations to Public Companies:



Management and the audit committee should
ensure that the internal auditors’ involvement in
the audit of the entire financial reporting process is
appropriate and properly coordinated with the
independent public accountant.
The SEC should require all public companies to
establish audit committees composed solely of
independent directors.
Audit committees should be informed, vigilant, and
effective overseers of the financial reporting
process and the company’s internal controls.
Treadway

Recommendations to Public Companies:



All public companies should develop a written
charter setting forth the duties and responsibilities
of the audit committee. The board should approve
the charter and review it periodically.
Audit committees should have adequate resources
and authority to discharge their responsibilities.
The audit committee should review management’s
evaluation of factors related to the independence of
the company’s public accountant. Both the audit
committee and management should assist the
public accountant in preserving his independence.
Treadway

Recommendations to Public Companies:

Before the beginning of each year, the audit
committee should review management’s plans for
engaging the company’s independent public
accountant to perform management advisory
services during the coming year, considering both
the types of services that may be rendered and the
projected fees.
Treadway

Recommendations to Public Companies:

All public companies should be required by SEC rule
to include in their annual reports management
reports signed by the CEO and the chief accounting
officer and/or the CFO. The report should
acknowledge management’s responsibilities for the
financial statements and internal control, discuss
how these responsibilities were fulfilled, and
provide management’s assessment of the
effectiveness of the company’s internal controls.
Treadway

Recommendations to Public Companies:



All public companies should be required by the SEC
to include in their annual reports a letter signed by
the chairman of the audit committee describing the
committee’s responsibilities and activities during
the year.
Management should advise the audit committee
when it seeks a second opinion on a significant
accounting issue.
The SEC should require public companies that
change their independent accountants to disclose
the nature of any material accounting or auditing
issue discussed with both its old and new auditor
during the three-year period prior to the change.
Treadway

Recommendations to Public Companies:


Audit committees should oversee the quarterly
reporting process.
COSO should cooperate in developing additional,
integrated guidance on internal control.
Treadway

Recommendations to CPAs:

The ASB should revise standards to restate the
independent public accountant’s responsibility for
detection of fraudulent financial reporting, requiring
the independent accountant to (1) take affirmative
steps in each audit to assess the potential for such
reporting, and (2) design tests to provide
reasonable assurance of detection. Revised
standards should include guidance for assessing
risks and pursuing detection when risks are
identified.
Treadway

Recommendations to CPAs:


The ASB should establish standards to require
independent public accountants to perform
analytical review procedures in all audit
engagements and should provide improved
guidance on the appropriate use of these
procedures.
The SEC should require independent public
accountants to review quarterly financial data of all
public companies before release to the public.
Treadway

Recommendations to CPAs:


The AICPA’s SEC Practice Section should strengthen
its peer review program by increasing review of
audit engagements involving public company clients
new to a firm. For each office selected for peer
review, the first audit of all such new clients should
be reviewed.
Public accounting firms should recognize and
control the organizational and individual pressures
that potentially reduce audit quality.
Treadway

Recommendations to CPAs:

The AICPA’s SEC Practice Section requirement for a
concurring (second) partner review should be
revised to
 require the concurring partner’s involvement in
the planning stage of the audit,
 require the concurring partner to have prior
experience with SEC registrants, and familiarity
with the client’s industry,
 require the concurring partner to consider
himself a peer of the engagement partner for
purposes of the review.
Treadway

Recommendations to CPAs:

The ASB should revise the auditor’s standard report


to state that the audit provides reasonable but not
absolute assurance that the audited financial statements
are free from material misstatements as a result of fraud
or error.
to describe the extent to which the independent public
accountant has reviewed and evaluated the system of
internal accounting control. The ASB also should provide
explicit guidance to address the situation where, as a
result of his knowledge of the company’s internal
accounting controls, the independent public accountant
disagrees with management’s assessment as stated in the
proposed management report.
Treadway

Recommendations to CPAs:

The AICPA should reorganize the ASB to afford a
full participatory role in the standard-setting
process to knowledgeable persons who are affected
by and interested in auditing standards but who
either are not CPAs or are CPAs no longer in public
practice.
Treadway

Recommendations to the SEC and regulators




The SEC should have the authority to impose civil
money penalties in administrative proceedings.
The SEC should have the authority to issue a cease
and desist order when it finds a securities law
violation.
The SEC should seek explicit statutory authority to
bar or suspend corporate officers and directors
involved in fraudulent financial reporting from
future service in that capacity in a public company.
Criminal prosecution of fraudulent financial
reporting cases should become a higher priority.
Treadway

Recommendations to the SEC and regulators



The SEC should require accounting firms that audit
public companies to be members of a professional
organization that has peer review and independent
oversight functions and is approved by the SEC,
such as the SEC Practice Section of the AICPA.
The SEC should take enforcement action when a
public accounting firm fails to remedy deficiencies
cited by the public accounting profession’s quality
assurance program.
The SEC must be given adequate resources to
perform existing and additional functions that help
prevent, detect, and deter fraudulent financial
reporting.
Treadway

Recommendations to the SEC and regulators


The Office of the Comptroller of the Currency, the
Federal Reserve Board, the F.D.I.C., and the Federal
Home Loan Bank Board should adopt measures
patterned on the Commission’s recommendations
directed to the SEC.
The financial institution regulatory agencies and the
public accounting profession should provide for the
regulatory examiner and the independent public
accountant to have mutual access to information
they develop about examined financial institutions.
Treadway

Recommendations to the SEC and regulators


State boards of accountancy should implement
positive enforcement programs that periodically
would review the quality of services that the
independent public accountants they license render.
Parties charged with responding to various tort
reform initiatives should consider the implications
that the perceived liability crisis holds for long-term
audit quality and the independent public
accountant’s detection of fraudulent financial
reporting.
Treadway

Recommendations to the SEC and regulators

The SEC should reconsider its longstanding
position, insofar as it applies to independent
directors, that the corporate indemnification of
officers and directors for liabilities that arise under
the Securities Act of 1933 is against public policy.
Treadway

Recommendations to Educators


Throughout the business and accounting curricula,
educators should foster knowledge and
understanding of the factors that may cause
fraudulent financial reporting and the strategies
that can lead to a reduction in its incidence.
The business and accounting curricula should
promote a better understanding of the function and
the importance of internal controls, including the
control environment, in preventing, detecting, and
deterring fraudulent financial reporting.
Treadway

Recommendations to Educators


Business and accounting students should be wellinformed about the regulation and enforcement
activities by which government and private bodies
safeguard the financial reporting system and
thereby protect the public interest.
The business and accounting curricula should help
students develop stronger analytical, problem
solving, and judgment skills to help prevent, detect,
and deter fraudulent financial reporting when they
become participants in the financial reporting
process.
Treadway

Recommendations to Educators


The business and accounting curricula should
emphasize ethical values by integrating their
development with the acquisition of knowledge and
skills to help prevent, detect, and deter fraudulent
financial reporting.
Business schools should encourage business and
accounting faculty to develop their own personal
competence as well as classroom materials for
conveying information, skills, and ethical values
that can help prevent, detect, and deter fraudulent
financial reporting.
Treadway

Recommendations to Educators


Professional certification examinations should test
students on the information, skills, and ethical
values that further the understanding of fraudulent
financial reporting and that promote its reduction.
As part of their continuing professional education,
independent public accountants, internal auditors,
and corporate accountants should study the forces
and opportunities that contribute to fraudulent
financial reporting, the risk factors that may
indicate its occurrence, and the relevant ethical and
technical standards.
Corporate Governance

Key regulatory and self-regulatory
events



The Foreign Corrupt Practices Act
The Treadway Report
The Blue Ribbon Committee on
Improving the Effectiveness of
Corporate Audit Committees
The Blue Ribbon Committee

The Blue Ribbon Committee





Instigated by the SEC
Sponsored by the NYSE and the NASD
11 committee members
Initiated in 1998, issued its report in 1999
At the time, the major exchanges
required companies to maintain audit
committees, but did not specify their
composition or function.
The Blue Ribbon Committee

The Blue Ribbon Committee members








NYSE Chairman and CEO Richard Grasso
NASD Chairman and CEO Frank Zarb
E&Y Chairman & CEO Philip Laskawy
PwC CEO James Schiro
POB board member Charles Bowsher
TIAA-CREF Chairman and CEO John Biggs
Retired Goldman Sachs Co-Chair Whitehead
Four others
The Blue Ribbon Committee

The Blue Ribbon Committee issued ten
recommendations:



Two to improve audit committee
independence
Three to improve audit committee
effectiveness
Five to address mechanisms for
accountability among the audit committee,
the external auditors, and management
The Blue Ribbon Committee

Audit committee independence:


Directed at NASD and NYSE companies with
market capitalization over $200 million.
All audit committee members should be
independent. Restrictions include:



Not employed by the company within the past
five years.
No compensation from the company except for
board service or under a retirement plan.
No family member who has served as an
executive officer of the company for the past five
years.
The Blue Ribbon Committee

Audit committee effectiveness:



Large companies should have audit
committees of at least three members, all of
whom are financially literate. At least one
member should have accounting or financial
management expertise.
Audit committees of all companies should
have written charters.
The SEC should require companies to
disclose information related to the audit
committee’s charter, and compliance
therewith.
The Blue Ribbon Committee

Accountability



The external auditors are ultimately
accountable to the board of directors and
the audit committee. The audit committee
is responsible for retaining the auditor.
The audit committee is responsible for
monitoring and ensuring the independence
of the external auditor.
GAAS should require auditors to discuss with
the audit committee the quality, not just the
acceptability, of the company’s financial
reporting.
The Blue Ribbon Committee

Accountability


The SEC should require companies to
include in its 10K a letter from the audit
committee indicating whether the committee
has discussed the audited financial
statements privately among its members,
with management, and with the auditors.
The SEC should require interim financial
reviews of 10Qs by the external auditors,
and the auditors should discuss quarterly
results with the audit committee.
The Blue Ribbon Committee

The Committee’s “guiding principles” for
best practices:





Audit committee oversight of the work of
others in the financial reporting process;
Private communication between the audit
committee and the internal auditors;
Private communication between the audit
committee and the external auditors;
Frank discussions with management;
Diligent and knowledgeable audit committee
members.
The Blue Ribbon Committee

In distributing the Blue Ribbon’s report
to interested parties, the POB included
a cover letter that stated:

“The POB believes that corporate America
stands on the threshold of sharply
increased effectiveness of corporate
governance, which hopefully will lead to
sounder financial reporting.”
The Blue Ribbon Committee

The Blue Ribbon Committee itself
stated:

“If an audit committee is determined to
be diligent in its oversight role, a sure
sense of appropriate action will follow;
credible diligence is not rocket science.”
The Blue Ribbon Committee
Robert K. Jaedicke
Dean, 1983 – 90, Stanford Graduate School of Business
and Director of the Audit Committee at Enron