Chapter-Two.pptxThis is what you want for auditing and assurance services course

This is what you want for auditing and assurance services course

1. Chapter-Two The Auditing Profession 2.1 CHARACTERISTICS OF A PROFESSION The most important of characteristics of every Profession includes Responsibility to Serve the Public the role of the independent auditor is to ensure that financial statements are fair to all parties and not biased to favor a certain group.

2. Cont’d Complex and Specialized Body of knowledge A profession has a specialized body of knowledge that every member of the profession should acquire through formal/informal education. Need for Public Confidence A profession will be successful if it gains public trust and confidence. This is an extremely important quality expected of the independent auditor as it leads to increased credibility.

3. Cont’d Standards of Conduct of Behavior A profession needs to have standards of conduct that governs the behavior and activities of the members of the profession. The code of professional conduct is a means by which the public measures and judges the professional quality of the members . the auditing profession has developed a code of professional conduct that has two parts: principles and rules

4. Cont’d Standards of Qualification for Admission Admission should be restricted by legal and educational requirements so as to provide quality service to the society.

5. 2.2 GENERALLY ACCEPTED AUDITING STANDARDS (GAAS) The existence of generally accepted auditing standards is evidence that auditors are very concerned with the maintenance of a uniformly high quality of audit work by all independent public accountants. The broadest guidelines available to auditors in the U.S. are the 10 generally accepted auditing standards(GAAS), which were developed by the AICPA. They are the backbone of the auditing profession . defined as the measures to which the auditor is expected to adhere in the conduct of an audit in a given auditing situation .

6. Cont’d the auditing standards have been divided in to the following three Categories. 1. General standards 2 . Standards of field work 3. Standards of Reporting   General Standards The audit is to be performed by a person or persons having adequate technical training and proficiency as an auditor . emphasizes that the independent auditor is required to have adequate knowledge (education) and experience in the field of auditing. Training and proficiency are obtained in the following ways: Through formal university education; Additional knowledge through a CPA review courses; Through technical training.

7. Cont’d 2 . In all matters relating to the assignment, independence in mental attitude is to be maintained by the auditor or auditors . An opinion by an independent public accountant as to the fairness of a company's financial statements is of no value unless the auditor is truly independent. The auditors may demonstrate independence in the following manner: The auditors should be free from management influence in deciding the scope of the audit work, audit procedures, and audit staff assignment. They should have free access to accounting records and other relevant evidence. The auditor’s opinion should be based on his/her findings and should not be influenced by the client’s management.

8. Cont’d 3. Due professional care is to be exercised in the performance of the audit and the preparation of the report. auditors are professionals responsible for fulfilling their duties diligently and carefully. includes consideration of the completeness of the audit documentation, the sufficiency of the audit evidence, and the appropriateness of the audit report. requires the auditors to carry out every step of the audit engagement in an alert and diligent manner

9. 2.2.2 Standard of Fieldwork -Accumulating Evidence 4. The work is to be adequately planned and assistants, if any, are to be properly supervised. ( Planning) requires the auditor to plan his/her work. Planning enables the auditor to perform an efficient and timely audit; ensure proper utilization of staff assistants; ensure that proper attention is given to potential problem areas and facilitate coordination with client’s staff and other concerned parties. the audit must be sufficiently planned to ensure an adequate audit and proper supervision of assistants depends on the size and complexity of the client’s business; the auditor’s previous experience with the client, if any, and knowledge of the client’s business.

10. Cont’d 5. A sufficient understanding of the internal control structure is to be obtained to plan the audit and to determine the nature, timing, and extent of tests to be performed. The auditor should obtain knowledge of the business and the industry where it belongs. This will alert the auditor to: Understand the complexity of business transactions, Understand the unique of accounting practice of the industry , Give adequate attention to major transactions, Judge the reasonableness of management estimate like inventory valuation, deprecation, bad debts, etc., Determine the competence required of the audit team.  

11. Cont’d The auditor may obtain knowledge of the client’s business and the industry from the following: Annual reports issued to the shareholders, Minutes of stockholders’ and meetings of board of directors, Previous years working papers, Client’s procedures manual, Journals, newsletters, newspapers A tour or a visit to the client’s offices and plants, Discussion with client’s management and staff, Previous year’s financial statements.

12. Cont’d 6. Sufficient competent evidential matter is to be obtained though inspection, observation, inquiries, and confirmation to offer a reasonable basis for an opinion regarding the financial statements under audit. (Audit Evidence) require that the auditors gather sufficient competent evidence to have a basis for expressing an opinion on the financial statements. The auditor should gather sufficient competent audit evidence using auditing techniques such as inspection, inquires, and observation to arrive at a reasonable conclusion about the fairness of the financial statements audited.

13. Cont’d 2.2.3 The Reporting Standards 7. The report shall state whether the financial statements are presented in accordance with general accepted accounting principles . 8. The report shall identify those circumstances in which such principles have not been consistently observed in the current period in relation to the preceding period . 9. Informative disclosures in the financial statements are to be regarded as reasonably adequate unless otherwise stated in the report. 10. The report shall either contain 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 should be stated. In all cases where an auditor's name is associated with the financial statements, the report should contain a clear- cut indication of the character of the auditor's examination, if any, and the degree of responsibility he is taking.

14. 2.3 PROFESSIONAL ETHICS OF AUDITING A code of ethics is a comprehensive statement of the values and principles which guide the daily work of auditors . provides direction to practitioners for maintaining professional attitude and encourages high level of performance . Enforcement of code of ethics assures the general public and the audited entities that the auditor’s work is fair and impartial. build the public confidence, to judge the quality of audit work and means of grounding guidance of conduct for practitioners .

15. Cont’d encourage high level of performance while preventing mal-practices . Important of Ethics in Auditing Maintenance of mental and physical independence, integrity and objectivity General competence and technical standards Responsibility to client and colleague Other responsibility and practices that have bearing on ethical conduct include acts discreditable to the profession, i.e. commission, incompatible occupation, soliciting, forms of practice, etc.

16. Cont’d Code of conduct for Auditors Rule 101—Independence: A member in public practice shall be independent in the performance of professional services. Auditors are required to be independent for certain services but not for all. A member must be independent in fact and appearance

17. Cont’d Interpretations of Rule 101 prohibits Direct investment in audit clients Indirect investments, such as ownership of stock in a client’s company by an auditor’s grandparents Former Practitioners Financial relationship Financial Interests and Employment of Immediate and Close Family Members Joint Investor or Investee Relationship with Client Director, Officer, Management, or Employee of a Company Litigation Between CPA Firm and Client Bookkeeping and Other Services Unpaid Fees

18. Cont’d Rule 102—Integrity and Objectivity In the performance of any professional service, a member shall maintain objectivity and integrity, shall be free of conflicts of interest, and shall not knowingly misrepresent facts or subordinate his or her judgment to others. A member should maintain objectivity and be free of conflicts of interest in discharging professional responsibilities. The auditor must be impartial and unbiased in all matters pertaining to an engagement. To illustrate the meaning of integrity and objectivity, assume the auditor believe that accounts receivable may not be collectible but accepts management’s opinion without an independent evaluation of collectability. It is inappropriate for an auditor who is also an attorney to represent a client in legal matters. The attorney is an advocate for the client, whereas the auditor must be impartial.

19. Cont’d Rule 201—General Standards . A member shall comply with the following standards and with any interpretations thereof by bodies designated by Council. A. Professional competence. Undertake only those professional services that the member or the member’s firm can reasonably expect to be completed with professional competence. B. Due professional care. Exercise due professional care in the performance of professional services. C. Planning and supervision. Adequately plan and supervise the performance of professional services. D. Sufficient relevant data. Obtain sufficient, relevant data to afford a reasonable basis for conclusions or recommendations in relation to any professional services performed

20. Con’d Rule 202—Compliance with Standards . A member who performs auditing, review, compilation, management consulting, tax, or other professional services shall comply with standards promulgated by bodies designated by Council. Rule 203—Accounting Principles. A member shall not (1) express an opinion or state affirmatively that the financial statements or other financial data of any entity are not presented in conformity with generally accepted accounting principles or (2) state that he or she is not aware of any material modifications that should be made to such statements or data in order for them to be in conformity with generally accepted accounting principles, if such statements or data contain any departure from an accounting principle promulgated by bodies designated by Council to establish such principles that has a material effect on the statements or data taken as a whole. If, however, the statements or data contain such a departure and the member can demonstrate that due to unusual circumstances the financial statements or data would otherwise have been misleading, the member can comply with the rule by describing the departure, its approximate effects, if practicable, and the reasons why compliance with the principle would result in a misleading statement.

21. Cont’d Rule 301—Confidential Client Information. A member in public practice shall not disclose any confidential client information without the specific consent of the client. This rule shall not be construed (1) to relieve a member of his or her professional obligations under Rules 202 and 203, (2) to affect in any way the member’s obligation to comply with a validly issued and enforceable subpoena or summons, or to prohibit a member’s compliance with applicable laws and government regulations, (3) to prohibit review of a member’s professional practice under AICPA or state CPA society or Board of Accountancy authorization, or (4) to preclude a member from initiating a complaint with, or responding to any inquiry made by, the professional ethics division or trial board of the Institute or a duly constituted investigative or disciplinary body of a state CPA society or Board of Accountancy. Members of any of the bodies identified in (4) above and members involved with professional practice reviews identified in (3) above shall not use to their own advantage or disclose any member’s confidential client information that comes to their attention in carrying out those activities. This prohibition shall not restrict members’ exchange of information in connection with the investigative or disciplinary proceedings described in (4) above or the professional practice reviews described in (3) above.

22. Cont’d Rule 302—Contingent Fees; A member in public practice shall not (1) Perform for a contingent fee any professional services for, or receive such a fee from, a client for whom the member or member’s firm performs: (a) an audit or review of a financial statement; or (b) a compilation of a financial statement when the member expects, or reasonably might expect, that a third party will use the financial statement and the member’s compilation report does not disclose a lack of independence; or (c) an examination of prospective financial information; or (2) Prepare an original or amended tax return or claim for a tax refund for a contingent fee for any client. The prohibition in (1) above applies during the period in which the member or the member’s firm is engaged to perform any of the services listed above and the period covered by any historical financial statements involved in any such listed services. Except as stated in the next sentence, a contingent fee is a fee established for the performance of any service pursuant to an arrangement in which no fee will be charged unless a specified finding or result is attained, or in which the amount of the fee is otherwise dependent upon the finding or result of such service. Solely for purposes of this rule, fees are not regarded as being contingent if fixed by courts or other public authorities, or, in tax matters, if determined based on the results of judicial proceedings or the findings of governmental agencies. A member’s fees may vary depending, for example, on the complexity of services rendered. CPA firms are permitted to charge contingent fees for non attestation services, unless the CPA firm is also performing attestation services for the same client.

23. Cont’d CPA firms are permitted to charge contingent fees for non attestation services, unless the CPA firm is also performing attestation services for the same client. Rule 501—Acts Discreditable A member shall not commit an act discreditable to the profession. Do excessive drinking, rowdy behavior, (1) a crime punishable by imprisonment for more than 1 year; (2) the willful failure to file any income tax return that the CPA, as an individual taxpayer, is required by law to file; (3) the filing of a false or fraudulent income tax return on the CPA’s or client’s behalf; or (4) the willful aiding in the preparation and presentation of a false and fraudulent income tax return of a client. to retain a client’s records after a demand is made for them

24. Cont’d Rule 502—Advertising and Other Forms of Solicitation : A member in public practice shall not seek to obtain clients by advertising or other forms of solicitation in a manner that is false, misleading, or deceptive. Solicitation by the use of coercion, overreaching, or harassing conduct is prohibited.

25. Cont’d Rule 503—Commissions and Referral Fees A. Prohibited commissions. A member in public practice shall not for a commission recommend or refer to a client any product or service, or for a commission recommend or refer any product or service to be supplied by a client, or receive a commission, when the member or the member’s firm also performs for that client: (a) an audit or review of a financial statement; or (b) a compilation of a financial statement when the member expects, or reasonably might expect, that a third party will use the financial statement and the member’s compilation report does not disclose a lack of independence; or (c) an examination of prospective financial information. This prohibition applies during the period in which the member is engaged to perform any of the services listed above and the period covered by any historical financial statements involved in such listed services. B. Disclosure of permitted commissions. A member in public practice who is not prohibited by this rule from performing services for or receiving a commission and who is paid or expects to be paid a commission shall disclose that fact to any person or entity to whom the member recommends or refers a product or service to which the commission relates. C. Referral fees. Any member who accepts a referral fee for recommending or referring any service of a CPA to any person or entity or who pays a referral fee to obtain a client shall disclose such acceptance or payment to the client.

26. Cont’d Rule 505—Form of Organization and Name : A member may practice public accounting only in a form of organization permitted by state law or regulation whose characteristics conform to resolutions of Council. A member shall not practice public accounting under a firm name that is misleading. Names of one or more past owners may be included in the firm name of a successor organization. A firm may not designate itself as “Members of the American Institute of Certified Public Accountants” unless all of its CPA owners are members of the Institute.

27. Legal liability & Responsibility of Auditors Responsibility of Auditors Better Communication Detection of significant Errors and irregularities Detection of illegal clients act Doubts as to the entities going concern assumption

28. Cont’d Definition of legal terms Prudent Person concept There is an agreement b/n a profession and the court that auditors are not guarantor/ insurer of financial statements. Auditors a re not be expected to be perfect Ordinary Negligence Absence of reasonable care that can be expected from a person in a set of circumstances. It is in terms of what other competent auditors would have done in the same situation.

29. Cont’d Gross Negligence It is the absence of even slight care in their audit engagement that can be expected from a person. Constructive Fraud፡ Existence of unusual or extreme negligence even though there was no intent to deceive/harm on others. Example failure to follow GAAS Gross negligence may constitute constructive fraud. Tort Action፡ failure of a party to meet its obligations there by causing injury to another party. Breach of Contract: failure of one or both parties in a contract to fulfill the requirements of the contract. Third Party Beneficiary: parties who do not have privity in the contract but known to contracting parties and intended to have certain rights and benefits under the contract

30. Liability to Clients The most common source of lawsuits against CPAs is from clients. May be caused by failure to complete an audit engagement on the agreed-upon date. Issue of inappropriate audit report Failure to exercise degree of care an ordinary person can exercise would exercise under the same circumstance Failure to exercise even slight care (Gross Negligence) Inappropriate withdrawal from an audit engagement failure to discover an embezzlement (theft of assets) such as the auditor did not discover an employee theft as a result of negligence in the conduct of the audit. breach of the confidentiality requirements of CPAs Typically, the amount of these lawsuits is relatively small, and they do not receive the publicity often given to suits involving third parties.

31. Auditor’s Defenses Against Client Suits The CPA firm normally uses one or a combination of four defenses when there are legal claims by clients: Lack of Duty :-The lack of duty to perform the service means that the CPA firm claims that there was no implied or expressed contract. For example, the CPA firm might claim that misstatements were not uncovered because the firm did a review service, not an audit. Many litigation experts believe that a well-written engagement letter significantly reduces the likelihood of adverse legal actions.

32. Cont’d Non negligent Performance Even if there were undiscovered misstatements, the auditor is not responsible if the audit was conducted properly. auditing standards make it clear that an audit is subject to limitations and cannot be relied on for complete assurance that all misstatements will be found.

33. Cont’d Contributory Negligence exists when the auditor claims the client’s own actions either resulted in the loss that is the basis for damages or interfered with the conduct of the audit in such a way that prevented the auditor from discovering the cause of the loss. Suppose a client claims that a CPA firm was negligent in not uncovering an employee’s theft of cash. If the CPA firm had notified the client (preferably in writing) of a deficiency in internal control that would have prevented the theft but management did not correct it, the CPA firm would have a defense of contributory negligence.

34. Cont’d Absence of Causal Connection Assume that an auditor failed to complete an audit on the agreed-upon date. The client alleges that this caused a bank not to renew an outstanding loan, which caused damages. A potential auditor defense is that the bank refused to renew the loan for other reasons, such as the weakening financial condition of the client .

35. Liability to Third Parties Third parties include actual and potential stockholders, vendors, bankers and other creditors, employees, and customers. Audit firm may be liable to third parties if a loss was incurred by the claimant due to reliance on misleading financial statements. A typical suit occurs when a bank is unable to collect a major loan from an insolvent customer and the bank then claims that misleading audited financial statements were relied on in making the loan and that the CPA firm should be held responsible because it failed to perform the audit with due care.

36. Cont’d Three of the four defenses available to auditors in suits by clients are also available in third-party lawsuits: A lack of duty defense in third-party suits contends lack of privity of contract. Absence of causal connection in third-party suits often means non reliance on the financial statements by the user. Assume that the auditor can demonstrate that a lender relied on an ongoing banking relationship with a customer, rather than the financial statements, in making a loan.

37. Cont’d Non negligent performance, Note Absence of causal connection can be difficult to establish because users may claim reliance on the statements even when investment or loan decisions were made without considering the company’s financial condition. Contributory negligence is ordinarily not available because a third party is not in a position to contribute to misstated financial statements.

38. Criminal Liability Auditors can be found guilty for criminal action under both federal and state laws. The professions response to legal liability the profession as a whole can do a number of things to reduce practitioners’ exposure to lawsuits: Seek protection from non meritorious litigation Improve auditing to better meet users’ needs Educate users about the limits of auditing Conduct research on auditing

39. Cont’d 5. Standard and rule setting. 6. Sanction members for improper conduct and performance. 7. Lobby for changes in laws. Practicing auditors may also take specific action to minimize their liability. Some of the more common actions are as follows:

40. Cont’d . Deal only with clients possessing integrity . Maintain independence. Understand the client’s business Perform quality audits Document the work properly. Seek legal council Carry adequate insurance Oppose lawsuits Establish peer review requirements Use engagement letter for every professional services Comply with standards Exercise professional skepticism: alert to potential misstatements, so that they can recognize misstatements when they exist.

41. THE END OF CHAPTER-TWO