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65 Cards in this Set
- Front
- Back
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• Agency Theory – Describe the consequences of the principal/agent conflict (conflicts of interest, information asymmetry, etc.)
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Information asymmetry means that the manager generally has more information about the “true” financial position and results of operations of the entity than does the absentee owner. Because their goals may not coincide, there is a natural conflict of interest because the manager and the absentee owner. If both parties seek to maximize their self interest, the manager may not always act in the best interest of the owner. Mangers may spend funds on excessive personal benefits or manipulate the reported earnings in order to inflate the price of the company’s stock so they can earn larger bonuses and sell stock holdings at artificially high prices.
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How does agency theory lead for a demand in accounting
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Since the managers don’t want to accept reduced compensation, the manager may agree to provide assurance to the owner that the manager will periodically report on how well they have managed the owners’ assets. Reporting of this financial information must follow some set of agreed upon accounting principles.
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Assurance
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Independent professional services that improve the quality of information, or its context, for decision makers
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Attestation
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occur when a practitioner is engaged to issue...a report on subject matter, or an assertion about subject matter, that is the responsibility of another party.
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Auditing
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is a systematic process of objectivity obtaining and evaluating evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between those assertions and established criteria and communicating the results to interested users.
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Key difference of Assurance
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Allows the auditor to report not only on reliability and credibility of information but also on the relevance and timeliness of that information. Assurance services can capture information, improve its quality, and enhance its usefulness for decision makers.
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Key difference of Attestation
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Not limited to economic events or actions, they can include prospective information, analyses, systems and processes, and even the actions of specified parties. Note that financial statement auditing is a specialized form of an attest service.
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Key difference of Auditing
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The auditor must objectively search for and evaluate the relevance and validity of evidence. While the type, quantity, and reliability of evidence may vary between audits, the process of obtaining and evaluating evidence makes up most of the auditors activities on an audit. The auditor compares the evidence gathered to assertions about economic activity in order to assess “the degree of correspondence between those assertions and established criteria.”
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Types of Auditing Services
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Forensic Auditing, Compliance Auditing, Audits of Financial Statements, Audits of Internal Control of Financial Reporting
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Types of Attestation Services
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Nonaudit reports on internal control, financial forecasts
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Types of Assurance Services
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CPA performance view, Cpa web trust, Cpa Sys Trust, cpa risk advisory, primeplus services
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Audit risk and why we cant eliminate it
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the risk that the auditor may unknowingly fail to appropriately modify his or her opinion on the financial statements that are materially misstated. We cannot eliminate audit risk because of cost considerations and sheer impossibility of investigating every item reflected in an entity’s financial statement. Even careful and competent auditors can only offer reasonable, rather than absolute, assurance.
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Materiality
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the magnitude of an omission or misstatement of accounting information that, in light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement. Def provided by FASB, it reflects what the auditor percieves as the view of a reasonable person.
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The relationship between materiality, audit risk, and evidence
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the lower level of materiality and audit risk the greater amount of evidence needed
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Introductory paragraph audit report
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indicates which financial statements are covered by the report, that the statements are the responsibility of management, and that the auditor has a responsibility to express an opinion.
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Second or Scope paragraph audit report
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communicates to the users, in very general terms, what an audit entails. In addition to indicating that the audit was conducted in accordance with applicable auditing standards, it emphasizes the fact that the audit provides only reasonable assurance that the financial statements contain no material misstatements. This paragraph also discloses that an audit involves an examination of evidence on a test basis, an assessment of accounting principles used and significant estimates, and an overall evaluation of financial statement presentation. Finally, the scope paragraph asserts the auditor’s belief that the audits provide a reasonable basis for the opinion to be expressed in the report.
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The third paragraph audit report
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contains the auditor’s opinion concerning the fairness of the financial statements based on the audit evidence. It indicates the criteria against which the auditor assesses management assertions. Second, emphasizing the concept of materiality. And also indicates the auditors opinion as to whether the financial statements are fairly presented in accordance with the criteria against which they were audited—GAAP.
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The fourth paragraph audit report
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contains explanatory language. When the auditors opinion on a public company’s financial statements is presented separately from the auditor’s report on the clients internal controls over financial reporting, the report must refer to the audit of internal control in an explanatory paragraph.
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WebTrust and SysTrust (assurance services)
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Provide assurance surrounding the security and effectiveness of retail and business internet commerce. These services were developed by the AICPA and CICA
Retail e-commerce sales will exceed $131 billion in 2007 92% of e-commerce in 2005 was B to B |
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PrimePlus
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Services help seniors and their families make difficult decisions concerning
– Health care – Living situations, and – Financial needs. PrimePlus services include – Providing for senior family members medical and living needs – Estate planning – Financial planning – Tax preparation – Cash flow management Formally known as ElderCare |
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Internal auditing
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an independent, objective assurance and consulting activity designed to add value and improve an organization’s operations. It helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control, and governance procedures.
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What mechanism help internal auditors be independent
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Organizational independence is achieved through reporting structures. Typically, internal audit departments should report directly to the audit committee. The Internal Audit Charter (defines authority/responsibilities; defines scope of engagements; defines reporting guidelines)
Personal independence is achieved through individual attitudes (e.g., Cynthia Cooper |
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Difference between external and internal auditing
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External auditors do their work with the purpose of expressing an opinion as to whether the entitys financial statements are free of material misstatements. Because external auditors rely on the concept of materiality, they typically are not concerned with auditing a particular area in a great deal of depth—they gather evidence until they obtain a reasonable assureance that no misstatements are present that would be considered material in the context of the financial statements take as a whole. They then report externally—outside of the organization being audited.
Internal auditors on the other hand, assist management and the board of directors in evaluating and managing risk, assessing compliance with laws and regulations, assessing operational efficiency, and performing detailed financial audies of areas requiring particular attention. Because their objectives are often different from those of external auditors, the concept of materiality is usually quite different as well. Some of the work performed by internal auditors is directly relevant to the work of the independent auditor. The external auditor can sometimes make use of controls testing work performed by the internal auditor. Similarly, discussed is Ch 5 is the external auditors use of work performed by the internal audit function in the context of the financial statement audit. Before relying on the work of internal auditors, the external auditor must evaluate the internal auditors objectivity and competence. If the external auditor decides that some reliance is justified, the cost savings in terms of the reduction in the external audit fee can be significant |
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Internal auditing
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an independent, objective assurance and consulting activity designed to add value and improve an organization’s operations. It helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control, and governance procedures.
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SAS 70 Service organizations
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Third-parties that process transactions for other entities. Many companies use third-parties to
– process payroll. – handle dividend distribution. – handle investments (banks, brokerage houses). The controls exist at the third-party provider – The auditors for the users of these services must ensure that those controls at the service provider are adequate. – Providers engage auditors to issue a special report concerning the controls. Service organization auditors’ reports may be based on controls placed in operation (Type 1). Service organization auditors’ reports may report on tests of effectiveness (Type 2). – Necessary to meet Sarbanes-Oxley’s Section 404 requirements. |
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What mechanism help internal auditors be independent
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Organizational independence is achieved through reporting structures. Typically, internal audit departments should report directly to the audit committee. The Internal Audit Charter (defines authority/responsibilities; defines scope of engagements; defines reporting guidelines)
Personal independence is achieved through individual attitudes (e.g., Cynthia Cooper |
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In order for the practitioner to examine management’s assertions about the effectiveness of internal control in an attestation engagement, the following conditions must be met:
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• Management of the entity accepts responsibility for the effectiveness of the entity’s internal control
• The responsible party evaluates the effectiveness of the entity’s internal control using suitable criteria. • Sufficient appropriate evidence exists or could be developed to support the responsible party’s evaluation |
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Internal auditing
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an independent, objective assurance and consulting activity designed to add value and improve an organization’s operations. It helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control, and governance procedures.
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What mechanism help internal auditors be independent
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Organizational independence is achieved through reporting structures. Typically, internal audit departments should report directly to the audit committee. The Internal Audit Charter (defines authority/responsibilities; defines scope of engagements; defines reporting guidelines)
Personal independence is achieved through individual attitudes (e.g., Cynthia Cooper |
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The practitioners report should include:
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• A title that includes the word independent
• An identification of the subject matter and the responsible party • A statement that the responsible is responsible for maintaining effective internal control over financial reporting • A statement that the practitioner’s responsibility is to express an opinion on the effectiveness of an entity’s internal control based on his or her examination. • A statement that the examination was conducted in accordance with attestation standards established by the AICPA. • A statement that the practitioner believes the examination provides a reasonable basis for his or her opinion. • A paragraph stating that, because of the inherent limitations of any internal control, misstatements due to errors or fraud may occur and not be detected. • The practitioner opinion on whether the entity has maintained, in all material respects, effective internal control over financial reporting as of the specified date, based on control criteria. • A statement restricting the use of the report to the specified parties |
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Difference between external and internal auditing
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External auditors do their work with the purpose of expressing an opinion as to whether the entitys financial statements are free of material misstatements. Because external auditors rely on the concept of materiality, they typically are not concerned with auditing a particular area in a great deal of depth—they gather evidence until they obtain a reasonable assureance that no misstatements are present that would be considered material in the context of the financial statements take as a whole. They then report externally—outside of the organization being audited.
Internal auditors on the other hand, assist management and the board of directors in evaluating and managing risk, assessing compliance with laws and regulations, assessing operational efficiency, and performing detailed financial audies of areas requiring particular attention. Because their objectives are often different from those of external auditors, the concept of materiality is usually quite different as well. Some of the work performed by internal auditors is directly relevant to the work of the independent auditor. The external auditor can sometimes make use of controls testing work performed by the internal auditor. Similarly, discussed is Ch 5 is the external auditors use of work performed by the internal audit function in the context of the financial statement audit. Before relying on the work of internal auditors, the external auditor must evaluate the internal auditors objectivity and competence. If the external auditor decides that some reliance is justified, the cost savings in terms of the reduction in the external audit fee can be significant |
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Financial forecasts
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prospective financial statements that present an entitys expected financial position, results of operations, and cash flows.
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SAS 70 Service organizations
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Third-parties that process transactions for other entities. Many companies use third-parties to
– process payroll. – handle dividend distribution. – handle investments (banks, brokerage houses). The controls exist at the third-party provider – The auditors for the users of these services must ensure that those controls at the service provider are adequate. – Providers engage auditors to issue a special report concerning the controls. Service organization auditors’ reports may be based on controls placed in operation (Type 1). Service organization auditors’ reports may report on tests of effectiveness (Type 2). – Necessary to meet Sarbanes-Oxley’s Section 404 requirements. |
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Difference between external and internal auditing
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External auditors do their work with the purpose of expressing an opinion as to whether the entitys financial statements are free of material misstatements. Because external auditors rely on the concept of materiality, they typically are not concerned with auditing a particular area in a great deal of depth—they gather evidence until they obtain a reasonable assureance that no misstatements are present that would be considered material in the context of the financial statements take as a whole. They then report externally—outside of the organization being audited.
Internal auditors on the other hand, assist management and the board of directors in evaluating and managing risk, assessing compliance with laws and regulations, assessing operational efficiency, and performing detailed financial audies of areas requiring particular attention. Because their objectives are often different from those of external auditors, the concept of materiality is usually quite different as well. Some of the work performed by internal auditors is directly relevant to the work of the independent auditor. The external auditor can sometimes make use of controls testing work performed by the internal auditor. Similarly, discussed is Ch 5 is the external auditors use of work performed by the internal audit function in the context of the financial statement audit. Before relying on the work of internal auditors, the external auditor must evaluate the internal auditors objectivity and competence. If the external auditor decides that some reliance is justified, the cost savings in terms of the reduction in the external audit fee can be significant |
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SAS 70 Service organizations
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Third-parties that process transactions for other entities. Many companies use third-parties to
– process payroll. – handle dividend distribution. – handle investments (banks, brokerage houses). The controls exist at the third-party provider – The auditors for the users of these services must ensure that those controls at the service provider are adequate. – Providers engage auditors to issue a special report concerning the controls. Service organization auditors’ reports may be based on controls placed in operation (Type 1). Service organization auditors’ reports may report on tests of effectiveness (Type 2). – Necessary to meet Sarbanes-Oxley’s Section 404 requirements. |
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In order for the practitioner to examine management’s assertions about the effectiveness of internal control in an attestation engagement, the following conditions must be met:
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• Management of the entity accepts responsibility for the effectiveness of the entity’s internal control
• The responsible party evaluates the effectiveness of the entity’s internal control using suitable criteria. • Sufficient appropriate evidence exists or could be developed to support the responsible party’s evaluation |
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Financial projections
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prospective financial statements that present, given one or more hypothetical assumptions, an entity’s expected financial position, results of operations, and cash flows.
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In order for the practitioner to examine management’s assertions about the effectiveness of internal control in an attestation engagement, the following conditions must be met:
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• Management of the entity accepts responsibility for the effectiveness of the entity’s internal control
• The responsible party evaluates the effectiveness of the entity’s internal control using suitable criteria. • Sufficient appropriate evidence exists or could be developed to support the responsible party’s evaluation |
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The practitioners report should include:
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• A title that includes the word independent
• An identification of the subject matter and the responsible party • A statement that the responsible is responsible for maintaining effective internal control over financial reporting • A statement that the practitioner’s responsibility is to express an opinion on the effectiveness of an entity’s internal control based on his or her examination. • A statement that the examination was conducted in accordance with attestation standards established by the AICPA. • A statement that the practitioner believes the examination provides a reasonable basis for his or her opinion. • A paragraph stating that, because of the inherent limitations of any internal control, misstatements due to errors or fraud may occur and not be detected. • The practitioner opinion on whether the entity has maintained, in all material respects, effective internal control over financial reporting as of the specified date, based on control criteria. • A statement restricting the use of the report to the specified parties |
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Report distribution options
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General use statements are presented by expected results. Therefore only financial forecasts can be made available for general use; financial projections are not to be made available for general use if an accountant report is involved.
Limited use of prospective financial statements refers to use of the statements by the responsible party alone or by the responsible party and third parties with whom the responsible is directly negotiating. |
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Financial forecasts
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prospective financial statements that present an entitys expected financial position, results of operations, and cash flows.
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The practitioners report should include:
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• A title that includes the word independent
• An identification of the subject matter and the responsible party • A statement that the responsible is responsible for maintaining effective internal control over financial reporting • A statement that the practitioner’s responsibility is to express an opinion on the effectiveness of an entity’s internal control based on his or her examination. • A statement that the examination was conducted in accordance with attestation standards established by the AICPA. • A statement that the practitioner believes the examination provides a reasonable basis for his or her opinion. • A paragraph stating that, because of the inherent limitations of any internal control, misstatements due to errors or fraud may occur and not be detected. • The practitioner opinion on whether the entity has maintained, in all material respects, effective internal control over financial reporting as of the specified date, based on control criteria. • A statement restricting the use of the report to the specified parties |
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Utilitarianism
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Recognizes that decision making involves trade-offs between the benefits and burdens of alternative actions and focuses on consequences and on individuals affected.
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Financial projections
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prospective financial statements that present, given one or more hypothetical assumptions, an entity’s expected financial position, results of operations, and cash flows.
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Financial forecasts
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prospective financial statements that present an entitys expected financial position, results of operations, and cash flows.
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Report distribution options
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General use statements are presented by expected results. Therefore only financial forecasts can be made available for general use; financial projections are not to be made available for general use if an accountant report is involved.
Limited use of prospective financial statements refers to use of the statements by the responsible party alone or by the responsible party and third parties with whom the responsible is directly negotiating. |
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Financial projections
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prospective financial statements that present, given one or more hypothetical assumptions, an entity’s expected financial position, results of operations, and cash flows.
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Utilitarianism
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Recognizes that decision making involves trade-offs between the benefits and burdens of alternative actions and focuses on consequences and on individuals affected.
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Report distribution options
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General use statements are presented by expected results. Therefore only financial forecasts can be made available for general use; financial projections are not to be made available for general use if an accountant report is involved.
Limited use of prospective financial statements refers to use of the statements by the responsible party alone or by the responsible party and third parties with whom the responsible is directly negotiating. |
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Utilitarianism
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Recognizes that decision making involves trade-offs between the benefits and burdens of alternative actions and focuses on consequences and on individuals affected.
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Justice-Based Approach
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concerned with issues such as equity, fairness, and impartiality.
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Rights-Based Approach
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Assumes that individuals have certain rights and other individuals have a duty to respect those rights when making decisions
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Principles of Professional Conduct
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setting forth ideal attitudes and behaviors
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Rules of Conduct
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defining minimum standards, most enforceable
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Interpretations of Rules of Conduct and Rulings
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are promulgated by the AICPA’s PEEC to provide guidelines as to the scope and application of the Rules of Conduct. Unlike the Rules of Conduct, interpretations and ethics rulings are not specifically enforceable, but an auditor who departs from them has the burden of justifying such departures.
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Audit Firms Quality Control (what they do to ensure quality:
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• Review of records pertaining to the quality control elements
• Review of engagement working papers, reports, and clients financial statements • Interviews with the firm’s personnel • Review of summarized reports, at least annually, on the findings of the monitoring procedures and the investigation of their causes so that improvements can be made • Determination of any corrective actions to be taken or improvements to be made • Communication of findings to appropriate firm management. • Follow-up on a timely basis by appropriate firm management and determination of what actions are necessary, including modification to the quality control system |
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PCAOB inspection process
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In addition to the AICPA peer review programs, the PCAOB conducts regular inspections of public accounting firms that are required to register with the Board. These inspections focus on selected audit and quarterly review engagements and evaluate the sufficiency of the quality control system of registered firms. The purpose of these inspections is to ensure that registered firms, in connection with their audits of public companies, comply with the Sarbanes Oxley Acts, PCAOB rules, and SEC rules, and professional standards
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Major Provisions of the Sarbanes-Oxley Act of 2002 (SOX):
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– Requirement of CEO/CFO certification of financial statements
– Requirement of auditor examination of company internal controls – Creation of the Public Company Accounting Oversight Board (PCAOB) to serve as an auditing profession “watchdog.” – Prohibition of certain client services by firms conducting a client’s audit. |
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Auditing Standards
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Auditing standards serve as guidelines for and measures of the quality of the auditor’s performance.
The PCAOB promulgates auditing standards for audits of public companies. |
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10 GAAS
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The Generally Accepted Auditing Standards are composed of three categories of standards: general standards, standards of field work, and standards of reporting.
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audit evidence
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The characteristics that must be satisfied: relevance and reliability, evidence must be relevant which refers to whether the evidence relates to the specific management assertion being tested, reliability refers to the diagnosticity of the evidence
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Hierarchy of evidence reliability
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Auditors’ direct personal knowledge
– Observe PPE, inventories External documentary evidence – A/R confirmations, bank confirmations External-internal evidence – Vendor invoices for purchases Internal documentary evidence – Client sales invoices Verbal and written representations – Management representations (SAS 85) |
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Understanding the Client’s Business
Methods and sources of information: |
– Gain an understanding of client’s ERM model
– Inquiry/observation of client personnel – Review corporate charter, board and committee minutes – Review of prior year working papers (anchoring could be a problem) – Study AICPA industry ACCT & Auditing practices – Read general business news (e.g., WSJ, BusinessWeek, etc.) – Read client-specific news articles, industry publications, etc. |
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Professional skepticism
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auditor’s questioning, evaluative, attitude toward management’s assertions and audit evidence
– Management’s assertions without sufficient corroboration. – Financial trends need investigation – Documents are checked for authenticity or alteration – Ask questions, get answers, then verify the answers. – A potential conflict of interest always exists between the auditor and the client. – Management wants to portray the company and its operations in the best possible light. – Auditors want to portray the company and its operations fairly. |
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Corporate Governance
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due to the way resources are invested and managed in the modern business world, a system of corporate governance is necessary, through which managers are overseen and supervised. Simply defined, corporate governance consists of all the people, processes, and activities in place to help ensure proper stewardship over an entity’s assets. Good corporate governance ensures that those managing an entity’s properly utilize their time, talents, and the entity’s resources in the best interest of absentee owners, and that they faithfully report the economic condition and performance of the enterprise. The body primarily responsible for management oversight in US corps is the board of directors. The audit committee, consisting of members of the board, oversees the internal and external auditing work done for the organization
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