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CHAPTER 1
AUDITING AND THE PUBLIC
ACCOUNTING PROFESSION
Learning Check
1.1 Several common attributes of activities defined as auditing are (a) systematic process, (b) objectively obtaining and evaluating evidence, (c) assertions about economic actions and events, (d) degree of correspondence, (e) established criteria, (f) communicating the results, and (g) interested users.
1.2 A financial statement audit involves obtaining and evaluating evidence about an entity's financial statements for the purpose of expressing an opinion on whether the statements are presented fairly in conformity with established criteria--usually GAAP. Thus, the nature of the auditor's report is an opinion on the fairness of the financial statements. A compliance audit involves obtaining and evaluating evidence to determine whether certain financial or operating activities of an entity conform to specified conditions, rules, or regulations. A report on a compliance audit takes the form of a summary of findings or assurance regarding degree of compliance. An operational audit involves obtaining and evaluating evidence about the efficiency and effectiveness of an entity's operating activities in relation to specified objectives. Reports on such audits include an assessment of efficiency and effectiveness and recommendations for improvements.
1.3 Independent auditors are individual practitioners or members of public accounting firms who render professional auditing services to clients. These services may involve financial statement audits, compliance audits, and operational audits. Internal auditors are employees of the companies they audit. They are involved in an independent appraisal activity, called internal auditing, as a service to the organization. Internal auditors are primarily concerned with compliance and operational audits. Government auditors are employed by various local, state, and federal governmental agencies. They may be involved in all three types of audits.
1.4 a. The origin of the company audit as we know it can be linked to British legislation during the
industrial revolution in the mid-1800s. Company audits were initially performed by one or more stockholders designated by other stockholders, but subsequent revisions in the legislation permitted the use of outside independent auditors, giving rise to the formation of auditing firms.
b. The migration of the company audit to the U.S. came about as English and Scottish investors sent their own auditors to check on the condition of American companies, such as breweries and railroads, in which they had heavily invested. This migration occurred in the late 1800s. The focus of these early audits was on finding errors in the balance sheet accounts and stemming the growth of fraud associated with the increasing phenomenon of professional managers and absentee owners.
1.5 Several important milestones in the rise of the U.S. profession were (1) passage of the first legislation providing for the licensing of CPAs by New York state in 1896, (2) the passage of similar legislation by all of the then forty-eight states by 1921, (3) the establishment of the American Institute of Accountants (now the AICPA) in 1917, (4) the publication in 1918 of a proposal for uniform accounting following a period of rapid growth in the public ownership of corporate securities and growing recognition of the need for greater uniformity in financial reporting as well as the need to employ accountants who understood reporting requirements, (5) the stock market crash of 1929 which drew attention to deficiencies in financial reporting and produced a challenge to the accounting profession to provide stronger leadership, (6) adoption of a requirement by the New York Stock Exchange in 1933 that all listed corporations obtain an audit certificate from an independent CPA, and (7) passage of the Securities Act of 1933 and the Securities Exchange Act of 1934 which added to the demand for audit services for
CHAPTER 1
AUDITING AND THE PUBLIC
ACCOUNTING PROFESSION
Learning Check
1.1 Several common attributes of activities defined as auditing are (a) systematic process, (b) objectively obtaining and evaluating evidence, (c) assertions about economic actions and events, (d) degree of correspondence, (e) established criteria, (f) communicating the results, and (g) interested users.
1.2 A financial statement audit involves obtaining and evaluating evidence about an entity's financial statements for the purpose of expressing an opinion on whether the statements are presented fairly in conformity with established criteria--usually GAAP. Thus, the nature of the auditor's report is an opinion on the fairness of the financial statements. A compliance audit involves obtaining and evaluating evidence to determine whether certain financial or operating activities of an entity conform to specified conditions, rules, or regulations. A report on a compliance audit takes the form of a summary of findings or assurance regarding degree of compliance. An operational audit involves obtaining and evaluating evidence about the efficiency and effectiveness of an entity's operating activities in relation to specified objectives. Reports on such audits include an assessment of efficiency and effectiveness and recommendations for improvements.
1.3 Independent auditors are individual practitioners or members of public accounting firms who render professional auditing services to clients. These services may involve financial statement audits, compliance audits, and operational audits. Internal auditors are employees of the companies they audit. They are involved in an independent appraisal activity, called internal auditing, as a service to the organization. Internal auditors are primarily concerned with compliance and operational audits. Government auditors are employed by various local, state, and federal governmental agencies. They may be involved in all three types of audits.
1.4 a. The origin of the company audit as we know it can be linked to British legislation during the
industrial revolution in the mid-1800s. Company audits were initially performed by one or more stockholders designated by other stockholders, but subsequent revisions in the legislation permitted the use of outside independent auditors, giving rise to the formation of auditing firms.
b. The migration of the company audit to the U.S. came about as English and Scottish investors sent their own auditors to check on the condition of American companies, such as breweries and railroads, in which they had heavily invested. This migration occurred in the late 1800s. The focus of these early audits was on finding errors in the balance sheet accounts and stemming the growth of fraud associated with the increasing phenomenon of professional managers and absentee owners.
1.5 Several important milestones in the rise of the U.S. profession were (1) passage of the first legislation providing for the licensing of CPAs by New York state in 1896, (2) the passage of similar legislation by all of the then forty-eight states by 1921, (3) the establishment of the American Institute of Accountants (now the AICPA) in 1917, (4) the publication in 1918 of a proposal for uniform accounting following a period of rapid growth in the public ownership of corporate securities and growing recognition of the need for greater uniformity in financial reporting as well as the need to employ accountants who understood reporting requirements, (5) the stock market crash of 1929 which drew attention to deficiencies in financial reporting and produced a challenge to the accounting profession to provide stronger leadership, (6) adoption of a requirement by the New York Stock Exchange in 1933 that all listed corporations obtain an audit certificate from an independent CPA, and (7) passage of the Securities Act of 1933 and the Securities Exchange Act of 1934 which added to the demand for audit services for
CHAPTER 1
AUDITING AND THE PUBLIC
ACCOUNTING PROFESSION
Learning Check
1.1 Several common attributes of activities defined as auditing are (a) systematic process, (b) objectively obtaining and evaluating evidence, (c) assertions about economic actions and events, (d) degree of correspondence, (e) established criteria, (f) communicating the results, and (g) interested users.
1.2 A financial statement audit involves obtaining and evaluating evidence about an entity's financial statements for the purpose of expressing an opinion on whether the statements are presented fairly in conformity with established criteria--usually GAAP. Thus, the nature of the auditor's report is an opinion on the fairness of the financial statements. A compliance audit involves obtaining and evaluating evidence to determine whether certain financial or operating activities of an entity conform to specified conditions, rules, or regulations. A report on a compliance audit takes the form of a summary of findings or assurance regarding degree of compliance. An operational audit involves obtaining and evaluating evidence about the efficiency and effectiveness of an entity's operating activities in relation to specified objectives. Reports on such audits include an assessment of efficiency and effectiveness and recommendations for improvements.
1.3 Independent auditors are individual practitioners or members of public accounting firms who render professional auditing services to clients. These services may involve financial statement audits, compliance audits, and operational audits. Internal auditors are employees of the companies they audit. They are involved in an independent appraisal activity, called internal auditing, as a service to the organization. Internal auditors are primarily concerned with compliance and operational audits. Government auditors are employed by various local, state, and federal governmental agencies. They may be involved in all three types of audits.
1.4 a. The origin of the company audit as we know it can be linked to British legislation during the
industrial revolution in the mid-1800s. Company audits were initially performed by one or more stockholders designated by other stockholders, but subsequent revisions in the legislation permitted the use of outside independent auditors, giving rise to the formation of auditing firms.
b. The migration of the company audit to the U.S. came about as English and Scottish investors sent their own auditors to check on the condition of American companies, such as breweries and railroads, in which they had heavily invested. This migration occurred in the late 1800s. The focus of these early audits was on finding errors in the balance sheet accounts and stemming the growth of fraud associated with the increasing phenomenon of professional managers and absentee owners.
1.5 Several important milestones in the rise of the U.S. profession were (1) passage of the first legislation providing for the licensing of CPAs by New York state in 1896, (2) the passage of similar legislation by all of the then forty-eight states by 1921, (3) the establishment of the American Institute of Accountants (now the AICPA) in 1917, (4) the publication in 1918 of a proposal for uniform accounting following a period of rapid growth in the public ownership of corporate securities and growing recognition of the need for greater uniformity in financial reporting as well as the need to employ accountants who understood reporting requirements, (5) the stock market crash of 1929 which drew attention to deficiencies in financial reporting and produced a challenge to the accounting profession to provide stronger leadership, (6) adoption of a requirement by the New York Stock Exchange in 1933 that all listed corporations obtain an audit certificate from an independent CPA, and (7) passage of the Securities Act of 1933 and the Securities Exchange Act of 1934 which added to the demand for audit services for
ACCOUNTING PROFESSION Learning Check 1.1 Several common attributes of activities defined as auditing are (a) systematic process, (b) objectively obtaining and evaluating evidence, (c) assertions about economic actions and events, (d) degree of correspondence, (e) established criteria, (f) communicating the results, and (g) interested users. 1.2 A financial statement audit involves obtaining and evaluating evidence about an entity's financial statements for the purpose of epressing an opinion on !hether the statements are presented fairly in conformity !ith established criteria""usually #AA$. %hus, the nature of the auditor's report is an opinion on the fairness of the financial statements. A compliance audit involves obtaining and evaluating evidence to determine !hether certain financial or operating activities of an entity conform to specified conditions, rules, or regulations. A report on a compliance audit ta&es the form of a summary of findings or assurance regarding degree of compliance. An operational audit involves obtaining and evaluating evidence about the efficiency and effectiveness of an entity's operating activities in relation to specified objectives. 'eports on such audits include an assessment of efficiency and effectiveness and recommendations for improvements. 1.( Independent auditors are individual practitioners or members of public accounting firms !ho render professional auditing services to clients. %hese services may involve financial statement audits, compliance audits, and operational audits. Internal auditors are employees of the companies they audit. %hey are involved in an independent appraisal activity, called internal auditing, as a service to the organi)ation. *nternal auditors are primarily concerned !ith compliance and operational audits. Government auditors are employed by various local, state, and federal governmental agencies. %hey may be involved in all three types of audits. 1.+ a. %he origin of the company audit as !e &no! it can be lin&ed to ,ritish legislation during the industrial revolution in the mid"1-..s. /ompany audits !ere initially performed by one or more stoc&holders designated by other stoc&holders, but subse0uent revisions in the legislation permitted the use of outside independent auditors, giving rise to the formation of auditing firms. b. %he migration of the company audit to the 1.S. came about as 2nglish and Scottish investors sent their o!n auditors to chec& on the condition of American companies, such as bre!eries and railroads, in !hich they had heavily invested. %his migration occurred in the late 1-..s. %he focus of these early audits !as on finding errors in the balance sheet accounts and stemming the gro!th of fraud associated !ith the increasing phenomenon of professional managers and absentee o!ners. 1.3 Several important milestones in the rise of the 1.S. profession !ere (1) passage of the first legislation providing for the licensing of /$As by 4e! 5or& state in 1-67, (2) the passage of similar legislation by all of the then forty"eight states by 1621, (() the establishment of the American *nstitute of Accountants (no! the A*/$A) in 1618, (+) the publication in 161- of a proposal for uniform accounting follo!ing a period of rapid gro!th in the public o!nership of corporate securities and gro!ing recognition of the need for greater uniformity in financial reporting as !ell as the need to employ accountants !ho understood reporting re0uirements, (3) the stoc& mar&et crash of 1626 !hich dre! attention to deficiencies in financial reporting and produced a challenge to the accounting profession to provide stronger leadership, (7) adoption of a re0uirement by the 4e! 5or& Stoc& 2change in 16(( that all listed corporations obtain an audit certificate from an independent /$A, and (8) passage of the Securities Act of 16(( and the Securities 2change Act of 16(+ !hich added to the demand for audit services for publicly o!ned companies. 1.7 a. %hree important changes in audit practice that evolved by the 1.+.s !ere (1) a shift from detailed verification of accounts to sampling or testing as the basis for rendering an opinion on the fairness of financial statements, (2) development of the practice of lin&ing the testing to be done to the auditor's evaluation of a company's internal controls, and (() deemphasis of the detection of fraud as an audit objective. b. *n recent years, the profession has come under increasing pressure to reverse the deemphasis on detecting fraud as the public's epectation that the auditor !ill detect fraud persists. 1.8 %he first A*/$A project that is influencing the shape of the accounting profession in the 21 st /entury is the A*/$A 9ision $roject. %his project involved over +... /$As !ho contributed to the development of the /$A profession, its core values, core competencies, and core services. %he second A*/$A project !as the Special /ommittee on Assurance Services, that has mar&et tested ne! services that re0uire assurance provided by /$As. 1.- :ive core values of the /$A profession are (1) continuing education and lifelong learning, (2) competence, (() integrity, (+) attunement !ith broad business issues, and (3) objectivity. /ontinuing education and lifelong learning is important to ensuring the public confidence in a /$As ability to maintain cutting edge s&ills in a rapidly changing environment. /$As must demonstrate competence in order to earn a client;s trust. %his normally consists of a broad competence plus many /$As develop specialties during their career. *ntegrity, !hich means practicing !ith honesty and acting !ith professional ethics is critical earning the public trust. Attunement to broad business issues is !hat separates /$As from other professionals and allo!s /$As to eercise the professional judgment that is so important in accounting. :inally, objectivity and the freedom of bias or conflicts of interest allo!s /$As to earn both a client;s and the public;s trust. *n combination, these core values have helps /$As earn a reputation for being a trusted business advisor. 1.6 a. %he core competencies associated !ith the /$A profession include< (a) communication and leadership s&ills, (b) strategic and critical thin&ing s&ills, (c) focus on the customer, client and mar&et, (d) interpretation of converging information, and (e) being technologically adept. b. %he auditing profession has been critici)ed for communicating primarily through a standard, one"si)e"fits"all report that communicates little uni0ue information. :urther, auditors are often seen as being more reporters of the past than problem solvers !ith a future orientation. Also they are seen as being standards driven and focuses on numbers and measurement, rather than focused on !hat the numbers communicate. c. Auditors use communication skills to raise appropriate in0uiries !ith management and to communicate findings !ith management, the board of directors, and third parties. Auditors use strategic and critical thinking skills to evaluate the appropriateness of accounting estimates and other information reported in the financial statements. %he auditor;s focus on the client and the market allo!s the auditor to be responsive to both the pubic and the client. Auditors must be able to interpret converging information. %he &ey analytic s&ill used throughout the audit is the ability to evaluate both financial and nonfinancial information and determine !hether financial statements are fairly presented. :inally, auditors must be technologically adept. Auditors must be able to evaluate information systems and internal controls that etensively use ne! technologies. 1.1. %he common attributes of all assurance services are that they are (a) independent profession services that (b) improve the 0uality of information, or its contet, for (c) decision"ma&ers. 1.11 a. %he financial statement audit !as the first form of assurance that !as provided by /$As. %his service !as so successful that today /$A assurance services have epanded revie!s services, various attest services and a compilation service. %he potential for additional services is based in large part on the fact that the financial statement audit has earned the public trust. %he logic used by auditor is performing the audit is also used in performing many of these other services. b. %oday auditors provide audit level assurance on financial statements only once a year, and revie! level assurance 0uarterly. =ne important change is the movement to!ard providing real"time assurance on financial information. An important part of the current audit process is its focus on internal controls. Auditors may li&ely use this s&ill to focus more attention on internal controls and attest to the reliability of the financial information systems rather than the financial information itself. 1.12 An attest service is one in !hich the /$A firm issues a !ritten communication that epresses a conclusion about the reliability of a !ritten assertion that is the responsibility of another party. Attest services include audits, eaminations, revie!s, and agreed"upon procedures. 1.1( =ther services performed by /$As do not result in the epression of an opinion, negative assurance, summary of findings, or any other form of assurance by the /$A firm. %hese services include accounting services such as technology services, management consulting, financial planning including ta services, and international services. 1.1+ (>islabeled as 1.12 in the tet). :our private sector organi)ations associated !ith the public accounting profession and their principal activities are as follo!s< (1) American *nstitute of /ertified $ublic Accountants !hich acts on behalf of its members and provides necessary support to assure that /$As serve the public interest in performing 0uality professional services (activities include developing standards dealing !ith professional services, 0uality control, 0uality revie!, and ethical conduct, developing and distributing continuing professional education materials and courses, and providing technical accounting and auditing assistance through a technical information hotline, technical library, and a variety of publications)? (2) State Societies of /ertified $ublic Accountants !hich cooperate !ith each other and the A*/$A in areas of mutual interest such as providing continuing professional education opportunities to members and enforcing ethical standards? (() $ractice 1nits (/$A firms) !hich are the organi)ation units through !hich /$As render professional services to the public? and (+) Accounting Standard Setting ,odies, principally the :inancial Accounting Standards ,oard (:AS,) and #overnmental Accounting Standards ,oard (#AS,) !hose primary functions are the development of generally accepted accounting principles for business and not"for"profit entities, and state and local governmental entities, respectively. 1.13 (>islabeled as 1.1( in the tet). :our divisions @ teams of the A*/$A that have a direct impact on auditing are< (1) Aivision for /$A :irms, (2) Buality 'evie! %eam, (() Auditing Standards %eam, and (+) $rofessional 2thics %eam. 1.17 (>islabeled as 1.1+ in the tet). a. A /$A firm may be organi)ed as a proprietorship, partnership, $rofessional /orporation, or any other form of organi)ation permitted by state la! or regulation (including limited liability partnerships (CC$s) and limited liability corporations (CC/s)). b. /$A firms are often classified into the follo!ing four groups< (1) ,ig Si, (2) Second %ier, (() 'egional, and (+) Cocal. 1.18 (>islabeled as 1.13 in the tet). Si public sector organi)ations associated !ith the public accounting profession and one or t!o principal activities of each are as follo!s< (1) State ,oards of Accountancy !hich administer state accountancy la!s in each state including oversight of the licensing of /$As and monitoring compliance !ith codes of professional ethics, mandatory continuing professional education re0uirements, and other positive enforcement programs? (2) Securities and 2change /ommission !hich (a) regulates the distribution of securities offered for public sale and the subse0uent trading of securities on stoc& echanges and over"the"counter mar&ets and (b) eerts considerable influence over auditing and the public accounting profession as !ell as the establishment of #AA$ for companies under its jurisdiction? (() 1.S. #eneral Accounting =ffice (#A=) !hich has the authority to issue standards pertaining to the audit of governmental organi)ations, programs, activities, and functions? (+) *nternal 'evenue Service !hich administers and enforces the federal ta la!s? (3) State and :ederal /ourts !hich (a) reach judgments as to !hether /$A firms have adhered to standards of performance established by the profession itself and (b) in some cases have ruled that the profession's standards are not ade0uate for the protection of the public? and (7) 1.S. /ongress !hich influences the profession through investigative and monitoring activities aimed at determining !hether the profession is meeting its responsibilities to the public, and through the passage of ta la!s and other legislation affecting the performance of professional services. 1.1- (>islabeled as 1.18 in the tet). a. %he purpose of the profession's multilevel regulatory frame!or& is to help assure 0uality in the performance of audits and other professional services. b. %he four components of the profession's multilevel regulatory frame!or& are< Standard"setting. %he private sector establishes standards for accounting, auditing, ethics, and 0uality control to govern the conduct of /$As and /$A firms. :irm regulation. 2ach /$A firm adopts policies and procedures to assure that practicing accountants adhere to professional standards. Self"or peer regulation. %he A*/$A has implemented a comprehensive program of self"regulation including mandatory continuing professional education, peer revie!, audit failure in0uiries, and public oversight. #overnment regulation. =nly 0ualified professionals are licensed to practice, and auditor conduct is monitored and regulated by state boards of accountancy, the S2/, and the courts. 1.16 (>islabeled as 1.1- in the tet). %he five elements of 0uality control are (1) independence, integrity and objectivity, (2) personnel management, (() acceptance and continuance of engagements, (+) engagement performance, and (3) monitoring. 1.2. (>islabeled as 1.16 in the tet). a. %he t!o sections of the A*/$A Aivision for :irms are (1) the S2/ $ractice Section and (2) the $rivate /ompanies $ractice Section. b. 1ni0ue membership re0uirements of the S2/ $ractice Section include (1) rotating audit partners on S2/ engagements periodically, (2) having an audit partner other than the partner in charge of the S2/ engagement revie! and concur in the audit report before it is issued, and (() refraining from performing certain proscribed management consulting services for S2/ audit clients. 1.21 (>islabeled as 1.16 in the tet). %he Buality /ontrol *n0uiry /ommittee (B/*/) is responsible for determining !hether la!suits alleging audit deficiencies brought against firms enrolled in the S2/ $ractice Section suggest (1) an aberrational error !hich no 0uality control system can totally eliminate, (2) a shortcoming in the charged firm's 0uality controls or its compliance !ith them, or (() a shortcoming in professional standards. %he $ublic =versight ,oard ($=,) closely monitors the !or& of the S2/ $ractice Section and recommends improvements for strengthening the Section's self"regulatory activities. %he $=, also distributes an annual report on its activities to all interested parties. Objective Questions 1.21 1. b 2. d (. a 1.22 1. b 2. c (. d 1.2( 1. b 2. d (. b Comprehensive Questions 1.2+ (2stimated time " 2. minutes) a. *nternal auditing is an independent appraisal activity performed by employees of the company being audited. %he objective of internal auditing is to assist management in the effective discharge of its responsibilities. 2ternal auditing is done by independent, eternal auditors for the purpose of epressing an opinion on the fairness of the company's financial statements. #overnmental auditing is done by government auditors to determine (1) fairness of financial reports, (2) compliance !ith applicable la!s and regulations, (() efficiency and economy of operations, and (+) effectiveness in achieving program results. b. $ractice standards for independent, internal, and government auditors are established by the American *nstitute of /ertified $ublic Accountants, *nstitute of *nternal Auditors, and the 1.S. #eneral Accounting =ffice, respectively. c. %he audits serve different purposes and are made by different types of auditors. Auditing only by internal auditing !ill not satisfy the re0uirements of stoc& echanges and the S2/ for independent audits by eternal auditors. >oreover, internal audits !ill not satisfy all government re0uirements for audits, particularly in the area of compliance !ith applicable la!s and regulations. *n sum, each type of auditing is necessary. 1.23 (2stimated time " (. minutes) a. Type of Audit b. Type of Auditor(s) c. rimary !ecipient(s) 1. :inancial statement (1) *ndependent(1) Stoc&holders, investors, regulatory agencies, and general public 2. =perational (() *nternal (2), *ndependent(1) Senior >anagement (. /ompliance (2) #overnment " *'S (+) *'S +. =perational (() #overnment " #A= (() /ongress 3. :inancial statement (1) *ndependent (1) /reditors 7. =perational (() *nternal (2) >anagement 8. /ompliance (2) #overnment " #A= (() /ongress -. /ompliance (2) *ndependent (1), *nternal (2), and #overnment " #A= (() /ongress 6. :inancial Statement (1) *ndependent (1) /iti)ens, tapayers 1.. =perational (() #overnment " #A= (() /ongress 11. /ompliance (2) *ndependent (1), *nternal (2) ,ondholders 12. /ompliance (2) *nternal (2), *ndependents (1) >anagement 1.27 (2stimated time " 2. minutes) Dhen /$As audit the value of inventory reported in the financial statements they are communicating the total pictures !ith clarity and objectivity. /$As step up the value chain by translating comple information into critical &no!ledge !hen they use information from the financial statements, such as inventory turnover and benchmar& a client;s performance against others in the industry. /$As anticipate and create opportunities !hen they identify ho! a client might improve its inventory turnover, for eample by advising the client;s management on ho! it might identify and eliminate slo! moving inventory. :inally, /$A in industry designs path!ays to transform vision into reality by ta&ing the steps that increase inventory turnover. %he independent /$A ho!ever, must ta&e care to not etend services beyond advisory services to ma&ing management decisions. 1.28 (2stimated time " (. minutes) Core "a#ue $mportance to %inancia# &tatement 'ser $mportance to the (oard of )irectors Continuing *ducation and Life#ong Learning :inancial statement users epect that auditors are &no!ledgeable about current professional standards (#AA$ and #AAS) and their application to the client. %he ,oard of Airectors epects that auditors are not only &no!ledgeable in #AA$ and #AAS but are familiar !ith current developments in their industry. Competence :inancial statement users epect auditors to be able to evaluate the fairness of presentation in the financial statements, given #AA$ and the entity;s performance. %he ,oard of Airectors epects that auditors can evaluate fair presentation in the financial statements, the 0uality of the entity;s internal control, and often the performance of their entity;s against others in the industry. $ntegrity :inancial statement users epect auditors to be independent of management and they epect an honest opinion on the entity;s financial statements. %he ,oard of Airectors epects auditors to be independent of management and to provide honest opinions on the entity;s financial performance and the 0uality of its internal controls. Core "a#ue $mportance to %inancia# &tatement 'ser $mportance to the (oard of )irectors Attuned to broad business issues :inancial statement users epect auditors to be able to evaluate the fair presentation of accounting estimates and needed disclosures given the current business environment. %he ,oard of Airectors epects that auditors to be able to evaluate the impact of current business developments on the entity;s financial performance, its internal control, and often they loo& to the auditor for recommendations on ho! to be more competitive in the industry. Objectivity :inancial statement users ecept auditors to be free of conflicts of interest and ma&e objective decisions even if it is not in entity;s interest, or the short"term interest of the auditor. %he ,oard of Airectors epects that auditors are free of conflicts of interest and independent of senior management. 1.2- (2stimated time " 2. minutes) 1. State boards of accountancy 1.. State societies of /$As 2. :AS, and #AS, 11. S2/, state and federal courts (. A*/$A 12. #AS, +. S2/ 1(. A*/$A 3. A*/$A, state societies of /$As, and state boards of accountancy 1+. State boards of accountancy 7. :AS, 13. A*/$A 8. State boards of accountancy 17. $ractice units -. S2/ 18. #A= 6. A*/$A 1-. *'S 1.26 (2stimated time " 2. minutes) a. %he four sets of standards in the private sector and the standard setting bodies are< (1) accounting by the :AS, and #AS,, (2) auditing by the A*/$A, (() professional ethics by the A*/$A, and (+) 0uality control by the A*/$A. b. %he other components of the regulatory frame!or& are< (1) firm regulation that occurs !ithin the public accounting firm through day"to" day monitoring of the actions of the firm's professional staff by the firm's management? (2) self"regulation, also called peer regulation, that relates to the activities of professional entities outside the firm such as the A*/$A's Aivision for /$A firms and its Buality 'evie! Aivision? and (() governmental regulation that occurs at both the state and federal levels through activities that range from positive enforcement programs to punitive actions. %his type of regulation is done by state boards of accountancy, the S2/, and state and federal courts of la!. 1.(. (2stimated time " (. minutes) o#icy+ rocedure *#ement (a) urpose of o#icy + rocedure (b) Additiona# rocedure (c) 1. $ersonnel >anagement $ersonnel should have the 0ualifications to fulfill responsibilities they may be called upon to assume in the future. 2stablish 0ualifications necessary for each level of responsibility in the firm. 2. 2ngagement $erformance Dor& at all levels should be supervised to assure that it meets the firm's standards of 0uality. 2stablish procedures for revie!ing !or&ing papers and reports. (. $ersonnel >anagement Dor& is assigned to people !ho have the technical training for the assignment and personnel should see& assistance, !hen necessary, from persons having appropriate epertise, judgment, and authority *dentify areas and speciali)ed situations for !hich consultation is re0uired. o#icy+ rocedure *#ement (a) urpose of o#icy + rocedure (b) Additiona# rocedure (c) +. *ndependence, *ntegrity and =bjectivity All professionals should be independent of clients. >onitor compliance !ith independence rules. 3. >onitoring Aetermine that procedures relating to the other elements are being effectively applied. $rovide for reporting inspection results to appropriate management levels in the firm. 7. $ersonnel >anagement =nly individuals !ho possess the 0ualities of integrity, competency, and motivation should be hired. >aintain a recruiting program to obtain ne! hires at the entry level. 8. $ersonnel >anagement $ersonnel should have the &no!ledge re0uired to fulfill assigned responsibilities. $rovide $rograms to develop epertise in speciali)ed areas and industries. -. 2ngagement $erformance $ersonnel should have the technical training and proficiency re0uired by the engagement. $ermit partner in charge of engagement to approve assignments. 6. Acceptance and /ontinuance of /lients and 2ngagements. %he firm should not be associated !ith clients !hose management lac&s integrity. 2stablish revie! procedures for continuing a client. 1.(1 (2stimated time " (. minutes) a. $racticing /$As associated !ith firms that audit S2/ clients cannot retain membership in the A*/$A unless their firms enroll in the S2/ $ractice Section of the Aivision for /$A firms. =ther practicing /$As cannot retain membership in the A*/$A unless their firms submit to a practice monitoring program that conforms to the re0uirements of the Buality 'evie! Aivision. b. %he t!o sections of the A*/$A Aivision for :irms are the S2/ $ractice Section and the $rivate /ompanies $ractice Section. %he objectives that are common to both sections are< *mprove the 0uality of service (or practice) by /$A firms through the establishment of practice re0uirements for member firms. 2stablish and maintain an effective system of self"regulation of member firms by means of mandatory peer revie!s, re0uired maintenance of appropriate 0uality controls, and the imposition of sanctions for failure to meet membership re0uirements. %he follo!ing membership re0uirements are common to both sections< Adhere to 0uality control standards established by the A*/$A. Submit to peer revie!s of the firm's accounting and audit practice every three years or at such additional times as designated by the eecutive committee, the revie!s to be conducted in accordance !ith revie! standards established by the section's peer revie! committee. (4ote " At the time this manual !ent to press, as noted in the footnote on page 2( of the tet, the A*/$A !as in the process of combining the peer revie! process for the $rivate /ompanies $ractice Section !ith the 0uality revie! program of the Buality 'evie! Aivision.) 2nsure that all professionals in the firm resident in the 1nited States, including /$As and non"/$As, participate in at least 2. hours of continuing professional education every year and in at least 12. hours every three years. c. %he peer revie! objective for both sections is to improve future practice. Eo!ever, !hen a firm fails to ta&e the corrective action considered necessary by the section, the section can impose sanctions. %he peer revie! teams are re0uired to ma&e a revie! of the firm's accounting and auditing services and to report on their findings to the section. %he findings are included in the public files of each section. d. %he Buality /ontrol *n0uiry /ommittee (B/*/) and the $ublic =versight ,oard ($=,) are involved !ith the S2/ $ractice Section. :irms in this practice section must report all litigation or regulatory proceedings involving audits of public companies to the B/*/ !ithin (. days of receiving the complaint. %he B/*/ then has the responsibility to determine !hether the allegations in a case suggest (1) an aberrational error that no system can totally eliminate, (2) a shortcoming in the charged firm's 0uality controls or its compliance !ith them, or (() a shortcoming in professional standards. Dhen the last t!o situations eist, the case is not closed until the B/*/ concludes that the firm has addressed the !ea&ness or the shortcomings have been reported to the appropriate standard setting body for its consideration. %he $=, enhances the effectiveness and credibility of the S2/ $ractice Section's self"regulatory activities by closely monitoring the !or& of the Section. *ts responsibilities include directly overseeing each peer revie! conducted by the Section and all B/*/ in0uiries alleging audit failures. e. %he primary activities of the Buality 'evie! Aivision are to (1) establish and conduct, in cooperation !ith state /$A societies, a 0uality revie! program for firms engaged in the practice of public accounting and not enrolled in one of the Sections of the A*/$A Aivision for :irms, and (2) conduct revie!s of firms enrolled in the program. (Note - Again, in accordance with the footnote on page 2 of the te!t, at the time this manual went to press the AI"#A was in the process of merging the peer review activity of the #rivate "ompanies #ractice $ection of the %ivision for "#A &irms into the 'uality (eview %ivision.) !esearch Questions :or the reasons specified in the introduction to this manual, solutions are not provided for this category of 0uestions.