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Chapter Two The Financial Statement Auditing Environment
A Time of Challenge and Change 1990 1990 2000 During the economic boom of the late 1990s and the early 2000s, accounting firms aggressively sought opportunities to market a variety of high-margin non-audit servicesto their audit clients.
A Series of Scandals Enron WorldCom Parmalat Lernout & Hauspie Ahold Arthur Andersen
Regulation Self-regulation by the profession versus government regulation Stricter regulation and more public oversight International Standards on Auditing more comprehensive
Auditors’ Legal Liability Threat of legal liability: Main deterrent to auditor’s misconduct • Legal doctrines: • Joint and several liability • Proportional liability • Liability caps • Litigation exposure and audit markets: • Concentration • Barriers to entry • Liability reforms
International Organisations that Affect the Accounting Profession International Federation of Accountants IFAC International Accounting Standards Board IASB International Organization of Securities Commissions IOSCO International Organization of Supreme Audit Institutions INTOSAI European Union EU EU 8th Directive on Statutory Audits United States Securities and Exchange Commission (SEC) Public Company Accounting Oversight Board (PCAOB) Financial Accounting Standards Board (FASB) American Institute of Certified Public Accountants (AICPA)
International Auditing and Assurance Standards Board (IAASB): Standards
IAASB issues International Standards on Auditing (ISAs). IFAC members Auditing Standards Auditing standards serve as guidelinesfor and measures of the quality of the auditor’s performance. ISAs are considered to be minimum standards of performance for auditors.
General Principles and Responsibilities • ISA 200 Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with International Standards on Auditing • ISA 210 Agreeing the Terms of Audit Engagements • ISA 220 Quality Control for an Audit of Financial Statements • ISA 230Audit Documentation • ISA 240 The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements • ISA 250 Consideration of Laws and Regulations in an Audit of Financial Statements • ISA 260 Communication with Those Charged with Governance • ISA 265 Communicating Deficiencies in Internal Control to Those Charged with Governance and Management
Risk Assessment and Response to Assessed Risks • ISA 300 Planning an Audit of Financial Statements • ISA 315 Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment • ISA 320 Materiality in Planning and Performing an Audit • ISA 330 The Auditor’s Responses to Assessed Risks • ISA 402 Audit Considerations Relating to an Entity Using a Service Organization • ISA 450 Evaluation of Misstatements Identified during the Audit
Audit Evidence • ISA 500 Audit Evidence • ISA 501 Audit Evidence – Specific Considerations for Selected Items • ISA 505 External Confirmations • ISA 510 Initial Engagements – Opening Balances • ISA 520 Analytical Procedures • ISA 530 Audit Sampling • ISA 540 Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures • ISA 550 Related Parties • ISA 560 Subsequent Events • ISA 570 Going Concern • ISA 580Written Representations
Using Work of Others • ISA 600 Special Considerations – Audits of Group Financial Statements (Including the Work of Component Auditors) • ISA 610 Using the Work of Internal Auditors • ISA 620 Using the Work of an Auditor’s Expert
Audit Conclusions and Reporting • ISA 700 Forming an Opinion and Reporting on Financial Statements • ISA 705 Modifications to the Opinion in the Independent Auditor’s Report • ISA 706 Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s Report • ISA 710Comparative Information – Corresponding Figures and Comparative Financial Statements • ISA 720 The Auditor’s Responsibilities Relating to Other Information in Documents Containing Audited Financial Statements
Specialised Areas • ISA 800 Special Considerations – Audits of Financial Statements Prepared in Accordance with Special Purpose Frameworks • ISA 805 Special Considerations – Audits of Single Financial Statements and Specific Elements, Accounts or Items of a Financial Statement • ISA 810 Engagements to Report on Summary Financial Statements
Sections in ISAs • Introductory material • Objectives • Definitions • Requirements • Application and other explanatory material
Society’s Expectations and the Auditor’s Responsibilities The auditor has a responsibility to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud. Because of the nature of audit evidence and the characteristics of fraud, the auditor is able to obtain reasonable, but not absolute, assurance that material misstatements are detected. The auditor has no responsibility to plan and perform the audit to obtain reasonable assurance that misstatements, whether caused by errors or fraud, that are not material to the financial statements will be detected.
Ethics, Independence, and IFAC Code of Ethics for Professional Accountants Ethics refers to a system or code of conduct based on moral duties and obligations that indicates how we should behave. Professionalism refers to the conduct, aims, or qualities that characterise or mark a profession or professional person. All professions operate under some type of code of ethics or code of conduct.
Conceptual Framework Approach • Principles • Integrity • Objectivity • Professional competence • and due care • Confidentiality • Professional behaviour Application to specific situations, including situations that threaten independence of mind orindependence in appearance Ethics, Independence, and IFAC Code of Ethics for Professional Accountants IFAC Code of Ethics
Audit Firms Audit firms range in size from a single proprietor to thousands of owners (or “partners”) and thousands of professional and administrative staff employees. Big 4 PwC Deloitte EY KPMG Mid-Tier BDO Grant Thornton RSM Praxity Baker Tilly Crowe Horwath National Local
Types of Services Offered by Audit Firms Assurance Services: Audit of financial statements, review of financial information, and other assurance services (e.g. assurance on a entity’s reporting on sustainability performance) Related Services: Agreed-upon procedures regarding financial information and compilation of financial information Other Services:Tax services, advisory services, accounting services and specialised services (e.g. forensic audit)
Types of Auditors External Auditors Internal Auditors Government Auditors Forensic Auditors
Context of Financial Statement Auditing The primary context with which an auditor is concerned is the industry or businessof his or her audit client. In other words, the context provided by the client’s business impacts the auditor and the audit, and is thus a primary component of the environment in which financial statement auditing is conducted. How would your concerns about the inventory account differ for a Computer Hardware Manufacturerand a Jewellery Store? What assertions would you be most concerned about and why?
A Model of Business Business organizations exist to create value for their stakeholders. Due to the way resources are invested and managed in the modern business world, a system of corporate governanceis necessary, through which managers are overseen and supervised. Board of Directors Audit Committee
A Model of Business Objectives Strategies Processes (5 broad categories) Transactions Controls Reports
A Model of Business Processes: Five Components Financing Process Purchasing Process Human Resource Management Process Inventory Management Process Revenue Process
Management Assertions Financial statements issued by management contain explicit and implicit assertions.
Presentation & Disclosure Account Balances Transactions Management asserts that the financial statements properly classify and presentthe inventory. Management asserts that the entity owns the inventory represented in theinventory account. Management asserts that transactionsrelated to inventory actually occurred. Management Assertions – An Example with Inventory Which specific assertion from the relevant category is being described in the three examples below? Occurrence Rights and Obligations Classification