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1.4. Types of Audit and Auditors
1.4.2. Types of Auditors
Several types of auditors are in practice today. The most common
are:
I. Certified Public Accounting Firms
II. Government Accountability Office Auditors
III.Internal Revenue Agents and
IV.internal auditors.
I. Certified Public Accounting Firms
Certified public accounting firms are responsible for auditing the
published historical financial statements of all publicly traded
companies, most other reasonably large companies, and many
smaller companies and noncommercial organizations
Because of the widespread use of audited financial statements in the
U.S. economy, as well as businesspersons’ and other users’ familiarity
with these statements, it is common to use the terms auditor and CPA
firm synonymously, even though several different types of auditors
exist.
Cont,….
The title certified public accounting firm reflects the fact that auditors
who express audit opinions on financial statements must be licensed
as CPAs.
CPA firms are often called external auditors or independent auditors
to distinguish them from internal auditors.
II. Government Accountability Office
Auditors
A government accountability office auditor is an auditor working for the
U.S. Government Accountability Office (GAO), a nonpartisan agency in the
legislative branch of the federal government.
Headed by the Comptroller General, the GAO reports to and is responsible
solely to Congress.
The GAO’s primary responsibility is to perform the audit function for
Congress, and it has many of the same audit responsibilities as a CPA firm.
The GAO audits much of the financial information prepared by various
federal government agencies before it is submitted to Congress. Because
the authority for expenditures and receipts of governmental agencies is
defined by law, there is considerable emphasis on compliance in these
audits
Cont,….
An increasing portion of the GAO’s audit efforts are devoted to
evaluating the operational efficiency and effectiveness of various
federal programs.
Also, because of the immense size of many federal agencies and the
similarity of their operations, the GAO has made significant advances
in developing better methods of auditing through the widespread use
of highly sophisticated statistical sampling and computer risk
assessment techniques.
Cont,…
In many states, experience as a GAO auditor fulfills the experience
requirement for becoming a CPA. In those states, if an individual
passes the CPA examination and fulfills the experience stipulations by
becoming a GAO auditor, he or she may then obtain a CPA certificate.
As a result of their great responsibility for auditing the expenditures
of the federal government, their use of advanced auditing concepts,
their eligibility to be CPAs, and their opportunities for performing
operational audits, GAO auditors are highly regarded in the auditing
profession.
III. Internal Revenue Agents
The IRS, under the direction of the Commissioner of Internal Revenue, is
responsible for enforcing the federal tax laws as they have been defined by
Congress and interpreted by the courts.
A major responsibility of the IRS is to audit taxpayers’ returns to determine
whether they have complied with the tax laws. These audits are solely
compliance audits. The auditors who perform these examinations are called
internal revenue agents.
It might seem that the audit of returns for compliance with the federal tax laws is
a simple and straightforward problem, but nothing is farther from the truth. Tax
laws are highly complicated, and there are hundreds of volumes of
interpretations.
The tax returns being audited vary from the simple returns of individuals who
work for only one employer and take the standard tax deduction to the highly
complex returns of multinational corporations.
Cont,….
Taxation problems may involve individual income taxes, gift taxes,
estate taxes, corporate taxes, trusts, and so on.
An auditor involved in any of these areas must have considerable tax
knowledge and auditing skills to conduct effective audits.
IV. Internal Auditors
Internal auditors are employed by all types of organizations to audit
for management, much as the GAO does for Congress. Internal
auditors’ responsibilities vary considerably, depending on the
employer.
Some internal audit staffs consist of only one or two employees doing
routine compliance auditing. Other internal audit staffs may have
more than 100 employees who have diverse responsibilities, including
many outside the accounting area.
Many internal auditors are involved in operational auditing or have
expertise in evaluating computer systems. To maintain independence
from other business functions, the internal audit group typically
reports directly to the president, another high executive officer, or the
audit committee of the board of directors.
Cont,…..
However, internal auditors cannot be entirely independent of the
entity as long as an employer–employee relationship exists.
Users from outside the entity are unlikely to want to rely on
information verified solely by internal auditors because of their lack
of independence.
This lack of independence is the major difference between internal
auditors and CPA firms.
In many states, internal audit experience can be used to fulfill the
experience requirement for becoming a CPA.
Many internal auditors pursue certification as a certified internal
auditor (CIA), and some internal auditors pursue both the CPA and
CIA designations.
1.4.3. CERTIFIED PUBLIC ACCOUNTANT
Use of the title certified public accountant (CPA) is regulated by state
law through the licensing departments of each state. Within any
state, the regulations usually differ for becoming a CPA and retaining
a license to practice after the designation has been initially achieved.
To become a CPA, three requirements must be met:
 Educational Requirements
 an undergraduate or graduate degree with a major in accounting including a
minimum number of accounting credit. At least 150 credit hours before
receiving CPA certificate.
 Uniform CPA Examinations
Computer based examination in different exam centers. The exam should
includes: Auditing and Attestation, Financial Accounting and Reporting,
Regulations, and Business Environment and Concepts.
 Experience Requirements
From 0 to 2 years minimum work experience particularly in government units
in most cases.
Chapter Two
The Auditing Profession
Except for certain governmental organizations, the audits of all general use
financial statements in the United States are done by CPA firms.
The legal right to perform audits is granted to CPA firms by regulation of
each state. CPA firms also provide many other services to their clients, such
as tax and advisory services
2.1. ACTIVITIES OF CPA FIRMS
CPA firms provide audit services, as well as other attestation and assurance
services.
Additional services commonly provided by CPA firms include accounting
and bookkeeping services, tax services, and management consulting
services.
CPA firms continue to develop new products and services, such as financial
planning, business valuation, forensic accounting, and information
technology advisory services.
I. Accounting and bookkeeping services
• Many small clients with limited accounting staff rely on CPA firms to
prepare their financial statements.
• Some small clients lack the personnel or expertise to use accounting
software to maintain their own accounting records. Thus, CPA firms
perform a variety of accounting and book-keeping services to meet
the needs of these clients.
• In many cases in which the financial statements are to be given to a
third party, a review or even an audit is also performed. When neither
of these is done, the financial statements are accompanied by a type
of report by the CPA firm called a compilation report, which provides
no assurance to third parties
II. Tax services.
• CPA firms prepare corporate and individual tax returns for both audit
and non audit clients.
• Almost every CPA firm performs tax services, which may include
estate tax, gift tax, tax planning, and other aspects of tax services.
• For many small firms, such services are far more important to their
practice than auditing, as most of their revenue may be generated
from tax services.
III. Management consulting services
• Most CPA firms provide certain services that enable their clients to
operate their businesses more effectively. These services are called
management consulting or management advisory services.
• These services range from simple suggestions for improving the
client’s accounting system to advice in risk management, information
technology and e-commerce system design, mergers and acquisitions
due diligence, business valuations, and actuarial benefit consulting.
• Many large CPA firms have departments involved exclusively in
management consulting services with little interaction with the audit
or tax staff.
2.2. STRUCTURE OF CPA FIRMS
CPA firms vary in the nature and range of services offered, which affects
the organization and structure of the firms. Three main factors influence
the organizational structure of all firms:
1. The need for independence from clients. Independence
permits auditors to remain unbiased in drawing conclusions about the
financial statements.
2. The importance of a structure to encourage
competence. Competence permits auditors to conduct audits and
perform other services efficiently and effectively.
3. The increased litigation risk faced by auditors. Audit
firms continue to experience increases in litigation-related costs. Some
organizational structures afford a degree of protection to individual
firm members.
2.3. Hierarchy of a Typical CPA Firm
The organizational hierarchy in a typical CPA firm includes partners or
shareholders, managers, supervisors, seniors or in-charge auditors,
and assistants.
A new employee usually starts as an assistant and spends 2 or 3
years in each classification before achieving partner status.
The titles of the positions vary from firm to firm, but the structure is
similar in all. When we refer in this text to the auditor, we mean the
person performing some aspect of an audit.
It is common to have one or more auditors from each level on larger
engagements.
Cont,….
• Advancement in CPA firms is fairly rapid, with evolving duties and
responsibilities.
• In addition, audit staff members usually gain diversity of experience across
client engagements.
• Because of advances in computer and audit technology, beginning
assistants on the audit are rapidly given greater responsibility and
challenges.
• The hierarchical nature of CPA firms helps promote competence.
• Individuals at each level of the audit supervise and review the work of
others at the level just below them in the organizational structure.
• A new staff assistant is supervised directly by the senior or in-charge
auditor. The staff assistant’s work is then reviewed by the in-charge as well
as by the manager and partner.
2.4. Establishing Standards and Rules
The AICPA(American Institution of Certified Public Accountants) sets
standards and rules that all members and other practicing CPAs must
follow.
Four major areas in which the AICPA has authority to set standards and
make rules are as follows:
 1. Auditing standards. The Auditing Standards Board (ASB) is responsible for issuing
pronouncements on auditing matters for all entities other than publicly traded companies.
 2. Compilation and review standards. The Accounting and Review Services
Committee is responsible for issuing pronouncements of the CPA’s responsibilities when a CPA
is associated with financial statements of privately owned companies that are not audited.
 3. Other attestation standards. Statements on Standards for Attestation
Engagements provide a framework for the development of standards for attestation
engagements.
 4. Code of Professional Conduct. The AICPA Professional Ethics Executive
Committee sets rules of conduct that CPAs are required to meet.
2.5. INTERNATIONAL AND U.S.
AUDITING STANDARDS
Auditing standards are general guidelines to aid auditors in fulfilling
their professional responsibilities in the audit of historical financial
statements.
They include consideration of professional qualities such as
competence and independence, reporting requirements, and
evidence.
The three main sets of auditing standards are International Standards
on Auditing, U.S. GenerallyAccepted Auditing Standards for entities
other than public companies, and PCAOB Auditing Standards.
I. International Standards on Auditing
International Standards on Auditing (ISAs) are issued by the
International Auditing and Assurance Standards Board (IAASB) of the
International Federation of Accountants (IFAC).
. IFAC is the worldwide organization for the accountancy profession,
with 159 member organizations in 124 countries, representing more
than 2.5 million accountants throughout the world.
The IAASB works to improve the uniformity of auditing practices and
related services throughout the world by issuing pronouncements on
a variety of audit and attest functions and by promoting their
acceptance worldwide.
II. U.S. Generally Accepted Auditing
Standards
Auditing standards for private companies and other entities in the
United States are established by the Auditing Standards Board (ASB)
of the AICPA.
These standards are referred to as Statements on Auditing Standards
(SASs).
These Generally Accepted Auditing Standards (GAAS) are similar to
the ISAs, although there are some differences.
If an auditor in the United States is auditing historical financial
statements in accordance with ISAs, the auditor must meet any ISA
requirements that extend beyond GAAS.
III. PCAOB Auditing Standards
The PCAOB initially adopted existing auditing standards established
by the ASB as interim audit standards.
In addition, the PCAOB considers international auditing standards
when developing new standards. As a result, auditing standards for
U.S. public and private companies are mostly similar.
 Standards issued by the PCAOB are referred to as PCAOB Auditing
Standards in the audit reports of public companies and when
referenced in the text, and apply only to the audits of public
companies.
To Summarize:
International auditing standards as adopted by standard-setting
bodies in individual countries apply to audits of entities outside the
United States
Generally accepted auditing standards are similar to international
auditing standards and apply to the audits of private companies and
other entities in the United States.
PCAOB auditing standards apply to audits of U.S public companies
and other SEC registrants.
2.6. GENERALLY ACCEPTED AUDITING
STANDARDS
The broadest guidelines available to auditors in the U.S. are the 10
generally accepted auditing standards (GAAS), which were developed
by the AICPA.
The 10 generally accepted auditing standards fall into three
categories:
General standards
Standards of field work
Reporting standards
I. General Standards
The general standards stress the important personal qualities that the
auditor should possess.
1. Adequate Technical Training and Proficiency
The first general standard is normally interpreted as requiring the auditor
to have formal education in auditing and accounting, adequate practical
experience for the work being performed, and continuing professional
education.
Recent court cases clearly demonstrate that auditors must be technically
qualified and experienced in those industries in which their audit clients
are engaged.
In any case in which the CPA or the CPA’s assistants are not qualified to
perform the work, a professional obligation exists to acquire the requisite
knowledge and skills, suggest someone else who is qualified to perform the
work, or decline the engagement.
Cont,…
2. Independence in Mental Attitude
The importance of independence was emphasized in under the
definition of auditing.
The Code of Professional Conduct and SASs stress the need for
independence.
CPA firms are required to follow several practices to increase the
likelihood of independence of all personnel.
For example, there are established procedures on larger audits when
there is a dispute between management and the auditors.
Cont,…
3. Due Professional Care
The third general standard involves due care in the performance of all
aspects of auditing. Simply stated, this means that auditors are
professionals responsible for fulfilling their duties diligently and
carefully.
Due care includes consideration of the completeness of the audit
documentation, the sufficiency of the audit evidence, and the
appropriateness of the audit report.
As professionals, auditors must not act negligently or in bad faith, but
they are not expected to be infallible.
II. Standards of Field Work
The standards of field work concern evidence accumulation and
other activities during the actual conduct of the audit.
1. Adequate Planning and Supervision
The first standard requires that the audit be sufficiently planned to
ensure an adequate audit and proper supervision of assistants.
Supervision is essential in auditing because a considerable portion of
the field work is done by less experienced staff members.
Cont,…
2. Understand the Entity and its Environment,
Including Internal Control
To adequately perform an audit, the auditor must have an
understanding of the client’s business and industry.
This understanding helps the auditor identify significant client
business risks and the risk of significant misstatements in the financial
statements.
For example, to audit a bank, an auditor must understand the nature
of the bank’s operations, federal and state regulations applicable to
banks, and risks affecting significant accounts such as loan loss
reserves
Cont,…
One of the most widely accepted concepts in the theory and practice
of auditing is the importance of the client’s system of internal control
for mitigating client business risks, safeguarding assets and records,
and generating reliable financial information.
If the auditor is convinced that the client has an excellent system of
internal control, one that includes adequate internal controls for
providing reliable data, the amount of audit evidence to be
accumulated can be significantly less than when controls are not
adequate.
In some instances, internal control may be so inadequate as to
preclude conducting an effective audit.
Cont,…
3. Sufficient Appropriate Evidence
Decisions about how much and what types of evidence to
accumulate for a given set of circumstances require professional
judgment.
A major portion of this book is concerned with the study of evidence
accumulation and the circumstances affecting the amount and types
needed.
III. Standards of Reporting
The four reporting standards require the auditor to prepare a report on the
financial statements taken as a whole, including informative disclosures.
The reporting standards also require that the report state whether the
statements are presented in accordance with GAAP and also identify any
circumstances in which GAAP have not been consistently applied in the current
year compared with the previous one.
1. The Auditor must state in the auditor’s report whether the financial statements
are presented in accordance with the generally accepted accounting
principles(GAAP).
2. The Auditor must identify in the auditor’s report those circumstances in which
such principles have not been consistently observed in the current period in
relation with the preceding period.
3. When the auditor determines that informative disclosure are not reasonably
adequate, the auditor must so state in the auditor’s report.
4. The auditor either express an opinion regarding the financial statements, taken
as a whole or state that an opinion can not be expressed, in the auditor’s
report.
I. STATEMENTS ON AUDITING STANDARDS
The 10 generally accepted auditing standards are too general to
provide meaningful guidance, so auditors turn to the SASs issued by
the ASB for more specific guidance.
These statements interpret the 10 generally accepted auditing
standards and have the status of GAAS and are often referred to as
auditing standards or GAAS, even though they are not part of the 10
generally accepted auditing standards.
Generally accepted auditing standards and SASs are regarded as
authoritative literature, and every member who performs audits of
historical financial statements is required to follow them under the
AICPA Code of Professional Conduct.
II. Classification of Statements on Auditing
Standards
All SASs are given two classification numbers: an SAS and an AU
number that indicates location in the Codification of Auditing
Standards. Both classification systems are used in practice.
The SAS number identifies the order in which it was issued in relation
to other SASs; the AU number identifies its location in the AICPA
codification of all SASs.
AUs beginning with a “2” are always interpretations of the general
standards. Those beginning with a “3” are related to field work
standards, and those beginning with a “4,” “5,” or “6” deal with
reporting standards.
III. GAAS and Standards of Performance
Although GAAS and the SASs are the authoritative auditing guidelines for
members of the profession, they provide less direction to auditors than might be
assumed.
A limited number of specific audit procedures are required by the standards, and
there are no specific requirements for auditors’ decisions, such as determining
sample size, selecting sample items from the population for testing, or evaluating
results.
Many practitioners believe that the standards should provide more clearly
defined guidelines for determining the extent of evidence to be accumulated.
Such specificity would eliminate some difficult audit decisions and provide a line
of defense for a CPA firm charged with conducting an inadequate audit.
However, highly specific requirements could turn auditing into mechanistic
evidence gathering, devoid of professional judgment.
From the point of view of both the profession and the users of auditing services,
there is probably greater harm in defining authoritative guidelines too specifically
than too broadly.
Cont,….
GAAS and the SASs should be looked on by practitioners as minimum
standards of performance rather than as maximum standards or ideals. At
the same time, the existence of auditing standards does not mean the
auditor must always follow them blindly.
If an auditor believes that the requirement of a standard is impractical or
impossible to perform, the auditor is justified in following an alternative
course of action.
Similarly, if the issue in question is immaterial in amount, it is also
unnecessary to follow the standard. However, the burden of justifying
departures from the standards falls on the auditor.
When auditors desire more specific guidelines, they must turn to less
authoritative sources, including textbooks, journals, and technical
publications.
Materials published by the AICPA, such as the Journal of Accountancy and
industry audit guides, furnish assistance on specific questions.
IV. QUALITY CONTROL
For a CPA firm, quality control comprises the methods used to ensure that
the firm meets its professional responsibilities to clients and others.
These methods include the organizational structure of the CPA firm and
the procedures the firm establishes.
For example, a CPA firm might have an organizational structure that
ensures the technical review of every engagement by a partner who has
expertise in the client’s industry.
Auditing standards require each CPA firm to establish quality control
policies and procedures.
The standards recognize that a quality control system can provide only
reasonable assurance, not a guarantee, that auditing standards are
followed.
Cont,….
Quality control is closely related to but distinct from GAAS.
To ensure that generally accepted auditing standards are followed on
every audit, a CPA firm follows specific quality control procedures that
help it meet those standards consistently on every engagement.
Quality controls are therefore established for the entire CPA firm,
whereas GAAS are applicable to individual engagements.
V. Elements of Quality Control
Each firm should document its quality control policies and procedures.
Procedures should depend on such things as the size of the firm, the
number of practice offices, and the nature of the practice.
The system of quality control should include policies and procedures that
address six elements:
1. Leadership responsibilities for quality within the firm (Tone of the top).
2. Relevant Ethical Requirements.
3. Acceptance and continuation of clients and engagement.
4. Human Resources
5. Engagement Performance
6. Monitoring
VI. Peer Review
Public accounting firms must be enrolled in an AICPA approved
practice-monitoring program for members in the firm to be eligible
for membership in the AICPA.
Practice-monitoring, also known as peer review, is the review, by
CPAs, of a CPA firm’s compliance with its quality control system.
The purpose of a peer review is to determine and report whether the
CPA firm being reviewed has developed adequate quality control
policies and procedures and follows them in practice.
Unless a firm has a peer review, all members of the CPA firm lose
their eligibility for AICPA membership.
Cont,…
The AICPA Peer Review Program is administered by the state CPA
societies under the overall direction of the AICPA peer review board.
Reviews are conducted every three years, and are normally
performed by a CPA firm selected by the firm being reviewed,
although the firm can request that it be assigned a reviewer through
the administering state society.
Peer review benefits individual firms by helping them meet quality
control standards, which, in turn, benefits the profession through
improved practitioner performance and higher-quality audits.
A firm having a peer review can further benefit if the review improves
the firm’s practice, thereby enhances its reputation and effectiveness,
and reduces the likelihood of lawsuits.
2.7. PROFESSIONAL ETHICS
Ethics can be defined broadly as a set of moral principles or values. Each
of us has such a set of values, although we may or may not have
considered them explicitly.
Philosophers, religious organizations, and other groups have defined in
various ways ideal sets of moral principles or values.
Examples of prescribed sets of moral principles or values include laws
and regulations, church doctrine, codes of business ethics for
professional groups such as CPAs, and codes of conduct within
organizations.
7.2.1. Need for Ethics
Ethical behavior is necessary for a society to function in an orderly
manner. It can be argued that ethics is the glue that holds a society
together.
Imagine, for example, what would happen if we couldn’t depend on
the people we deal with to be honest.
The need for ethics in society is sufficiently important that many
commonly held ethical values are incorporated into laws.
However, many of the ethical valuessuch as caring, cannot be
incorporated into laws because they cannot be defined well enough
to be enforced. That does not imply, however, that the principles are
less important for an orderly society.
7.2.2. CODE OF PROFESSIONAL CONDUCT
The AICPA Code of Professional Conduct provides both general
standards of ideal conduct and specific enforceable rules of conduct.
There are four parts to the code: principles, rules of conduct,
interpretations of the rules of conduct, and ethical rulings.
The parts are listed in order of increasing specificity; the principles
provide ideal standards of conduct, whereas ethical rulings are highly
specific.
A few definitions, taken from the AICPA Code of Professional
Conduct, must be understood to help interpret the rules.
Cont,….
Client. Any person or entity, other than the member’s employer, that
engages a member or a member’s firm to perform professional services.
Firm. A form of organization permitted by law or regulation whose
characteristics conform to resolutions of the Council of the American
Institute of Certified Public Accountants that is engaged in the practice of
public accounting. Except for the purposes of applying Rule 101,
Independence, the firm includes the individual partners thereof.
Institute. The American Institute of Certified Public Accountants.
Member. A member, associate member, or international associate of the
American Institute of Certified Public Accountants.
Practice of public accounting. The practice of public accounting consists of
the performance for a client, by a member or a member’s firm, while
holding out as CPA(s), of the professional services of accounting, tax,
personal financial planning, litigation support services, and those
professional services for which standards are promulgated by bodies
designated by Council.
7.2.3. Ethical Principles
1. Responsibilities: In carrying out their responsibilities as professionals,
members should exercise sensitive professional and moral judgments in all
their activities.
2. The Public Interest: Members should accept the obligation to act in a
way that will serve the public interest, honor the public trust, and demonstrate
commitment to professionalism.
3. Integrity: To maintain and broaden public confidence, members should
perform all professional responsibilities with the highest sense of integrity.
4. Objectivity and Independence: A member should maintain
objectivity and be free of conflicts of interest in discharging professional
responsibilities. A member in public practice should be independent in fact and
appearance when providing auditing and other attestation services.
5. Due Care: A member should observe the profession’s technical and ethical
standards, strive continually to improve competence and quality of services,
and discharge professional responsibility to the best of the member’s ability.
6. Scope and Nature of Services: A member in public practice should
observe the principles of the Code of Professional Conduct in determining the
scope and nature of services to be provided.
7.2.4. Principles of Professional Conduct
The section of the AICPA Code dealing with principles of professional
conduct includes a general discussion of characteristics required of a CPA.
The principles section consists of two main parts: six ethical principles and
a discussion of those principles.
The ethical principles are listed in the box above. Discussions throughout
this chapter include ideas taken from the principles section.
The first five of these principles are equally applicable to all members of
the AICPA, regardless of whether they practice in a CPA firm, work as
accountants in business or government, are involved in some other aspect
of business, or are in education.
One exception is the last sentence of objectivity and independence. It
applies only to members in public practice, and then only when they are
providing attestation services such as audits.
The sixth principle, scope and nature of services, applies only to members
in public practice.
7.2.5. Rules of Conduct
This part of the Code includes the explicit rules that must be followed by every
CPA in the practice of public accounting.
Those individuals holding the CPA certificate but not practicing public accounting
must follow most, but not all requirements.
Because the section on rules of conduct is the only enforceable part of the code,
it is stated in more precise language than the section on principles.
Because of their enforceability, many practitioners refer to the rules as the AICPA
Code of Professional Conduct.
When practitioners conduct themselves at the minimum level , this does not
imply unsatisfactory conduct.
The profession has presumably set the standards sufficiently high to make the
minimum conduct satisfactory.
At what level do practitioners conduct themselves in practice? As in any
profession, the level varies among practitioners. Most practitioners conduct
themselves at a high level. Unfortunately, a few conduct themselves below the
minimum level set by the profession.
2.7.5.1 INDEPENDENCE RULE OF CONDUCT AND
INTERPRETATIONS.
Rule 101—Independence
A member in public practice shall be independent in the performance of
professional services as required by standards promulgated by bodies
designated by Council.
CPA firms are required to be independent for certain services that they provide,
but not for others. The last phrase in Rule 101, “as required by standards
promulgated by bodies designated by Council” is a convenient way for the AICPA
to include or exclude independence requirements for different types of services.
For example, the Auditing Standards Board requires that auditors of historical
financial statements be independent. Rule 101 therefore applies to audits.
Independence is also required for other types of attestations, such as review
services and audits of prospective financial statements.
However, a CPA firm can do tax returns and provide management services
without being independent. Rule 101 does not apply to those types of services
Cont,…
Interpretations of Rule 101
Prohibit covered members from owning any stock or other direct
investment in audit clients because it is potentially damaging to
actual audit independence (independence of mind), and it certainly is
likely to affect users’ perceptions of the auditors’ independence
(independence in appearance).
Indirect investments, such as ownership of stock in a client’s
company by an auditor’s grandparent, are also prohibited, but only if
the amount is material to the auditor.
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.
To illustrate the meaning of integrity and objectivity, assume the
auditor believes that accounts receivable may not be collectible but
accepts management’s opinion without an independent evaluation of
collectability.
The auditor has subordinated his or her judgment and thereby lacks
objectivity.
Cont,….
An interpretation of Rule 102 states that apparent conflicts of
interest may not be a violation of the rules of conduct if the
information is disclosed to the member’s client or employer.
For example, if a partner of a CPA firm recommends that a client have
the security of its Internet Web site evaluated by a technology
consulting firm that is owned by the partner’s spouse, a conflict of
interest may appear to exist.
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.
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 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.
(3) 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.
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
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.
Rule 501—Acts Discreditable
A member shall not commit an act discreditable to the profession.
Interpretations of Rule 501 identify several acts that are considered
to be discreditable.
For example, it is discreditable to retain a client’s records after a
demand is made for them or whenever a member is found to have
violated any federal, state, or local antidiscrimination laws.
The solicitation or disclosure of the Uniform CPA examination
questions and answers without permission of the AICPA is also not
permitted.
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.
Solicitation consists of the various means that CPA firms use to
engage new clients other than accepting new clients who approach
the firm.
Examples include taking prospective clients to lunch to explain the
CPA’s services, offering seminars on current tax law changes to
potential clients, and advertising in the Yellow Pages of a phone book.
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.
Cont,…..
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.
Cont,….
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.
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.
APP I  Lecture Notes  to students 0f 4the year
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APP I Lecture Notes to students 0f 4the year

  • 1. 1.4. Types of Audit and Auditors 1.4.2. Types of Auditors Several types of auditors are in practice today. The most common are: I. Certified Public Accounting Firms II. Government Accountability Office Auditors III.Internal Revenue Agents and IV.internal auditors.
  • 2. I. Certified Public Accounting Firms Certified public accounting firms are responsible for auditing the published historical financial statements of all publicly traded companies, most other reasonably large companies, and many smaller companies and noncommercial organizations Because of the widespread use of audited financial statements in the U.S. economy, as well as businesspersons’ and other users’ familiarity with these statements, it is common to use the terms auditor and CPA firm synonymously, even though several different types of auditors exist.
  • 3. Cont,…. The title certified public accounting firm reflects the fact that auditors who express audit opinions on financial statements must be licensed as CPAs. CPA firms are often called external auditors or independent auditors to distinguish them from internal auditors.
  • 4. II. Government Accountability Office Auditors A government accountability office auditor is an auditor working for the U.S. Government Accountability Office (GAO), a nonpartisan agency in the legislative branch of the federal government. Headed by the Comptroller General, the GAO reports to and is responsible solely to Congress. The GAO’s primary responsibility is to perform the audit function for Congress, and it has many of the same audit responsibilities as a CPA firm. The GAO audits much of the financial information prepared by various federal government agencies before it is submitted to Congress. Because the authority for expenditures and receipts of governmental agencies is defined by law, there is considerable emphasis on compliance in these audits
  • 5. Cont,…. An increasing portion of the GAO’s audit efforts are devoted to evaluating the operational efficiency and effectiveness of various federal programs. Also, because of the immense size of many federal agencies and the similarity of their operations, the GAO has made significant advances in developing better methods of auditing through the widespread use of highly sophisticated statistical sampling and computer risk assessment techniques.
  • 6. Cont,… In many states, experience as a GAO auditor fulfills the experience requirement for becoming a CPA. In those states, if an individual passes the CPA examination and fulfills the experience stipulations by becoming a GAO auditor, he or she may then obtain a CPA certificate. As a result of their great responsibility for auditing the expenditures of the federal government, their use of advanced auditing concepts, their eligibility to be CPAs, and their opportunities for performing operational audits, GAO auditors are highly regarded in the auditing profession.
  • 7. III. Internal Revenue Agents The IRS, under the direction of the Commissioner of Internal Revenue, is responsible for enforcing the federal tax laws as they have been defined by Congress and interpreted by the courts. A major responsibility of the IRS is to audit taxpayers’ returns to determine whether they have complied with the tax laws. These audits are solely compliance audits. The auditors who perform these examinations are called internal revenue agents. It might seem that the audit of returns for compliance with the federal tax laws is a simple and straightforward problem, but nothing is farther from the truth. Tax laws are highly complicated, and there are hundreds of volumes of interpretations. The tax returns being audited vary from the simple returns of individuals who work for only one employer and take the standard tax deduction to the highly complex returns of multinational corporations.
  • 8. Cont,…. Taxation problems may involve individual income taxes, gift taxes, estate taxes, corporate taxes, trusts, and so on. An auditor involved in any of these areas must have considerable tax knowledge and auditing skills to conduct effective audits.
  • 9. IV. Internal Auditors Internal auditors are employed by all types of organizations to audit for management, much as the GAO does for Congress. Internal auditors’ responsibilities vary considerably, depending on the employer. Some internal audit staffs consist of only one or two employees doing routine compliance auditing. Other internal audit staffs may have more than 100 employees who have diverse responsibilities, including many outside the accounting area. Many internal auditors are involved in operational auditing or have expertise in evaluating computer systems. To maintain independence from other business functions, the internal audit group typically reports directly to the president, another high executive officer, or the audit committee of the board of directors.
  • 10. Cont,….. However, internal auditors cannot be entirely independent of the entity as long as an employer–employee relationship exists. Users from outside the entity are unlikely to want to rely on information verified solely by internal auditors because of their lack of independence. This lack of independence is the major difference between internal auditors and CPA firms. In many states, internal audit experience can be used to fulfill the experience requirement for becoming a CPA. Many internal auditors pursue certification as a certified internal auditor (CIA), and some internal auditors pursue both the CPA and CIA designations.
  • 11. 1.4.3. CERTIFIED PUBLIC ACCOUNTANT Use of the title certified public accountant (CPA) is regulated by state law through the licensing departments of each state. Within any state, the regulations usually differ for becoming a CPA and retaining a license to practice after the designation has been initially achieved. To become a CPA, three requirements must be met:  Educational Requirements  an undergraduate or graduate degree with a major in accounting including a minimum number of accounting credit. At least 150 credit hours before receiving CPA certificate.  Uniform CPA Examinations Computer based examination in different exam centers. The exam should includes: Auditing and Attestation, Financial Accounting and Reporting, Regulations, and Business Environment and Concepts.  Experience Requirements From 0 to 2 years minimum work experience particularly in government units in most cases.
  • 12. Chapter Two The Auditing Profession Except for certain governmental organizations, the audits of all general use financial statements in the United States are done by CPA firms. The legal right to perform audits is granted to CPA firms by regulation of each state. CPA firms also provide many other services to their clients, such as tax and advisory services 2.1. ACTIVITIES OF CPA FIRMS CPA firms provide audit services, as well as other attestation and assurance services. Additional services commonly provided by CPA firms include accounting and bookkeeping services, tax services, and management consulting services. CPA firms continue to develop new products and services, such as financial planning, business valuation, forensic accounting, and information technology advisory services.
  • 13. I. Accounting and bookkeeping services • Many small clients with limited accounting staff rely on CPA firms to prepare their financial statements. • Some small clients lack the personnel or expertise to use accounting software to maintain their own accounting records. Thus, CPA firms perform a variety of accounting and book-keeping services to meet the needs of these clients. • In many cases in which the financial statements are to be given to a third party, a review or even an audit is also performed. When neither of these is done, the financial statements are accompanied by a type of report by the CPA firm called a compilation report, which provides no assurance to third parties
  • 14. II. Tax services. • CPA firms prepare corporate and individual tax returns for both audit and non audit clients. • Almost every CPA firm performs tax services, which may include estate tax, gift tax, tax planning, and other aspects of tax services. • For many small firms, such services are far more important to their practice than auditing, as most of their revenue may be generated from tax services.
  • 15. III. Management consulting services • Most CPA firms provide certain services that enable their clients to operate their businesses more effectively. These services are called management consulting or management advisory services. • These services range from simple suggestions for improving the client’s accounting system to advice in risk management, information technology and e-commerce system design, mergers and acquisitions due diligence, business valuations, and actuarial benefit consulting. • Many large CPA firms have departments involved exclusively in management consulting services with little interaction with the audit or tax staff.
  • 16. 2.2. STRUCTURE OF CPA FIRMS CPA firms vary in the nature and range of services offered, which affects the organization and structure of the firms. Three main factors influence the organizational structure of all firms: 1. The need for independence from clients. Independence permits auditors to remain unbiased in drawing conclusions about the financial statements. 2. The importance of a structure to encourage competence. Competence permits auditors to conduct audits and perform other services efficiently and effectively. 3. The increased litigation risk faced by auditors. Audit firms continue to experience increases in litigation-related costs. Some organizational structures afford a degree of protection to individual firm members.
  • 17. 2.3. Hierarchy of a Typical CPA Firm The organizational hierarchy in a typical CPA firm includes partners or shareholders, managers, supervisors, seniors or in-charge auditors, and assistants. A new employee usually starts as an assistant and spends 2 or 3 years in each classification before achieving partner status. The titles of the positions vary from firm to firm, but the structure is similar in all. When we refer in this text to the auditor, we mean the person performing some aspect of an audit. It is common to have one or more auditors from each level on larger engagements.
  • 18. Cont,…. • Advancement in CPA firms is fairly rapid, with evolving duties and responsibilities. • In addition, audit staff members usually gain diversity of experience across client engagements. • Because of advances in computer and audit technology, beginning assistants on the audit are rapidly given greater responsibility and challenges. • The hierarchical nature of CPA firms helps promote competence. • Individuals at each level of the audit supervise and review the work of others at the level just below them in the organizational structure. • A new staff assistant is supervised directly by the senior or in-charge auditor. The staff assistant’s work is then reviewed by the in-charge as well as by the manager and partner.
  • 19. 2.4. Establishing Standards and Rules The AICPA(American Institution of Certified Public Accountants) sets standards and rules that all members and other practicing CPAs must follow. Four major areas in which the AICPA has authority to set standards and make rules are as follows:  1. Auditing standards. The Auditing Standards Board (ASB) is responsible for issuing pronouncements on auditing matters for all entities other than publicly traded companies.  2. Compilation and review standards. The Accounting and Review Services Committee is responsible for issuing pronouncements of the CPA’s responsibilities when a CPA is associated with financial statements of privately owned companies that are not audited.  3. Other attestation standards. Statements on Standards for Attestation Engagements provide a framework for the development of standards for attestation engagements.  4. Code of Professional Conduct. The AICPA Professional Ethics Executive Committee sets rules of conduct that CPAs are required to meet.
  • 20. 2.5. INTERNATIONAL AND U.S. AUDITING STANDARDS Auditing standards are general guidelines to aid auditors in fulfilling their professional responsibilities in the audit of historical financial statements. They include consideration of professional qualities such as competence and independence, reporting requirements, and evidence. The three main sets of auditing standards are International Standards on Auditing, U.S. GenerallyAccepted Auditing Standards for entities other than public companies, and PCAOB Auditing Standards.
  • 21. I. International Standards on Auditing International Standards on Auditing (ISAs) are issued by the International Auditing and Assurance Standards Board (IAASB) of the International Federation of Accountants (IFAC). . IFAC is the worldwide organization for the accountancy profession, with 159 member organizations in 124 countries, representing more than 2.5 million accountants throughout the world. The IAASB works to improve the uniformity of auditing practices and related services throughout the world by issuing pronouncements on a variety of audit and attest functions and by promoting their acceptance worldwide.
  • 22. II. U.S. Generally Accepted Auditing Standards Auditing standards for private companies and other entities in the United States are established by the Auditing Standards Board (ASB) of the AICPA. These standards are referred to as Statements on Auditing Standards (SASs). These Generally Accepted Auditing Standards (GAAS) are similar to the ISAs, although there are some differences. If an auditor in the United States is auditing historical financial statements in accordance with ISAs, the auditor must meet any ISA requirements that extend beyond GAAS.
  • 23. III. PCAOB Auditing Standards The PCAOB initially adopted existing auditing standards established by the ASB as interim audit standards. In addition, the PCAOB considers international auditing standards when developing new standards. As a result, auditing standards for U.S. public and private companies are mostly similar.  Standards issued by the PCAOB are referred to as PCAOB Auditing Standards in the audit reports of public companies and when referenced in the text, and apply only to the audits of public companies.
  • 24. To Summarize: International auditing standards as adopted by standard-setting bodies in individual countries apply to audits of entities outside the United States Generally accepted auditing standards are similar to international auditing standards and apply to the audits of private companies and other entities in the United States. PCAOB auditing standards apply to audits of U.S public companies and other SEC registrants.
  • 25. 2.6. GENERALLY ACCEPTED AUDITING STANDARDS The broadest guidelines available to auditors in the U.S. are the 10 generally accepted auditing standards (GAAS), which were developed by the AICPA. The 10 generally accepted auditing standards fall into three categories: General standards Standards of field work Reporting standards
  • 26. I. General Standards The general standards stress the important personal qualities that the auditor should possess. 1. Adequate Technical Training and Proficiency The first general standard is normally interpreted as requiring the auditor to have formal education in auditing and accounting, adequate practical experience for the work being performed, and continuing professional education. Recent court cases clearly demonstrate that auditors must be technically qualified and experienced in those industries in which their audit clients are engaged. In any case in which the CPA or the CPA’s assistants are not qualified to perform the work, a professional obligation exists to acquire the requisite knowledge and skills, suggest someone else who is qualified to perform the work, or decline the engagement.
  • 27. Cont,… 2. Independence in Mental Attitude The importance of independence was emphasized in under the definition of auditing. The Code of Professional Conduct and SASs stress the need for independence. CPA firms are required to follow several practices to increase the likelihood of independence of all personnel. For example, there are established procedures on larger audits when there is a dispute between management and the auditors.
  • 28. Cont,… 3. Due Professional Care The third general standard involves due care in the performance of all aspects of auditing. Simply stated, this means that auditors are professionals responsible for fulfilling their duties diligently and carefully. Due care includes consideration of the completeness of the audit documentation, the sufficiency of the audit evidence, and the appropriateness of the audit report. As professionals, auditors must not act negligently or in bad faith, but they are not expected to be infallible.
  • 29. II. Standards of Field Work The standards of field work concern evidence accumulation and other activities during the actual conduct of the audit. 1. Adequate Planning and Supervision The first standard requires that the audit be sufficiently planned to ensure an adequate audit and proper supervision of assistants. Supervision is essential in auditing because a considerable portion of the field work is done by less experienced staff members.
  • 30. Cont,… 2. Understand the Entity and its Environment, Including Internal Control To adequately perform an audit, the auditor must have an understanding of the client’s business and industry. This understanding helps the auditor identify significant client business risks and the risk of significant misstatements in the financial statements. For example, to audit a bank, an auditor must understand the nature of the bank’s operations, federal and state regulations applicable to banks, and risks affecting significant accounts such as loan loss reserves
  • 31. Cont,… One of the most widely accepted concepts in the theory and practice of auditing is the importance of the client’s system of internal control for mitigating client business risks, safeguarding assets and records, and generating reliable financial information. If the auditor is convinced that the client has an excellent system of internal control, one that includes adequate internal controls for providing reliable data, the amount of audit evidence to be accumulated can be significantly less than when controls are not adequate. In some instances, internal control may be so inadequate as to preclude conducting an effective audit.
  • 32. Cont,… 3. Sufficient Appropriate Evidence Decisions about how much and what types of evidence to accumulate for a given set of circumstances require professional judgment. A major portion of this book is concerned with the study of evidence accumulation and the circumstances affecting the amount and types needed.
  • 33. III. Standards of Reporting The four reporting standards require the auditor to prepare a report on the financial statements taken as a whole, including informative disclosures. The reporting standards also require that the report state whether the statements are presented in accordance with GAAP and also identify any circumstances in which GAAP have not been consistently applied in the current year compared with the previous one. 1. The Auditor must state in the auditor’s report whether the financial statements are presented in accordance with the generally accepted accounting principles(GAAP). 2. The Auditor must identify in the auditor’s report those circumstances in which such principles have not been consistently observed in the current period in relation with the preceding period. 3. When the auditor determines that informative disclosure are not reasonably adequate, the auditor must so state in the auditor’s report. 4. The auditor either express an opinion regarding the financial statements, taken as a whole or state that an opinion can not be expressed, in the auditor’s report.
  • 34. I. STATEMENTS ON AUDITING STANDARDS The 10 generally accepted auditing standards are too general to provide meaningful guidance, so auditors turn to the SASs issued by the ASB for more specific guidance. These statements interpret the 10 generally accepted auditing standards and have the status of GAAS and are often referred to as auditing standards or GAAS, even though they are not part of the 10 generally accepted auditing standards. Generally accepted auditing standards and SASs are regarded as authoritative literature, and every member who performs audits of historical financial statements is required to follow them under the AICPA Code of Professional Conduct.
  • 35. II. Classification of Statements on Auditing Standards All SASs are given two classification numbers: an SAS and an AU number that indicates location in the Codification of Auditing Standards. Both classification systems are used in practice. The SAS number identifies the order in which it was issued in relation to other SASs; the AU number identifies its location in the AICPA codification of all SASs. AUs beginning with a “2” are always interpretations of the general standards. Those beginning with a “3” are related to field work standards, and those beginning with a “4,” “5,” or “6” deal with reporting standards.
  • 36. III. GAAS and Standards of Performance Although GAAS and the SASs are the authoritative auditing guidelines for members of the profession, they provide less direction to auditors than might be assumed. A limited number of specific audit procedures are required by the standards, and there are no specific requirements for auditors’ decisions, such as determining sample size, selecting sample items from the population for testing, or evaluating results. Many practitioners believe that the standards should provide more clearly defined guidelines for determining the extent of evidence to be accumulated. Such specificity would eliminate some difficult audit decisions and provide a line of defense for a CPA firm charged with conducting an inadequate audit. However, highly specific requirements could turn auditing into mechanistic evidence gathering, devoid of professional judgment. From the point of view of both the profession and the users of auditing services, there is probably greater harm in defining authoritative guidelines too specifically than too broadly.
  • 37. Cont,…. GAAS and the SASs should be looked on by practitioners as minimum standards of performance rather than as maximum standards or ideals. At the same time, the existence of auditing standards does not mean the auditor must always follow them blindly. If an auditor believes that the requirement of a standard is impractical or impossible to perform, the auditor is justified in following an alternative course of action. Similarly, if the issue in question is immaterial in amount, it is also unnecessary to follow the standard. However, the burden of justifying departures from the standards falls on the auditor. When auditors desire more specific guidelines, they must turn to less authoritative sources, including textbooks, journals, and technical publications. Materials published by the AICPA, such as the Journal of Accountancy and industry audit guides, furnish assistance on specific questions.
  • 38. IV. QUALITY CONTROL For a CPA firm, quality control comprises the methods used to ensure that the firm meets its professional responsibilities to clients and others. These methods include the organizational structure of the CPA firm and the procedures the firm establishes. For example, a CPA firm might have an organizational structure that ensures the technical review of every engagement by a partner who has expertise in the client’s industry. Auditing standards require each CPA firm to establish quality control policies and procedures. The standards recognize that a quality control system can provide only reasonable assurance, not a guarantee, that auditing standards are followed.
  • 39. Cont,…. Quality control is closely related to but distinct from GAAS. To ensure that generally accepted auditing standards are followed on every audit, a CPA firm follows specific quality control procedures that help it meet those standards consistently on every engagement. Quality controls are therefore established for the entire CPA firm, whereas GAAS are applicable to individual engagements.
  • 40. V. Elements of Quality Control Each firm should document its quality control policies and procedures. Procedures should depend on such things as the size of the firm, the number of practice offices, and the nature of the practice. The system of quality control should include policies and procedures that address six elements: 1. Leadership responsibilities for quality within the firm (Tone of the top). 2. Relevant Ethical Requirements. 3. Acceptance and continuation of clients and engagement. 4. Human Resources 5. Engagement Performance 6. Monitoring
  • 41. VI. Peer Review Public accounting firms must be enrolled in an AICPA approved practice-monitoring program for members in the firm to be eligible for membership in the AICPA. Practice-monitoring, also known as peer review, is the review, by CPAs, of a CPA firm’s compliance with its quality control system. The purpose of a peer review is to determine and report whether the CPA firm being reviewed has developed adequate quality control policies and procedures and follows them in practice. Unless a firm has a peer review, all members of the CPA firm lose their eligibility for AICPA membership.
  • 42. Cont,… The AICPA Peer Review Program is administered by the state CPA societies under the overall direction of the AICPA peer review board. Reviews are conducted every three years, and are normally performed by a CPA firm selected by the firm being reviewed, although the firm can request that it be assigned a reviewer through the administering state society. Peer review benefits individual firms by helping them meet quality control standards, which, in turn, benefits the profession through improved practitioner performance and higher-quality audits. A firm having a peer review can further benefit if the review improves the firm’s practice, thereby enhances its reputation and effectiveness, and reduces the likelihood of lawsuits.
  • 43. 2.7. PROFESSIONAL ETHICS Ethics can be defined broadly as a set of moral principles or values. Each of us has such a set of values, although we may or may not have considered them explicitly. Philosophers, religious organizations, and other groups have defined in various ways ideal sets of moral principles or values. Examples of prescribed sets of moral principles or values include laws and regulations, church doctrine, codes of business ethics for professional groups such as CPAs, and codes of conduct within organizations.
  • 44. 7.2.1. Need for Ethics Ethical behavior is necessary for a society to function in an orderly manner. It can be argued that ethics is the glue that holds a society together. Imagine, for example, what would happen if we couldn’t depend on the people we deal with to be honest. The need for ethics in society is sufficiently important that many commonly held ethical values are incorporated into laws. However, many of the ethical valuessuch as caring, cannot be incorporated into laws because they cannot be defined well enough to be enforced. That does not imply, however, that the principles are less important for an orderly society.
  • 45. 7.2.2. CODE OF PROFESSIONAL CONDUCT The AICPA Code of Professional Conduct provides both general standards of ideal conduct and specific enforceable rules of conduct. There are four parts to the code: principles, rules of conduct, interpretations of the rules of conduct, and ethical rulings. The parts are listed in order of increasing specificity; the principles provide ideal standards of conduct, whereas ethical rulings are highly specific. A few definitions, taken from the AICPA Code of Professional Conduct, must be understood to help interpret the rules.
  • 46. Cont,…. Client. Any person or entity, other than the member’s employer, that engages a member or a member’s firm to perform professional services. Firm. A form of organization permitted by law or regulation whose characteristics conform to resolutions of the Council of the American Institute of Certified Public Accountants that is engaged in the practice of public accounting. Except for the purposes of applying Rule 101, Independence, the firm includes the individual partners thereof. Institute. The American Institute of Certified Public Accountants. Member. A member, associate member, or international associate of the American Institute of Certified Public Accountants. Practice of public accounting. The practice of public accounting consists of the performance for a client, by a member or a member’s firm, while holding out as CPA(s), of the professional services of accounting, tax, personal financial planning, litigation support services, and those professional services for which standards are promulgated by bodies designated by Council.
  • 47. 7.2.3. Ethical Principles 1. Responsibilities: In carrying out their responsibilities as professionals, members should exercise sensitive professional and moral judgments in all their activities. 2. The Public Interest: Members should accept the obligation to act in a way that will serve the public interest, honor the public trust, and demonstrate commitment to professionalism. 3. Integrity: To maintain and broaden public confidence, members should perform all professional responsibilities with the highest sense of integrity. 4. Objectivity and Independence: A member should maintain objectivity and be free of conflicts of interest in discharging professional responsibilities. A member in public practice should be independent in fact and appearance when providing auditing and other attestation services. 5. Due Care: A member should observe the profession’s technical and ethical standards, strive continually to improve competence and quality of services, and discharge professional responsibility to the best of the member’s ability. 6. Scope and Nature of Services: A member in public practice should observe the principles of the Code of Professional Conduct in determining the scope and nature of services to be provided.
  • 48. 7.2.4. Principles of Professional Conduct The section of the AICPA Code dealing with principles of professional conduct includes a general discussion of characteristics required of a CPA. The principles section consists of two main parts: six ethical principles and a discussion of those principles. The ethical principles are listed in the box above. Discussions throughout this chapter include ideas taken from the principles section. The first five of these principles are equally applicable to all members of the AICPA, regardless of whether they practice in a CPA firm, work as accountants in business or government, are involved in some other aspect of business, or are in education. One exception is the last sentence of objectivity and independence. It applies only to members in public practice, and then only when they are providing attestation services such as audits. The sixth principle, scope and nature of services, applies only to members in public practice.
  • 49. 7.2.5. Rules of Conduct This part of the Code includes the explicit rules that must be followed by every CPA in the practice of public accounting. Those individuals holding the CPA certificate but not practicing public accounting must follow most, but not all requirements. Because the section on rules of conduct is the only enforceable part of the code, it is stated in more precise language than the section on principles. Because of their enforceability, many practitioners refer to the rules as the AICPA Code of Professional Conduct. When practitioners conduct themselves at the minimum level , this does not imply unsatisfactory conduct. The profession has presumably set the standards sufficiently high to make the minimum conduct satisfactory. At what level do practitioners conduct themselves in practice? As in any profession, the level varies among practitioners. Most practitioners conduct themselves at a high level. Unfortunately, a few conduct themselves below the minimum level set by the profession.
  • 50. 2.7.5.1 INDEPENDENCE RULE OF CONDUCT AND INTERPRETATIONS. Rule 101—Independence A member in public practice shall be independent in the performance of professional services as required by standards promulgated by bodies designated by Council. CPA firms are required to be independent for certain services that they provide, but not for others. The last phrase in Rule 101, “as required by standards promulgated by bodies designated by Council” is a convenient way for the AICPA to include or exclude independence requirements for different types of services. For example, the Auditing Standards Board requires that auditors of historical financial statements be independent. Rule 101 therefore applies to audits. Independence is also required for other types of attestations, such as review services and audits of prospective financial statements. However, a CPA firm can do tax returns and provide management services without being independent. Rule 101 does not apply to those types of services
  • 51. Cont,… Interpretations of Rule 101 Prohibit covered members from owning any stock or other direct investment in audit clients because it is potentially damaging to actual audit independence (independence of mind), and it certainly is likely to affect users’ perceptions of the auditors’ independence (independence in appearance). Indirect investments, such as ownership of stock in a client’s company by an auditor’s grandparent, are also prohibited, but only if the amount is material to the auditor.
  • 52. 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. To illustrate the meaning of integrity and objectivity, assume the auditor believes that accounts receivable may not be collectible but accepts management’s opinion without an independent evaluation of collectability. The auditor has subordinated his or her judgment and thereby lacks objectivity.
  • 53. Cont,…. An interpretation of Rule 102 states that apparent conflicts of interest may not be a violation of the rules of conduct if the information is disclosed to the member’s client or employer. For example, if a partner of a CPA firm recommends that a client have the security of its Internet Web site evaluated by a technology consulting firm that is owned by the partner’s spouse, a conflict of interest may appear to exist.
  • 54. 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.
  • 55. 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.
  • 56. 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 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. (3) 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.
  • 57. 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
  • 58. 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.
  • 59. Rule 501—Acts Discreditable A member shall not commit an act discreditable to the profession. Interpretations of Rule 501 identify several acts that are considered to be discreditable. For example, it is discreditable to retain a client’s records after a demand is made for them or whenever a member is found to have violated any federal, state, or local antidiscrimination laws. The solicitation or disclosure of the Uniform CPA examination questions and answers without permission of the AICPA is also not permitted.
  • 60. 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. Solicitation consists of the various means that CPA firms use to engage new clients other than accepting new clients who approach the firm. Examples include taking prospective clients to lunch to explain the CPA’s services, offering seminars on current tax law changes to potential clients, and advertising in the Yellow Pages of a phone book.
  • 61. 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.
  • 62. Cont,….. 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.
  • 63. Cont,…. 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.
  • 64. 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.