Audit I - Chapter 2, Pt. I, The Auditing Profession (1).pptx

CHAPTER TWO
The Auditing Profession
Part 1

Topics
– Part I-The Auditing Profession
 The Regulatory Framework Governing Auditing-The Need
for Regulation
 Rights and Duties, Appointment, Dismissal and
Resignation of an Auditor
 International Regulations & Standard Setters
– International Standards on Auditing (ISA)
 National Regulations & Standard Setters
 The Role of Professional Bodies
– Auditing Standards (The ISAs, The AICPA Auditing
Standards & PCAOB’s Auditing Standards)
– The Quality Control Standards
– Part II
 Professional Ethics: Fundamental Principles, Threats
and Safeguards
 Legal Liability of Auditors
2
Auditing part I YA, AAUSC, 2022

• What makes a profession Different from a
vocation/natural ability?
–All of the recognized professions (eg.
medicine, engineering, accounting, etc)
have the following common characteristics:
A responsibility to serve the public
A complex body of knowledge
Standards of admission to the
profession
A need for public confidence
3

The Need for Regulation
– The accounting and auditing professions have
become under strict regulations/code of
practice more than ever due to :
– certain events that make the public to lack
confidence on how companies are run and
audited. (eg the high level
scandals/disgraces/dishonors by Ernon and its
auditor Arthur Anderson)
– In the US, this resulted in the Sarbanes-Oxley Act
2002 which has not only radically changed the
regulation of the accounting profession in the
US but also influenced such issues worldwide.)
4

• Triggered by the bankruptcies and alleged audit failures involving such companies as
Enron and WorldCom, the Sarbanes–Oxley Act is considered by many to be the most
important legislation affecting the auditing profession since the 1933 and 1934 Securities
Acts. The provisions of the Act dramatically changed the relationship between publicly
held companies and their audit firms.
• The Sarbanes–Oxley Act established the Public Company Accounting Oversight Board
(PCAOB), appointed and overseen by the SEC.
• The PCAOB provides oversight for auditors of public companies; establishes auditing,
attestation, and quality control standards for public company audits; and performs
inspections of audit engagements as well as the quality controls at audit firms performing
those audits
• auditors of brokers and dealers registered with the Securities and Exchange Commission
are also required to register with the PCAOB, are subject to inspections, and must follow
PCAOB auditing and attestation standards.
• The PCAOB conducts inspections of registered accounting firms to assess their
compliance with the rules of the PCAOB and SEC, professional standards, and each
firm’s own quality control policies. The PCAOB requires annual inspections of accounting
firms that audit more than 100 issuers (public companies) and inspections of other
registered firms at least once every three years
5

• Security and Exchange Commission
6

The Need for Regulation….
 Auditors are regulated by:
 Professional bodies, (AICPA-Americal
Institute of Certified Public Accountants,
ACCA-Association of Chartered Certified
accountants)
 International bodies (eg. IFAC-international
Federation of Accountants)
 National bodies (eg. PCAOB-public
companies accounting oversight board in
US, the FRC, the Financial Reporting
Council in UK)-
7

….The Need for Regulation
 In order to regain trust in the auditing profession, national and
international standard setters and regulators have tried to
introduce three initiatives:
 Harmonization of auditing procedures, - to increase
users confidence in the nature of audits around the
world
 Focus on audit quality
 Adherence to a strict ethical code of conduct
 In order to achieve this, practitioners have to follow
regulatory guidance:
-National Corporate Law (The Companies act 2006 in
UK, The Sarbanes Oxley Act in US)
-Auditing Standards
-Code of Ethics
8

 Legal Requirements for Audits and Auditors
 -Different countries may have different requirements, but
the same principles apply across the world.
 National Law includes:
 Which companies are required to have an audit
 Who can and can not carry out an audit
 Auditor appointment, resignation and removal
 The rights and duties of an auditor
9

 Which companies are required to have an audit?
 In most countries, companies are required by law to have an
audit
 Small or owner managed companies are often exempt,
because of the less value in an audit for these companies
 However, these exemptions do not apply to companies in
certain regulated sectors, (eg. Financial services companies or
companies listed on stock exchange)
 Who can and can not carry out an audit?
 To be eligible to act as auditor, a person must be
– A member of a Recognized Supervisory Body (RSB) eg.
ACCA, AICPA and allowed by the rules of that body to
be an auditor or
– Someone directly authorized by the state (sole
practitioners, partners in partnership, members of
limited liability partnership, Directors of an audit
Company)
10

 Who may not act as an auditor?
 Excluded by Law: The law in most countries
excludes:
– those who manage or work for a company
– those who have business or personal
connections with them from auditing that
company
 Excluded by the code of Ethics: Auditors
must also comply with a code of Ethics. The
code of Ethics require the auditor to consider
any factors that would prevent them from acting
as auditor such as independence, competence,
or issues regarding confidentiality.
11

 Who Appoints the Auditor?
- Members/shareholders of the company appoint the
auditor by voting.
- Auditors of public Companies are appointed from
one Annual General Meeting to the next one
- Auditors of private companies are appointed
until they are removed
12

..The Need for Regulation
Appointments of Auditors
 Auditors have to be reappointed at every annual general
meetings(AGM)
 Reappointment is not automatic, to prevent auditors from
simply staying in office
 Prior to the first AGM, the directors can appoint the first
auditors,
 If an auditor resigns for some reason, directors can appoint
another auditor to fill the casual vacancy. These
appointments only last until the next AGM.
 In any case, Government ensure that all companies have
auditor
13

…The Auditing Profession
Auditors Rights
In order to carryout their duties properly, auditors have very powerful
rights:
 They have access to all records they require
 They have a right to receive information and explanation of all
transactions
 They have a right to attend and receive notice about general
meetings (where all shareholders appear) and they have right to
speak at general meetings
 They have the right to receive in advance information about any
resolutions that are proposed to be put at these general meetings
 They have the right to require the Company’s FSs should be
presented at the general meeting
 The right to be informed about, attend, speak and be heard at
general meetings gives auditors an opportunity to communicate
with shareholders
14

Auditors Duties
 The External Auditor’s primary duty - is to audit the
financial statements and provide an opinion on
whether the financial statements give a true and fair
view (or are fairly presented in all material respects)
 They may have additional reporting responsibilities
required by local national law, such as confirming
that the financial statements are properly prepared in
accordance with those laws, reporting on internal
control system as required by Sarbanes Oxley Act
of US)
15

…. ..The Need for Regulation
Resignation of an Auditor
 In practice, if the auditor and management find it difficult to work
together, the auditor will usually resigns
 On resignation, auditors give written notice and statement of
circumstances to the shareholders and regulatory authority
Why they are required to issue a statement of circumstances?
 Auditors may have resigned because they are deeply concerned
about some aspect of the company’s activities
 Statement of circumstances explains why the auditor has
resigned (may be due to innocent reasons, eg. The auditor feels
that the Co. is now too large for the audit firm to deal with. )
 If the auditors are really concerned about the Company, and that
is why they have resigned, they may insist the directors to call a
general meeting , to explain for shareholders the reason for their
resignation
16

…The Auditing Profession The Need for Regulation
Dismissal of Auditors
 Auditors can be removed from office:
 Directors begin the process to remove the auditor, but the
resolution must be passed by the shareholders (by simple
majority at AGM)
 The reason for the removal should be legitimate, eg, the auditor
may have failed to detect a material fraud and directors have
lost confidence in their competence; or because of the increase
in the company’s size, international/larger audit firm may be
needed)
 The reason may be due to disagreement b/n the auditors and the
Mgt. (eg. When auditors insist a change in some part of financial
statement, or when they issue a modified opinion, directors may
decide to remove the auditors). It is for this reason that auditors are
required to deposit a ‘statement of circumstances’, a copy of it will
be sent to regulatory bodies.
 The auditors can also receive notices, speak at a general meetings
17

…...The Need for Regulation
International Regulation
IFAC(The International Federation of Accountants)
IESBA’s (International Ethics
Standards Board for
Accountants) Code of Ethics
IAASB (International Auditing &
Assurance Standards Board)
International Standards on
Auditing (ISAs)
International
Standards on
Quality Control
(ISQC)
18

 IFAC(The International Federation of Accountants)
 It is a global organization for the accountancy
profession
 The IFAC promotes international regulation of the
accountancy profession by ensuring minimum
requirements for :
 the accountancy qualifications,
 post qualification experience,
 guidance on accounting and assurance for
accountants around the world, so that there will be
greater confidence in the profession as a whole.
 The Purpose of IFAC is to serve the public interest by
establishing and promoting adherence to high quality
professional standards
19

 IFAC(The International Federation of Accountants), has a number of
boards including:
-ISSAB- -sets International Standards on Auditing (ISAs)
and other assurance standards
-IESBA(International Ethics Standards Board for Accountants)-
issues the International Code of Ethics for professional
Accountants)
International Standards on Auditing (ISAs)
- Set by ISSAB
- Currently there are 37 ISAs and one International
Standards on Quality Control (ISQC)
20

The relationship b/n International and national
Standards and Regulations
- IFAC (international) is simply a grouping of accountancy
bodies, it has no legal standing in individual countries.
- Countries need to have their own arrangements in place for
 Regulating the Audit profession
 Implementing auditing standards
- National standard setters
 May develop their own auditing standards and ethical
standards
 May adopt and implement ISAs, possibly after modifying
them to suit national needs
- In the event of a conflict b/n the two sets of guidance, local
regulations will apply, eg in US, the (Sarbanes–Oxley Act and
Public Company Accounting Oversight Board , the SEC)
21

Sarbanes–Oxley Act and Public Company Accounting Oversight
Board
– The Sarbanes–Oxley Act is considered by many to be the
most important legislation affecting the auditing profession
since the 1933 and 1934 Securities Acts
– The provisions of the Act dramatically changed the relationship
between publicly held companies and their audit firms
– Sarbanes–Oxley Act and the Securities Exchange
Commission restrict public company auditors from
providing many consulting services to their publicly
traded audit clients.
– However, there is no restriction on providing
consulting services to non-audit clients.
22

• The Sarbanes–Oxley Act established the Public
Company Accounting Oversight Board (PCAOB) to:
– Provide oversight for auditors of public companies
– Establish auditing, attestation, and quality control
standard for public company audits
– Perform inspections of audit engagements and the
quality controls at audit firms performing those
audits
23

Public Company Accounting Oversight Board (PCAOB) :
Main Functions of the PCAOB
 It provides oversight for auditors of public companies
 Establishes auditing, attestation, and quality control standards for
public company audits;
 Performs inspections of audit engagements as well as the quality
controls at audit firms performing those audits.
 Requires annual inspections of accounting firms auditing more
than 100 public companies
 If it identifies a violation during its inspection of a registered
accounting firm, PCAOB
– can enforce disciplinary action against the accounting firm
– report the matter to the Securities and Exchange
Commission (SEC)
24

Securities and Exchange Commission (SEC)
– The SEC is an agency of the US federal government,
– The SEC assists in providing investors with reliable
information upon which to make investment decisions
– The SEC has considerable influence in setting GAAP and
disclosure requirements for financial statements as a result of
its authority for specifying reporting requirements considered
necessary for fair disclosure to investors
 the attitude of the SEC is generally considered in any
major change proposed by the FASB.
– The SEC has power to establish rules for any CPA
associated with audited financial statements submitted to
the commission
 The overall purpose of the Securities and Exchange
Commission is to assist in providing investors with reliable
information upon which to make investment decisions
25

The Role of Professional Bodies
Professional bodies such as the American Institute of Certified
Public Accountants AICPA, promote quality with in the
profession through the provision of:
– Rigorous qualifications to acquire the knowledge and
skills needed to provide a competent service
– Support to members to demonstrate high professional and
ethical values
– Technical expertise to governments on accounting and
auditing matters . This input may help shape the
introduction of new laws and regulations affecting the
profession.
The AICPA is the largest professional association for
CPAs in the United States
26

Major functions of the American Institute of Certified Public
Accountants AICPA)
– Setting standards and rules -that all members and other
practicing CPAs must follow.
 These standards consist of :
– auditing standards for auditors of private companies
– compilation and review standards, other attestation
standards, and
– the Code of Professional Conduct.
 Research and publication on many different subjects-
related to accounting, auditing, attestation and assurance
services, management consulting services, and taxes.
– AICPA publications include
• the Journal of Accountancy,
• industry audit guides for several industries,
• periodic updates of the Codification of Statements on
Auditing Standards, and
• the Code of Professional Conduct.
27

…Major functions of the AICPA
 Promoting the accounting profession through organizing national
advertising campaigns
 Promoting new assurance services
 Developing specialist certifications to help market and ensure the
quality of services in specialized practice areas such as business
valuation, financial planning, information technology, financial
forensics, and global management accounting.
 Writing and grading the uniform CPA examination
 Providing continuing education seminars for its members
• A CPA must meet continuing education requirements to maintain their license
to practice
• Membership in the AICPA is voluntary and is restricted to CPAs
– However, membership in the AICPA is not restricted to CPAs who are
currently practicing as independent auditors.
– Membership in the AICPA is not mandatory for all licensed practicing
CPAs (Not all CPAs join and not all members are practicing as
independent auditors)
28

• To obtain membership, a person must
– Successfully complete the exams provided by AICPA,
– Be able to demonstrate appropriate practical experience
(usually a minimum of three years)
– Complete an ethical assessment
• If a member is found not to have compiled with the rules of the
Professional body, disciplinary actions will be taken which may
involve fines, reprimands/warning, suspension from
membership for a limited time, or withdrawal from membership.
• Such rigorous membership requirements and disciplinary
actions are needed to ensure that professional accountants are
performing work of a high standard which increases trust in the
profession as a whole.
29

Audit standards used in professional practice by audit firms in US,
1. International Standards on Auditing (ISAs) issued by the
International Auditing and Assurance Standards Board (IAASB).
2. AICPA Auditing Standards (referred to as U.S. Generally Accepted
Auditing Standards (GAAS), set by the Auditing Standards Board
(ASB) of the AICPA
3. PCAOB (Public Company Accounting Oversight Board)Auditing
Standards
How these standards relate? Reading Assignment
 The International Standards on Auditing (ISAs) have many of the
same standards as the Auditing Standards Board (ASB )
 The Auditing Standards Board has revised most of its standards to
converge with the international standards.
 The ASB Clarity Project was intended to make the U.S. auditing
standards easier to read, understand, and apply.
 The ASB redrafted existing AICPA auditing standards to align
them with respective ISAs
 The PCAOB considers International Standards on Auditing (ISA)
when developing its standards.
30

• ….The Need for Regulation
1. International Standards on Auditing (ISAs)
- IASs are issued by the International Auditing and
Assurance Standards Board (IAASB) of the
International Federation of Accountants (IFAC)
– The IAASB works to improve the uniformity of
auditing practices and related services throughout
the world
– Currently, International Audit Standards (IAS) have 37
Standard And 1 Quality Control Standard:
31

 Main features of International Standards on Auditing
(ISAs)
- ISAs are professional guidance that the auditor must follow to
ensure each audit is performed consistently and to a required
standard of quality
- ISAs are not legal requirements. If a country has a law in place
which is inconsistent with the requirements of ISAs, local law
should be followed
- ISAs are written in the context of and audit of FSs, but can be
applied to the audit of other historical financial information
- ISAs must be applied in all, but exceptional cases., where the
auditor deems it necessary to depart from ISA to achieve the
overall aim of the audit, the departure must be justified
- ISAs contain basic principles and requirements followed by
application and other explanatory materials to aid the auditor on
how to follow the requirements
32

Development of ISAs
-For ISA to be issued, a lengthy process of discussion and
debate occurs to ensure the members affected by the
guidance have had an input
-An exposure draft (ED) is issued for a public comment and
these comments may result in revisions to the ED.
-Approval of two thirds of the ISSAB members is required
for the ISA to come in to force.
33

….International Standards on Auditing (ISAs)
1. 200 Series: General Principles and Responsibilities
2. 300 and 400 Series: Assessment and Response to Assessed
Risks
3. 500 Series: Evidence
4. 600 Series: Using the work of others
5. 700 Series: Audit conclusions and reporting
6. International Standard on Quality Control (ISQC) 1
34

200 Series: 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 230: Audit 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
35

300 and 400 Series: 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
36

500 Series: Evidence
 ISA 500: Audit Evidence
 ISA 501: Audit Evidence-Specific Considerations for Selected Items
 ISA 505: External Confirmations
 ISA 510: Initial Audit 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 580: Written Representations
37

600 Series and 700 Series
 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
 ISA 700: Forming an Opinion and Reporting on Financial Statements
 ISA 701:Communicating Key Audit Matters in the Independent Auditors
Report
 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 710: Comparative Information-Corresponding Figures and
Comparative Financial Statements
 ISA 720: The Auditor’s Responsibilities Relating to Other Information in
Documents Containing Audited Financial Statements
1. International Standard on Quality Control (ISQC) 1, Quality Controls for
Firms that Perform Audits and Reviews, and Other Assurance Services
38

2. The AICPA Auditing Standards
– These are auditing standards for private companies and other entities
in the United States, and are set by the Auditing Standards Board
(ASB) of the AICPA
– They are also referred to as U.S. generally accepted auditing
standards (GAAS); also referred to as Statements on Auditing
Standards (SASs) . SASs are pronouncements issued by the Auditing
Standards Board of the AICPA, and are considered to be
interpretations of the 10 GAASs
– ASB (through Clarity project) has harmonized its agenda with the
IAASB, thus, the AICPA auditing standards are similar to the ISAs,
although there are some differences.
– When developing a new SAS, the ASB uses the ISA as the base
standard and then modifies that base standard only when
modifications are appropriate for the U.S. environment.
– 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 the requirements in the AICPA
39

3. Public Company Accounting Oversight Board
(PCAOB) Auditing Standards
• These are standards issued by the PCAOB apply only to
the audits of U.S. public companies and other SEC
registrants, including brokers and dealers
• The PCAOB also considers international auditing
standards (IASs) when developing new standards
40

… The Need for Regulation
Figure 2.1 Relation of U.S. and International Auditing Standards
41

Organization of U.S. Auditing Standards (How it is
structured)
• Historically, US auditing standards (Generally Accepted Auditing Standards
(GAAS) have been organized into three categories:
– GAAS 1: The General standard- has 3 sections, (GAAS 1 relate to
(1.1) training and proficiency of auditors, (1.2) the need for
independence and (1.3) due care in the audit profession)
– GAAS 2: The field work standard –has 3 sections,(GAAS 2 relate to
accumulating and evaluating evidence sufficient for the auditors to
express an opinion on the financial statements (2.1 Adequate Planning
and Supervision of the audit; 2.2 Sufficient Understanding of Internal
Control 2.3 Sufficient Competent Evidential Matters
– GAAS 3: The reporting Standard –has 4 sections,(GAAS 3 relate
what audit reports should show: (3.1, whether the financial statements
are prepared as per GAAPs 3.2, If principles have not been
consistently applied 3.3, The need for informative disclosures 3.4 an
expression of opinion regarding the financial statements taken as a
whole, or an assertion to the effect that an opinion cannot be
42

..Organization of U.S. Auditing Standards (How it is structured)-
The current structure
– As part of its Clarity Project, the ASB issued a Preface to the
Codification of Auditing Standards that contains the
“Principles Underlying an Audit in Accordance with
Generally Accepted Auditing Standards” (referred to as the
principles).
– The principles underlying an audit provide a framework to
help auditors fulfill the two objectives:
 Obtain reasonable assurance about whether the financial
statements as a whole are free from material
misstatement, whether due to fraud or error
 Report on the financial statements, and communicate
as required by GAAS, in accordance with the auditor’s
findings
43

…Organization of U.S. Auditing Standards (How it is structured )
• The principles are not requirements and do not carry authority,
• but they provide structure for the Codification. The
structure(arrangement) is organized around the following
principles:
(1) Purpose of an audit-To Provide opinion about financial
statements
(2)Responsibilities-Personal responsibilities of an auditor,
 Possess appropriate competence and capabilities
 Comply with ethical requirements
 Maintain professional skepticism and
 Exercise professional judgment
44

…Organization of U.S. Auditing Standards (How it is structured)
(3) Performance
 Obtain reasonable assurance about whether financial statements
are free of material misstatement
 Plan work and supervise assistants
 Determine and apply materiality level or levels
 Identify and assess risks of material misstatement based on
understanding of entity and its environment, including internal
controls
 Obtain sufficient appropriate audit evidence
(4) Reporting
 Express opinion on financial statements in a written report
– Whether financial statements are presented fairly in accordance
with financial reporting framework
45

…Organization of U.S. Auditing Standards (How it is structured)
Principles versus auditing Standards
The principles underlying auditing standards-
• are too general to provide meaningful guidance, so
• Auditors turn to the Statements of the Auditing Standards
(SASs) issued by the AICPA and
• the PCAOB auditing standards (ASs) for more specific
guidance.
The principles are not requirements and do not carry
authority, but they provide structure for the Codification.
46

Auditing standards are regarded as
authoritative/convincing/respected literature, and
every member who performs audits of historical
financial statements is required to follow them under
the AICPA Code of Professional Conduct.
47

…Organization of U.S. Auditing Standards (How it is
structured)
• Classification of auditing Standards
– All SASs issued by the AICPA are given two classification
numbers:
– SAS and AU-C number that indicates its location in the
Codification of Auditing Standards.
– Both classification systems are used in practice. For example, the
Statement on Auditing Standards, Substantive Changes Related
to Using the Work of Internal Auditors, is SAS No. 128 and AU-C
610.
 The SAS number identifies the order in which it was issued in
relation to other SASs; (there are about 129 SASs)
 the AU-C number identifies its location in the AICPA
Codification of all SASs. The AU-C section numbering is
equivalent to the ISA numbers.
– The letter “C” is used to distinguish clarified standards from
48

…Organization of U.S. Auditing Standards (How it is
structured)
……Classification of auditing Standards
– Auditing Standards issued by the PCAOB are also
numbered consecutively (e.g., AS1, AS2).
– The AICPA standards adopted by the PCAOB as
interim standards retained the original AU classification
that was used for those standards.
– The PCAOB is proposing a numerical reorganization of
their standards by topical area to avoid confusion with
the AICPA AU-C section numbering, this can also
facilitate comparison of the two sets of auditing
standards.
49

Application of Auditing Standards in Performance of Audit
(Standards of Performance)
Though it is specific and detailed, SASs do not prescribe
specific auditing procedures to be followed.
• For specific audit problems, auditors can refer to less
authoritative sources such as the Industry Audit Guides and
audit procedures issued by AICPA, auditing text books, and
articles in journals such as the Journal of Accountancy.
• Compliance with SASs does not represent an ideal of
audit performance, but rather a minimum standard for all
audit engagements. Thus, the AICPA principles and the
auditing standards should be viewed by practitioners as
minimum standards of performance rather than as
maximum standards or ideals
50

……. Application of Auditing Standards in Performance of
Audit (Standards of Performance)
Auditor must not always need to 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,
provided that sufficient appropriate evidence is obtained.
• 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.
51

Quality control
• Quality control comprises the methods used to ensure that
the firm meets its professional responsibilities to clients
and others
• Quality control for a CPA firm includes- the organizational
structure of the 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.
52

……Quality control
Quality Control & Auditing Standards
 Quality control is closely related to but distinct from auditing
standards.
• The standards- recognize that a quality control system can
provide only reasonable assurance, not a guarantee, that
auditing standards are followed.
• A CPA firm- must make sure that auditing standards are
followed on every audit.
 Quality controls are the procedures used by the entire CPA firm to
ensure that the principles in auditing standards are followed on
every audit.
• Quality controls are established for the entire CPA firm, whereas
auditing standards are applicable to individual engagements.
53

Peer Review
 Public accounting firms must be enrolled in an AICPA-
approved practice-monitoring program, also known as
peer review, for members in the firm to be eligible for
membership in the AICPA
 It is a practice monitoring by a CPA firm for another
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.
54

…Peer Review
• 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.
• The AICPA has established audit practice and quality
center as resource centers to improve audit practice
quality:
55

…Peer Review
• Firms required to be registered with and inspected by
the PCAOB must be reviewed by the AICPA National Peer
Review Committee to evaluate the non-SEC portion of the
firm’s accounting and auditing practice that is not
inspected by the PCAOB.
• After the review is completed, the reviewers issue a report
stating their conclusions and recommendations.
• Results of the peer review are included in a public file by
the AICPA.
56

Advantages of Peer Review
• 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 enhancing its
reputation and effectiveness and reducing the likelihood of
lawsuits.
• However, peer reviews are expensive to conduct, so the
benefits come at a cost.
57

The Six Elements of Quality Control Standards
1. Leadership responsibilities for quality within the firm
— The firm should promote a culture that quality is
essential in performing engagements and should establish
policies and procedures that support that culture.
2. Relevant ethical requirements — All personnel on
engagements should maintain independence in mind and
in appearance, perform all professional responsibilities
with integrity/honesty and maintain
objectivity/impartiality in performing their professional
responsibilities.
58

…Elements of Quality Control Standards
3. Acceptance and continuation of client relationships
and engagements — Policies and procedures should
be established for deciding whether to accept or continue
a client relationship or specific engagement.
-These policies and procedures should minimize the risk
of associating with a client whose management lacks
integrity.
The firm should also only undertake engagements that
can be completed with professional competence.
59

4. Human resources — Policies and procedures should be
established to provide the firm with reasonable assurance that:
 all new personnel are qualified to perform their work
competently,
 work is assigned to personnel who have adequate
technical training and proficiency,
 all personnel should participate in continuing
professional education and professional development
activities that enable them to fulfill their assigned
responsibilities, and
 personnel selected for advancement should have the
qualifications necessary for the fulfillment of their assigned
responsibilities.
60

5. Engagement performance — Policies and procedures should exist
to ensure that the work performed by engagement personnel meets
applicable professional standards , legal and regulatory
requirements, and the firm's standards of quality.
6. Monitoring — Policies and procedures should exist to ensure that
the other quality control elements are being effectively applied.
Quality control standards are established by:
 the Auditing Standards Board for auditors of private companies
and
 the Public Company Accounting Oversight Board for auditors of
public companies.
61

Audit practice and Quality Centers
• The AICPA has established audit practice and quality centers
as resource centers to improve audit practice quality:
– The Center for Audit Quality (CAQ) is a public policy
organization affiliated with the AICPA serving investors,
public company auditors, and the capital markets
– The Center’s mission is to foster confidence in the audit
process and to make public company audits even more
reliable and relevant for investors.
– The Private Companies Practice Section provides practice
management information to firms of all sizes
• In addition to these firm resources, the AICPA has established
audit quality centers for governmental audits and employee
benefit plan audits.
62

Figure 2.4 Ways the Profession and Society Encourage CPAs to
Conduct Themselves at a High Level
Because CPA firms play an important social role, several organizations, including the
PCAOB, SEC, and AICPA, provide oversight to increase the likelihood of appropriate
audit quality and professional conduct.
63

Types of CPA Firms
 Except for certain governmental organizations, the audits of most
financial statements in the United States are done by CPA firms
• Three size categories are used to describe CPA firms:
 Big Four international firms- (Deloitte, Pwc, Ernst & Young,
KPMG); these four firms have offices throughout the United
States and throughout the world)
 National/Regional firms- National CPA firms in the United
States have offices in most major cities while regional firms
have several offices in a state or region and serve a large
radius of clients. They compete with big 4 for clients
 Local firms- Some local firms have only one office and serve
clients primarily within commuting distances while others may
have several offices. They usually audit smaller and not for
profit organizations
64

Activities of CPA Firms
• CPA firms provide audit services, as well as other
attestation/confirmation and assurance services.
Additional services include:
– Accounting and bookkeeping services
– Tax services
– Management consulting and risk advisory services
– Business valuation
– Forensic accounting
– Corporate responsibility and sustainability reporting
– Information technology advisory services
65

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:
– The need for independence from clients
– The importance of a structure to encourage
competence
– The increased litigation risk faced by auditors
66

Organizational Structures
• There are six organizational structures available to CPA firms:
– Proprietorship- firms with only one owner
– General Partnership-similar to a proprietorship, but multiple owners.
– General Corporation-Shareholders in a general corporation are liable
only to the extent of their investment in the corporation. Many states
prohibit CPA firms from organizing as a general corporation.
– Professional Corporation-A professional corporation provides
professional services and is owned by one or more shareholders.
Personal liability protection for shareholders in professional
corporations varies widely from state to state.
– Limited Liability Company-This form combines the most favorable
attributes of a general corporation and a general partnership. LLCs are
typically structured and taxed like a general partnership, but its owners
have limited personal liability similar to that of a general corporation.
– Limited Liability Partnership-Partners are personally liable for the acts
of those under their supervision.
67

Table 2.2 Staff Levels and
Responsibilities
Staff Level
Average
Experience
Typical Responsibilities
Staff assistant 0-2 years Performs most of the detailed audit work.
Senior or in-
charge
auditor
2-5 years Coordinates and is responsible for the
performance of audit procedures,
including supervising and reviewing
staff work.
Manager and
senior
manager
5-10 years Helps the in-charge plan and manage
the audit, reviews the in-charge’s work,
and manages relations with the client.
A manager may be responsible for
more than one engagement at the
same time.
68

Table 2.2 Staff Levels and
Responsibilities
Staff Level
Average
Experience
Typical Responsibilities
Partner 10+ years Reviews the overall audit work and is
involved in significant audit decisions. A
partner is an owner of the firm and
therefore has the ultimate responsibility
for conducting the audit and serving the
client.
69

End of Chapter 2: Part - 1
Questions
70

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