The document discusses professional standards and regulations for auditors and accounting firms. It covers the authorities that set standards, such as the PCAOB and AICPA. It also discusses generally accepted auditing standards, including general standards, standards of fieldwork, and standards of reporting. The hierarchy of accounting guidance under GAAP is presented. The roles of auditing organizations in regulating the profession are defined.

1. Chapter 2
Professional
Standards
McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Authority of Organizations
 Public Company Accounting Oversight Board

Auditing, Attestation, Quality Control, Independence,
Ethical Standards for audits of public companies
 American Institute of Certified Public
Accountants

Auditing, Attestation, Quality Control, Independence
Ethical, Accounting and Review Standards for
engagements involving nonpublic companies
 State Boards of Accountancy
 License CPAs and CPA firms to practice in jurisdictions
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3. Regulation of the Public Accounting Profession
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4. Generally Accepted Auditing
Standards--General Standards
 Adequate technical training and
proficiency
 Independence in mental attitude is to be
maintained
 Due professional care is to be exercised
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5. Generally Accepted Auditing
Standards--Standards of Field Work
 Auditor must adequately plan and
properly supervise work
 Auditor must obtain a sufficient
understanding of entity, and its
environment, including internal control
to assess risk of material misstatement
and to design further audit procedures
 Auditor must obtain sufficient
appropriate audit evidence to afford a
reasonable basis for the opinion
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6. Generally Accepted Auditing
Standards--Standards of Reporting
 State whether the financial statements are
presented in accordance with GAAP
 Identify circumstances in which such principles
have not been consistently applied
 Informative disclosures are adequate unless
otherwise stated in the report
 Report should clearly state the degree of
responsibility being assumed by the auditors by
expressing an opinion or stating that one cannot
be expressed, and the reason therefor
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7. Terminology in Auditing Standards
(Figure 2.2)
Responsibility Meaning Words Used to Indicate
Level Responsibility
Unconditional Auditor must fulfill responsibilities “Must”
Responsibility “Is required”
“Shall” (PCAOB only)
Presumptively Auditor must comply with requirements unless “Should”
Mandatory auditor demonstrates and documents that
alternative actions were sufficient to achieve the
objectives of the standards
Responsibility to Auditor should consider; whether the auditor “Might”
Consider complies with the requirements depends on the “Could”
exercise of professional judgment in the Other phrases indicating a
circumstances responsibilities to consider
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8. The GAAS Hierarchy (Figure 2.3)
Category Status Audit Guidance
1. Standards Auditors should be prepared to justify  The 10 GAAS
departures from these standards.  SASs
 Other standards for
PCAOB, govt. audits, etc.
2. Interpretative Recommendations on the application of  Appendices to SASs
Publications the SASs. If not followed, the auditors  Interpretation of SASs
should be prepared to explain how they  Auditing guidance in AICPA
complied with the SAS provisions Audit and accounting Guides
addressed.  AICPA auditing Statements
of
Position
3. Other Auditing No authoritative status, but may help  Auditing articles
Publications the auditor understand and apply the  Continuing education
standards programs
 Textbooks
 Guidebooks
 Audit programs
 Checklists
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9. Auditor Responsibility for the
Detection of Errors and Fraud (1 of 2)
 Obtain information to assess the inherent risks and
fraud risks
 Information about the company and its
environment
 Discussion among audit team members

Inquiries of management and others

Planning analytical procedures, including those
involving revenue
 Assess the risk of errors and fraud that may cause the
financial statements to contain a material
misstatement.
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10. Auditor Responsibility for the
Detection of Errors and Fraud (2 of 2)
 Based on that assessment, plan and perform the
audit to obtain reasonable assurance that
material misstatements, whether caused by
errors or fraud, will be detected (including those
procedures required by AU 316 (SAS No. 99,
113)
 Exercise due care in planning, performing and
evaluating the results of audit procedures, and
the proper degree of professional skepticism to
achieve reasonable assurance that material
misstatements due to error or fraud will be
detected.
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11. Auditor Responsibility for
the Detection of Illegal Acts
 Those that could have a direct and material
effect on financial statement amounts--same as
for errors and fraud. An audit obtains
reasonable assurance of detecting these types
of illegal acts.
 Those with an indirect effect on financial
statement amounts:

Be aware of possible occurrence.

If information comes to the auditor’s attention, apply
audit procedures directed at determining whether an
illegal act has occurred. An audit does not provide
assurance that indirect-effect illegal acts will be
detected.
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12. The Standard Auditors’ Report for
Nonpublic Companies
 Title
 Addressee
 Content
 Introductory Paragraph
 Scope Paragraph

Opinion Paragraph
 Signature
 Date
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13. The Standard Auditors’ Report--
Introductory Paragraph
We have audited the accompanying balance sheet
of XYZ Company as of December 31, 20X1 and the
related statements of income, retained earnings, and
cash flows for the year then ended . These financial
statements are the responsibility of the Company's
management. Our responsibility is to express an
opinion on these financial statements based on our
audit.
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14. The Standard Auditors’ Report—
Scope Paragraph
We conducted our audit in accordance with auditing
standards generally accepted in the United States of
America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about
whether the financial statements are free of material
misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing
the accounting principles used and significant estimates
made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit
provides a reasonable basis for our opinion.
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15. The Standard Auditors’ Report--
Opinion Paragraph
In our opinion, the financial statements referred to above
present fairly, in all material respects, the financial position
of XYZ Company as of December 31,20X1, and the results
of its operations and its cash flows for the year then ended
in conformity with accounting principles generally accepted
in the United States of America.
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16. The GAAP Hierarchy
 Authoritative Body Pronouncements
 Pronouncements of Bodies Composed of
Expert Accountants, That Are Exposed for
Public Comment
 Pronouncements of Bodies of Expert
Accountants That Are Not Exposed for Public
Comment
 Widely Recognized Practices and
Pronouncements
 Other Accounting Literature
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17. Other Types of Auditors’ Reports
 Standard unqualified report
 Financial statements follow GAAP and auditor does not add explanatory
language for any issue
 Other reports

Unqualified with explanatory language
• Example: A lack of consistency in application of accounting
principles
 Qualified opinion
• Examples: Scope limitation or departure from GAAP

Adverse opinion
• Examples: Departure from GAAP so significant that financial
statements as a whole are misleading

Disclaimer of opinion
• Example: Unable to determine an opinion due to a very significant
scope limitation
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18. Public Company Audit Report
 Titleis “Report of Registered Independent
Public Accounting Firm”
 Refers to standards of the PCAOB rather
than GAAS
 Includes a fourth paragraph that refers to
report on internal control
 City and State (or Country) of audit firm
must be included
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19. Applicability of SSAEs
2-19

20. Elements of Quality Control
 Leadership responsibilities for quality
within the firm (“tone at the top”)
 Relevant ethical requirements
 Personnel management
 Acceptance and continuance of clients
and engagements
 Engagement performance
 Monitoring
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21. QC Element 1: Leadership responsibilities
for quality within the firm
 Firm’s internal culture recognizes that quality is
essential in performing engagements and
recognizes the need to

perform work that complies with professional
standards and regulatory and legal requirements and

issue reports that are appropriate in the
circumstances.
 Example: Assign management responsibilities
so that commercial considerations do not
override the quality of work performed.
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22. QC Element 2: Relevant ethical
requirements
 Firm and its personnel comply with
relevant ethical requirements
 Example: At least annually, the firm should
obtain written confirmation of compliance
with its independence policies and
procedures from all firm personnel who
are required to be independent
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23. QC Element 3: Acceptance and
Continuance
 Firm will undertake to continue relationships and
engagements only where the firm:
1. Has considered client integrity.
2. Is competent to perform the engagement.
3. Can comply with legal and ethical requirements.
 Example: Background information is gathered on all
prospective audit clients, including the attitude of
principal owners, key management, and those charged
with governance on matters such as aggressive
accounting and internal control over financial reporting.
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24. 2-24
QC Element 4: Human Resources
 Firm has personnel with the capabilities, competence,
and commitment to ethical principles to:
1. Perform engagements in accordance with professional
standards and regulatory and legal requirements.
2. Enable the firm to issue reports that are appropriate in the
circumstances.
 Example: Design effective recruitment processes and
procedures to help the firm select individuals meeting
minimum academic requirements established by the
firm, and maturity, integrity and leadership.
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25. QC Element 5: Engagement
Performance
 Firm’s engagements are consistently performed in
accordance with professional standards and regulatory
and legal requirements, with policies and procedures
addressing:
1. Engagement performance.
2. Supervision responsibilities.
3. Review responsibilities.
 Example: Design policies and procedures that address
the tracking of progress of each engagement.
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26. QC Element 6: Monitoring
 Firm’s policies and procedures
established for each of the elements are
suitably designed and effectively applied.
 Example: Working papers, reports, and
client financial statements are reviewed to
assess compliance with the firm’s quality
control policies and procedures.
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27. Quality Control Procedures
 Not specified by AICPA
 Depend on size of firm, number of offices
and nature of firm’s practices
 Every CPA firm should have quality
control procedures applicable to every
aspect of its practice
 Establish controls to provide assurance
that the CPA firm meets its responsibilities
to clients and public
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28. Regulation of the Public Accounting
Profession
 Public Companies

Public Company Accounting Oversight Board
• Registration of public accounting firms that audit public
companies
• Conduct inspections of public company practice of
registered public accounting firms
 Nonpublic Companies
 AICPA & State Boards of Accountancy
• Peer review for nonpublic practice segments
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29. PCAOB
 Composed of 5 members – only two may
be CPAs
 Members appointed by SEC and may
serve no more than two five-year terms
 All accounting firms that audit SEC
registrants must register with PCAOB

Pledge to cooperate with PCAOB inquiries
 PCAOB can impose monetary damages, suspend
firms or make referrals to Justice Department
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30. Peer Reviews
 Members of AICPA
 Conducted by CPAs or other CPA firms
 Two types of peer reviews

System review
• Study of CPA firms’ system of quality control
• Select sample of firms’ engagements and examine related
working paper files
 Engagement review
• Sample of CPA work including reports to evaluate
appropriateness
• Less in scope than system review
 Report: pass, pass with deficiencies, or fail
2-30

31. PCAOB Inspections
 Conducted by PCAOB staff
 Focus:
 Primarily evaluating performance of sample of
individual audit and review engagements
 selected quality control issues only. This
differs from a peer review.
 Report
 Written report to SEC, part of which is made
public
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32. International Accounting
Standards
 International
Financial Reporting
Standards (IFRS)
 Developed by International Accounting
Standards Board (IASB)
 SEC accepts IFRS for foreign companies that
issue securities in US markets
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33. International Audit Report
 Contains expanded description of management’s
responsibility
 Contains an enhanced explanation of the audit
process
 May state “present fairly, in all material respects” or
“give a true and fair view”
 Report may indicate that the financial statements
comply with the provisions of the country’s relevant
statutes or laws
 Must include city of the auditors’ office
 May be signed using the personal name of the
auditor or the audit firm or both
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