Becker Professional Education CPA Exam Review Auditing 1

Transcription

1 The 10 GAAS Standards and the "Old" Auditor's Reporting Model The AICPA has stated that it will test both the Clarified SASs and the "old" SASs on the Auditing exam starting on July 1, The AICPA has not given a definitive time period for this dual-testing, but has stated that it will continue until the Clarified SASs fully replace the old SASs (most likely at the end of 2014). The good news is that Becker is well-positioned to prepare you for the Auditing exam during this period of transition from the old SASs to the Clarified SASs. This Audit B textbook (Clarified SASs), is essentially the Audit A textbook (old SASs) with enhancements to cover the new/clarified provisions of the Clarified SASs. This new section has been added to your Audit 1 lecture to cover two old SAS topics, the ten GAAS standards and the old auditor's reporting model, that are not part of the Clarified SASs, but may still be tested on your Audit Exam. If you would like to print out this new topic, please go to 2013 Edition course updates for the Audit B textbook available at I. Generally Accepted Auditing Standards The ten Generally Accepted Auditing Standards comprise the foundation of auditing. These standards are qualitative in nature and set minimum requirements for the profession. Auditing standards differ from auditing procedures in that "procedures" relate to acts to be performed, whereas "standards" deal with measures of audit quality and the objectives to be achieved in an audit. Auditing standards (as distinct from auditing procedures) concern themselves not only with the auditor's professional qualities, but also with the judgment exercised in the performance of the examination and in the auditor's report. A. General Standards General Standards 1. Training "The auditor must have adequate technical training and proficiency to perform the audit." Comment: The auditor must have the education in accounting, the practical experience in auditing, and knowledge of the particular industry being audited. 2. Independence "The auditor must maintain independence in mental attitude in all matters relating to the audit." Comment: This standard is often called the cornerstone of the profession since it is necessary to add credibility to what we do. It is defined as independence in fact and appearance. The auditor is judicially impartial. Various independence standards are discussed in depth in the Ethics and Professional Responsibilities section of this lecture. a. Independence in Fact and in Appearance The auditor must be independent in fact and in appearance. Auditors must leave no doubt as to their independence in the mind of the general public. Activities or relationships that even suggest or imply a possible lack of independence must be avoided by the auditor. For example, assume the auditor owns an insignificant amount of the client's common stock, and the auditor can in no way influence corporate policy. Thus, the auditor is independent in fact. However, the appearance of independence is nonetheless impaired. Any direct ownership of a company, no matter how small, will impair independence. (An indirect financial interest that is immaterial does not impair independence.) 2012 DeVry/Becker Educational Development Corp. All rights reserved. A1-67

2 Auditing 1 Becker Professional Education CPA Exam Review 3. Professional Care "The auditor must exercise due professional care in the planning and performance of the audit and the preparation of the report." Due professional care imposes a responsibility upon each person within an independent auditor's organization to observe the standards of fieldwork and reporting. The auditor will be held to exercise the same components of professional care as a reasonable auditor would exercise, which include good faith, integrity, and diligence, but due professional care does not imply infallibility. Due professional care is concerned with what the auditor does and how well it is done. The exercise of due professional care implies that the auditor will obtain sufficient appropriate audit evidence to limit audit risk to a low level. The high level of assurance expected to be obtained is referred to as "reasonable assurance"; absolute assurance is not possible. Due professional care also requires the auditor to exercise professional skepticism. Professional skepticism can be defined as the maintenance of an objective attitude throughout the audit, including a questioning mind and a critical assessment of audit evidence. The auditor neither presumes management dishonesty nor presumes unquestioned management honesty. The auditor needs to exercise professional skepticism throughout the audit process, from engagement planning through conducting fieldwork. Comment: Often called the "average auditor" concept. The auditor should do what the average auditor would do and never less, including review of work performed by assistants and maintaining an attitude of professional skepticism. Evidence of "due professional care" is indicated by critical management reviews of work performed at every level of supervision. B. Standards of Fieldwork 1. Planning and Supervision Standards of Fieldwork "The auditor must adequately plan the work and must properly supervise any assistants." Comment: Audit programs are designed to enumerate appropriate action, and all work of staff auditors should be reviewed by a qualified auditor. 2. Internal Control, Entity, and Environment "The auditor must obtain a sufficient understanding of the entity and its environment, including its internal control, to assess the risk of material misstatement of the financial statements whether due to error or fraud, and to design the nature, extent, and timing of further audit procedures." Comment: Appropriate internal controls provide the auditor with confidence that material misstatements will be prevented, or detected and corrected, on a timely basis. a. Strong controls imply the auditor will require less evidence from substantive procedures. b. Weak controls imply the auditor will require more evidence from substantive procedures. A DeVry/Becker Educational Development Corp. All rights reserved.

3 3. Evidence "The auditor must obtain sufficient appropriate audit evidence by performing audit procedures to afford a reasonable basis for an opinion regarding the financial statements under audit." Comment: All specific audit work is performed in order to gather evidence. C. Standards of Reporting Standards of Reporting 1. Accounting = GAAP "The auditor must state in the auditor's report whether the financial statements are presented in accordance with generally accepted accounting principles (GAAP)." Comment: Explicit statement in auditor's report. 2. Consistency "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 to the preceding period." Comment: Implicit in auditor's report. 3. Disclosure "When the auditor determines that informative disclosures are not reasonably adequate, the auditor must so state in the auditor's report." Comment: Implicit in auditor's report. 4. Express Opinion "The auditor must either express an opinion regarding the financial statements, taken as a whole, or state that an opinion cannot be expressed, in the auditor's report. When the auditor cannot express an overall opinion, the auditor should state the reasons in the auditor's report. In all cases where an auditor's name is associated with financial statements, the auditor should clearly indicate the character of the auditor's work, if any, and the degree of responsibility the auditor is taking, in the auditor's report." Comment: Explicit statement in auditor's report. Pass Key The examiners test on which reporting standards are explicit (Accounting is GAAP & Express Opinion) and which standards are implicit (Consistency & Disclosure). a. The objective of the fourth standard of reporting is to prevent misinterpretation of the degree of responsibility the auditor is assuming when his/her name is associated with financial statements. (1) The auditor, when associated with the financial statements, has two major choices: (a) To render an opinion on the financial statements taken as a whole; or (b) To disclaim an opinion (e.g., because not enough audit work was done, or because the auditor was not independent) DeVry/Becker Educational Development Corp. All rights reserved. A1-69

4 Auditing 1 Becker Professional Education CPA Exam Review (2) Taken as a whole applies equally to a complete set of financial statements including footnotes, and to an individual financial statement, such as a balance sheet. (a) The auditor may express an unqualified opinion on one of the financial statements (e.g., a balance sheet), while rendering a qualified opinion or disclaimer of opinion on another financial statement, such as the income statement (covered later). (b) The auditor may report on one basic financial statement and not the others, as long as access is not limited to information underlying the basic financial statement. This is considered a "limited" reporting engagement. II. Auditor's standard report (unqualified opinion) The auditor's unqualified report states that the financial statements are presented fairly in all material respects. The three-paragraph standard report includes all of the following: A. Title "Independent" (auditor's report) must be included in the report title. B. Addressee The report is generally addressed to the company, its stockholders and/or its board of directors. It generally is not addressed to management. C. Introductory Paragraph The introductory paragraph contains the following: 1. A statement that the financial statements as identified in the report were audited; and 2. A statement that the financial statements are the responsibility of management and that the auditor's responsibility is to express an opinion. D. Scope Paragraph The scope paragraph contains the following: 1. A statement that the audit was conducted in accordance with United States GAAS; a. For audits of issuers, reference is made to PCAOB standards instead of United States GAAS. 2. A statement that the audit was planned and performed to obtain reasonable assurance that the financial statements are free from material misstatement; 3. Statements that the audit included examining evidence on a test basis; assessing the accounting principles used and significant estimates made by management; and evaluating the overall presentation; and 4. A statement that the audit provides a reasonable basis for an opinion. E. Opinion Paragraph The opinion paragraph of the report contains the following: 1. A statement referring to the financial statements specifically identified in the introductory paragraph; 2. An opinion as to the fair presentation of the financial statements; and 3. A statement regarding conformity with United States generally accepted accounting principles. A DeVry/Becker Educational Development Corp. All rights reserved.

5 F. Firm Name The firm's name, either printed or signed, must appear in the report. G. Report Date The date of the audit report must be included in the report. 1. The report should be dated on or after the date on which appropriate audit evidence, sufficient to support the opinion, has been obtained. Sufficient appropriate audit evidence includes evidence that: a. Audit documentation has been reviewed, b. Financial statements have been prepared, and c. Management has taken responsibility for the financial statements. 2. The report date shows the final date of the auditor's responsibility. 3. For comparative statements, the date appropriate for the most recent audit should be used. III. Unqualified opinion A. Sample Report Unqualified Opinion (reporting on a single year) Auditor's Standard Report INDEPENDENT AUDITOR'S REPORT We have audited the accompanying balance sheet of ABC Company as of December 31, 20XX, 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. 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. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of ABC Company as of (at) December 31, 20XX, 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. (Name) (Date) Heading Intro Scope Opinion Sign 2012 DeVry/Becker Educational Development Corp. All rights reserved. A1-71

6 Auditing 1 Becker Professional Education CPA Exam Review B. Sample Report Unqualified Opinion (reporting on a single financial statement) (UNQUALIFIED) OPINION ON BALANCE SHEET ONLY INDEPENDENT AUDITOR'S REPORT We have audited the accompanying balance sheet of X Company as of December 31, 20XX. This financial statement is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement based on our audit. 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 balance sheet is 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. In our opinion, the balance sheet referred to above presents fairly, in all material respects, the financial position of X Company as of (at) December 31, 20XX, in conformity with accounting principles generally accepted in the United States of America. C. PCAOB Standards 1. Audits of Issuers PCAOB Auditing Standard No. 1 requires the auditor's report to include a reference to the standards of the Public Company Accounting Oversight Board (United States). a. An auditor reporting on the audit of financial statements of an issuer should state in the scope paragraph: "We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit " b. An auditor's report on the financial statements of an issuer should also include identification of the city and state (or country) from which the report was issued. Generally, this information is included with the signature and date. 2. Audits of Nonissuers An auditor may (but is not required to) conduct the audit of a nonissuer in accordance with both GAAS and the auditing standards of the PCAOB. Additional language may be added to the scope paragraph to describe this situation: "We conducted our audit in accordance with generally accepted auditing standards as established by the Auditing Standards Board (United States) and in accordance with the auditing standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit " A DeVry/Becker Educational Development Corp. All rights reserved.

7 Pass Key When the examiners require CPA candidates to respond to questions concerning the standard audit report, you must remember: GAAS GAAP Scope Paragraph Opinion Paragraph Example Which paragraphs of an auditor's standard report on financial statements should refer to Generally Accepted Auditing Standards (GAAS) and Generally Accepted Accounting Principles (GAAP)? GAAS GAAP a. Opening Scope b. Scope Scope c. Scope Opinion d. Opening Opinion Solution: Choice "c" is correct. The auditor states that the audit was conducted in accordance with U.S. GAAS in the scope paragraph. The auditor expresses an opinion on the financial statements' conformity with U.S. GAAP in the opinion paragraph. D. International Standards on Auditing There are three major differences between the audit report under U.S. auditing standards and the International Standards on Auditing: 1. The ISA audit report includes expanded descriptions of management's and the auditor's responsibilities (shown in the sample report below). 2. The ISA audit report should be addressed as required by the circumstances of the engagement and should name the location in the country or jurisdiction where the auditor practices. 3. When an audit is conducted in accordance with both the auditing standards of a specific jurisdiction and International Standards on Auditing, the auditor's report may refer to both the national auditing standards of that jurisdiction and the International Auditing Standards only if there is no conflict between the two sets of standards that would impact the report and the audit report includes all elements required by the ISAs. [Appropriate Addressee] INDEPENDENT AUDITOR'S REPORT We have audited the accompanying financial statements of X Company, which comprise the balance sheet as of December 31, 20XX, and the statement of comprehensive income, statement of changes in equity and cash flow statement for the year then ended, and a summary of significant accounting policies and other explanatory information DeVry/Becker Educational Development Corp. All rights reserved. A1-73

8 Auditing 1 Becker Professional Education CPA Exam Review Management's Responsibility for the Financial Statements Management is responsible for the preparation and fair presentation of these financial statements in accordance with International Financial Reporting Standards, and for such internal control as management determines is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error. Auditor's Responsibility Our responsibility is to express an opinion on this financial statement based on our audit. We conducted our audit in accordance with International Standards on Auditing. Those standards required that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor's judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity's preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity's internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that the audit evidence that we have obtained is sufficient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, the financial statements present fairly, in all material respects, (or give a true and fair view of) the financial position of X Company as at December 31, 20XX, and (of) its financial performance and its cash flows for the year then ended in accordance with International Financial Reporting Standards. [Auditor's signature] [Date of the auditor's report] [Auditor's address] IV. TYPES OF OPINIONS A. Unqualified (Clean) Opinion An unqualified opinion states that the financial statements present fairly, in all material respects, the financial position, results of operations, and cash flows of the entity in conformity with United States GAAP. This is the opinion expressed in the standard report. 1. Explanatory Language (modified unqualified opinion) Explanatory language may be added to the auditor's standard (unqualified) report. Certain circumstances, even those not affecting the auditor's unqualified opinion on the financial statements, may require that the auditor add an explanatory paragraph (or other explanatory language) to the report. B. Qualified Opinion (except for) A qualified opinion states that, "except for" the effects of the matter(s) to which the qualification relates, the financial statements present fairly, in all material respects, the financial position, results of operations, and cash flows of the entity in conformity with United States GAAP. A DeVry/Becker Educational Development Corp. All rights reserved.

9 C. Adverse Opinion An adverse opinion states that the financial statements do not present fairly the financial position, results of operations, or cash flows of the entity in conformity with United States GAAP. D. Disclaimer of Opinion A disclaimer of opinion states that the auditor does not express an opinion on the financial statements because he or she was not able to perform an audit sufficient in scope to render an opinion. V. BRIEF SUMMARY OF WHEN TO USE DIFFERENT OPINIONS (covered in greater detail later) Materiality of Problem Conformity with GAAP Adherence to GAAS None or immaterial = Unqualified Unqualified Material = Qualified Opinion (modify opinion paragraph) Qualified Opinion (modify scope and opinion paragraphs) Highly Material = Adverse Opinion Disclaimer of Opinion Pass Key A candidate must be able to identify the types of opinions available for GAAP issues (Qualified "Except for" & Adverse) and for GAAS issues (Qualified "Except for" & Disclaimer). VI. UNQUALIFIED OPINION Unqualified Opinion Qualified "Except for" GAAP 1. Non-GAAP Change 2. Inadequate Disclosure 3. Unjustified Departure from GAAP 4. Unreasonable Acctg. Estimate Qualified "Except for" GAAS 1. Uncertainty 2. Scope Limitation Adverse GAAP 1. Non-GAAP Change 2. Inadequate Disclosure 3. Unjustified Departure from GAAP 4. Unreasonable Acctg. Estimate Disclaimer GAAS 1. Uncertainty 2. Scope Limitation 3. Lack of Independence 4. Unaudited Withdraw False, Fraudulent, Deceptive, or Misleading 2012 DeVry/Becker Educational Development Corp. All rights reserved. A1-75

10 Auditing 1 Becker Professional Education CPA Exam Review A. Uncertainty 1. General Unqualified An uncertainty involves a matter for which conclusive audit evidence Uncertainty concerning its outcome is not currently available and will not be available until such time in the future when the matter is resolved. (Note the use of the word "conclusive"; existing conditions and events to date may provide some audit evidence; see below.) Uncertainties include (but are not limited to) contingencies. Uncertainties 2. Management's Responsibility Management must analyze the existing conditions, and in accordance with GAAP, either: a. Estimate the effect of future events on the financial statements and record and present this estimate, or b. Determine that a reasonable estimate cannot be made and make the required disclosures to that effect. 3. Auditor's Responsibility The auditor's responsibility involves an assessment of whether the audit evidence that is or should be available is sufficient to support management's analysis and conclusions regarding presentation or disclosure of the uncertainty in the financial statements (that is, management's assertion regarding the uncertainty). a. If management's analysis is supported and properly reported or disclosed, the auditor issues an unqualified opinion with no reference to the uncertainty in the audit report. b. If the auditor is unable to obtain sufficient audit evidence involving an uncertainty and its presentation or disclosure in the financial statements, the auditor should consider the need to express a qualified (GAAS) opinion or to disclaim an opinion due to a limitation in scope. c. If the auditor concludes that the financial statements are materially misstated due to a departure from GAAP related to an uncertainty, the auditor should express a qualified (GAAP) or adverse opinion. GAAP departures related to uncertainties include inadequate disclosure, use of inappropriate accounting principles, and use of unreasonable accounting estimates. Pass Key A commonly tested area is the concept of uncertainty. The chart below will assist in your mastering this area. GAAP & Evidence Auditor agrees with management Unqualified UNCERTAINTY No Evidence Auditor unable to obtain evidence Qualified (GAAS) or Disclaimer Non-GAAP Auditor disagrees with management Qualified (GAAP) or Adverse A DeVry/Becker Educational Development Corp. All rights reserved.

11 B. Modified Unqualified Opinion There are several situations in which an auditor must modify the standard unqualified report to explain or emphasize a matter. This modification, however, does not constitute a qualified opinion. Variations of the auditor's standard report will occur in several situations. 1. Modified Wording Division of responsibility: The auditor's opinion is based in part on the report of another auditor. 2. Explanatory Paragraph a. Necessary and justified departure from GAAP: Due to unusual circumstances, a GAAP departure prevents the financial statements from being misleading. b. Going concern: There is substantial doubt about the entity's ability to continue as a going concern. c. To emphasize a matter regarding the financial statements, the auditor may add an explanatory paragraph. d. A justified lack of consistency is caused by a material change in GAAP between periods or a change in the method of the application of accounting principles. e. Required SEC regulation S-K quarterly financial data has been omitted or has not been reviewed. f. When a designated accounting standard setter requires information to accompany an entity's basic financial statements. g. Other information in a document containing audited financial statements is materially inconsistent with information appearing in the financial statements. Pass Key You will probably have questions involving the "modified" unqualified opinion. We will cover each of these examples later. It is important to note, however, that this still represents an unqualified opinion. The additional language is used to highlight the above circumstances. C. General Rule on Position of Explanatory Paragraph 1. Unqualified Opinion The explanatory paragraph generally would follow the opinion paragraph. 2. Qualified, Adverse, and Disclaimer of Opinion The explanatory paragraph generally would precede the opinion paragraph. 3. Exceptions The following are exceptions to the general rules above. The explanatory paragraph may be placed either before or after the opinion paragraph. a. Justified GAAP departure b. Emphasis of a matter 2012 DeVry/Becker Educational Development Corp. All rights reserved. A1-77