Chapter 2 Professional Standards

1. Chapter 2Professional Standards ©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

2. Presentation Outline • Types of Practice Standards • Generally Accepted Auditing Standards (GAAS) • Attestation Standards • Quality Control Standards for CPA Firms • The Public Company Accounting Oversight Board (PCAOB) ©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

3. I. Types of Practice Standards ©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

4. II. Generally Accepted Auditing Standards (GAAS) • Engagement Overview and GAAS • General Standards • Standards of Fieldwork • Evidence Considerations • Characteristics of Appropriate Evidence • Reporting Standards • Independent Auditor’s Report (AS 1, AS 2) • Types of Audit Report Opinions ©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

5. OBTAIN (OR RETAIN) CLIENT ENGAGEMENT PLANNING EVIDENCE GATHERING REPORTING INTERNAL CONTROL EVALUATION General Standards • GAAS is used to measure the quality of the auditor’s performance. They are the same from audit to audit. • Audit procedures are the particular and specialized actions that auditors take to obtain evidence in a specific audit engagement. A. Engagement Overview and GAAS Standards of Fieldwork Reporting Standards ©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

6. B. General Standards The General Standards affect all phases of the audit, including client acceptance or retention. • The audit must be performed by a person or persons having adequate technical training and proficiency as an auditor. • In all matters relating to the assignment, an independence in mental attitude is to be maintained by the auditor or auditors. • Due professional care is to be exercised in the performance of the audit and the preparation of the report. ©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

7. C. Standards of Fieldwork The Fieldwork Standards guide the planning, internal control evaluation, and the evidence gathering phases of the engagement. • The auditor must adequately plan the work and must properly supervise any assistants. • 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, timing, and extent of further audit procedures. • The auditor must obtain sufficient appropriate audit evidence through audit procedures performed to afford a reasonable basis for an opinion regarding the financial statements under audit. ©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

8. D. Evidence Considerations The auditor must "obtain sufficient, appropriate audit evidence” to support opinion. • Sufficient Evidence • Enough to support opinion • Persuasive enough to convince another person (judge, jury?) • Essentially a matter of professional judgment • Appropriate Evidence • Competent, valid, relevant, reliable ©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

9. E. Characteristics of Appropriate Evidence • Relevance • Testing what you want to test (e.g., direction of testing) • Evidence Source • Generally an externally generated piece of evidence more reliable than an internal (client-generated) piece of evidence • Evidence Hierarchy • Direct personal knowledge • External evidence • External-internal evidence • Internal Evidence • Verbal and written • Objective v. SubjectiveEvidence ©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

10. F. Reporting Standards The Reporting Standards guide the reporting phase of the audit engagement. • The report shall state whether the financial statements are presented in accordance with GAAP. • The report shall identify those circumstances in which such principles have not been consistently observed in the current period in relation to the preceding period. • Informative disclosures in the financial statements are to be regarded as reasonably adequate unless otherwise stated in the report. • The report shall either contain an expression of opinion regarding the financial statements, taken as a whole, or an assertion to the effect that an opinion cannot be expressed. When an overall opinion cannot be expressed, the reasons therefore should be stated. In all cases where an auditor's name is associated with financial statements, the report should contain a clear-cut indication of the character of the auditor's work, if any, and the degree of responsibility the auditor is taking. ©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

11. G. Independent Auditor’s Report (AS 1, AS 2) Report Title Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders Apollo Shoes, Inc. We have audited the accompanying balance sheets of Apollo Shoes, Inc. as of December 31,2006 and 2005, and the related statements of operations, stockholders’ equity and comprehensive income, and cash flows for the years 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 audits. 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 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 Apollo Shoes, Inc. as of December 31, 2006 and 2005, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Apollo Shoes Inc.’s' internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 22, 2007 expressed an unqualified opinion on management's assessment of, and the effective operation of, internal control over financial reporting. Smith & Smith, CPAs February 22, 2007 Report Address • Introductory Paragraph: • Notice of audit, • F/S Examined • Auditor, Management responsibilities Scope Paragraph: Description of an audit Opinion Paragraph Extra Internal Control Paragraph (AS 2) Signature Report Date ©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

12. H. Types of Audit Report Opinions • Unqualified: The financial statements present fairly the financial condition and operations of the company in conformity with U.S. GAAP. • Qualified: Except for one (limited) item, the financial statements present fairly …. • Adverse: The financial statements do not present fairly …. • Disclaimer: The auditors do not express an opinion…. ©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

13. III. Attestation Standards • Provides guidance on attest engagements other than audits: • “An engagement in which a practitioner is engaged to issue or does issue a report on subject matter or an assertion about the subject matter that is the responsibility of another party.” • Same basic set of rules as GAAS, except more general. • “Attest function” vs. “audit” • “Practitioner” vs. “auditor” • “Engagement” vs. “audit” • Differences between Attestation and Audit Engagements (Exhibit 2.4) ©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

14. IV. Quality Control Standards for CPA Firms • Quality Control Standards guide the performance of firm-wide audit and attestation practice • Independence, integrity, objectivity • Personnel management • Acceptance and continuance of clients • Engagement performance • Monitoring ©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

15. V. The Public Company Accounting Oversight Board (PCAOB) • Formation of the PCAOB • PCAOB: Standard Setting Role • PCAOB Monitoring Role ©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

16. A. Formation of the PCAOB • The PCAOB was formed to ensure that audit quality is not compromised and that auditor performance continues to meet public expectations. • The membership of the board consists of five SEC-appointed public members (business executives, investment analysts) and is supported by fees paid by publicly traded companies. • The Board’s tasks include • registering and monitoring accounting firms that prepare audit reports for public companies. • establishing rules to govern auditing, quality control, ethics, and independence. ©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

17. B. PCAOB: Standard Setting Role • Congress has taken the responsibility for creating standards for the audits of publicly traded companies from the Auditing Standards Board (ASB) of the AICPA and turned that responsibility over to the newly created Public Company Accounting Oversight Board (PCAOB). • Rather than starting from scratch, the PCAOB has declared that, for the time being, the previously created practice standards (e.g., ASB’s SASs) will function as the PCAOB’s Interim Professional Auditing Standards for audits of public companies. ©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

18. C. PCAOB: Monitoring Role • The Board’s goal is to ensure that audit quality is not compromised and that auditor performance continues to meet public expectations. • Soon after it began operations in early 2003, the PCAOB began registering professional services firms providing auditing services to public entities. Firms not registered are not allowed to conduct audits of public companies. • Other Board monitoring activities include inspections of registered auditing firms (similar to peer reviews), special investigations, and disciplinary proceedings. ©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

19. Summary • Standards for public, private, governmental, and foreign companies. • Generally accepted auditing standards • Audit evidence and reporting • Attestation standards • Quality control standards and peer review • Public Company Accounting Oversight Board (PCAOB) ©2007 by the McGraw-Hill Companies, Inc. All rights reserved.