1 / 48

AUDITING CHAPTER 2

AUDITING CHAPTER 2. Standards, Materiality, & Risk By David N. Ricchiute. TOPICS. Audit & Attestation standards Auditing concepts Audit risk Materiality in financial statement audit. EARLY DEVELOPMENT OF STANDARDS. 1941 Accounting Series Release (ASR)#21 SEC requires audit report

niveditha
Download Presentation

AUDITING CHAPTER 2

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. AUDITINGCHAPTER 2 Standards, Materiality, & Risk By David N. Ricchiute

  2. TOPICS • Audit & Attestation standards • Auditing concepts • Audit risk • Materiality in financial statement audit GBW Ch. 2 8th ed

  3. EARLY DEVELOPMENT OF STANDARDS • 1941 Accounting Series Release (ASR)#21 • SEC requires audit report • Audit conducted in accordance with generally accepted standards • 1948 AICPA approves generally accepted auditing standards (GAAS) GBW Ch. 2 8th ed

  4. RECENT DEVELOPMENT OF STANDARDS • 1970s practitioners criticized GAAS as not sufficiently specific • 1986 Attestation standards developed • Umbrella for engagement standards • GAAS applies exclusively to financial statement audits GBW Ch. 2 8th ed

  5. COMPARING GAAS & ATTESTATION AttestationGAAS GBW Ch. 2 8th ed

  6. GENERAL STANDARDS AttestationGAAS GBW Ch. 2 8th ed

  7. FIELDWORK STANDARDS AttestationGAAS GBW Ch. 2 8th ed

  8. REPORTING STANDARDS AttestationGAAS GBW Ch. 2 8th ed

  9. STANDARDS FOR PUBLIC COMPANY ENGAGEMENTS • Sarbanes-Oxley Act of 2002 • Creates Public Company Accounting Oversight Board (PCAOB) • Delegates authority to PCAOB to • Oversee, regulate accounting and auditing professions • Develop accounting, auditing standards or • Accept accounting standards from FASB • Accept auditing standards from AICPA GBW Ch. 2 8th ed

  10. AUDITING CONCEPTS • Independence • Due care • Evidence • Reporting GBW Ch. 2 8th ed

  11. INDEPENDENCE EXPLAINED • In fact • State of mind • Attitude of impartiality • In appearance • Free of overt interest in client GBW Ch. 2 8th ed

  12. CONSULTING & PUBLIC COMPANY ENGAGEMENTS 2000 … consulting & other services may shorten the distance between the auditor & management. Independence—if not in fact, then certainly in appearance—becomes a more elusive proposition. … In this dual role, the auditor, who guards the integrity of the numbers, now both oversees & answers to management. Arthur Levitt, Jr., “Renewing the Covenant with Investors” Speech at NYU Center for Law & Business, 5/10/00. GBW Ch. 2 8th ed

  13. SEC PUBLIC COMPANIES INDEPENDENCE REFORMS 2000 • Engagement team model of independence • Team & immediate family prohibited from investments in clients • Increased restrictions for IT and internal audit consulting • Required disclosure audit/nonaudit fees in proxy statement GBW Ch. 2 8th ed

  14. SARBANES-OXLEY, & INDEPENDENCE 2002 • Establishes PCAOB • Addresses accountability for corporate & criminal fraud • Limits audit firm’s consulting services to public company clients • Client board of directors to approve consulting services provided by auditor GBW Ch. 2 8th ed

  15. SERVICES PROHIBITED BY SARBANES-OXLEY For public companies: • Bookkeeping, other accounting services • Information systems design, implementation • Valuation or appraisal services • Actuarial services • Internal audit outsourcing services • Management functions, human resources • Broker, dealer, investment advisor • Legal, expert services • Other services to be determined GBW Ch. 2 8th ed

  16. SEC, INDEPENDENCE, & PUBLIC COMPANIES 2003 • Further independence regulations • Rotate engagement partner 5-7 years • Restrict firm’s independence for 1 year when client hires member of audit team • Violates independence if auditor’s compensation based on selling service other than attest • Require auditor report certain matters to client’s audit committee • Critical accounting policies GBW Ch. 2 8th ed

  17. DUE CARE EXPLAINED • Care when providing professional services • Adequate training for professional services GBW Ch. 2 8th ed

  18. DUE CARE IN LAW Every man who offers his service to another & is employed assumes the duty to exercise such skill as he possesses with reasonable care & diligence. …if one offers his service, he is understood as holding himself out to the public as possessing the degree of skill commonly possessed by others in the same employment & if his pretensions are unfounded, he commits a species of fraud upon every man who employs him . . . Cooley on Torts GBW Ch. 2 8th ed

  19. DUE CARE & WORLDCOM 2002 • 2nd largest long-distance carrier restated financial statements for 5 quarters • Network access fees capitalized instead of expensed • Overstated net income by $11 billion • Overstated balance sheet by $75 billion • Not GAAP • Auditor knew but did not challenge GBW Ch. 2 8th ed

  20. DUE CARE &PRUDENT PRACTITIONER • Foresee unreasonable risk to others • Attend to extra risks • Consider unusual circumstances or relationships • Identify unfamiliar situation & take precautions • Resolve doubt • Keep current • Review work of assistants GBW Ch. 2 8th ed

  21. DUE CARE OPERATIONALIZED • Auditor obtains knowledge of business to understand events, transactions, practices with significant effect on financial statements • Plan audit to limit audit risk to low level • Assess possible errors on balance sheet GBW Ch. 2 8th ed

  22. EVIDENCE EXPLAINED • Underlying accounting data • Journals, ledgers, reconciliations, accounting manuals • Corroborating information • Receiving reports, invoices, contracts, representations from 3rd parties GBW Ch. 2 8th ed

  23. EVIDENCE • Basis for all decisions • Evidential matter • Planning & supervision • Internal control GBW Ch. 2 8th ed

  24. EVIDENCE: SUFFICIENCY & COMPETENCE • Sufficiency • Quantity useful evidence collected at reasonable cost • Competence • Validity: varies with source • Relevance: related to assertion GBW Ch. 2 8th ed

  25. EVIDENCE HIERARCHY • Independent sources more reliable than management • Banks, debtors • Evidence obtained directly more persuasive than indirect evidence from management • Physical examination, observation, computation, inspection • Effective internal control systems produce more reliable evidence GBW Ch. 2 8th ed

  26. PLANNING & SUPERVISION EXPLAINED • Planning • Developing objectives & strategy • Supervision • Directing assistants toward objectives • Determining when objectives are met GBW Ch. 2 8th ed

  27. INTERNAL CONTROL • Policies & procedures of management & board of directors • Provides reasonable assurance their objectives will be achieved • Auditor must understand client’s internal controls • To plan audit • To design audit tests GBW Ch. 2 8th ed

  28. REPORTING EXPLAINED • Report states conclusion • Attestation report • Whether management’s assertion conforms with stated criteria • Audit report • Whether financial statements conform to GAAP GBW Ch. 2 8th ed

  29. AUDIT REPORT CONCLUSION In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the company . . ., & the results of its operations and its cash flows . . ., in conformity with generally accepted accounting principles. GBW Ch. 2 8th ed

  30. STRATEGY FOR RISK • Risk of omissions or misstatements • Design engagement to control material omissions or misstatements • Provide reasonable not absolute assurance of detecting omissions or misstatements GBW Ch. 2 8th ed

  31. ATTESTATION RISK Probability that attester may unknowingly fail to modify a written conclusion about an assertion that is materially misstated D. N. Ricchiute, Auditing, 8th ed. GBW Ch. 2 8th ed

  32. AUDIT RISK Probability that auditor may unknowingly fail to modify opinion on financial statements that are materially misstated D. N. Ricchiute, Auditing, 8th ed. GBW Ch. 2 8th ed

  33. COMPONENTS OF AUDIT RISK • Client sources of risk • Inherent risk • Control risk • Auditor source of risk • Detection risk GBW Ch. 2 8th ed

  34. COMPONENTS OF AUDIT RISK DEFINED • Inherent risk • Risk that errors will occur • Control risk • Risk that internal controls won’t prevent, detect, correct errors • Detection risk • Risk that audit procedures won’t find errors GBW Ch. 2 8th ed

  35. INHERENT RISK SOURCES Risk that errors will occur • Business • Industry • Management’s predisposition to manage earnings • Aggressive use of GAAP • Specific accounts • Liquid assets vs. nonliquid assets GBW Ch. 2 8th ed

  36. CONTROL RISK SOURCES Risk that internal controls won’t prevent, detect, correct errors • Outdated technology • Outdated software • Lack of respect for controls by top management GBW Ch. 2 8th ed

  37. DETECTION RISK SOURCES Likelihood that errors could occur and not be detected by audit procedures • Nature of audit procedures • Extent of audit procedures • Timing of audit procedures • Auditor’s judgment GBW Ch. 2 8th ed

  38. AUDIT RISK MODEL:SAS No. 47 AR = IR x CR x DR DR = AR IR x CR GBW Ch. 2 8th ed

  39. AUDITOR’S BUSINESS RISK The probability that a practitioner might incur damages despite issuing an appropriate report • Ex.: litigation • Factors affecting auditor’s business risk • Aggressive financial reporting • Management integrity or reputation • Conflicts of interest & regulatory problems • Industry characteristics GBW Ch. 2 8th ed

  40. AUDITOR’S RESPONSE TO BUSINESS RISK • If business risk is higher, adjust audit risk assessment • Set audit risk lower • Decrease acceptable level of detection risk • Increase evidence • Drop client • If assurance levels all same, do not adjust audit risk GBW Ch. 2 8th ed

  41. AUDIT FAILURE DEFINED • Failing to perform procedures that would reduce audit risk to a relatively low level • Ex.: Sunbeam Sunbeam’s auditor a) identified reserves not in compliance with GAAP; b) proposed adjustments which management rejected; c) accepted reserves as stated after incorrectly applying materiality analysis GBW Ch. 2 8th ed

  42. MATERIALITY The magnitude or an omission or misstatement of accounting information that, in the judgment of a reasonable person relying on the information, would have been changed or influenced by the omission or misstatement.1 Statement of Financial Accounting Standards No. 2, “Qualitative Characteristics of Accounting Information,” Stamford: FASB, 1980, par 132. GBW Ch. 2 8th ed

  43. MATERIALITY IN PRACTICE • Preliminary estimate of materiality for planning guides audit effort, evidence collection • SAS No. 22, “Planning & Supervision” GBW Ch. 2 8th ed

  44. AUDIT RISK, MATERIALITY, AUDIT EFFORT • Inverse relationship between audit risk and materiality • Low audit risk suggests it would take larger amounts to be material • Inverse relationship between materiality and audit effort (hours worked) • Higher materiality threshold suggests less audit effort GBW Ch. 2 8th ed

  45. QUANTITATIVE MATERIALITY CRITERIA • Effect on • Net income • Total assets • Total revenue GBW Ch. 2 8th ed

  46. SAS 99 ON MATERIALITY • Auditors should • Not rely solely on quantitative materiality criteria • Judge materiality of misstatements both individually & in aggregate • Recognize that intentional but immaterial misstatements are inappropriate & may be unlawful GBW Ch. 2 8th ed

  47. QUALITATIVE MATERIALITY CONSIDERATIONS • Misstatement may not be immaterial if: • Affects debt compliance requirements • Masks change in earnings • Conceals unlawful transaction • Prompts undue expectations • Hides failure to meet analysts’ expectations • Associated with an estimate • Affects management’s compensation GBW Ch. 2 8th ed

  48. ALLOCATING PRELIMINARY MATERIALITY ESTIMATES • On the basis of • Relative magnitude of financial statement accounts • Relative variability of financial statement accounts • Professional judgment GBW Ch. 2 8th ed

More Related