The Audit Standards’ Setting Process Chapter 2 The Audit Standards’ Setting Process 1

Learning Objectives Describe the nature of CPA firms, what they do, and their structure. Understand the role of the Public Company Accounting Oversight Board and the effects of the Sarbanes-Oxley Act on the CPA profession. Summarize the role of the Securities and Exchange Commission in accounting and auditing.

Learning Objectives Describe the functions performed by the AICPA. Understand the role of international auditing standards and their relation to U.S. auditing standards. Use U.S. auditing standards as a basis for further study. Identify quality control standards and practices within the accounting profession.

1 Describe the nature of CPA firms, what they do, and their structure.

Certified Public Accounting Firms The legal right to perform audits is granted to CPA firms by regulation in each state. CPA firms also provide many other services to their clients, such as tax and advisory services. CPA firms continue to develop new products and services—such as financial planning, business valuation, forensic accounting, and information technology advisory services.

Certified Public Accounting Firms Big Four international firms National firms Regional and large local firms Small local firms 2-6

Certified Public Accounting Firms The four largest CPA firms in the United States are called the “Big Four” international CPA firms. These four firms have offices throughout the United States and in many cities throughout the world. Over 30 years ago the largest CPA firms were known as the “Big Eight”. These eight firms dominated the market and audited the vast majority of public and large private companies. Several “Big Eight” firms merged to increase their geographic presence in 1988 and 1989. Another merger occurred in 1997 to create the “Big Five”. When Arthur Andersen liquidated in 2002, only four large international firms remained.

Certified Public Accounting Firms

Activities of CPA Firms Accounting and bookkeeping services Tax services Management consulting services Many small companies with limited accounting staff rely on CPA firms to prepare their financial statements. CPA firms prepare corporate and individual tax returns for both audit and non-audit clients. Almost every CPA firm performs tax services. Most CPA firms provide certain services that enable their clients to operate their businesses more effectively. The ability to provide this value added service often distinguishes one firm from another.

Structure of CPA Firms Three main factors influence the organizational structure of all firms: 1. The need for independence from clients. 2. The importance of a structure to encourage competence. 3. The increased litigation risk faced by auditors. Independence permits auditors to remain unbiased in drawing conclusions about financial statements. Competence permits auditors to conduct audits and perform other services efficiently and effectively. Litigation costs are increasing for all audit firms. Some organizational structures afford a degree of protection to individual firm members.

Organizational Structure Proprietorship General Partnership General Corporation Professional Corporation LLC combines the most favorable attributes of a general corporation and a partnership. Owners have limited personal liability. An LLP is owned by one or more partners and taxed like a general partnership, but the personal liability protection of an LLP is less than that of a general corporation or an LLC. Limited Liability Company Limited Liability Partnership

Hierarchy of a Typical CPA Firm Average Experience 10+ years 5-10 years 2-5 0-2 Partners Managers Seniors and In-Charge Auditors Staff Assistants Staff perform most of the audit field work. Seniors are responsible for the field work and supervise the staff. Managers help plan the audit, manage the audit, review the audit work and work with the client to resolve any issues identified. Partners review all audit areas and makes significant decisions. The partner signs the audit report.

2 Understand the role of the Public Company Accounting Oversight Board and the effects of the Sarbanes-Oxley Act on the CPA profession.

Sarbanes-Oxley Act This Act is considered by many observers to be the most important legislation affecting the auditing profession since the 1930s. The provisions of the Act apply to publicly held companies and their audit firms.

Sarbanes-Oxley Act SEC PCAOB (Public Company Accounting Oversight Board) The Sarbanes-Oxley Act established the PCAOB which is overseen by the SEC. The PCAOB provides oversight for auditors of public companies, establishes auditing and quality control standards for public company audits and performs inspections of the quality controls at audit firms performing those audits.

3 Summarize the role of the Securities and Exchange Commission in accounting and auditing.

Securities and Exchange Commission The purpose is to assist in providing investors with reliable information upon which to make investment decisions The Securities Act of 1933 The Securities Exchange Act of 1934 The 1933 Act requires most companies planning to issue new securities to the public to submit a registration statement to the SEC for approval. The 1934 Act provides additional protection by requiring public companies and others to file detailed annual reports with the Commission. The Commission examines these statements for completeness and adequacy before permitting the company to sell its securities through the exchanges.

Securities and Exchange Commission Form S-1 Form 8-K Form 10-K Form 10-Q Form S-1 applies to new securities. Form 8-K is field to report significant events that are of interest to public investors. Form 10-K must be filed annually within 60-90 days after the close of each fiscal year, depending on the size of the company. Form 10-Q must be filed quarterly for all publicly held companies.

Describe the key functions performed by the AICPA. 4 Describe the key functions performed by the AICPA.

AICPA Performs the following services for CPAs: Sets professional requirements Conducts research Publishes materials related to services performed Such services include the following: Accounting, auditing, attestation and assurance services, management consulting services, and taxes. All AICPA members and other practicing CPAs must follow the standards and guidelines set by the AICPA. Empowered to set standards (guidelines) and rules

Establishing Standards and Rules 1. Auditing standards 2. Compilation and review standards 3. Other attestation standards 4. Code of Professional Conduct

Other AICPA Functions The CPA examination Research and Grants Publishes a variety of materials Provides seminars and continuing education

5 Understand the role of international auditing standards and their relation to U.S. auditing standards The AICPA auditing standards board has undertaken a significant effort to make U.S. Generally Accepted Auditing Standards (GAAS) easier to read, understand and apply. The project originated with the ASB plan to converge U.S. GAAS with the ISAs and align its agenda with the IAASB. The foundation of the clarity project is the establishment of an objective for each auditing standard to reflect a principles–based approach to the standard setting.

Statements on Auditing Standards Classification of Statements on Auditing Standards GAAS and Standards of Performance

International Standards on Auditing IFAC is the worldwide organization for the accountancy profession. The IAASB works to improve the uniformity of auditing practices and related services throughout the world.

International Standards on Auditing ISAs do not override a country's regulations governing the audit of financial or other information as each country’s own regulations generally govern audit practices.

Use U.S. auditing standards as a basis for further study 6 Use U.S. auditing standards as a basis for further study

GAAS These standards represent the minimum standards of performance.

PCAOB Auditing Standards – United States General Standards 1. Adequate training and proficiency 2. Independence in mental attitude 3. Due professional care The auditor must have adequate technical training and proficiency to perform the audit. The auditor must maintain independence in mental attitude in all matters relating to the audit. The auditor must exercise due professional care in the performance of the audit and the preparation of the report.

PCAOB Auditing Standards – United States Standards of Field Work 1. Proper planning and supervision 2. Understanding of the entity 3. Sufficient appropriate evidence 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 and to design further audit procedures. The auditor must obtain sufficient and appropriate audit evidence by performing audit procedures to afford a reasonable basis for an opinion regarding the financial statements under audit.

PCAOB Auditing Standards – United States Standards of Reporting 1. Statements prepared in accordance with GAAP 2. Circumstances when GAAP not followed 3. Adequacy of disclosures 4. Expression of opinion on financial statements The report shall state whether the financial statements are presented in accordance with generally accepted accounting principles. 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 contain an expression of opinion regarding the financial statements, taken as a whole.

Relationship Between ASB and PCAOB Auditing Standards The PCAOB initially adopted GAAS as interim standards. The term generally accepted auditing standards is no longer used for public company audits. The term ASB will be used for audits of private companies. Public company audits refer to PCAOB auditing standards. Public company audits Private company audits

Statements on Auditing Standards The 10 generally accepted auditing standards are too general to provide meaningful guidance. SAS interpret the 10 generally accepted auditing standards and are the most authoritative references available to auditors.

7 Identify quality control standards and practices within the accounting profession.

Elements of Quality Control Leadership responsibilities for quality Relevant ethical requirements Acceptance and continuation of clients and engagements Human resources Engagement performance Each firm should document its quality control policies and procedures. Procedures should depend on such things as the size of the firm, number of practice offices and the nature of the practice. Monitoring

Relationships

CPAs Encouraged to Conduct Themselves at a High Level Auditing standards Continuing education requirements CPA examination Quality control Conduct of CPA firm personnel Legal liability Peer review AICPA practice and quality centers Code of Professional Conduct PCAOB and SEC

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