Chapter 2 Professional Standards “All my growth and development led me to believe that if you really do the right thing, and if you play by the rules, and if you’ve got good enough, solid judgment and common sense, that you’re going to be able to do whatever you want to do with your life….” – Barbara Jordan, first African-American woman from the South ever elected to the U.S. House of Representatives McGraw-Hill/IrwinCopyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

Practice Standards Client Public Entities Private Entities Governmental Entities Foreign Entities Rule- making body Public Company Accounting Oversight Board (PCAOB) AICPA Auditing Standards Board (ASB) U.S. Government Accountability Office (GAO) IFAC International Auditing and Assurance Standards Board (IAASB) StandardsAuditing Standards (ASs) Statements on Auditing Standards (SASs) Government Auditing Standards (The “Yellow Book”) International Standards on Auditing (ISAs) Web sitewww.pcaobus.orgwww.aicpa.orgwww.gao.govwww.ifac.org 2-2

Generally Accepted Auditing Standards Measures of the quality of auditors’ performance Same from audit to audit Auditing standards versus auditing procedures 2-3

Exhibit 2.1 Generally Accepted Auditing Standards 2-4

Engagement Overview and GAAS OBTAIN (OR RETAIN) CLIENT RISK ASSESSMENT SUBSTANTIVE PROCEDURES ISSUE REPORT ENGAGEMENT PLANNING General Standards (Due Professional Care) Standards of Field Work Standards of Reporting 2-5

General Standards Affect all phases of audit 1.Training and proficiency –Experience and expertise 2.Independence –Independence in fact vs. independence in appearance –Financial and managerial relationships 3.Due professional care –Observe standards of field work and standards of reporting. 2-6

Standards of Field Work Affect conduct of the audit 1.Planning and supervision –Use of audit program –Interim and year-end work 2.Understanding of entity and environment (including I/C) –Assess risk of material misstatement –Determine effectiveness of substantive procedures 3.Sufficient appropriate evidence –Sufficient = quantity –Appropriate = quality (relevance, reliability) 2-7

Sufficient evidence Related to quantity (number of transactions or components examined) Influenced by effectiveness of entity’s internal control Effective internal control Lower level of control risk Reduced effectiveness of substantive procedures Ineffective internal control Higher level of control risk Increased effectiveness of substantive procedures 2-8

Appropriate Evidence Relates to the quality of evidence Reliability (from highest to lowest) –Auditors’ direct personal knowledge –External documentary evidence –External-internal evidence –Internal documentary evidence –Verbal and written representations 2-9

Examples of Evidence Auditors’ direct personal knowledge –Observe PPE, inventories External documentary evidence –A/R confirmations, bank confirmations External-internal evidence –Vendor invoices for purchases Internal documentary evidence –Client sales invoices Verbal and written representations –Management representations (SAS 85) 2-10

Standards of Reporting Identify contents of auditors’ reports 1.Are F/S in conformity with GAAP? 2.Have GAAP been consistently applied (implicit reporting)? 3.Are disclosures adequate (implicit reporting)? 4.Report must express or disclaim an opinion 2-11

Independent Auditors’ Report (AS 5) Report of Independent Registered Public Accounting Firm To the Board of Directors and Shareholders APOLLO SHOES, INC. We have audited the accompanying balance sheets of APOLLO SHOES, INC. as of December 31, 2008 and 2007, and the related statements of income, comprehensive income, shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, These financial statements are the responsibility of the APOLLO SHOES, INC.’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 audits provide 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, 2008 and 2007, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2008 in conformity with accounting principles generally accepted in the United States of America. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), APOLLO SHOES INC.’S' internal control over financial reporting as of December 31, 2008, 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 January 29, 2009 expressed an unqualified opinion on the effective operation of internal control over financial reporting. Smith & Smith, CPAs January 29, 2009 Report Title Report Address Introductory Paragraph Scope Paragraph Opinion Paragraph Signature Report Date Internal Control Paragraph (AS 5) 2-12

Types of Audit Opinions Unqualified –F/S are in conformity with GAAP Qualified –Except for one (limited) item, F/S are in conformity with GAAP –Can issue for GAAP departure and scope limitation Adverse –F/S are not in conformity with GAAP –Can issue for GAAP departure (more serious) Disclaimer –Auditors do not express an opinion –Can issue for scope limitation (more serious) 2-13

Attestation Standards Cover a broader range of engagements than GAAS Differences from GAAS –Subject matter must be evaluated against reasonable criteria –No requirement to assess risk of material misstatement (unless attestation engagement involves risk of material misstatement) –May have limited distribution of report 2-14

Quality Control Standards for Accounting Firms Guide the performance of firm-wide services Categories –Independence, integrity, objectivity –Personnel management –Acceptance and continuance of clients –Engagement performance –Monitoring 2-15

The Public Company Accounting Oversight Board (PCAOB) Establishes standards (Auditing Standards) –Auditors’ reports (AS 1) –Audit documentation (AS 3) –Material weaknesses in internal control (AS 4) –Audits of internal control over financial reporting (AS 5) Standards must be approved by SEC ASB and AICPA standards prior to April 16, 2003 are Interim Auditing Standards –May be modified or amended by Auditing Standards 2-16

The Public Company Accounting Oversight Board (PCAOB) Monitors accounting firms through inspections –Firms auditing > 100 public entities: annual –Firms auditing < 100 public entities: every 3 years Inspection reports list deficiencies in audits conducted by registered firms 2-17