© The McGraw-Hill Companies, 2010 The Financial Statement Auditing Environment Chapter Two.

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Presentation transcript:

© The McGraw-Hill Companies, 2010 The Financial Statement Auditing Environment Chapter Two

© The McGraw-Hill Companies, 2010 A Time of Challenge and Change 1990 During the economic boom of the late 1990s and the early 2000s, accounting firms aggressively sought opportunities to market a variety of high-margin non-audit services to their audit clients

© The McGraw-Hill Companies, 2010 A Time of Challenge and Change

© The McGraw-Hill Companies, 2010 A Series of Scandals Enron WorldCom Parmalat Lernout & Hauspie Ahold Arthur Andersen

© The McGraw-Hill Companies, 2010 Regulation Self-regulation by the profession versus government regulation Stricter regulation and more public oversight International Standards on Auditing more comprehensive

© The McGraw-Hill Companies, 2010 Auditors’ Legal Liability Threat of legal liability: Main deterrent to auditor’s misconduct Legal doctrines: Joint and several liability Proportional liability Liability caps Litigation exposure and audit markets: Concentration Barriers to entry Liability reforms

© The McGraw-Hill Companies, 2010 International Federation of Accountants (IFAC)

© The McGraw-Hill Companies, 2010 International Organisations that Affect the Accounting Profession International Federation of Accountants IFAC International Accounting Standards Board IASB International Organization of Securities Commissions IOSCO International Organization of Supreme Audit Institutions INTOSAI European Union EU EU 8 th Directive on Statutory Audits United States Securities and Exchange Commission (SEC) Public Company Accounting Oversight Board (PCAOB) Financial Accounting Standards Board (FASB) American Institute of Certified Public Accountants (AICPA)

© The McGraw-Hill Companies, 2010 International Auditing and Assurance Standards Board (IAASB): Standards

© The McGraw-Hill Companies, 2010 Auditing Standards Auditing standards serve as guidelines for and measures of the quality of the auditor’s performance. IFAC members IAASB issues International Standards on Auditing (ISAs). ISAs are considered to be minimum standards of performance for auditors.

© The McGraw-Hill Companies, 2010 General Principles and Responsibilities ISA 200 Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with International Standards on Auditing ISA 210 Agreeing the Terms of Audit Engagements ISA 220 Quality Control for an Audit of Financial Statements ISA 230 Audit Documentation ISA 240 The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements ISA 250 Consideration of Laws and Regulations in an Audit of Financial Statements ISA 260 Communication with Those Charged with Governance ISA 265 Communicating Deficiencies in Internal Control to Those Charged with Governance and Management

© The McGraw-Hill Companies, 2010 Risk Assessment and Response to Assessed Risks ISA 300 Planning an Audit of Financial Statements ISA 315 Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment ISA 320 Materiality in Planning and Performing an Audit ISA 330 The Auditor’s Responses to Assessed Risks ISA 402 Audit Considerations Relating to an Entity Using a Service Organization ISA 450 Evaluation of Misstatements Identified during the Audit

© The McGraw-Hill Companies, 2010 Audit Evidence ISA 500 Audit Evidence ISA 501 Audit Evidence – Specific Considerations for Selected Items ISA 505 External Confirmations ISA 510 Initial Engagements – Opening Balances ISA 520 Analytical Procedures ISA 530 Audit Sampling ISA 540 Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures ISA 550 Related Parties ISA 560 Subsequent Events ISA 570 Going Concern ISA 580 Written Representations

© The McGraw-Hill Companies, 2010 Using Work of Others ISA 600 Special Considerations – Audits of Group Financial Statements (Including the Work of Component Auditors) ISA 610 Using the Work of Internal Auditors ISA 620 Using the Work of an Auditor’s Expert

© The McGraw-Hill Companies, 2010 Audit Conclusions and Reporting ISA 700 Forming an Opinion and Reporting on Financial Statements ISA 705 Modifications to the Opinion in the Independent Auditor’s Report ISA 706 Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s Report ISA 710 Comparative Information – Corresponding Figures and Comparative Financial Statements ISA 720 The Auditor’s Responsibilities Relating to Other Information in Documents Containing Audited Financial Statements

© The McGraw-Hill Companies, 2010 Specialised Areas ISA 800 Special Considerations – Audits of Financial Statements Prepared in Accordance with Special Purpose Frameworks ISA 805 Special Considerations – Audits of Single Financial Statements and Specific Elements, Accounts or Items of a Financial Statement ISA 810 Engagements to Report on Summary Financial Statements

© The McGraw-Hill Companies, 2010 Sections in ISAs Introductory material Objectives Definitions Requirements Application and other explanatory material

© The McGraw-Hill Companies, 2010 Society’s Expectations and the Auditor’s Responsibilities The auditor has a responsibility to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud. Because of the nature of audit evidence and the characteristics of fraud, the auditor is able to obtain reasonable, but not absolute, assurance that material misstatements are detected. The auditor has no responsibility to plan and perform the audit to obtain reasonable assurance that misstatements, whether caused by errors or fraud, that are not material to the financial statements will be detected.

© The McGraw-Hill Companies, 2010 Ethics, Independence, and IFAC Code of Ethics for Professional Accountants Ethics refers to a system or code of conduct based on moral duties and obligations that indicates how we should behave. Professionalism refers to the conduct, aims, or qualities that characterise or mark a profession or professional person. All professions operate under some type of code of ethics or code of conduct.

© The McGraw-Hill Companies, 2010 Ethics, Independence, and IFAC Code of Ethics for Professional Accountants IFAC Code of Ethics Conceptual Framework Approach Principles Integrity Objectivity Professional competence and due care Confidentiality Professional behaviour Application to specific situations, including situations that threaten independence of mind or independence in appearance

© The McGraw-Hill Companies, 2010 Audit Firms Audit firms range in size from a single proprietor to thousands of owners (or “partners”) and thousands of professional and administrative staff employees. Big 4 PwC Deloitte EY KPMG Mid-Tier BDO Grant Thornton RSM Praxity Baker Tilly Crowe Horwath NationalLocal

© The McGraw-Hill Companies, 2010 Annual Global Revenue of Major Audit Network Firms

© The McGraw-Hill Companies, 2010 Audit Teams

© The McGraw-Hill Companies, 2010 Types of Services Offered by Audit Firms Assurance Services: Audit of financial statements, review of financial information, and other assurance services (e.g. assurance on a entity’s reporting on sustainability performance) Related Services: Agreed-upon procedures regarding financial information and compilation of financial information Other Services: Tax services, advisory services, accounting services and specialised services (e.g. forensic audit)

© The McGraw-Hill Companies, 2010 Global Practice Mix of Services by Major Audit Network Firms (Revenue)

© The McGraw-Hill Companies, 2010 Types of Auditors External AuditorsInternal Auditors Government Auditors Forensic Auditors

© The McGraw-Hill Companies, 2010 Context of Financial Statement Auditing The primary context with which an auditor is concerned is the industry or business of his or her audit client. In other words, the context provided by the client’s business impacts the auditor and the audit, and is thus a primary component of the environment in which financial statement auditing is conducted. How would your concerns about the inventory account differ for a Computer Hardware Manufacturer and a Jewellery Store? What assertions would you be most concerned about and why?

© The McGraw-Hill Companies, 2010 A Model of Business Board of Directors Audit Committee Business organizations exist to create value for their stakeholders. Due to the way resources are invested and managed in the modern business world, a system of corporate governance is necessary, through which managers are overseen and supervised.

© The McGraw-Hill Companies, 2010 A Model of Business ObjectivesStrategies Processes (5 broad categories) Controls Transactions Reports

© The McGraw-Hill Companies, 2010 A Model of Business Processes: Five Components Financing Process Purchasing Process Human Resource Management Process Inventory Management Process Revenue Process

© The McGraw-Hill Companies, 2010 An Overview of Business

© The McGraw-Hill Companies, 2010 Management Assertions Financial statements issued by management contain explicit and implicit assertions.

© The McGraw-Hill Companies, 2010 Management Assertions – An Example with Inventory Which specific assertion from the relevant category is being described in the three examples below? Account Balances Management asserts that the entity owns the inventory represented in the inventory account. Presentation & Disclosure Management asserts that the financial statements properly classify and present the inventory. Transactions Management asserts that transactions related to inventory actually occurred. Occurrence Rights and Obligations Classification

© The McGraw-Hill Companies, 2010 End of Chapter 2