CHAPTER6

MANAGEMENTOFA
PUBLICACCOUNTANCYPRACTICE
Questions
1.

The special function performed by the public accounting profession is the

attestation to the fairness of the financial statements of clients. The special
function ensures the reliability and integrity of the financial reporting system.
Judge Burger described the special function as "certifying the public reports that
collectively depict a corporation's financial status," which involves "a public
responsibility transcending any employment relationship with the client."

2.

Complexity affects the demand for auditing services in that both users and
management need the expertise of professionals who understand the underlying
economic substance of transactions and financial instruments and, thus, who
have the ability to determine the appropriate accounting best to "fairly" portray
the economic substance of an organization's activities and financial condition.
The business environment in which the auditor must function is increasingly
complex. The major forms of complexity relate to:

3.

a.

Computer systems, which are becoming increasingly interdependent

across organizations.

b.

Increased complexity of financial instruments and transactions entered

into by organizations.

c.

The economic environment in which we all must operate. The changing

environment includes such items as the increased need to have a global
outlook in providing goods and services and the need to be attuned to
societal regulations in such areas as environmental protection.

For the most part, local CPA firms are subject to the same auditing and
accounting standards as the large international CPA firms. The differences relate
to whether the audit firms have (a) public clients, or (b) international clients. If
a firm has public clients, then the firm is subject to the standards of the PCAOB.
If a firm has clients that are domiciled in other countries, then they should utilize
international auditing standards. If the audit firm only has non-pubic clients,
then they are subject to auditing standards promulgated by the PICPA.

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4.

A network of accounting firms is a body to which individual CPA firms come

together to pursue common interests. The services generally provided by the
network include:

centralized staff that provides accounting and auditing expertise to its

members on a world-wide basis,

a referral service for audit firms that have clients in different parts of the
country or world,

a referral service for a firm to utilize when clients desire expertise or

consulting services that the audit firm does not provide.

standard audit programs and/or procedures manuals for the member audit
firms.

In some cases, the network can be a network of firms that are not otherwise
affiliated. In other cases, the network firms all operate under one common name,
e.g. Grant Thornton International.
5.

a.

Professional skepticism represents a state of mind that is characterized by

appropriate questioning and a critical assessment of audit evidence. When
employing professional skepticism, auditors will not simply accept all
evidence provided and assume that clients are unquestionably honest.
However, the statement that you really have to question everything the
client tells you is a bit exaggerative and goes beyond the concept of
professional skepticism.

b.

It is correct that internal evidence is generally of lower quality than external

evidence. However, the necessary quality of evidence depends upon the risk
of material misstatement and the effectiveness of the clients internal
control. In this case, the staff auditors statement that internal evidence is
obtained because of time and cost considerations is not appropriate, unless
the risk of material misstatement permits lower quality of evidence because
of other reasons.

c.

While appropriate planning will allow audits to be conducted on a timely

basis, it is not appropriate for auditors to ignore transactions and events
between the interim date (in this case, November 1) and the clients fiscal
year end. Some testing would need to be performed following the year end
for transactions occurring between November 1 and December 31.

d.

While the primary purpose of evaluating internal control is to determine the

nature, timing, and extent of substantive tests, auditors must still conduct
some study of internal control to ensure that the condition of the clients
internal control has not changed from prior years. If it has, the substantive

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tests performed by auditors may no longer be appropriate. In addition, for

public companies, auditors are required to study internal control and report
on the effectiveness of the clients internal controls under Auditing
Standard No. 5.
e.

For departures from PFRS, the choice among opinions would be between a
qualified opinion (for less material departures) and an adverse opinion (for
more material departures).

f.

While the concept of materiality does consider dollar amounts and their
effects on users decisions, qualitative factors also need to be considered
when assessing materiality. For example, a small dollar amount (in absolute
terms) may influence a companys ability to meet its earnings expectations
or report higher earnings than in previous years. Situations such as this need
to be considered as well as the absolute dollar amount of an item in
assessing materiality.

Multiple Choice Questions

1.
2.
3.
4.
5.

D
D
D
D
A

Cases
1.

(1) Auditing does not involve the creation of goods. However, it does serve a
worthwhile purpose in our society because it enhances the flow of reliable
financial information needed to conduct commerce in our economy. It also
assists in the conduct of government by providing reliable information for
tax purposes and regulatory purposes. Audits have been legally mandated to
ensure objective information. However, research has indicated that audits
would be required even if not mandated. The initial audits performed in
conjunction with the settlement of the new world arose because of owners'
need to have an independent assessment of the returns earned by their
managers.
(2) The accounting profession did provide early warning signals of the potential
problems within many industries. However, it clearly failed in other areas.
Some of the problems were related to the impreciseness of accounting
principles (e.g. Enron) while others were more closely related to regulatory
failures (e.g. Savings & Loan Industry). However, many of the failures were

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due to systematic problems in the accounting profession that has been
addressed by Sarbanes-Oxley.
(3) Finding fraud may be important. However, many misstatements that are
made in conjunction with an organization's financial statements are not
intentional but are simply the result of errors. The audit function is designed
to detect material misstatements -- whether they are due to errors or fraud.
Thus, the audit function is actually broader than the colleague had desired.
Ensuring that a financial statement contains no material misstatements also
ensures that the auditor addresses the likelihood that material fraud may
also have occurred.
(4) There is a potential problem with the auditors being hired by management.
The Sarbanes-Oxley Act requires companies that are publicly traded to have
an audit committee composed of independent directors (nonmembers of
management) that have the responsibility for evaluating the performance of
the auditors. The audit committee should exist to present the views and
interests of outside owners of the organization and provide effective
insulation against undue pressure by management on the audit function. The
SEC is very cognizant of independence issues and periodically addresses
actions or relationships that they believe may impair the auditors
independence.
(5) PFRS represents rules and conventions that are acceptable at one point in
time. Much of the diversity in accounting principles is necessary to reflect
real economic differences between organizations and the types of
transactions in which the organization is engaged. Beyond this argument,
differences such as Weighted Average / FIFO accounting have evolved over
the years. The profession attempts to mitigate the potential problems
associated with the diversity by providing disclosure of the differences and
by developing other procedures to make it difficult for firms to change
accounting principles. Thus, the financial statements of a company should
be comparable over a period of time.
(6) It seems that this individual really wants to have a career in auditing.
External auditing has changed; in today's environment, the auditor must
thoroughly understand a company's business in order to audit it. A key
function of internal auditors is to add value through their recommendations.
(7) The external audit is designed to present an opinion on the fairness of a
companys financial statement in accordance with PFRS. It is not directly
designed to assess the performance of management, although the financial
statements may provide some evidence on the performance of management.
(8) Auditors operate in an environment in which they must have a sense of trust
with management at least to the extent that confidential or proprietary

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information is not made public. Thus, if all recommendations made to

management were to be made public, management might simply ask that
recommendations no longer be made. Further, it must be recognized that
many of the recommendations made to improve operations are informal in
nature and might not be based on thorough study of a particular area.
Auditors may justifiably fear litigation from recommendations made public
that were made only on informal observations.
(9) Congress, in developing the Sarbanes-Oxley Act believes this statement is
true. Maintaining adequate controls is a significant part of corporate
governance. Congress believes the owner (shareholder) should receive
reports on the quality of controls implemented by management. In the first
three years of public reports on internal control, there has been a dramatic
change in the quality of controls in many organizations. During the first
year of Sarbanes-Oxley, approximately 16% of the companies received
adverse reports on the quality of their internal controls. This percentage has
gone down dramatically.
2.

(a) There seems to be a misinterpretation on the part of many users that a

"clean" audit opinion means that the company is in good health. This,
unfortunately, is a miscommunication. A "clean" audit opinion means only
that the financial statements are fairly presented, not that they represent a
company that is in good financial health. The audit function provides data
that are "fairly presented" in accordance with PFRS, but such information
alone does not constitute all the information an informed user should know
about a company.
(b) The auditor is a guarantor only of following auditing standards in
determining whether the statements are fairly presented, in all material
respects, in accordance with financial reporting standards. Fair presentation
is guaranteed only within the context of PFRS.
(c) This question and should encourage a widely ranging discussion by users.
Topics that might be addressed include these:
1. The potential deficiencies in PFRS.
2. The ability to detect fraud when management has attempted to cover
it up.
3. The responsibilities of users to perform their own work and to not
expect someone else to make decisions for them.
4. The overall responsibility of management for the integrity of the
financial statements.
5. The value of reports on internal control.

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6. The difficulty of measuring the economics of complex transactions.