ACC 4200 Section 1 (Chapters 1 & 2, and Module B) Online Class Notes Spring 2017

Chapter 1 – Auditing and Assurance Services

Question for Consideration

• What do you suppose organic cereal and an annual report have in common?
Both certified by 3rd parties
• Why is this important?
• Management’s responsibilities
• Financial Statements
• Financial Reporting System
• Internal Controls
• Employees (As agencies to the organization; not personally)
• Auditor’s responsibilities
• The audit Opinion

A brief history of the Big 8 to the “Final 4”

Big 8 – 1970s & 1980s
Arthur Andersen
Arthur Young & Company
Coopers & Lybrand
Ernst & Whinney
Deloitte, Haskins & Sells
KPMG
Price Waterhouse
Touche Ross
2 Big Mergers
Big 6 – 1989-1998
Arthur Andersen
Coopers 7 Lybrand
KPMG
Price Waterhouse
Ernst & Young
Deloitte & Touche
Big 5 – 1998-2002
Arthur Anderson
KPMG
Ernst & Young
Deloitte & Touche
PricewaterhouseCoopers
Big 4 – 2002-Present
KPMG
Ernst & Young
Deloitte
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ACC 4200 Section 1 (Chapters 1 & 2, and Module B) Online Class Notes Spring 2017

PricewaterhouseCoopers

Take Me Out to the Ballgame

Umpires & Auditors
• Home Plate Umpire
• Financial Statement Auditor

Management Assertions (AKA Financial Statement Assertions)

• The cornerstone of the financial statement audit
• Are not explicitly spoken or stated; are embodied in the financial statements
• Auditors collect and evaluate evidence in order to determine whether the assertions that
management have made about the financial statements are valid
• The testing of these assertions drives the audit plan and audit program
• Exhibit 1.5, textbook page 13 (packet page 15) – Management Assertions

• SAS No. 31, as amended by SAS No. 80 (PCAOB)

• Existence/Occurrence
• Rights/Obligations
• Completeness
• Valuation/Allocation
• Presentation/Disclosure
• Still applicable guidance for audits of issuers
• SAS 106, adopted in 2006, is the applicable guidance for audits of non-issuers (ASB)
• Consistent with management assertions included in International Standard on Auditing (ISA) 500
• Practical differences between SAS 31 and SAS 106 are minimal – primarily categorical

• Occurrence / Existence 
• Transactions and events that have been recorded really happened and pertain to the entity (did
the sales transaction occur?); Assets, liabilities, and equity interest are really there (does the
asset exist?); have been recorded, should have been recorded

• Completeness 
• All transactions and events, and all assets, liabilities, and equity interest that should have been
recorded, have been recorded (is the record complete?)

Example Audit Plan for Inventory

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ACC 4200 Section 1 (Chapters 1 & 2, and Module B) Online Class Notes Spring 2017

Chapter 2 – Professional Standards

See Exhibit 2.1, textbook page 45 (packet page 47) re GAAS and the Fundamental Principles

Section 201 of the Sarbanes-Oxley Act of 2002 (SOX)

Prohibited Auditor Activities
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ACC 4200 Section 1 (Chapters 1 & 2, and Module B) Online Class Notes Spring 2017

 The following activities are prohibited by an auditor of an issuer

o Bookkeeping or other services related to the accounting records or financial statements
of the audit client
o Financial information systems design and implementation
o Appraisal or valuation services, fairness opinions, or contribution-in-kind reports
o Actuarial services
o Internal audit outsourcing activities
o Management functions or human resources
o Broker or dealer, investment advisor, or investment banking services
o Legal services and expert services unrelated to the audit
o Any other service the Board determines, by regulation, is impermissible
 An auditor of an issuer may engage in any non-audit service, including tax services, that is not
described in the list above, only if the activity is approved in advance by the audit committee of
the issuer

Restatement Story

iPAC 1 Discussion
 See also textbook pages 78-83 (packet pages 128-133) in Chapter 3

Client Acceptance/Retention Decision

• Should be assessed annually
• New auditor is required to meet with previous auditor, but must obtain client’s permission first
• Engagement letter delineates responsibilities and expectations for both parties
• Client Acceptance example

Building Client Knowledge and Assessing Management Integrity

Ways to Build Knowledge

• Visit company plants and facilities
• Meet with marketing and sales management to understand the company’s products and markets
• Review competitor financial statements and nonfinancial information
• Read trade journals in the client’s industry

Management Integrity Assessment

• Inquiry in professional community
• Review of recent regulatory or court cases against client, including recent SEC filings
• Review of financial press and Internet databases for info and articles about the company and its
management
• Inquiry of predecessor auditor
• Thorough review of previous financials
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ACC 4200 Section 1 (Chapters 1 & 2, and Module B) Online Class Notes Spring 2017

Example CPA Exam Qs

1. In performing an attest engagement, a CPA typically
a. Supplies litigation support services. (Consulting)
b. Assesses control risk at a low level. (
c. Expresses a conclusion about a written assertion.
d. Provides management consulting advice. (Consulting)
Page 10 – Attestation Services, assurances. FS Are complete

2. Who establishes generally accepted auditing standards?

a. Auditing Standards Board and the Public Company Accounting Oversight Board.
b. Financial Accounting Standards Board and the Governmental Accounting Standards
Board.
c. State Boards of Accountancy.
d. Securities and Exchange Commission.
Designated by the AICPA board. PCAOB created by SOX

3. Which of the following best describes what is meant by the term “generally accepted auditing
standards?”
a. Rules acknowledged by the accounting profession because of their universal application.
b. Pronouncements issued by the Auditing Standards Board.
c. Measures of the audit quality.
d. Procedures to be used to gather evidence to support financial statements.

4. Before accepting an audit engagement, an auditor should make specific inquiries of the
predecessor auditor regarding the predecessor’s
a. Awareness of the consistency in the application of generally accepted accounting
principles between periods.
b. Evaluation of all matters of continuing accounting significance.
c. Opinion of any subsequent events occurring since the predecessor’s audit report was
issued.
d. Understanding as to the reasons for the change of auditors.
AU315 – LOOK UP

5. In designing written audit plans, an auditor should establish specific audit objectives that relate
primarily to the
a. Timing of audit procedures.
b. Cost-benefit of gathering evidence.
c. Selected audit techniques.

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ACC 4200 Section 1 (Chapters 1 & 2, and Module B) Online Class Notes Spring 2017

d. Financial statement assertions.

Module B – Professional Ethics

[Ethics IQ Quiz – Supplementary Material (FYI)]

Question for Consideration:

• Is maintaining public trust more important than retaining a client?

A Story…

Ethical Problems vs. Dilemmas

Ethical Problem
• Ethics versus self-interest
– Example
Ethical Dilemma
• Conflicting moral duties/obligations
– Example

Ethical Dilemma Exercise

You’re the plant manager in one of ABC Company’s five plants. You’ve worked for the company for 15
years, working your way up from the factory floor after the company sent you to college. Your boss just
told you in complete confidence that the company will have to lay off 200 workers. Luckily, your job
won’t be affected. But a rumor is now circulating in the plant, and one of your workers (an old friend
who now works for you) asks the question, “Well, Pat, what’s the word? Is the plant closing? Am I going
to lose my job? The closing on our new house is scheduled for next week. I need to know!” What
should you say? What will you say?

Ethical Frameworks

Auditor Independence?

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ACC 4200 Section 1 (Chapters 1 & 2, and Module B) Online Class Notes Spring 2017

Some Independence Issues Examples from the Andersen/Enron Case

Consulting, Consulting, Consulting

• 1990s: Consulting was where it was at
• 1999 AICPA publication

AICPA Code of Professional Conduct

• Rule 101: Independence (audit/attest only)

Auditor Independence
• Question for Consideration:
• Why is it considered the most important characteristic of an auditor?

Threats to Auditor Independence

• Compensation schemes
– Partner compensation  Attracting/retaining clients  Keeping clients happy
• Definition of who the client is
– Management? Audit Committee? Shareholders?
• Client familiarity
– Professional/personal relationships with management developed over years
• Time pressures
– Low bid  Less time budgeted  Less in-depth and/or “eating time” issues
• Rationalization
– Potential misstatement detected  Rationalize it’s immaterial due to time restraints
and/or management pressure
• Auditing own work
– “I did a great job!”

Some ways to manage these threats:

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ACC 4200 Section 1 (Chapters 1 & 2, and Module B) Online Class Notes Spring 2017

• Codes of conduct, balanced compensation schemes, reviews of client acceptance and retention
decisions, separation of consulting, independent reviews, peer reviews, improved hiring
practices
• Why is the SEC concerned with auditor independence?
– Fairly-presented financials are crucial to a capital market system
Of Note:
The peer review process had become a rubber stamp process
Standards changed – See book

Rules of Thumb for Independence

• Covered members
– Those presumed to be able to influence a client’s attest engagement
– The firm is also considered to be a covered member
– Covered members must avoid certain business and financial relationships with the attest
client in order to maintain independence
• Financial interests
• Relatives
• Loans

The following always impair independence re financial interest*

All considered to be Covered Members:
• A staff member (including temps and interns) on the audit engagement itself
• A manager in the firm, working in the same office as the audit
• Any partner in the audit firm, regardless of office location
*stock ownership, loans

Direct and Material Indirect Financial Interest

• From Interpretation 101-15: “Independence shall be considered to be impaired if, during the
period of the professional engagement, a covered member had or was committed to acquire any
direct or material indirect financial interest in the client.”

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ACC 4200 Section 1 (Chapters 1 & 2, and Module B) Online Class Notes Spring 2017

* Dependent based on Tax Rules

• Direct financial interest (5% threshold – noncovered member)
– Individual makes the investment decisions
– e.g. Direct purchase/sale of shares of stock for personal investment portfolio
– Includes: Self, spouse/spousal equivalent/domestic partner, dependent member of
household, partnership interest (Immediate Family)

• Indirect financial interest (5% threshold – materiality)

– Individual does not make the investment decisions
– e.g. Owning shares in a mutual fund. While the investment itself is direct, the
investments of the mutual fund are considered indirect

Can a relative work for an audit client?

• Okay, as long as not:
• Audit sensitive area or key financial position [see list on textbook page 602 (packet page 92)]
• AND a significant relative: spouse/spousal equivalent/domestic partner, dependent member of
household, siblings, parents, non-dependent children (Immediate and Close Family)

Can the auditor work for an audit client?

• Not during period covered by financial statements
• AND in a managerial position
• See textbook pages 604-605 (packet pages 94-95)

Loans [Same relative rules as for direct/indirect financial interest (Immediate Family)]
• Car loans/leases:
– Okay
• Small personal loans:
– Okay; $10,000 threshold
• Large loans, i.e. home mortgages:
– Not okay unless established prior to auditor/client relationship

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ACC 4200 Section 1 (Chapters 1 & 2, and Module B) Online Class Notes Spring 2017

Key Exhibits in Module B: B.1, textbook page 600 (packet page 90) – Summary of Rule 101
Interpretations, and B.2, textbook page 601 (packet page 91) – Comparison of SEC and AICPA Selected
Definitions

Key Terms
• Close vs. Immediate
• Material vs. Immaterial
• Direct vs. Indirect
• Key vs. Nonkey

Question: Can one share of stock impair independence? – Yes since the individual was a partner

Auditor Independence Exercise

SEC and PCAOB Independence Rules – Discussion begins on textbook page 605 (packet page 95)

SEC Independence Principles Exercise

The following are five situations in which auditors may find themselves. For each of the situations,
indicate whether it appears to violate the SEC’s independence principles. Explain your answer.
1. Spencer is the partner in charge of the audit of Flip Company. He has half interest in a joint
venture with Flip’s CEO, but the joint venture is audited by a separate independent CPA firm.
Yes, Violating
2. Victoria is the senior-in-charge of the audit of Holder Company. During the past year, she filled
in for the chief accountant, who had surgery and was out for six weeks.
Yes, violating
3. Brandon has been asked by an audit client to represent the client in negotiations with
management of another company that the client wants to acquire.
Yes, violating
4. Sanders is the partner-in-charge of the audit of the Marshall Co. The CEO and CFO have asked
Sanders to prepare their personal federal and state income tax returns as well as the tax returns
for the company. Sanders agreed, and prepared all tax returns.
Company – No
Personal – Yes
5. Marianne Keuhn is an audit partner and a member of Blackhawk Country Club. She is a low-
handicap golfer and plays in a regular foursome every Saturday morning that includes Shelly
Paris, the CFO of one audit client, and Nancy Sprague, the CEO of another audit client.
Yes, violating based on close relationship

(the rest of) The AICPA Code of Professional Conduct

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ACC 4200 Section 1 (Chapters 1 & 2, and Module B) Online Class Notes Spring 2017

• Rule 102: Integrity and Objectivity

• Rule 201: General Standards
• Rule 202: Compliance with Standards
• Rule 203: Accounting Principles
• Rule 301: Confidential Client Information
• Confidential vs. Privileged Information
• 4 exceptions (w/o client consent):
• Compliance w/ Rules 202 and 203* [*Information is not considered confidential
if its disclosure is necessary to prevent the financial statements from being
misleading]
• Subpoena or compliance with applicable laws
• Review/Inspection
• Disciplinary investigations
• Rule 302: Contingent Fees (audit/attest only)
• Rule 501: Acts Discreditable (see textbook page 615, packet page 105)
• Rule 502: Advertising/Solicitation
• Rule 503: Commissions (audit/attest only) and Referral Fees
• Rule 505: Form of Organization and Name

Fees
• Contingent fees: Okay, so long as client is not an attestation client
• Commissions: Okay, so long as client is not an attestation client, and client is notified
• Referral fees: Okay, so long as client is notified

AICPA’s Code of Professional Conduct Exercise

Is the CPA in violation of the AICPA’s Code of Professional Conduct?
Indicate “yes” or “no”
1. Tom Busy is unable to perform a service requested by the client. Therefore, Busy refers the
client to Able, who pays Busy $200 for referring the business. Neither Busy nor Able tells the
client about the referral fee. Yes
2. Mr. Big’s wife owns 100 shares of common stock in an audit client of Big’s CPA firm, in which he
is a partner. Yes
3. Ian Agreeable personally visits potential clients without invitation for the purpose of obtaining
business from them. No
4. C. P. Lawyer, a CPA sole practitioner, serves as legal counsel to his audit client. Yes
5. A public accounting firm places a full-page, four-color advertisement in Business Week that
describes some of the services it provides. No
6. Tom Hart, CPA, does the bookkeeping, prepares the tax returns, and performs various
management services for Sanders, Inc. One management service involved the assessment of the
company’s computer needs and identification of equipment to meet those needs. Hart

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ACC 4200 Section 1 (Chapters 1 & 2, and Module B) Online Class Notes Spring 2017

recommended a product sold by Computer Co., which has agreed to pay Hart a 10 percent
commission if Sanders buys its product. Hart informs Sanders of the arrangement. No
7. Nancy Heck, CPA, has agreed to perform an inventory control study and recommend a new
inventory control system for Ettes, Inc., a new client. Currently, Ettes engages another CPA firm
to audit its financial statements. The financial arrangement is that Ettes, Inc. will pay Heck 50
percent of the savings in inventory costs over the two-year period following implementation of
the new system. No
8. Chris Holt, CPA, conducted an audit and issued a report on the 2010 financial statements of Tree,
Inc. Tree has not yet paid the audit fees for that audit prior to Holt issuing the audit report on
2011 statements. Yes - Can impair auditor independence.

Example CPA Exam Qs

6. Ben, CPA, is a staff auditor participating in the audit engagement of Jerry, Inc. Which of the
following circumstances most likely impairs Ben’s independence?
a. During the period of the professional engagement, Jerry, Inc. gives Ben tickets to a
basketball game worth $75.
b. Ben owns stock in a corporation that Jerry, Inc.’s 401(k) plan also invests in. These
interests are immaterial.
c. Ben’s friend, an employee of another local accounting firm, prepares Jerry, Inc.’s tax
returns.
d. Ben’s sibling is the director of internal auditing for Jerry, Inc.

7. According to the ethical standards of the profession, which of the following acts is generally
prohibited?
a. Purchasing a product from a third party and reselling it to a client.
b. Writing a financial management newsletter promoted and sold by a publishing company.
c. Accepting a commission for recommending a product to an audit client.
d. Accepting engagements obtained through the efforts of third parties.

8. According to the PCAOB, an accounting firm’s independence is least likely to be impaired if the
firm
a. Provides a service to the audit client for a contingent fee.
b. Receives a commission from the audit client.
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c. Has an audit client that employs a former firm professional.

d. Provides tax services to a person in a financial reporting oversight role at the audit client.

9. When Congress passed the Sarbanes-Oxley Act of 2002, it imposed greater regulation on public
companies and their auditors and required increased accountability. Which of the following is
not a provision of the act?
a. Executives must certify the appropriateness of the financial statements.
b. The act provides criminal penalties for fraud.
c. Auditors may not provide specific nonaudit services for their audit clients.
d. Audit firms must be rotated on a periodic basis.

10. The Sarbanes-Oxley Act of 2002 has strengthened auditor independence by requiring that
management of a public company
a. Include only independent persons on the board of directors.
b. Report the nature of disagreements with former auditors.
c. Select auditors through audit committees.
d. Hire a different CPA firm from the one that performs the audit to perform the company’s
tax work.

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