ba 427 – assurance and attestation services lecture 1 introduction

BA 427 – Assurance and Attestation Services

Lecture 1Introduction

Lecture 1 – Introduction Syllabus

Course Requirements

Course Materials and Resources

Corporate Governance

Lecture 1 – Grading

Three Exams55%

Final Exam30%

quizzes, cases,

participa-tion15%

Lecture 1 – course materials Gleim’s 2006 CPA Review Guide:

Auditing & Attestation, available from the OSU bookstore and from the publisher’s website.

Course Readings Packet, available from the OSU bookstore.

Additional required readings will be distributed in class and others are available on the web.

Optional: Auditing and Assurance Services by Arens, Elder & Beasley, 11th edition

Lecture 1 – course objectives Help you succeed in your first weeks on

the job

Help you pass the CPA exam

Help you in your first two promotions

Lecture 1 – course objectives These objectives have driven the following

choices for the course:

Gleim as our “textbook”

Extensive use of source documents

Coverage of topics that will help you advance in your career, but that are not included in the firm’s continuing education training

Six outside speakers from the accounting profession

Lecture 1 – course objectives The great issues of our day

The detection of fraud

The independence of the independent public accountant

Corporate governance and aggressive financial reporting

Self-regulation by the public accounting profession

Lecture 1 – how to succeed Do not fall behind on the readings.

Understand how to learn from Gleim.

Understand how to skim materials in the readings packet.

Participate in class discussions, particularly when outside speakers are here.

Lecture 1 – Introduction Syllabus

Course Requirements

Course Materials and Resources

Corporate Governance

Overview of the CourseOverview of the Course

Corporate Governance &

Reporting

The Public Audit

Regulatory Oversight

The Audit Committee

Internal Controls

Internal Auditing

A Framework for everything we do: Ask five questions:

Who When What Why How

A Framework for everything we do:

Ask five questions: Who: the private sector, a regulator, a self-

regulatory body? When: the sequence of events is important. What: is this a study, a recommendation, a

rule, and what is its impact? Why: Motives; what is the economic, legal

and political context? How: what provided this entity or person

the resources or clout to have an impact?

The PlayersThe Private Sector

Self-regulatory Bodies

RegulatorsThe SEC

U.S. Congress

The Courts

Public Accounting Firms

Investors

Financial Accounting

Standards BoardThe New York Stock ExchangeAuditing Standards

Board

American Institute of Certified Public

Accountants

Public Oversight Board

Wall Street

Companies doing business in the U.S.

The PCAOB

State Boards

The GAO

Ethics Division of the AICPA

An example: “Audit Committees: A Call to Action”:

Who Lynn Turner, SEC Chief Accountant from about 1997 to

2001, under SEC Chairman Arthur Levitt When

October 5, 2000 (before the bubble burst; see next slide) What

A public speech delivered in New York Why

To encourage self-regulation and regulatory reform How

The SEC Chief Accountant is a high-profile position

An example: “Audit Committees: A Call to Action”

Yet investors and the business community learned a very valuable lesson 70 years ago—that the trust and confidence in markets can be shaken and lost. We learned that liquidity can disappear and capital quickly dry up. Fair and orderly markets can dissolve much more quickly than they are built. An economy that is seemingly the Emerald City of Oz with roads of gold can turn to a bowl of dust overnight.

An example: “Audit Committees: A Call to Action”:

Here are all (or most) of the sources that Turner references and quotes in his speech: The Blue Ribbon Committee on Improving the

Effectiveness of Corporate Audit Committees The Committee of Sponsoring Organizations

(COSO) 1999 report “Fraudulent Financial Reporting: 1987 – 1997”

The Panel on Audit Effectiveness SAS 89 and SAS 90, issued by the APB Warren Buffett “New Responsibilities and Requirements for

Audit Committees,” by Arthur Andersen

Corporate Governance Key regulatory and self-regulatory

events The Foreign Corrupt Practices Act The Treadway Report The Blue Ribbon Committee on Improving

the Effectiveness of Corporate Audit Committees

The FCPA The Foreign Corrupt Practices Act

In 1976, bribes originating from Lockheed Aircraft led to the arrest of a former Prime Minister of Japan.


Signed by President Carter in 1977 Best known for its prohibition against U.S.

companies bribing foreign officials This prohibition is sometimes incorrectly

characterized as prohibiting “grease payments” to foreign government bureaucrats. It does not do that.

The FCPA also imposes on U.S. public companies internal accounting control and bookkeeping requirements.


The increased bookkeeping and internal accounting controls requirements were intended to supplement the anti-bribery provisions, by increasing corporate accountability; decreasing the likelihood that illegal

payments can be concealed.


The bookkeeping requirements: Every public company shall make and keep

books, records, and accounts which, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the issuer.


The Act requires companies to devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that: Transactions are executed in accordance with

management’s general or specific authorization. Transactions are recorded as necessary to permit

preparation of financial statements in conformity with GAAP, and to maintain accountability for assets.

Access to assets is permitted only in accordance with management’s general or specific authorization.

The recorded accountability for assets is compared with the existing assets at reasonable intervals and appropriate action is taken with respect to any differences.


The Act codified existing concepts and “best practices”

The Act is concerned with accounting controls only, not all internal controls.

The Act acknowledges that all controls are subject to a cost/benefit test.

For the first time, weak internal controls can subject public companies, their officers and employees to civil liability and criminal prosecution under federal law.


events The Foreign Corrupt Practices Act The Treadway Report The Blue Ribbon Committee on Improving

the Effectiveness of Corporate Audit Committees

Treadway Formally, The Report of the National

Commission on Fraudulent Financial Reporting.

Chaired by James Treadway, Jr., Executive V.P. and General Counsel of Paine Webber (and former SEC Commissioner).

The Commission conducted a two-year study of the financial reporting system in the U.S., and issued its report in October, 1987.

Treadway The Commission was sponsored and

funded by: The AICPA The American Accounting Association The Institute of Internal Auditors The National Association of Accountants (now the

Institute of Management Accountants) The Financial Executives Institute (now Financial

Executives International) These organizations constitute “COSO”, the

Committee of Sponsoring Organizations

Treadway Key conclusion:

“Fraudulent financial reporting is indeed a serious problem. Infrequent though its occurrence arguably may be, its consequences can be widespread and significant.

The Treadway Report consists primarily of a series of recommendations

Treadway Recommendations to Public Companies:

The Tone at the Top: the tone set by top management—the corporate environment or culture within which financial reporting occurs—is the most important factor contributing to the integrity of the financial reporting process.


Top management must identify, understand, and assess the factors that may cause the company’s financial statements to be fraudulently misstated.

Public companies should maintain internal controls that provide reasonable assurance that fraudulent financial reporting will be prevented or subject to early detection.

Public companies should develop and enforce written codes of conduct that foster a strong ethical climate and open channels of communication. The Audit Committee should review annually the program that management establishes to monitor compliance with the code.


Public companies should maintain accounting functions that are designed to meet their financial reporting obligations.

Public companies should maintain an effective internal audit function staffed with an adequate number of qualified personnel.

Public companies should ensure that their internal audit functions are objective.

Internal auditors should consider the implications of their nonfinancial audit findings for the company’s financial statements.


Management and the audit committee should ensure that the internal auditors’ involvement in the audit of the entire financial reporting process is appropriate and properly coordinated with the independent public accountant.

The SEC should require all public companies to establish audit committees composed solely of independent directors.

Audit committees should be informed, vigilant, and effective overseers of the financial reporting process and the company’s internal controls.


All public companies should develop a written charter setting forth the duties and responsibilities of the audit committee. The board should approve the charter and review it periodically.

Audit committees should have adequate resources and authority to discharge their responsibilities.

The audit committee should review management’s evaluation of factors related to the independence of the company’s public accountant. Both the audit committee and management should assist the public accountant in preserving his independence.


Before the beginning of each year, the audit committee should review management’s plans for engaging the company’s independent public accountant to perform management advisory services during the coming year, considering both the types of services that may be rendered and the projected fees.


All public companies should be required by SEC rule to include in their annual reports management reports signed by the CEO and the chief accounting officer and/or the CFO. The report should acknowledge management’s responsibilities for the financial statements and internal control, discuss how these responsibilities were fulfilled, and provide management’s assessment of the effectiveness of the company’s internal controls.


All public companies should be required by the SEC to include in their annual reports a letter signed by the chairman of the audit committee describing the committee’s responsibilities and activities during the year.

Management should advise the audit committee when it seeks a second opinion on a significant accounting issue.

The SEC should require public companies that change their independent accountants to disclose the nature of any material accounting or auditing issue discussed with both its old and new auditor during the three-year period prior to the change.


Audit committees should oversee the quarterly reporting process.

COSO should cooperate in developing additional, integrated guidance on internal control.

Treadway Recommendations to CPAs:

The ASB should revise standards to restate the independent public accountant’s responsibility for detection of fraudulent financial reporting, requiring the independent accountant to (1) take affirmative steps in each audit to assess the potential for such reporting, and (2) design tests to provide reasonable assurance of detection. Revised standards should include guidance for assessing risks and pursuing detection when risks are identified.


The ASB should establish standards to require independent public accountants to perform analytical review procedures in all audit engagements and should provide improved guidance on the appropriate use of these procedures.

The SEC should require independent public accountants to review quarterly financial data of all public companies before release to the public.


The AICPA’s SEC Practice Section should strengthen its peer review program by increasing review of audit engagements involving public company clients new to a firm. For each office selected for peer review, the first audit of all such new clients should be reviewed.

Public accounting firms should recognize and control the organizational and individual pressures that potentially reduce audit quality.


The AICPA’s SEC Practice Section requirement for a concurring (second) partner review should be revised to require the concurring partner’s involvement in

the planning stage of the audit, require the concurring partner to have prior

experience with SEC registrants, and familiarity with the client’s industry,

require the concurring partner to consider himself a peer of the engagement partner for purposes of the review.


The ASB should revise the auditor’s standard report to state that the audit provides reasonable but not

absolute assurance that the audited financial statements are free from material misstatements as a result of fraud or error.

to describe the extent to which the independent public accountant has reviewed and evaluated the system of internal accounting control. The ASB also should provide explicit guidance to address the situation where, as a result of his knowledge of the company’s internal accounting controls, the independent public accountant disagrees with management’s assessment as stated in the proposed management report.


The AICPA should reorganize the ASB to afford a full participatory role in the standard-setting process to knowledgeable persons who are affected by and interested in auditing standards but who either are not CPAs or are CPAs no longer in public practice.

Treadway Recommendations to the SEC and regulators

The SEC should have the authority to impose civil money penalties in administrative proceedings.

The SEC should have the authority to issue a cease and desist order when it finds a securities law violation.

The SEC should seek explicit statutory authority to bar or suspend corporate officers and directors involved in fraudulent financial reporting from future service in that capacity in a public company.

Criminal prosecution of fraudulent financial reporting cases should become a higher priority.


The SEC should require accounting firms that audit public companies to be members of a professional organization that has peer review and independent oversight functions and is approved by the SEC, such as the SEC Practice Section of the AICPA.

The SEC should take enforcement action when a public accounting firm fails to remedy deficiencies cited by the public accounting profession’s quality assurance program.

The SEC must be given adequate resources to perform existing and additional functions that help prevent, detect, and deter fraudulent financial reporting.


The Office of the Comptroller of the Currency, the Federal Reserve Board, the F.D.I.C., and the Federal Home Loan Bank Board should adopt measures patterned on the Commission’s recommendations directed to the SEC.

The financial institution regulatory agencies and the public accounting profession should provide for the regulatory examiner and the independent public accountant to have mutual access to information they develop about examined financial institutions.


State boards of accountancy should implement positive enforcement programs that periodically would review the quality of services that the independent public accountants they license render.

Parties charged with responding to various tort reform initiatives should consider the implications that the perceived liability crisis holds for long-term audit quality and the independent public accountant’s detection of fraudulent financial reporting.


The SEC should reconsider its longstanding position, insofar as it applies to independent directors, that the corporate indemnification of officers and directors for liabilities that arise under the Securities Act of 1933 is against public policy.

Treadway Recommendations to Educators

Throughout the business and accounting curricula, educators should foster knowledge and understanding of the factors that may cause fraudulent financial reporting and the strategies that can lead to a reduction in its incidence.

The business and accounting curricula should promote a better understanding of the function and the importance of internal controls, including the control environment, in preventing, detecting, and deterring fraudulent financial reporting.


Business and accounting students should be well-informed about the regulation and enforcement activities by which government and private bodies safeguard the financial reporting system and thereby protect the public interest.

The business and accounting curricula should help students develop stronger analytical, problem solving, and judgment skills to help prevent, detect, and deter fraudulent financial reporting when they become participants in the financial reporting process.


The business and accounting curricula should emphasize ethical values by integrating their development with the acquisition of knowledge and skills to help prevent, detect, and deter fraudulent financial reporting.

Business schools should encourage business and accounting faculty to develop their own personal competence as well as classroom materials for conveying information, skills, and ethical values that can help prevent, detect, and deter fraudulent financial reporting.


Professional certification examinations should test students on the information, skills, and ethical values that further the understanding of fraudulent financial reporting and that promote its reduction.

As part of their continuing professional education, independent public accountants, internal auditors, and corporate accountants should study the forces and opportunities that contribute to fraudulent financial reporting, the risk factors that may indicate its occurrence, and the relevant ethical and technical standards.


events The Foreign Corrupt Practices Act The Treadway Report The Blue Ribbon Committee on

Improving the Effectiveness of Corporate Audit Committees

The Blue Ribbon Committee The Blue Ribbon Committee

Instigated by the SEC Sponsored by the NYSE and the NASD 11 committee members Initiated in 1998, issued its report in 1999 At the time, the major exchanges required

companies to maintain audit committees, but did not specify their composition or function.

The Blue Ribbon Committee The Blue Ribbon Committee members

NYSE Chairman and CEO Richard Grasso NASD Chairman and CEO Frank Zarb E&Y Chairman & CEO Philip Laskawy PwC CEO James Schiro POB board member Charles Bowsher TIAA-CREF Chairman and CEO John Biggs Retired Goldman Sachs Co-Chair Whitehead Four others

The Blue Ribbon Committee The Blue Ribbon Committee issued ten

recommendations: Two to improve audit committee

independence Three to improve audit committee

effectiveness Five to address mechanisms for

accountability among the audit committee, the external auditors, and management

The Blue Ribbon Committee Audit committee independence:

Directed at NASD and NYSE companies with market capitalization over $200 million.

All audit committee members should be independent. Restrictions include: Not employed by the company within the past

five years. No compensation from the company except for

board service or under a retirement plan. No family member who has served as an

executive officer of the company for the past five years.

The Blue Ribbon Committee Audit committee effectiveness:

Large companies should have audit committees of at least three members, all of whom are financially literate. At least one member should have accounting or financial management expertise.

Audit committees of all companies should have written charters.

The SEC should require companies to disclose information related to the audit committee’s charter, and compliance therewith.

The Blue Ribbon Committee Accountability

The external auditors are ultimately accountable to the board of directors and the audit committee. The audit committee is responsible for retaining the auditor.

The audit committee is responsible for monitoring and ensuring the independence of the external auditor.

GAAS should require auditors to discuss with the audit committee the quality, not just the acceptability, of the company’s financial reporting.

The Blue Ribbon Committee Accountability

The SEC should require companies to include in its 10K a letter from the audit committee indicating whether the committee has discussed the audited financial statements privately among its members, with management, and with the auditors.

The SEC should require interim financial reviews of 10Qs by the external auditors, and the auditors should discuss quarterly results with the audit committee.

The Blue Ribbon Committee The Committee’s “guiding principles” for

best practices: Audit committee oversight of the work of

others in the financial reporting process; Private communication between the audit

committee and the internal auditors; Private communication between the audit

committee and the external auditors; Frank discussions with management; Diligent and knowledgeable audit committee

members.

The Blue Ribbon Committee In distributing the Blue Ribbon’s report

to interested parties, the POB included a cover letter that stated: “The POB believes that corporate America

stands on the threshold of sharply increased effectiveness of corporate governance, which hopefully will lead to sounder financial reporting.”

The Blue Ribbon Committee The Blue Ribbon Committee itself

stated: “If an audit committee is determined to

be diligent in its oversight role, a sure sense of appropriate action will follow; credible diligence is not rocket science.”

Robert K. JaedickeDean, 1983 – 90, Stanford Graduate School of Business

and Director of the Audit Committee at Enron

The Blue Ribbon Committee

ba 427 – assurance and attestation services lecture 1 introduction

Documents

course objectives

course readings packet

course materials gleims

accounting professionlecture

audit committees

slidewhata public speech

attestation services

assurance services