The Role of the

Public Accountant in

the American

Economy

Chapter 01

McGraw-Hill/Irwin Copyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

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Assurance services

The broad range of information

enhancement services that are provided

by certified public accountants (CPAs).

Two types:

Increase reliability of information

Putting information into a form or context that

facilitates decision making.

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Types of Services

Assurance Services

Attestation Services

Example: Audits of Financial Statements,

Examinations of Internal Control

Other Assurance Services

Example: CPA ElderCare Prime Plus Services

NonAssurance Services

Tax Services

Management Consulting Services

Other

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Attestation Services

To attest to information means to provide

assurance as to its reliability

Attest engagement:

A practitioner is engaged to issue or does

issue an examination, a review, or an agreed-

upon procedures report on subject matter or

an assertion about subject matter that is the

responsibility of another party (e.g.

management)

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The Attest Function

Management

Subject

Matter

Suitable

Criteria

The CPA

Gathers

Evidence

Subject

Matter* The Attest

Report

Issues

Report

*May be managements assertion about the subject matter.

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Suitable criteria

Standards established or developed by groups of experts.

Example: Internal control audit standards established by a committee of experts on internal control

Example: Financial statement audit standards are GAAP. For a financial statement audit suitable criteria are referred to as the applicable financial reporting framework.

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Forms of Attestation

1-8 *Applicable financial reporting framework

Audit of Financial Statements

Management

Prepares

Financial

Statements

Criteria

(e.g., GAAP)

The

Auditors

Gathers

Evidence

Financial

Statements The Auditors

Report

Issues

Report

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Financial Statement Audit

Auditors gather evidence and provide a high

level of assurance that the financial statements

follow GAAP, or some other appropriate basis of

accounting

Audit involves searching and verifying

accounting records and examining other

documents

Evidence necessary to issue an audit report that

states auditors opinion

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Audit Evidence

Evidence focuses on whether financial statements are

presented in accordance with GAAP; examples:

Balance sheet contains all liabilities

Income statement

Sales really occurred

Sales have been recorded at appropriate amounts

Recorded costs and expenses are applicable to period

All expenses have been recognized

Financial statement amounts

Accurate, properly classified and summarized

Notes are informative and complete

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What Creates the Demand for Audits?

Audits lend credibility to information by reducing information risk, the risk that information is materially misstated

Financial statement misstatements arise due to-- Accidental errors

Lack of knowledge of accounting principles

Unintentional bias

Deliberate falsification

Audits do not directly address business risk, the risk that a company will not be able to meet its financial obligations due to economic conditions or poor management decisions

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History of the Attest Function

Period Developments Audit Objective Nature of Audit

Ancient - 1850 Audits of city states,

individuals & ventures

Detection of fraud Detailed; No reliance on

controls

1850-1905 Industrial revolution

resulted in the need for

corporate audits

Detection of fraud &

clerical errors

Some testing; No reliance

on controls

1905-1940 Development of stock

markets - increased

emphasis on earnings

Determination of

fairness; detection of

fraud & errors

Increased emphasis on

testing; Slight reliance on

controls

1940-1975 Development of auditing

standards

Determination of

fairness

Substantial reliance on

controls

1975-1985 Criticism by Congress;

Increased self-regulation

Determination of

fairness

Internal control

determines scope of

audit

1985-1995 Increased demands for

reporting on compliance &

internal control

Determination of

fairness

Risk assessment

determines audit scope;

must assess risk of fraud

1995-Present Panel on Audit

Effectiveness; Sarbanes-

Oxley Act of 2002

Determination of

fairness

Business risk approach

to audits

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The Accounting Professions Credibility Crisis

2000The Panel on Audit Effectiveness made a variety of suggestions to improve audits.

2001Enron Bankruptcy

2002WorldCom Fraud

2002Sarbanes-Oxley Act

2003Public Company Accounting Oversight Board began operations

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Financial Audits

Audit of the financial statements of an

entity Covers the balance sheet and related statements of

income, retained earnings and cash flows

Goal is to determine if prepared in conformity with

GAAP

Performed by CPAs

Users include management, investors, bankers,

creditors, financial analysts, government agencies

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Other Types of Audits

Compliance Audits Example: IRS audit of income tax return

Operational Audits Example: Effectiveness of operations of

receiving department of a manufacturing

company

Integrated Audits Example: Assurance on both the financial

statements and effectiveness of internal

control over financial reporting

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Other Types of Auditors

Internal Auditors

Government Accountability Office Auditors

Tax Auditors

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Internal Auditors

Employed by a company as an employee

They often

perform operational and compliance audits

address internal control

report to the audit committee of the board of directors and to the president

The Institute of Internal Auditors is the international organization of internal auditors.

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Government Accountability Office

Auditors (GAO Auditors)

Headed by the comptroller general

Responsibility of supporting Congress

Perform

Compliance, operational and financial audits

of government agencies

Examinations of corporations holding

government contracts to verify contract

payments have been proper

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Tax Auditors

Responsible for enforcement of tax laws of

various sorts (e.g., state and federal

income taxes, property taxes, sales taxes)

Internal revenue agents generally perform

compliance audits of income tax returns

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AICPAs Traditional Role

Establish Standards

Research and Publication

Continuing Professional Education

Self-Regulation

Note: Much of the standards setting and regulation roles relating to public companies (referred to as issuers) has been taken over by the SEC and the PCAOB.

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Establishes Standards--Examples

AICPA Auditing Standards Board Issues official pronouncements on auditing matters

for nonpublic companies (nonissuers)

Statements on Auditing Standards (SASs)

Statements on Standards for Attestation

Engagements (SSAEs)

Guidance for attesting to information other than

financial statements such as financial forecasts

Accounting and Review Services Committee

Statements on Standards for Accounting and Review

Services (SSARS)

Standards for compilations or reviews not audits of

financial statements

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Research and Publication

Publications

Journal of Accountancy (monthly)

The Tax Advisor

Audit publications

Industry Audit and Accounting Guides

Audit Risk Alerts

Auditing Practice Releases

Other publications

Accounting Research Studies

Statements of Position

Accounting Trends & Techniques

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Continuing Professional

Education Development of continuing professional

education programs

Necessary for continuing education

requirement for CPA certificate

Offered by

AICPA

State societies

Other professional organizations

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Professional Regulation

Regulations of Individual CPAs

Code of Professional Conduct ethical rules

for CPAs

Requirements for regular membership in

AICPA

Regulation of Public Accounting Firms

Division for Public Accounting Firms

Center for Public Company Audit Firms

Private Companies Practice Section (PCPS)

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The CPA Examin