2-1 What major characteristics of the organization and conduct of CPA firms

permit them to fulfill their social function competently and independently?

The major characteristics of CPA firms that permit them to fulfill their
social
function competently and independently are:

1. Organizational form A CPA firm exists as a separate entity to avoid an

employer-employee relationship with its clients. The CPA firm employs
a professional staff of sufficient size to prevent one client from
constituting a significant portion of total income and thereby
endangering the firm’s independence.
2. Conduct A CPA firm employs a professional staff of sufficient size to
provide a broad range of expertise, continuing education, and
promotion of a professional independent attitude and competence.
3. Peer review This practice evaluates the performance of CPA firms
in an attempt to keep competence high.

2-2 What events led to the creation of the Public Company

Accounting Oversight Board and what is their role in the
oversight of audit firms?
The Public Company Accounting Oversight Board (PCAOB) was
established by the Sarbanes-Oxley Act of 2002 in the wake of multiple
accounting scandals and alleged audit failures, including those of Enron
and WorldCom. The PCAOB provides oversight for auditors of public
companies, including establishing auditing and quality control
standards for public company audits, and performing inspections of the
quality controls at audit firms performing those audits.

2-3 Describe the role of the SEC in society and discuss its
relationship with and influence on the practice of auditing.
The purpose of the Securities and Exchange Commission is to assist in
providing investors with reliable information upon which to make
investment decisions. Since most reasonably large CPA firms have
clients that must file reports with the SEC each year (all companies
filing registration statements under the securities acts of 1933 and
1934 must file audited financial statements and other reports with the
SEC at least once each year), the profession is highly involved with the
SEC requirements.
The SEC has considerable influence in setting generally accepted
accounting principles and disclosure requirements for financial
statements because of its authority for specifying reporting
requirements considered necessary for fair disclosure to investors. In
addition, the SEC has power to establish rules for any CPA associated
with audited financial statements submitted to the Commission.

2-4 What are the purposes of the AICPA Statements on

Standards for Attestation Engagements?
Statements on Standards for Attestation Engagements provide a framework
for attest engagements, including detailed standards for specific types
of attestation engagements.

2-5 Who is responsible for establishing auditing standards for

audits of U.S. public companies? Who is responsible for
establishing auditing standards for audits of U.S. private
companies? Explain.
The PCAOB has responsibility for establishing auditing standards for
U.S. public companies, while the Auditing Standards Board (ASB) of the
AICPA establishes auditing standards for U.S. private companies. Prior
to the creation of the PCAOB, the ASB had responsibility for
establishing auditing standards for both public and private companies.
Because existing auditing standards were adopted by the PCAOB as
interim auditing standards for public company audits, there is
considerable overlap in the two sets of auditing standards.

2-6 Describe the role of International Standards on Auditing.

What is the relationship between International Standards on
Auditing and U.S. auditing standards?
International Standards on Auditing (ISAs) are issued by the
International Auditing and Assurance Standards Board (IAASB) of the
International Federation of Accountants (IFAC) and are designed to
improve the uniformity of auditing practices and related services
throughout the world. The IAASB issues pronouncements on a variety
of audit and attest functions and promotes their acceptance worldwide.
As a result of efforts by the Auditing Standards Board to converge U.S.
GAAS with international standards, AICPA auditing standards and
International Standards on Auditing are similar in most respects.

2-7 Distinguish between auditing standards and generally

accepted accounting principles, and give two examples of each.
Auditing standards represent the combination of the four principles and all the
Statements on Auditing Standards (SASs) that are codified in the AU-‐C sections. The
principles outlined in Figure 2-‐2 provide a framework for the auditing standards.
Examples of auditing standards include any of the SASs (e.g., SAS No. 125), covering
topics such as audit planning or assessing the risk of material misstatement.
Generally accepted accounting principles are specific rules for accounting
for transactions occurring in a business enterprise. Examples may be
any of the opinions of the FASB, such as accounting for leases,
pensions, or fair value assets.

2-8 The Responsibilities principle requires that auditors be

responsible for having appropriate competence and
capabilities to perform the audit. What are the vari ous ways in
which auditors can fulfill this principle?
Auditors develop their competency and capabilities for performing an
audit through formal education in auditing and accounting, adequate
practical experience, and continuing professional education. Auditors
can demonstrate their proficiency by becoming licensed to practice as
CPAs, which requires successful completion of the Uniform CPA
Examination. The specific requirements for licensure vary from state to
state.

2-9 (Auditing standards have been criticized by different

sources for fail ing to provide useful guidelines for conducting
an audit. The critics believe the standards should be more
specific to enable practitioners to improve the quality of their
perfor mance. As the standards are now stated, some critics
believe that they provide little more than an excuse to conduct
inadequate audits. Evaluate this criticism of auditing
standards.
For the most part, auditing standards, including SASs, are general
rather than specific. Many practitioners along with critics of the
profession believe the standards should provide more clearly defined
guidelines as an aid in determining the extent of evidence to be
accumulated. This would eliminate some of the difficult audit decisions
and provide a source of defense if the CPA is charged with conducting
an inadequate audit. On the other hand, highly specific requirements
could turn auditing into mechanical evidence gathering, void of
professional judgment. From the point of view of both the profession
and the users of auditing services, there is probably a greater harm
from defining authoritative guidelines too specifically than too broadly.

2-10 Objective 2-8) What is meant by the term quality control

as it relates to a CPA firm?
Quality controls are the procedures used by a CPA firm that help it
meet its professional responsibilities to clients. Quality controls are
therefore established for the entire CPA firm as opposed to individual
engagements.

2-11 The following is an example of a CPA firm’s quality

control procedure requirement: “Any person being considered
for employment by the firm must have com pleted a basic
auditing course and have been interviewed and approved by
an audit part ner of the firm before he or she can be hired for
the audit staff.” Which element of quality control does this
procedure affect and what is the purpose of the requirement?
The element of quality control is personnel management. The purpose
of the requirement is to help assure CPA firms that all new personnel
are qualified to perform their work competently. A CPA firm must have
competent employees conducting the audits if quality audits are to
occur.

2-12 (Objective 2-8) State what is meant by the term peer

review. What are the implications of peer review for the
profession?
A peer review is a review, by CPAs, of a CPA firm’s compliance with its
quality control system. A mandatory peer review means that such a
review is required periodically. AICPA member firms are required to
have a peer review every three years. Registered firms with the PCAOB
are subject to quality inspections. These are different than peer
reviews because they are performed by independent inspection teams
rather than another CPA firm.
Peer reviews can be beneficial to the profession and to individual firms. By
helping firms meet quality control standards, the profession gains if reviews
result in practitioners doing higher quality audits. A firm having a peer review
can also gain if it improves the firm’s practices and thereby enhances its
reputation and effectiveness, and reduces the likelihood of lawsuits. Of
course, peer reviews are costly. There is always a trade-off between cost and
benefits.