Accounting 403:

Chapter 2:
Section 1: Generally Accepted Auditing Standards (GAAS)
 The relevant pronouncements of the AICPA and PCAOB are collectively referred to as Generally
Accepted Auditing Standards (GAAS)
 GAAS are auditing standards that identify necessary qualifications and characteristics of auditors
and guide the conduct of the audit examination
 The purpose of GAAS is to meet the objectives of an audit examination which are:
1. To obtain reasonable assurance about whether the financial statements as a whole are
free of material misstatement, whether due to fraud or error
2. To issue a report on the financial statements
 Audit Procedures are the particular and specialized actions that auditors take to obtain evidence
in specific audit engagement
 Auditing Standards are quality guides to the audit that apply to all audits
 Organization of GAAS
 The body of GAAS is based on three fundamental principles identified by the ASB that
underlie all audits
 These fundamental principles relate to:
1. Responsibilities of the audit team
 Defines objectivity and identifies the important role that objectivity
plays in the audit
2. Performance of the audit
 Requires auditors to plan the work and to obtain and evaluate evidence
through assessing the risk of material misstatement and gathering
sufficient appropriate evidence
3. Reporting the results of the engagement
 Provides guidance for communicating the results of the audit about
whether the financial statements are prepared using established criteria

Section 2: Fundamental Principle; Responsibilities

 The fundamental principle of responsibilities related to the personal integrity and professional
qualifications of auditors
 The principle addresses the following responsibilities of auditors:
 Having appropriate competence and capabilities to perform the audit
 Complying with relevant ethical requirements
 Maintaining professional skepticism and exercising professional judgment throughout
the planning and performance of the audit
 Competence and Capabilities
 Competence and Capabilities begin with education in accounting because auditors hold
themselves out as experts in accounting standards, financial reporting, and auditing
 Independence and Due Care
  The responsibilities principle requires auditors to comply with appropriate ethical
requirements:
 Two important requirements relate to Independence and Due Care
 This state of mind is often referred to as the auditor possessing Independence in Fact
 This independence allows auditors to form an opinion on the entity's financial
statements without being affected by influences that might compromise the
opinion
 Independence in Appearance related to others' perceptions of auditors' independence
 Although independence is a complex concept and many different threats to
independence exist, two general types of relationships that are believed to compromise
independence are:
 Financial Relationships
 Managerial Relationships
 Due Care reflects a level of performance that would be exercised by reasonable auditors
in similar circumstances
 Professional Skepticism and Professional Judgment
 Professional Skepticism is a state of mind that is characterized by appropriate
questioning and a critical assessment of audit evidence
 When exhibiting professional skepticism, auditors do not assume that management is
dishonest, or do they assume that management is unquestionably honest. Rather
auditors evaluate and consider:
 Contradictory audit evidence obtained through different procedures
 The reliability of document evidence
 The reliability of information obtained from management and those charged
with governance of the entity
 Professional Judgment is the application of relevant training, knowledge, and experience
in making informed decisions about appropriate courses of action during the audit
engagement
 Stages of an Audit
 Obtain Engagement -> Engagement Planning -> Risk Assessment -> Audit
Evidence -> Reporting

Section 3: Fundamental Principle; Performance

 GOAL is to provide reasonable assurance that financial statements do not contain material
misstatements
 Auditing does not provide absolute assurance over anything, and does not concern itself with
immaterial misstatements, given that immaterial things - by definition - do not matter
 The fundamental principle of performance sets forth general quality criteria for conducting an
audit
 The performance principle states that:
 The auditor plans the work and properly supervises an assistants
 Determines and applies appropriate materiality level or levels throughout the audit
 Identifies and assesses risks of material misstatement, whether due to fraud or error,
based on an understanding of the entity and its environment, including the entity's
internal control
  Obtains sufficient appropriate audit evidence about whether material misstatements
exist, through designing and implementing appropriate responses to the assessed risks
 As the preceding reflects, the performance principle contains five elements:
 Reasonable assurance
 Planning and supervision
 Materiality
 Risk assessment
 Audit evidence
 Reasonable Assurance
 Reasonable Assurance recognizes that a GAAS audit may not detect all material
misstatements and auditors are not insurers or guarantors regarding the fairness of the
entity's financial statements
 Planning and Supervision
 The professional standards contain several considerations for planning and supervising
and audit
 They are concerned with:
1. Preparing an audit plan and supervising the audit work
2. Obtaining knowledge of the client's business
3. Dealing with differences of opinion among the accounting firm's own personnel
 Audit Plan is a list of the audit procedures that auditors need to perform to gather
sufficient appropriate evidence on which to base their opinion on the financial
statements
 Materiality
 Materiality recognizes that auditors should focus on matter that are important to
financial statement users
 Risk Assessment
 Internal Control Over Financial Reporting may be defined as the policies and procedures
implemented by an entity to prevent or detect material accounting frauds or errors and
provide for their correction on an timely basis
 This understanding provides the foundation for the work auditors do in assessing the
Risk of Material Misstatement a combination of Inherent Risk and Control Risk
 The primary purpose of assessing the risk of material misstatements is to help auditors
determine the nature, timing, and extend of further audit procedures necessary for
gathering evidence about the fairness of the entity's financial statements. The process
of risk assessment presumes two necessary relationships:
1. Effective internal control reduces control risk, and auditors thus have a
reasonable basis for reducing the necessary effectiveness of further audit
procedures
2. Ineffective internal control increases control risk, and auditors must increase the
necessary effectiveness of further audit procedures
 Because these further audit procedures are used to obtain evidence with respect to the
fairness of the account balance they are referred to as Substantive Procedures
 Audit Evidence
 Evidence is the information that auditors use in arriving at the conclusions on which to
base the audit opinion and includes the underlying accounting data and all available
corroborating information
 The performance requires auditors to gather sufficient appropriate evidence and
Appropriate
  Professional standards note the following with respect to the reliability of evidence:
 Evidence created by sources external to the entity is more reliable than that
created by the entity
 Evidence created by sources outside the entity is more reliable when received
directly from the external source than when received from sources internal to
the entity
 Evidence obtained from entities with more effective internal controls is more
reliable than that obtained from entities with less effective internal controls
 Evidence obtained from original source documents is more reliable than that
obtained from electric documents
 Appropriateness relates to evidence quality and Sufficiency relates to evidence quantity
 Detection Risk represents the risk that the audit team's substantive procedures will fail
to detect a material misstatement
 Types of Audit Opinions
 Unmodified
 Financial statements are in conformity with GAAP
 Modified
 Except for limited items, financial statements are in conformity with GAAP
 Adverse
 Financial statements are NOT in conformity with GAAP
 Disclaimer
 Auditors do not express any opinion

Section 4: Fundamental Principle; Reporting

 Financial Reporting Framework is a set of criteria used to determine the measurement,
recognition, presentation, and disclosure of material items in the financial statements
 Other types of opinions that can be expressed include the following:
 An adverse opinion concludes that the entity's financial statements are not presented in
conformity with GAAP
 A qualified opinion concludes that except for a relatively isolated departure, the entity's
financial statements are presented in conformity with GAAP
 In some cases, auditors may choose not to express an opinion on the entity's financial
statements

Section 5: Evaluating the Quality of Public Accounting Firms’ Practices

 System of Quality Control
 System of Quality Control is to provide the firm reasonable assurance that the firm and
its personnel:
 Comply with professional standards and applicable regulatory and legal
requirements
 Issue reports that are appropriate in the circumstances
 These areas serve as the basis for the following six elements of a system of quality
control identified by SQCS 8:
 Leadership responsibilities for quality within the firm
  Relevant ethical requirements
 Acceptance and continuance of client relationships and specific engagements
 Human resources
 Engagement performance
 Monitoring
 PCAOB Inspection of Firms
 Inspection:
 For the firms performing audits of more than 100 issuers, inspections are
conducted on an annual basis
 For firms performing audits of 100 or fewer issuers, inspections are conducted
at least every three years