Audit Solutions for Chapter Essay Example

Audit Solutions for Chapter Paper I Focused on short-term prices; failed to perform long-term growth analysis; abdicated all responsibilities to management as long as stock price increased. Board of Directors Broad Role: the major representative Of stockholders to ensure that he organization is run according to the organization charter and there is proper accountability. Specific activities include: * Selecting management. * Reviewing management performance and determining compensation. Declaring dividends * Approving major changes, e. G. Mergers * Approving corporate strategy * Overseeing accountability activities. Inadequate oversight of Approval of management compensation plans, particularly management. Stock options that provided perverse incentives, including incentives to manage earnings. Independent, often dominated by management. * to spend sufficient time or have sufficient expertise to perform duties. * Continually re-priced stock options when market price declined. Management Broad Role: Operations and Accountability, Managing the organization effectively and provide accurate and timely accountability to shareholders and other stakeholders, Specific activities include: * Formulating strategy and risk appetite. Implementing effective internal controls. Developing financial reports. * Developing other reports to meet public, stakeholder, and regulatory requirements. I ;k Earnings management to meet analyst expectations. Granduncle financial reporting. Pushing accounting concepts to achieve reporting objective. * Viewed accounting as a tool, not 3 framework for accurate reporting. Audit Committees Of the Board of Directors I Broad Role: Provide oversight of the internal and external audit function and the process Of preparing the annual accuracy financial statements and public reports on internal control. We will write a custom essay sample on Audit Solutions for Chapter specifically for you for only $16.38 $13.9/page Order now We will write a custom essay sample on Audit Solutions for Chapter specifically for you FOR ONLY $16.38 $13.9/page Hire Writer We will write a custom essay sample on Audit Solutions for Chapter specifically for you FOR ONLY $16.38 $13.9/page Hire Writer Specific activities include: Selecting the external audit firm. * Approving any non-audit work performed by audit firm. Selecting and/or approving the appointment of the Chief Audit Executive (Internal Auditor), * Reviewing and approving the scope and budget of the internal audit function. * Discussing audit findings with internal auditor and external auditor and advising the Board (and management) on specific actions that should be taken. * Similar to Board members did not have expertise or time to provide effective oversight of audit functions. Were not viewed by auditors as the audit client, Rather the power to hire and fire the auditors often rested with management. I Self-Regulatory Organizations: CPA, FAST Broad Role: Setting accounting and auditing standards dictating underlying tangential reporting and auditing concepts. Set the expectations of audit quality and accounting quality. Specific roles include: * Establishing accounting principles ;k Establishing auditing standard s ;k Interpreting previously issued standards * Implementing quality control processes to ensure audit quality, * Educating members on audit and accounting requirements. Peer reviews did not take a public perspective; rather than looked at standards that ever developed and reinforced internally. ;k CPA: Leadership transposed the organization for a public Organization to a trade association that looked for revenue enhancement opportunities for its members. Did not actively involve third parties in standard setting. FAST: Became more rule-oriented in response to (a) complex economic transactions; and (b) an auditing profession that was more oriented to pushing the rules rather than enforcing concepts. * FAST: Pressure from Congress to develop rules that enhanced economic growth, e. . Allowing organizations to not expense stock options. Other Self-Regulatory Organizations, e. G. NYSE, NASA Broad Role: Ensuring the efficiency of the financial markets including oversight of trading and oversight of companies that are allowed to trade on the exchange. Specific activities include: * Establishing listing requirements including accounting acquirement, govern ance requirements, etc. * Overseeing trading activities, Pushed for improvements tort better corporate governance procedures by its members, but failed to implement those same procedures for its governing board, management, and trading specialists. Regulatory Agencies: the SEC Broad Role: Ensure the accuracy, timeliness, and fairness of public reporting of financial and other information for public companies. Specific activities include: * Reviewing all mandatory filings with the SEC, * Interacting with the V-CAB in setting accounting standards, k Specifying independence standards required of auditors that report on public financial statements, * Identify corporate frauds, investigate causes, and suggest remedial actions. Identified problems but was never granted sufficient resources by Congress or the Administration to deal with the issues. External Auditors I Broad Role: Performing audits of company financial statements to ensure that the statements are free of material misstatements including misstatements that may be due to fraud. Specific activities include: * Audits Of public company financial Statements, * Audits Of non-public company financial statements, * Other accounting related work such as tax or consulting. Pushed accounting concepts to the limit to help organizations achieve earnings objectives. Promoted personnel based on ability to sell non-audit products. Replaced direct tests Of accounting balances with a greater use of inquiries, risk analysis, and analytics. * Failed to uncover basic frauds in cases such as World and Healthful because fundamental audit procedures were not performed. Internal Auditors I Broad Role: Perform audits of companies for compliance with company policies and laws, audits to evaluate the efficiency of operations, and audits to determine the accuracy financial reporting processes. Specific activities include: * Reporting results and analyses to management, (including operational management), and audit committees, Evaluating internal controls. Focused efforts on t)operational audits and assumed that financial auditing was addressed sufficiently by the external audit function. Reported primarily to management with little effective reporting to the audit committee. In Some instances (Healthful, World) did not have access to the corporate financial accounts. I 2-3. The board of directors is often at the top of the list when it comes to responsibility for corporate governance failures. Some of the problems with the road Of directors included: * Inadequate oversight Of management. * Approval of management compensation plans, particularly stock options that provided perverse incentives, including incentives to manage earnings. Non-independent, often dominated by management. * Did not spend sufficient time or have sufficient expertise to perform duties. * Continually re-priced stock options when market price declined. 2-4. Some of the ways the auditing profession was responsible were: * Too concerned about creating revenue enhancement opportunities for the firm, and less concerned about their core services or talents * Were willing to push counting standards to the limit to help clients achieve earnings goals Began to use more audit Shortcuts such as inquiry and analytical procedures instead to direct testing to account balance. ;k Relied on management representations instead of testing management representations. * Were too often advocates of management rather than protectors of users. 2-5. Cookie jar reserves are essentially liabilities or contra-assets that companies have overestimated in previous years to use when times are tougher to smooth earnings. The rationale is that the funds are then used to smooth earnings in he years when earnings need a boost. Smooth earnings typically are looked upon more favorably by the stock market An example of a cookie jar reserve would be over-estimating an allowance account, such as allowance for doubtful accounts. The allowance account is then written down (and into the income statement) in a bad year. The result is to increase earnings in the subsequent year. 2-6. Seers should expect auditors to have the expertise, independence, and professional skepticism to render an unbiased and justified opinion on the financial statements. Auditors are expected to gather sufficient applicable evidence to render an independent opinion on the financial statements. 2-7. The Serbians-Cooley Act was designed to clean-up; corporate America, especi ally in the realms of financial reporting. The overall intent was to encourage better corporate governance; to make the audit committee the auditors client; encourage the independence and oversight of the board, and improve the independence of the external audit profession. There were certainly many factors that led to the Serbians-Cooley Act, but the failures at Enron and World will probably be pointed to in the future as the major factors that led o the act being passed when it was. The Congress intended to develop a new reporting process that would provide just cause for the public to again trust financial statements and the audit processes leading up to the audit opinion. 2-8. The PEPCO is mandated by Congress to set standards for audits of public companies and perform quality control inspections of CPA firms that audit public companies. In order to carry out these responsibilities, the APACE requires all firms that audit LIST. Listed (public) companies to register With it. It performs annual inspections on all audit firms that audit more than 100 public companies each year. It performs less frequent inspections, usually once every three years, for audit firms that audit less than 100 companies annually. The PEPCO issues Inspection Reports for each inspection that is performed. The first part describes problems they encountered in their review;. 5 of audits and that part is made public. The second part describes problems that the firms have with their quality control process. The second part is not issued publicly unless the firms fail to address the problems pointed out within a reasonable time frame usually no more than a year. 2-9, Management has always been responsible for fairness, completeness, and accuracy attitudinal statements, but the Serbians-Cooley Act goes a step further by requiring the CEO and COOP to certify the accuracy of financial statements with criminal penalties as a punishment for materially misstated statements. The CEO and COOP must make public their certifications and assume responsibility for the fairness of the financial presentations. It thereby encourages organizations to improve their financial reporting functions. 2-10. Whistle blowing enables violations of a companys ethical code to be reported to appropriate levels in an organization, including the audit committee. Because of its presence, potential violators know that there is a real possibility and simple avenue by which inappropriate actions may be revealed. As such, it contains a preventive component that is indirectly helpful to the audit committee in fulfilling its corporate governance role. 2-11. There are a number of provisions that are designed to increase auditor independence. First, Rule 201 Of the Act prohibits any registered public accounting firm from providing many non-audit services to their public audit clients. Second, the audit committee became the client instead of management, and only the audit committee can hire and fire auditors. Third, audit partners are required to rotate every five years. Finally, the auditors are expected to follow fundamental principles of independence that have been enacted by the SEC (more details in Chapter 3). 2-12. Management is responsible for issued financial statements. Although other parties may he sued for what is contained in the statements, management is ultimately responsible. Ownership is important because it establishes responsibility and accountability, Management must set up and monitor financial reporting systems that help it meet its reporting obligations. It cannot delegate this responsibility to the auditors, 2-13. An audit committee is a subcommittee of the board of directors that is composed of independent, outside directors. The audit committee has oversight responsibility (on behalf of the full board of directors and its stockholders) for the outside reporting of the company (including annual financial statements); risk monitoring and control processes; and both internal and external audit functions. 2-14. An outside director is not a member of management, legal counsel, a major vendor, outside service provider, former employee, or others who may eave a personal relationship with management that might impair their objectivity or independence. The audit committee is responsible for assessing the independence of the external auditor and engage only auditors it believes are independent. Auditors are now hired and tired by audit committee members, not management. The intent is to make auditor accountability more congruent with stockholder and third-party needs. 2-15. The primary point of this question is for students to understand that the audit committees role is one of oversight rather than direct responsibility, Poor example, management is responsible for the fairness of the financial statements. Auditors are responsible for their audit and independent assessment of financial reporting. The audit committee is not designed to replace the responsibility of either of these functions. The audit committees oversight processes are to see that the management processes for financial reporting are adequate and the auditors carry out their responsibilities in an independent and competent manner. -16. The audit committee has the ability to hire and fire both the internal auditor and the external auditor _ However, in the case Of the internal audit unction, the audit committee has the ability to hire and fire the head of internal audit as well as set the audit plan and budget. The audit committee does not control regulatory auditors. But should meet with regulatory auditors to understand the scope of their work and to discuss audit findings with them. 2-17. The Serbians-Cooley Act applies only to public companies. Therefore, the Act does not require non-public companies to have audit committees. That is not to say that it does not happen or is not a good idea, however. Most stakeholders want an independent party to ensure that their interests are being considered, The CPA recommends audit committees tort smaller public companies. 2-18. The external auditor should discuss any controversial accounting choices with the audit committee and must communicate all significant adjustments made to the financial statements during the course of the audit In addition, the processes used in making judgments and estimates as well as any disagreements with management should be communicated. Other items that need to be communicated include: * All adjustments that were not made during the course Of the audit, Difficulties in conducting the audit, * The auditors assessment Of the accounting principles used and overall airiness of the financial presentation, * The clients consultation with other auditors, * Any consultation with management before accepting the audit engagement, * Significant deficiencies in internal control. 2-19. The audit committee needs to ensure that the auditor is independent with respect to the annual audit. In order to ensure that independence, the audit committee must consider all other services that might be performed by the external auditor and approve any such services, in advance. Fifth audit committee approves the services, they are in essence saying that the provision of he services will not impair the auditors independence. 2-20. Good governance is important to the external auditor for a number of reasons, including, but not limited to the following. Good governance ;k usually leads to better corporate performance, * reflects a commitment to a high level of ethics, integrity, and sets a strong tone for the organizations activities, ;k requires a commitment to financial reporting competencies and to good internal controls, * reduces the risk that the company will have materially misstated financial statements. If a client does not have good governance, there are greater risks associated tit the client. Boor example, their poor performance may lead to financial failure and lack of payment of the audit fee. Or their poor governance may lead to improprieties in financial reporting Which puts the auditor at risk in terms Of litigation (if the improprieties go undetected by the auditor). 2-21. The auditor might utilize the following procedures in determining the actual level of governance in an organization: * observe the functioning of the audit committee by participating in the meetings, noting the quality of the audit committee questions and responses, interactions with management regarding issues related to the audit, e. . Providing requested information on a timely basis, * quality of financial personnel in making judgments, * accounting choices that tend to push the limits towards aggressiveness or creating additional reported net income, the quality of internal controls within the organization. Review the minutes of the board of directors meetings to determine that they are consistent with good governance, review internal audit reports and especially determine the actions taken by management concerning the internal auditors findings and recommendations, * review the compensation plan for top management, k review management expense reimbursements to determine (a) com pleteness of documentation, (b) appropriateness of requested reimbursement, and (c) extent of such requests. ;k review managements statements to the financial press to determine if they are consistent With the companys operations. -22. Good corporate governance is correlated With increased corporate performance as measured by return on equity, or return on capital. Generally, good corporate governance reduces audit risk as it is less likely that the organization will suffer from problems of management integrity, or would have n environment that might allow or permit fraud. Less audit risk implies that the amount of work to render an opinion on the financial statements would also be less than that required for a company with poorer corporate governance. 2-23. The three categories of audit standards are general standards, fieldwork standards, and reporting standards. General standards cover the characteristics of the auditor technical training and proficiency, independence, and due professional care, Fieldwork standards provide guidance concerning planning and performing the audit. Reporting standards cover the essential elements of he auditors communication, including the opinion, the criteria against which the assertions were tested, and an explanation of the basis for the testators opinion. -24. Due professional care is the expectation that an audit will be conducted with the skill and care of a professional. The standard of due professional care plays a role in litigation against auditors. Plaintiffs will try to show that the auditor did not do what a reasonably prudent auditor would have done. To evaluate the standard, a third-party also decides whether someone with similar skills in a similar situation would have acted in the same w ay. -25. There are three important dimensions identified in Exhibit 2. : * Scope of Information on which assurance is provided, * Nature of Organizations on which assurance is provided, Company being audited. * Domicile of These three dimensions influence the identification of applicable auditing standards as follows: A U. S. Public company filing annual reports follows PEPCO standards. U. S. Non-public company issuing financial statements, follows CPA standards, A foreign company tiling financial statements in a different country follows International Standards or the standards of that country, * IS. S, companies reporting on other than financial information follows CPA Attestation or Assurance Standards, 2-26. Poor the most part, the standards issued by the SAAB are quite similar to that of the two LLC. S. Based audit standard setters. They differ in the following major ways: * The auditor must assess the appropriateness Of the accounting framework against which the audit opinion will be given (U. S. Standards require only that the auditor communicate if the accounting is not consistent With LIST. IGMP. ) SAAB utilizes a concept of Professional Skepticism rather than independence. The SAAB utilizes a concept of reasonable assurance compared with the U. S. Evidence on sufficiency of audit evidence and due professional care, *The AIMS standards include both audit standards and assurance standards. 2-27. The SAAB Audit Standards are quite consistent with that of the PEPCO as well as that of the CPA. Most of the concepts are the same, but are stated differently. They are very similar in the following ways: ;k Requirement of independence, * Gathering and evaluation of sufficient evidence, ;k Documentation of audit work, * Audit designed to minimize audit risk, ;k Due professional care vs.. Seasonable assurance, * Nature of the audit report The CPA and the SAAB have announced a plan to work towards convergence of existing and future standards. The PEPCO has not yet announced a plan for convergence. 2-28. An audit engagement applies to the development Of an opinion on an organizations financial statements. It is planned that the financial statements Will be used by t hird parties Who do not hue direct access to client data. The audit engagement is a form of positive assurance in which an opinion must be rendered. An assurance engagement differs from an audit in a number of important dimensions: It can apply to almost any assertion that management wants to make as long as there is agreed-upon criteria by which to test managements assertion. It is preferable that the criteria are generally accepted. * An assurance engagement generally requires a third party (although assurance can also be provided to the audit client), but it is an identified third-party as opposed to a potential user of financial statements, Assurance can be given on individual items of a companys financial statements, rather than the full set of statements. -29. Assurance engagements are designed to provide positive assurance, i. . The item being attested to is either properly presented, or is not properly presented. Poor example, one of the Big 4 firms provides assurance to the audience that the votes are properly maintained and counted for the Emmy Awards _ A limited assurance engagement does not contemplate a full audit or assurance engagement such that sufficient information (evidence) is gathered to warrant a positive statement about Whether the item being assured is, or is not, properly presented. Rather, based on a more limited amount of work. He auditor either states that nothing came to his or her attention based on the emitted procedures that indicates something is not fairly presented. This is often referred to as negative assurance. An even more limited assurance engagement is one in which the accountant expresses no assurance whatsoever on the item being reported. * Auditing Standards apply to the auditors task of developing and then communicating an opinion on financial statements and, where applicable, independent opinions on the quality of an organizations internal control over financial statements to the board, management, and outside third parties. Assurance Standards apply the auditors task of developing and communicating n opinion on financial information outside of the normal financial statements, or on non-financial information to management, the board, and outside third- parties. Assurance services are engagements in which a practitioner expresses a conclusion designed to enhance the degree of confidence of the intended users about the outcome of the evaluation or measurement of a subject matter against criteria. Attestation Standards is a term used by the CPA to describe assurance services that involve gathering evidence regarding specific assertions and communicating an opinion On the fairness Of the presentation to a third party. k Compilation and Review Standards refer to CPA Standards that apply only to non-public companies where the board or a user has requested some assurance on the fairness of presentation financial statements. These are referred to as negative assurance standards because the auditor does not gather enough evidence to support a statement as to whether the financial statements are fairly presented. -31. Independence means objectivity and freedom from bias. The auditor can favor neither the client nor the third party in evaluating the fairness of the financial statements The auditor must be independent in fact and in appearance. Independence in fact means the auditor is unbiased and objective. An auditor could be independent in tact it he or she owned a few shares of co mmon stock in an audit client, but might not appear independent to a third party. Independence in appearance means that a third party with knowledge of the auditors relationship with the client would consider the auditor to be independent. Professional skepticism, as used in the standards promulgated by the PASS, has a broader meaning in that it refers to all of the factors that valued affect an auditors ability to exercise proper skepticism in an audit engagement. The actors to be considered Vary from those associated With the individual, such as objectivity, to those associated with the structure of the firm. These are similar to the independence standards that emphasize both audit firm relationships to the client as well as objectivity. However, the SAAB emphasis on professional skepticism goes a bit further: an auditor could be Objective, but not necessarily exercise professional skepticism, i. E. Being open to potential explanations of events that are not consistent with the auditors prior experiences. Professional skepticism appears to be a broader term than independence.