McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter 2 Professional Standards

Objectives
1. Name the various practice standards for internal, governmental,
2.
3.
4.
5.
6.

and independent auditors and public accounting firms and

identify their sources.
Understand generally accepted auditing standards (GAAS) and
explain how GAAS affect the audit teams responsibilities.
Describe how the audit examination is affected by the
fundamental principles of responsibilities and performance.
Understand the principle of reporting and identify the basic
contents of the auditors report.
Identify the need for attestation standards and explain how
attestation standards differ from generally accepted auditing
standards.
Understand the role of a system of quality control and
monitoring efforts in enabling public accounting firms to meet
appropriate levels of professional quality.

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Practice Standards
Client

Public
Entities

Private
Entities

Rulemaking
body

Public
Company
Accounting
Oversight
Board
(PCAOB)

AICPA
Auditing
Standards
Board (ASB)

Standard
s

Auditing
Standards
(ASs)

Statements
on Auditing
Standards
(SASs)

Governmental
Entities
U.S.
Governmen
t
Accountabil
ity Office
(GAO)

Governme
nt Auditing
Standards
(The
Yellow
Book)

Foreign
Entities
IFAC
International
Auditing and
Assurance
Standards
Board (IAASB)
International
Standards on
Auditing
(ISAs)

2-3

Generally Accepted Auditing

Standards
Identify necessary qualifications and
characteristics of auditors and guide the
conduct of the audit
Purpose of GAAS is to achieve the following
objectives of an audit examination
Obtain reasonable assurance about whether
financial statements are free of material
misstatement
Report on the financial statements and
communicate in accordance with auditors findings
2-4

GAAP vs. GAAS

Pronouncements issued
by

Primary impact of
pronouncements

Effect on audit
examination

GAAP

Financial Accounting
Standards Board

Preparation and presentation

of financial statements and
footnote disclosures

Auditors evaluate financial

statement presentation and
preparation against GAAP

GAAS

PCAOB and AICPA (and

others)

Conduct of the audit

examination

Auditors must perform

required procedures and
follow specific guidelines
in audit examination

Comparison of AICPA GAAS to Principles: Performance

General Standards
1.
2.

Training and proficiency

Independence in mental attitude

3.

Due professional care

Standards of Field Work

1.
2.

Planning and supervision

Understanding of entity and environment to

assess risk of material misstatement
3.

Obtain sufficient appropriate evidence

Responsibilities Principle
Auditors are responsible for:
competence and capabilities
ethical requirements (independence and due care)
professional skepticism and professional judgment
Performance Principle
To obtain reasonable assurance:
Plan work and supervise assistants
Determine and apply appropriate materiality levels
Identify and assess risks of material misstatement
Obtain sufficient appropriate evidence

2-5

Comparison of AICPA GAAS to

Principles: Reporting
Standards of Reporting

Reporting Principle

1. Financial statements in accordance

with GAAP
2. GAAP applied consistently (only
report if not consistent)
3. Adequacy of disclosures (only
report if not adequate)
4. Express or disclaim an opinion

Express an opinion or state that an

opinion cannot be expressed
Opinion is based on conformity of
financial statements with applicable
financial reporting framework

2-6

Engagement Overview and

Principles
OBTAIN
(OR RETAIN)
CLIENT

Responsibilities:
Competence and
capabilities,
Independence

ENGAGEMENT
PLANNING

RISK
ASSESSMENT

AUDIT
EVIDENCE

REPORTING

Responsibilities: Professional skepticism, Professional

judgment, Due care

Performance

Reporting

2-7

Responsibilities Principle
1.
2.

3.
4.

Competence and capabilities

Experience and expertise

Independence

Independence in fact vs. independence in appearance

Financial and managerial relationships

Due care

Level of performance by reasonable auditor in similar circumstances

Professional skepticism and judgment

Skepticism: Appropriate questioning and critical assessment of evidence

Judgment: Application of training, knowledge, and experience in making informed

decisions during audit

Performance Principle

Goal is to provide reasonable assurance that financial statements do not contain material
misstatements
1.Planning and supervision

Preparation of audit plan

2.Materiality

Influences decisions of financial statement users

Considered throughout the audit

3.Risk assessment

Understand entity and environment (including internal control)

Determine necessary effectiveness of substantive tests

4.Audit evidence

Sufficient = quantity (How many transactions or components?)

Appropriate = quality (What level of reliability needed? Source?)

2-8

Sufficient evidence

Related to quantity (number of transactions or components examined)

Influenced by effectiveness of entitys internal control

Effectiveinternal
control

Lowerlevelof
controlrisk

Ineffectiveinternal
control

Higherlevelof
controlrisk

Evaluatelessevidence

Evaluatemoreevidence

Appropriate Evidence

Relates to the quality of evidence

Relevance: Does evidence address assertion(s) of interest?
Reliability: Source of evidence
Auditors direct personal knowledge
External documentary evidence
External-internal evidence
Internal documentary evidence
Verbal evidence

High
Low
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Examples of Evidence
Auditors direct personal knowledge
Observe PPE, inventories

External documentary evidence

A/R confirmations, bank confirmations

External-internal evidence

Vendor invoices for purchases

Internal documentary evidence

Client sales invoices

Verbal evidence

Based on inquiries of client

Management representations (SAS 85)
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Reporting Principle

Express an opinion (or indicate that an opinion

cannot be expressed) on entitys financial
statements
Assess financial statements against financial
reporting framework

Set of criteria used to determine the measurement,

recognition, presentation, and disclosure of material
itrems in the financial statements
Examples include GAAP, IFRS, or special purpose
framework
2-11

Independent Auditors Report (AS 5)

Report Title

Report of Independent Registered Public Accounting Firm

Addressee

The Board of Directors and Shareholders,

Wal-Mart Stores, Inc.

Introductory
Paragraph

WehaveauditedtheaccompanyingconsolidatedbalancesheetsofWalMartStores,Inc.asofJanuary31,2009and
2008,andtherelatedconsolidatedstatementsofincome,shareholdersequity,andcashflowsforeachofthethreeyears
intheperiodendedJanuary31,2009.ThesefinancialstatementsaretheresponsibilityoftheCompanysmanagement.
Ourresponsibilityistoexpressanopiniononthesefinancialstatementsbasedonouraudits.
WeconductedourauditsinaccordancewiththestandardsofthePublicCompanyAccountingOversightBoard
(UnitedStates).Thosestandardsrequirethatweplanandperformtheaudittoobtainreasonableassuranceabout
whetherthefinancialstatementsarefreeofmaterialmisstatement.Anauditincludesexamining,onatestbasis,
evidencesupportingtheamountsanddisclosuresinthefinancialstatements.Anauditalsoincludesassessingthe
accountingprinciplesusedandsignificantestimatesmadebymanagement,aswellasevaluatingtheoverallfinancial
statementpresentation.Webelievethatourauditsprovideareasonablebasisforouropinion.
Inouropinion,thefinancialstatementsreferredtoabovepresentfairly,inallmaterialrespects,theconsolidated
financialpositionofWalMartStores,Inc.atJanuary31,2009and2008,andtheconsolidatedresultsofitsoperations
anditscashflowsforeachofthethreeyearsintheperiodendedJanuary31,2009,inconformitywithU.S.generally
acceptedaccountingprinciples.
As discussed in Notes 5 and 13 to the consolidated financial statements, respectively, effective February 1, 2007 the
Company changed its method of accounting for income taxes in accordance with Financial Accounting Standards Board
Interpretation No. 48, Accounting for Uncertainty in Income Taxes , and effective January 31, 2009, the Company
adopted the measurement elements of Statement of Financial Accounting Standards No. 158, Employers Accounting for
Defined Benefit Pension and Other Postretirement Plans .

Scope
Paragraph

Opinion
Paragraph

Explanatory
Paragraph

Internal Control
Paragraph

Wealsohaveaudited,inaccordancewiththestandardsofthePublicCompanyAccountingOversightBoard(United
States),WalMartStores,Inc.sinternalcontroloverfinancialreportingasofJanuary31,2009,basedoncriteria
establishedinInternalControlIntegratedFrameworkissuedbytheCommitteeofSponsoringOrganizationsofthe
TreadwayCommissionandourreportdatedMarch27,2009expressedanunqualifiedopinionthereon.
/s/Ernst&YoungLLP
Rogers,Arkansas
March27,2009

2-12

Major Items in Auditors Report

Auditors and management responsibility in financial reporting

process
Audit conducted in accordance with PCAOB standards
Opinion on financial statements
Opinion on internal control over financial reporting
Report dated on audit completion date

Types of Audit Opinions

Unqualified
F/S are in conformity with GAAP
Qualified
Except for one (limited) item, F/S are in conformity with GAAP
Can issue for GAAP departure and scope limitation
Adverse
F/S are not in conformity with GAAP
Can issue for GAAP departure (more serious)
Disclaimer
Auditors do not express an opinion
Can issue for scope limitation (more serious)
2-13

Attestation Standards
Cover a broader range of engagements than
GAAS
Areas of standards
General
Field Work
Reporting

While attestation standards parallel GAAS,

different types of engagements may result
in some GAAS not being applicable
2-14

System of Quality Control

Provides firm with reasonable assurance that the firm and its
personnel
Comply with professional standards and regulatory/legal
requirements
Issue reports that are appropriate in the circumstances

Categories

Leadership (tone at the top)

Relevant ethical requirements
Acceptance and continuance of clients
Human resources
Engagement performance
Monitoring

2-15

Public Company Accounting Oversight Board

(PCAOB)
Monitors public accounting firms through
inspections
Firms auditing > 100 public entities: annual
Firms auditing < 100 public entities: every 3 years

Inspection reports list deficiencies in audits

conducted by registered firms (http://
www.pcaob.org/Inspections/Public_Reports/index
.aspx
)
2-16