FINANCIAL STATEMENT AUDITS

INTRODUCTION: ACCOUNTING -V- AUDIT

1. A non-issuer i.e. private co gets the following benefits of an audit:
More favorable cost of capital
Insights into adequacy of internal controls
Benchmark an entitys performance with other similar entities.
2. Remember the F/S are prepared by the Mgt so it is the Mgt who is primarily
responsible for the fairness of an entitys F/S. i.e. F/S are representations of mgt.
3. AICPAs Auditing Standards Board (ASB) issues auditing stds applicable to audits
of private companies and other non-issuers. E.g. clarity stds
4. Public Company Accounting Oversight Board (PCOAB) issues auditing stds
applicable to audits of public companies i.e. issuers.
5. U.S Government Accountability Office (GAO) issues auditing stds applicable to
audits of governmental entities.
6. GAAP are the stds by which the quality of the F/S is judged.
7. GAAS since the clarity stds went into effect, GAAS now refers to the set of
Statements on Auditing Stds issued by the ASB. It was referred to as the 10
specific criteria that measure the quality of the auditors performance b4.
However, the ASB has adopted 7 principles as a framework for audit stds setting
in place of the original 10 GAAS. 10 GAAS however, still apply to PCOAB.
8. The auditors primary role is to provide an impartial (independent) assessment of
reliability of Mgts F/S. The auditors responsibility for an entitys F/S is
confined to the expression of an opinion on those F/S.
An auditor may draft an entitys F/S based on info from Mgts a/cing
system provided that the co is not SEC -regulated. Auditors are
specifically prohibited from drafting AND auditing the F/S for SEC-
regulated companies.

GAAS & PRINCIPLES (TIPPICANOE) PCAOB

1. These existed b4 clarity stds
2. This applies to PCAOB (public co/issuer) which has not adopted the clarity stds.
3. These general concepts apply to all audits and so still important.
4. GAAS are considered overall measures of the quality of the auditors
performance. These stds are always the same even if procedures differ.
5. The AICPAs Statements on Auditing Stds collectively are known as GAAS.
6. Sorted into 3 categories:
General stds all aspects of engagement from acceptance to completion.
Fieldwork stds gathering of evidence
Reporting stds only manner in which audit report is written.

1
GENERAL STDS (TIP)
This relates to quality of auditor and quality of work.
1. TRAINING & PROFICIENCY proper education, knowledge, practical
experience i.e. CPE.
2. INDEPENDENCE ability to deal with integrity & objectivity
3. DUE PROFESSIONAL CARE
critical review of judgement used at every level.
Using due diligence i.e. no negligence
Attitude of professional skepticism

FIELDWORK STDS (PIC)

This relates to how audit is planned and how audit evidence is accumulated &
evaluated.
4. PLANNING & SUPERVISION - adequately plan & supervise assistants.
5. INTERNAL CONTROLS obtain a sufficient understanding of the entity and the
environment, including its internal control to assess the risk of material
misstatement and whether need for further audit procedures. If reliance high then
need for substantive testing is lower and vice versa.
6. CORROBORATIVE AUDIT EVIDENCE must obtain sufficient, appropriate
(corroborative) audit evidence by performing audit procedures to form an
opinion.

REPORTING STDS (ANOE)

7. A/CING PRINS IN ACC WITH US GAAP must be explicitly stated whether the
F/S are presented in conformity with US GAAP.
8. NO NEW A/CING PRINS APPLIED i.e. consistency implicit that the prins
have been consistently observed in the current period.
9. OMITTED INFORMATIVE DISCLOSURES - none have been omitted implicit
that information disclosures are adequate unless otherwise stated.
10. EXPRESSION OF AN OPINION explicitly state auditors opinion regarding
the F/S taken as a whole, or an assertion to that fact that an opinion cannot be
expressed.

2
CLARITY STDS
ASB issued a series of stds referred to as the clarity stds to make GAAS easier to
understand and to apply. These apply to audits of non-issuers i.e not public entities.
There are two levels of PROFESSIONAL reqs that are imposed on auditors:
1. Unconditional requirement = must / is reqed to
This must be complied with in order for an an aud to complete an engagement in
accordance with GAAS.
2. A presumptively mandatory req = should
Here auditor is also expected to comply with in every circumstance to which it
applies but in rare circumstances, the auditor may depart from it. On some
occasions, a std will include an indication that the auditor shud consider a
procedure this establishes the req to consider the procedure but does not
establish a requirement to perform the procedure.
The 7 principles are not requirements and have no auth status. However, they
are intended to be as helpful as a framework for audit std setting.
The 7 principles are organized around 4 primary themes- (PRPR)
I. Purpose/premise to provide F/S users with an opinion unmodified or
otherwise in acc with AFRF. Also, mgt is responsible prepn of F/S and
providing the auditor with all info.
II. Responsibilities (replaces the General stds (TIP) describing the xtics the
auditor brings to the engagement). Auditors are responsible for having
competence, ethical reqs, maintaining professional skepticism and
exercising professional judgment, thru out the audit. Professional
skepticism here means being alert to indications that F/S may be
materially misstated. The auditor must exercise due professional care
which includes critical review of judgements used at every level and
skill and care of a prudent CPA. Properly document judgements made by
others.
III. Performance replaces the Fieldwork stds (PIC) describing the evidence-
gathering activities). Inherent limitations like I/C system, a QC system
provides reasonable assurance not absolute, reflecting implicit cost-
benefit trade-offs, the nature of audit procedures and the nature of F/rep.
IV. Reporting an opinion whether the F/S are presented fairly, in all material
aspects, in acc with AFRF not necessarily GAAP as could also be IFRS or
other special purpose frameworks.

The clarity project also changed the format, with each std including the following
sections:
Introduction this includes the purpose and scope of each std. This enables us
to know then the individual stds do or do not apply.
Objectives this includes what requirements are expected to be achieved with
relation to determining if audit procedures to those reqed are necessary, and in

3
 evaluating whether the auditor has obtained sufficient appropriate audit evidence.
The auditor may determine that the objv of a relevant objective has not been
achieved in which case the auditor will need to either modify the audit report or
withdraw from the engagement. The inability to meet an objv is considered a
significant finding, which the auditor is reqed to document.
Definitions identifies definitions that are particular to that std.
Requirements the auditor has to identify unconditional and presumptively
mandatory reqs. The auditor is expected to comply with every req to achieve the
objv of the std. the only exceptions will apply when:
An entire GAAS does not apply e.g. the co has no internal auditors.
A specific req does not apply becoz the condition does not exist e.g. weak
internal controls do not exist so no req to communicate sgf weaknesses.
Application and Other Explanatory Material is the final section which provides
guidance, further explanations, and suggestions as to how to go about applying
the reqs and therefore complying with those stds.
The clarity stds also introduced some new terminology and new defns such as
the APPLICABLE FINANCIAL REPORTING FRAMEWORK, Audit report
terminology and Group financial audits etc.
The clarity stds also imposed some new reqs that auditor will need to fulfill:
The auditor is reqed to evaluate the acceptability of the applicable
financial reporting framework. In this regard, the auditor needs to
evaluate the NEEDS of users, evaluate whether the applicable
framework MEETS those needs, and evaluate whether it is the MOST
APPROPRIATE FRAMEWORK, under the circumstances.
Mgt also now has 2 major responsibilities added to the audit report
The auditor is now reqed to apply Quality Control procedures at the
engagement level.
There were also sgf changes made to the form and content of the audit
report.
Interpretive publications include: appendices to the SASs, auditing interpretations
of the SASs, the AICPA Audit & A/cing guides, and AICPA auditing Statements of
Position. These are interpretative suggestion that do not constitute a professional
req.
Articles in the Journal of A/cancy & CPA Letter are recommendations that have
no authoritative status, and would be classified as other auditing publications.

RESPONSIBILITIES OF THE AUDITOR

4
The clarity stds also set out the auditors responsibilities. Note this is very similar to
GAAS General stds TIP.
To perform an audit, the auditor is responsible for having appropriate training
and proficiency. This is obtained thru proper education, knowledge of industry,
practical experience and CPE.
Complying with relevant ethical reqs including ability to act with integrity and
objectivity and independence from the audit client. The client is not a spouse,
dependent kids or dependent relatives. The auditor must be independent for
attestation engagements (ERAS).
Examinations/audits
Reviews
Agreed upon procedure engagements and other engagements covered by
attestation standards leading to findings
Special reports

The auditor need not be independent for compilations as no assurance is

needed, but in such cases, must mention explicitly if not independent.
Also need not be independent for taxes, consultations, F/S preparation
engagement, bookkeeping or payroll services provided.
By independence we mean no DIRECT financial interest & MATERIAL
INDIRECT financial interest (money in mutual funds) It should appear
that you are independent and not accept managements responsibility.
Another point to note is that if audit fee is accrued for more than one
year. Therefore, payment must be made for last year.
Other independence impairments include relative employed as internal
auditor, no material loans from co, material litigation, entering into a capital
lease, accepting more than a token gift.

AUDITING STDS -V- AUDIT PROCEDURES

Auditing stds deal with measures of the quality of the auditors performance e.g. GAAS
or clarity stds. While auditing procedures relate to specific acts to be performed.
Materiality and relative risk underlie the application of all the stds.

QUALITY CONTROL
These stds relate to the Auditing firm itself and all the engagements they do. GAAS
relates to the auditors quality of work for each engagement it performs. i.e. GAAS
relates to an auditor performing one job-v-QC relates within the firm on all their jobs.
GAAS = engagement level, QC = firm level.

5
 The purpose of a firms system of QC is to provide the firm with reasonable
assurance that the firm (and its personnel) comply with professional stds and
issue reports that are appropriate in the circumstances.
The stds explicitly limit application to auditing and a/cing and review services.
Although the QC stds may be applied to other segments of a firms practice (e.g.
mgt advisory services and tax), the stds do not require it.
Each CPA firm is different. The specific procedures regarding the nature and
extent of a firms QC depend on factors such as size, degree of operating
autonomy allowed, nature of the practice, organization and the cost-benefit
r/ships.
The 2nd or wrap-up review by a partner who has not been involved in the audit is
part of a firms QC system. Its primary focus is to ensure that the fair presentation
of the F/S in conformity with GAAP.
The AICPA QCS req the firms providing a/cing and auditing services obtain
written confirmation of compliance with independence requirements from all
appropriate personnel at least annually.
There is no quality control element on internal control.
AICPA firm may communicate its QC policies and procedures to its personnel
either orally or written.
The firm should establish policies and procedures requiring appropriate
documentation of the operation of each element of the system of QC.
Differences of opinion the firm should establish policies and procedures for
dealing with and resolving differences of opinion within the engagement team,
with those consulted, and btw the engagement partner and the EQC reviewer.
The conclusions reached must be documented and implemented and the report
is not released until the matter is resolved.
The main difference btw clarified SAS and the corresponding International std on
auditing is that SAS requires the QC review must be completed before the
engagement partner releases the auditors report, whereas the ISA requires that
the QC review must be completed before the engagement partner dates the
auditors report.
ENGAGEMENT QC REVIEW - This is a process designed to provide an
objective evaluation, b4 the report is released of the sgf judgements the
engagement team made and the conclusions it reached. This is not applicable to
all audits but to only those where the firm has determined that an engagement
QC review is reqed.
ENGAGEMENT QC REVIEWER this is the person in the firm, a suitably
qualified external person, or a team, none of whom is part of the engagement
team, with adequate experience and authority to objectively evaluate the sgf
judgements that the engagement team made and the conclusions reached in the
audit report.
AU-C 220 QUALITY CONTROL FOR ENGAGEMENT IN ACC WITH GAAS

6
 This relates to QC specifically at the engagement level. This pronouncement
states that the auditors objective is to implement QC procedures at the
engagement level that provide reasonable assurance that:
The audit complies with professional stds and applicable legal and
regulatory requirements and,
The auditor issues an appropriate report.
The administration may be vested in one person but everybody shares the
responsibility.
To obtain reasonable assurance, which is high, but not absolute, the auditor:
I. Plans the work and properly supervises any assistants
II. Determines and applies appropriate materiality level/levels
III. Identifies and assesses RMM, whether due to fraud or error, based on
understanding of the entity and its environment, including I/C.
IV. Obtain sufficient appropriate audit evidence about whether MM exist, thru
designing and implementing appropriate responses to the assessed risks.

ELEMENTS OF A QUALITY CONTROL SYSTEM (HEAL ME)

1. Human Resources (Personnel mgt) the firm shud establish policies and
procedures for effective hiring, development, assignment and advancement of
staff. Professional stds on QC require that a firm establish policies and
procedures to ensure that personnel selected for advancement have the
qualifications necessary for the work they will be required to perform.
2. Ethical Requirements (Independence) the firm shud establish procedures to
ensure that independence is maintained in attest engagements. Firm must
ensure there is integrity and objectivity in the performance of work.
3. Acceptance and continuance of client r/ships and specific engagements the
firm shud establish policies and procedures to be followed b4 acceptance of new
clients. Associate with those firms whose mgt have integrity or who are not too
risky.
4. Leadership responsibilities for quality within the firm (tone at the top) the
firms leadership must assume ultimate responsibility for the firms qc.
5. Monitoring the firm shud establish procedures to verify compliance. Also there
should be an ongoing assessment of the adequacy of the design and operating
effectiveness of the system of QC. Remember, controls that are effective at one
point in time, may deteriorate over time owing to neglect/changed circumstances.
6. Engagement performance the firm shud establish policies and procedures to
ensure it meets applicable professional stds in the performance of engagements.

THE AUDIT PROCESS

Four basic steps:

7
 1. Planning
2. Internal control considerations obtain an understanding of internal control for
planning purposes and contemplating reliance as a basis to decide the level of
substantive testing. If the reliance is high due to certain identified internal control
strengths then substantive testing will be reduced for those areas. The auditor
must then perform tests of control to determine that those specific controls are
operating effectively.
3. Substantive Audit procedures consist of test of details (ending balances and
transactions) & analytical procedures (as well as that obtained thru inspection,
observation, inquiries and confirmation) with the purpose of detecting material
misstatements if there are any.
4. Reporting conclusions are expressed in writing using stdardized language to
avoid miscommunication.

ENGAGEMENT LETTER
Once the auditor has made the decision to accept the engagement, the auditor is reqed
to send a written engagement letter or a comparable written agreement to the client.
The engagement letter documents the understanding btw the auditor and the client
regarding the following:
Nature and scope of the services to be performed,
Expected fees, and the basis for billing
The responsibilities of the auditor conducting an audit in acc with GAAS,
informing the client of any improvements in control or economy of operations that
come to the auditors attention during the engagement. Also, include a statement
of inherent limitations of an audit that there may be material misstatements
undetected.
The clients responsibilities in preparing for an audit presentation & preparation
of F/S, making available all records, not limiting the scope of the auditors work
and paying the fees. Also shud include a written confirmation that the mgt will
give a MGT REP LETTER that talks about all the representations made during
the audit. Client usu prepares the lead schedules.
The need for other services to be performed.
Reporting auditor has to mention in the letter that they cannot provide
assurance that an unmodified opinion will be given.
Note: an auditor is not expected to discuss the audit procedures with the client, those
are a matter of judgement and not subject to disclosure to the client.
AUDIT REPORTING
Prior to the clarity stds, an Unqualified report was structured into 3 parts;
1. Introduction

8
 2. Scope
3. Opinion
After clarity stds, an Unmodified report is presented in 4 sections:
1. Introduction (1 sentence)
2. Managements responsibility section (1 sentence)
3. Auditors responsibility section (3 paras made up of 9 sentences)
4. Opinion (1 sentence) The auditor should identify the AFRF in the opinion
para of the std audit report.
An auditor may give 4 types of opinions on the F/S:
1. Unmodified
2. Qualified misstatement, such as a GAAP departure (material but not
pervasive effect).
3. Adverse - Reasons for adverse opinion cud be misstatement, such as a
GAAP departure.
4. Disclaimer scope limitation both material and pervasive effect.
AICPA Professional Stds require the auditors report to identify the city and state
of the CPA firms office that is responsible for the engagement.