Chapter Five Audit Responsibilities and Accounting Fraud

1. Chapter Five Audit Responsibilities and Accounting Fraud

2. The Contents of the Audit Report • Introductory Paragraph • Identifies the financial statements • Clarifies management’s responsibilities for the statements • States the auditor’s responsibilities to express an (independent) opinion on those statements • Scope Paragraph • Defines the auditor’s responsibility in conducting an audit • Opinion Paragraph

3. Audit Opinions • Unqualified (clean or standard opinion) • Unqualified with explanatory paragraph • financial statements “present fairly” • Financial position • Results of operations • Cash flows • Stockholders’ Equity • Qualified • Adverse • Disclaimer

4. Explanatory Paragraph • Going concern • Consistent application of accounting principles • Emphasis • Report on internal control over financial reporting

5. Generally Accepted Auditing Standards (GAAS) • Auditing Standards Board • Privately owned businesses • Public Company Accounting Oversight Board (PCAOB) • Public companies • General Standards • Standards of Field Work • Standards of Reporting

6. Auditing Procedures • Specific acts performed to gather evidence about management assertions • Help to obtain an understanding of the entity and its environment • Assess risks of material misstatements • Test the operating effectiveness of controls • Preventing material misstatements • Detecting material misstatements

7. Limitations of the Audit Report • Reasonable assurance • Due care • Relation of independence and client relationships • Not an absolute guarantee • Followed GAAS, gathering sufficient competent evidential matter • Failure to follow GAAS allegation of negligence • Materiality • Magnitude of an omission or misstatement of accounting information that the judgment of reasonable person relying on the information would have been changed or influenced by the omission or misstatement

8. Limitations of the Audit Report(cont) • Present fairly • Accounting principles used have general acceptance • Accounting principles are appropriate • Financial statements are informative • Information presented is classified and summarized in a reasonable manner • Financial statements reflect the underlying transactions and events in a manner that is consistent with materiality and reflects economic substance

9. Expectations Gap • Difference between • What the public and users of financial statements perceive as the responsibilities of accountants and auditors and • What accountants and auditors themselves see as their responsibilities

10. Error versus Fraud • Error • Innocent mistake in application of GAAP • Omission of information • Mathematical mistake • Fraud • Deliberate decision made to deceive another party • Fraudulent financial reporting • Misappropriation of assets

11. Auditors Responsibilities for Fraud Prevention, Detection, and Reporting • Description and Characteristics of Fraud • Management Fraud • Defalcations • Auditors’ Fraud Risk Assessment • Identifying risks of material misstatements of the financial statements • Determining appropriate audit response • Perform procedures

12. Fraud Triangle • Incentives/Pressures • Self-serving • Pressures to meet financial numbers • Financial distress • Home Problems • Opportunity • Employees who have access to assets such as cash and inventory • Internal controls to help safeguard assets • Backdating stock options • Rationalization • Company had to make numbers • Fear losing job • I’m entitled since I’m underpaid

13. Fraud Risk Assessment • Evaluation of evidence about the potential client before accepting engagement • Communication with predecessor auditor • Make inquiries about the risks of fraud and how they are addressed • Consider • any unusual or unexpected relationships • whether one or more fraud risk factors exist • other information • Fraud Risk Factors • Overstating revenues and assets • Understating expenses and liabilities • Giving disclosures that are misleading or omit important information

14. Revisiting the Expectation Gap 8 Risk assessment statements for non-public companies give: • More in-depth understanding of • Entity and its environment, • Including its internal control • Identify the risks of material misstatement • What entity is doing to mitigate risk • More rigorous assessment of the risk of material misstatement of the financial statements based on that understanding • Improved linkage between the assessed risks and the nature, timing, and extent of audit procedures performed in response to those risks

15. Internal Control – Integrated Framework • Internal control as a process • Effected by board of directors, management, and other personnel • Designed to provide reasonable assurance • Effectiveness and efficiency of operations • Reliability of financial reporting • Compliance with laws and regulations • COSO Findings on Financial Fraud • Enterprise Risk Management Integrated Framework

16. PCAOB Standards • Auditing Std No. 4 – audit on whether previously reported material weakness no longer exists • Auditing Std No. 5 – audit of assessment of effectiveness of internal control over financial reporting • Auditing Std No. 6 – auditor’s evaluation of the consistency of the financial statements

17. Restatements of Financial Statements • Downward trend since 2006 peak year • Improved reliability of ICFR implementations • Relaxed approach adopted by SEC • Materiality • Need to file restatements • Drop in severity of restatements • Smaller cut out of profits