ACCT 4240- AUDITING by yaohongm

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									ACCT 4240: Auditing

      Audit Reports Other Than
             Unqualified




                                 1
Three Conditions Requiring
a Departure from an
Unqualified Audit Report
• The scope of the audit has been restricted.
  (Auditor has not accumulated sufficient
  evidence to conclude whether financial
  statements are stated in accordance with
  GAAP.)
   Restrictions imposed by the client, for
    example:
     – Unable to observe inventories.
     – Unable to confirm material receivables.
                                                 2
Three Conditions Requiring
a Departure from an
Unqualified Audit Report
   Circumstances beyond either the client’s or
    the auditor’s control
     – Unable to observe inventories.
     – Unable to confirm material receivables.
• The financial statements have not been
  prepared in accordance with GAAP.
• The auditor is not independent.

                                                  3
Audit Reports Other than
Unqualified

      • A Qualified Opinion
      • An Adverse Opinion
      • A Disclaimer of Opinion



                                  4
Qualified Opinions
• The auditor must conclude that the overall
  financial statements are fairly presented.
• Qualified opinions can result from two conditions:
   A limitation on the scope of the audit.
   Failure to follow GAAP.
• If the auditor believes the condition being reported
  on is highly material, a disclaimer or an adverse
  report must be used.
 Not material      Somewhat material    Very material
Standard Opinion   Qualified Opinion   Adverse Opinion
                                                         5
Qualified Opinions
• A qualified opinion is considered to be the least
  severe type of departure from an unqualified
  report.
• A qualified report can take the form of a
  qualification of both the scope and the opinion, or
  of the opinion alone.
• When a qualified report is issued, the term except
  for must be used in the opinion paragraph. Except
  for cannot be used with any other type of opinion.
• Explanatory paragraphs always are inserted before
  the opinion paragraph.
                                                      6
Qualified Opinion—Scope
Limitations
• Examples of scope limitations include:
   Failure to observe client’s ending inventories,
    because of client’s requests or a late
    appointment of the auditor by the client.
   Failure to confirm accounts receivable,
    because of client’s requests or missing or
    incomplete customer records.
   Other situations where inadequate
    accounting records exist.
                                                  7
          Qualified Opinion—Scope
                  Limitations
                                             Yes   Perform procedures
                          Are alternative          and issue standard
    Scope Limitation
                           procedures              report*
                            available?

                                     No

                               Is the        Yes
                           restriction a           Issue a disclaimer of
                            significant            opinion
                            limitation?

                                     No
* Assuming that no
  departures from GAAP   Issue a qualified
  are noted              opinion

                                                                        8
Adverse Opinion
• Used only when the auditor believes the
  overall financial statements are so materially
  misstated or misleading that they do not
  present fairly the financial position or the
  results of operations and cash flows in
  conformity with GAAP.
• The adverse opinion can be given only when
  the auditor has specific knowledge of the
  absence of conformity with GAAP.
                                               9
Disclaimer of Opinion
• A disclaimer is issued whenever the auditor has
  been unable to satisfy himself that the overall
  financial statements are fairly presented.
• Two conditions may lead to a disclaimer:
    A severe limitation on the scope of the audit.
    A nonindependent relationship between the
     auditor and the client.
• A disclaimer is distinguished from an adverse
  opinion in that it can arise only from a lack of
  knowledge by the auditor.
                                                     10
Circumstances Concerning
Comparative Financial Statements

• Different opinions on the financial statements
   Most often occurs in first-year audit with disclaimer on
    income statement and unqualified on balance sheet.
• Updating an opinion
   Opinion or report may be different than previously
    reported (on comparative financial statements) and
    auditor must explain the change in the report. Add
    paragraph just before opinion paragraph explaining
    the change.
                                                          11
Comparative Statements
• The SEC requires two years of balance
  sheets and three years of income statements
  and statements of cash flows.
• The auditor updates previous reports when
  issuing a new report.
• The updated report carries the same date as
  the current report.

                                              12
Opinion Interrelationships
    Qualified opinion                                  Adverse opinion
• Inconsistency                                      Accounting principles
                                                       violation
 Accounting principles                               Inadequate disclosure
   violation
 Inadequate disclosure                              _____Disclaimer_____
 Scope limitation                                   • Lack of
                                                      independence
 Material contingency                                 Scope limitation
  or uncertainty
                                                      Material contingency
                                                      or uncertainty
             Indicates increasing degree of materiality of condition causing
the other-than-unqualified opinion.
                                                                         13
              Comparison of Compilation, Review, and
                       Audit Engagements
                                    Type of Engagement
                   Compilation            Review                  Audit
1. Engagement    No assurance as to Limited assurance      Statements are
  objective      GAAP               as to GAAP             fairly presented in
                                                           accordance with
                                                           GAAP
2. Entities      Nonpublic only      Nonpublic             Public or nonpublic
  covered
3. CPA           Knowledge of        Knowledge same        Extensive
  knowledge of   accounting          as compilation plus   knowledge of
  client’s       principles and      increased             economy, industry,
  industry       practices of        understanding of      and client’s
                 industry and        the entity’s          business (SAS
                 general             business.             #22).
                 understanding of
                 business.
                 Comparison of Compilation, Review, and
                          Audit Engagements
                                         Type of Engagement
                     Compilation                Review                   Audit
4. Inquiry        Inquiries not           Inquiry and analytical Inquiry, analytical
   procedures     required unless         procedures required (SAS #23), and
                  information supplied    plus additional        audit procedures.
                  by entity is            procedures if
                  questionable.           information appears
                                          questionable.
5. Disclosures    Substantially all       All disclosures         Inadequate
   omitted        disclosures required    required by GAAP        disclosure requires
                  by GAAP may be          must be included.       qualified—”except
                  omitted—without                                 for”—or adverse
                  restriction on use.                             opinion.
6. Departures     Disclosure required     Disclosure required     Departure from
   from GAAP      in compilation          in review report.       GAAP requires
   measurement    report.                                         qualified—”except
                                                                  for” or adverse audit
                                                                  opinion.
              Comparison of Compilation, Review, and
                       Audit Engagements

                                       Type of Engagement
                       Compilation          Review                Audit
7. CPA’s             CPA does not      Lack of              Non-independence
  independence       have to be        independence         disclaimer
                     independent.      precludes review     required.
                                       engagement.
8. Standard report   Two paragraphs.   Three paragraphs.    Two paragraphs.
  form               Disclaimer.       Negative
                                       assurance.
9. Representation    No mention.       May obtain.          Required.
  letter.
10. Engagement       May wish to       May wish to obtain. No mention, see
    letter           obtain.                               International Audit
                                                           Guide.
                    Comparison of Audits, Reviews and
                   Compilations of Financial Statements
                            AUDIT              REVIEW           COMPILATION
Level of assurance
                          Reasonable            Limited            None
provided?
Study and
evaluation of
                              Yes                 No                 No
internal control
required?
Procedures                Sufficient to       Inquiry and       None, unless
required?              express an opinion   analytical review    information
                                                                appears to be
                                                                unacceptable
Independence
required?                     Yes                 Yes                No

Omission of
                              No                  No                Yes
footnotes allowed?
                 Comparison of Audits, Reviews and
                Compilations of Financial Statements

                           AUDIT              REVIEW          COMPILATION
Modification of          “Except for”         Paragraph          Paragraph
report for departure    qualification or      describing         describing
from GAAP?             adverse opinion        departure          departure


Modification of
report for change in     “Except for”
                                                None               None
accounting               qualification
principle?
Modification of        Unqualified with
report for material     explanatory             None               None
uncertainty?             paragraph
Modification of         “Except for”
                                           Report cannot be   Report cannot be
report for scope       qualification or
                                               issued             issued
limitation?              disclaimer
Special Reports
• Reports on financial statements prepared in accordance
  with a comprehensive basis of accounting other than
  generally accepted accounting principles.
• Reports on specific elements, accounts, or items of financial
  statements.
• Reports on compliance with aspects of contractual
  agreements or regulatory requirements related to audited
  financial statements.
• Reports on audited financial information presented in
  prescribed forms or schedules that require a prescribed
  form of auditors’ report.

                                                             19
Quarterly Information
 • Form 10-Q required by SEC.
 • Quarterly information is in more condensed
   form.
 • Quarterly reports are not audited but must be
   reviewed by an independent accountant.
 • If the company states in the 10-Q that the
   statements have been reviewed, the auditor
   must include a report.


                                                   20
 Management’s Assessment of
 Controls
• The Sarbanes-Oxley Act requires each annual report of an
  issuer to contain an "internal control report", which:
    states the responsibility of management for establishing
     and maintaining an adequate internal control structure
     and procedures for financial reporting;
    contains an assessment, as of the end of the issuer's
     fiscal year, of the effectiveness of the internal control
     structure and procedures of the issuer for financial
     reporting.



                                                                 21
 Management’s Assessment of
 Controls
• Each issuer's auditor must attest to, and
  report on, the assessment made by the
  management of the issuer.
• The attestation should be performed in
  accordance with standards for attestation
  engagements.
• An attestation engagement should not be
  the subject of a separate engagement.
                                              22
Overview: Internal/Disclosure Controls
                            Section 302(a)4-6                 Section 103/404
                “Disclosure Controls and Procedures”     “Internal Control—
Definition                                               Financial Reporting”
                “Internal Control—Financial Reporting”
            CEO/CFO certifies:                           103: Auditor’s report
            Established and maintained DC&P              describes scope of testing
            Effective design—material information        of internal control
            Evaluated effectiveness                      404: Management
Requirement                                              provides report that states:
            Disclosed any fraud and deficiencies to
            auditors and audit committees                • Their responsibility
            Disclosed changes and any corrective         • Their assessment
            action                                       accompanied by auditor’s
                                                         attestation report
                Current—Periodic evaluation, within 90   Annual assessment—as
Timing          days prior to filing date                of the end of the most
                Proposed—As of the end of the period     recent fiscal year

Source: Deloitte & Touche
Internal Control: Financial Reporting

        Notes                 Financial Reporting Controls
              Cash Flow
                            Income
                            Statement   Balance
                                        Sheet     Financial
                                                  Statements




Source: Deloitte & Touche                                      24
  Internal Control
   Authorization
                                        Safeguarding
        of
                                          of Assets
   Transactions



                            Financial
                            Reporting


                                           Assets
     Accounting                         Compared to
      Records                           Accounting
                                          Records


Source: Deloitte & Touche
  Internal Control


                                          FCPA/
                    Disclosure            Attest
                     Controls

                                               Certify/
                                              Report on
                             Laws and         Evaluation
   Operations
                            Regulations


Source: Deloitte & Touche
   Missing Link




    The “weakest link” is a compliance
    program and infrastructure to
    measure and monitor the
    effectiveness and alignment
    between corporate governance and
    business unit/functional control
    activities to provide a basis for
    certification.

Source: Deloitte & Touche
  Audit Scope:
  Pre 404 vs. Post 404




Source: Deloitte & Touche
PCAOB Auditing Standard No. 2
And Section 404

1.   Section 404 of the Act requires the management of a
     public company to (1) assess the effectiveness of the
     company’s internal control over financial reporting; and
     (2) include in the annual report management’s
     assessment about whether the internal control is
     effective.
2.   Section 404 also requires (1) auditors to attest to and
     report on management’s assessment of internal
     controls; and (2) the PCAOB establish professional
     standards governing the auditor’s attestation.


                                                           29
Benefits of the New
Internal Control Reporting
   • Enhance companies’ internal control over financial
     reporting by enabling more timely identification and
     remediation of weaknesses.
   • Through the creation of an ongoing management
     requirement, companies will learn from their evaluation
     process and remediate identified deficiencies on an
     ongoing basis, which should result in more reliable
     financial reporting and greater investor confidence.
   • Internal control over financial reporting is intended to
     provide reasonable assurance about the reliability of
     financial reporting.
   • Cost of compliance with Section 404 (significant for
     many public companies).

                                                            30
Roles and Responsibilities—Internal Control over
Financial Reporting
• Management: Designs and implements the system of
  internal control over financial reporting; evaluates the
  effectiveness of the company’s internal control over financial
  reporting and provides a public report on that assessment;
  prepares the financial statements.
• Audit Committee: Has responsibility for oversight of the
  company’s financial reporting process.
• Independent Auditor: Performs an audit of internal control
  over financial reporting and issues a report on
  management’s assessment of internal control over financial
  reporting and on the effectiveness of internal control over
  financial reporting; also performs an audit of the company’s
  financial statements.
                                                             31
What Management’s Report
Will Include
Under the SEC rules, management’s report on internal control over
  financial reporting should include the following information:
• Statement of management’s responsibility for establishing and
  maintaining adequate internal control over financial reporting.
• Statement identifying the framework used by management to evaluate
  the effectiveness of internal control over financial reporting.
• Management’s assessment of the effectiveness of the company’s
  internal control over financial reporting as of the end of the company’s
  most recent fiscal year, including an explicit statement as to whether that
  control is effective and disclosing any material weakness identified by
  management in that control.
• Statement that the registered public accounting firm that audited the
  financial statements included in the annual report has issued an
  attestation report on management’s internal control assessment.



                                                                         32
PCAOB Auditing Standard No. 2:
An Audit of Internal Control over Financial Reporting Performed in Conjunction with
an Audit of Financial Statements



    1. AS No. 2 required three integrated reports on:
         a. Financial statements audited by registered public accounting
            firms.
         b. Management’s assessment of the effectiveness of internal
            control over financial reporting (Section 404).
         c. The effectiveness of internal control over financial reporting
            over financial reporting based on the auditor’s attestation of
            internal control.
    2. AS No. 2 was effective beginning June 17, 2004.


                                                                             33
The Independent Auditor’s Opinion
The content of the auditor’s report is prescribed by the
  PCAOB standard. The most common opinions on the
  effectiveness of internal control over financial reporting will
  be:
• Unqualified Opinion. An opinion that internal control over
  financial reporting is effective: no material weaknesses in
  internal control over financial reporting exist as of the fiscal
  year-end assessment date.
• Adverse Opinion. An opinion that internal control over
  financial reporting is not effective: one or more material
  weaknesses exist as of the fiscal year-end assessment
  date.
• Disclaimer of Opinion. A report stating that restrictions on
  the scope of the auditor’s work prevent the auditor from
  expressing an opinion on the company’s internal control
  over financial reporting.
                                                                34
           Report of Independent Registered Public
                       Accounting Firm
                  1. Introductory                                    2. Scope                                       3. Definition
                  Paragraph                                          Paragraph                                      Paragraph




                   6. Inherent                                    5. Explanatory                                    4. Opinion
                   Limitations                                    Paragraph*                                        Paragraph
                   Paragraph




                  7. Signature                                       8. City and                                    9. Date
                                                                     State or
                                                                     County

*The explanatory paragraph is required only when the auditor’s opinion is other than unqualified and may also be placed after the opinion paragraph
when the auditor issues two separate reports on the audit of financial statements and internal controls, thus making reference to opinion on the
financial statement audit in the report on the internal control audit.

                                                                                                                                              35
                                                                                                          36
Source: Release No. 2004-001, pages 116−137, Appendix A—Illustrative Reports, available at pcaobus.org.
Source: Release No. 2004-001, pages 116−137, Appendix A—Illustrative Reports, available at pcaobus.org.   37
Source: Release No. 2004-001, pages 116−137, Appendix A—Illustrative Reports, available at pcaobus.org.   38
Suitable Internal Control Framework
(Example: COSO)




Source: Deloitte & Touche             39
Framework of Integrated Financial and
Internal Control Reporting (IFICR)

Required by                             Integrated financial                  Demanded by the
policymakers (SOX),                     and internal control                  capital markets
regulators (SEC),                       reporting (IFICR)                     (investors)
standard setters
(PCAOB)

                                       Overseen by the board
                                       of directors (the audit
                                       committee)
Prepared by
management                                                           Audited by the
(executive                                                           independent
certifications)                                                      auditors




                      Submitted to shareholders and filed with the
                      SEC in the form of:
                      Executive certifications of financial
                      statements and internal controls
                      Management’s assessment of internal
                      control over financial reporting (ICFR)                                   40
                      Audit report on financial statements (Form
                      10-K)
                      Audit report on ICFR
 Integrated Financial and Internal Control Reporting
 (IFICR)
                           Pre-SOX                                                           Post-SOX



                                                         SEC Rules and PCAOB AS No. 2                      SEC Interpretive Guidance and
                                                                 (2004–2006)                              PCAOB AS No. 5 (2007–beyond)

Audit        Very limited involvement of           1.     Review of audited financial statements     1.     Review of audited financial
Committee    the audit committee in                       and recommendation to the board of                statements and recommendation to
             IFICR                                        directors that financial statements be            the board of directors that financial
                                                          disseminated to shareholders                      statements be disseminated to
                                                   2.     Review of management’s assessment                 shareholders
                                                          of the effectiveness of ICFR               2.     Review of management’s
                                                   3.     Review of the auditor’s opinion on:               assessment of the effectiveness of
                                                            a. Management’s assessment of                   ICFR
                                                                  the effectiveness of ICFR          3.     Review of the auditor’s opinion on:
                                                            b. Effectiveness of ICFR                          a. Effectiveness of ICFR
                                                            c. Fair presentation of financial                 b. Fair presentation of financial
                                                                  statements in conformity with                    statements in conformity with
                                                                  GAAP                                             GAAP
Management   1.Fair presentation of financial      1.Fair presentation of financial statements in    1.Fair presentation of financial statements
             statements in conformity with GAAP    conformity with GAAP.                             in conformity with GAAP
             2.Design and maintenance of           2.Design and maintenance of adequate and          2.Design and maintenance of adequate
             adequate and effective internal       effective internal control system to prevent,     and effective internal control system to
             control system to prevent, detect,    detect, and correct material misstatements        prevent, detect, and correct material
             and correct material misstatements,   whether caused by error or fraud                  misstatements whether caused by error or
             whether caused by error or fraud      3.Report on management’s assessment of            fraud
                                                   the effectiveness of ICFR                         3.Report on management’s assessment of
                                                   4.Disclosure of significant deficiencies to the   the effectiveness of ICFR
                                                   audit committee                                   4.Disclosure of significant deficiencies to
                                                   5.Disclosure of material weakness in ICFR to      the audit committee
                                                   shareholders                                      5.Disclosure of material weaknesses in
                                                                                                     ICFR to shareholders
                                                                                                     6.More cost-effective, efficient, and
                                                                                                     scalable management involvement and
                                                                                                     reporting on ICFR



                                                                                                                                41
           Integrated Financial and Internal
            Control Reporting (IFICR) (cont.)
                           Pre-SOX                                                               Post-SOX



                                                       SEC Rules and PCAOB AS No. 2                          SEC Interpretive Guidance and
                                                               (2004–2006)                                  PCAOB AS No. 5 (2007–beyond)


Independent   1.Opinion on fair presentation of    1.Internal control testing                      1.Internal control testing
Auditor       financial statements in conformity   2.Account balance testing                       2.Account balance testing
              with GAAP                            3.Opinion on whether management’s               3.Opinion on whether management’s assessment
              2.Combination of internal control    assessment of the effectiveness of ICFR is      of the effectiveness of ICFR is fairly stated
              and account balance testing to       fairly stated                                   4.Opinion on the effectiveness of ICFR
              achieve financial statement          4.Opinion on the effectiveness of ICFR          5.Opinion on fair presentation of financial
              efficiency                           5.Opinion on fair presentation of financial     statements in conformity with GAAP
                                                   statements in conformity with GAAP              6.More cost-effective, efficient, and scalable
                                                                                                   testing of ICFR with a keen focus on a top-down,
                                                                                                   risk-based, and principles-based audit



Internal      Limited involvement in financial     Extensive involvement with management           1.Assisting management with its report on ICFR
Auditors      reporting and ICFR process           reporting on ICFR                               2.Cooperation with external auditors in their
                                                                                                   reporting on ICFR
                                                                                                   3.A more-balanced engagement in operational,
                                                                                                   compliance, and ICFR internal audit activities
                                                                                                   4.Internal auditor assurance report on ICFR




                                                                                                                                 42
Other Overriding Causes
of the Financial Crisis
→ Greedy and incompetent             → Government policies
  executives                           promoting home ownership
→ Subprime mortgage crisis           → Securitization of mortgage-
→ Falling asset pricing, including     backed assets
  houses                             → Inadequate risk assessment of
→ Highly leveraged financials          business transactions
→ Inactive credit markets            → Lack of transparency of public
→ Credit-driven rather than            financial information
  equity-driven markets              → Failure of accounting
                                       standards to properly
                                       measure fair value of financial
                                       instruments
Overriding Effects of Financial Crisis
1.   Results in a global crisis that will take time
2.   Encourages regulatory reforms
3.   Creates significant risk to GDP growth
4.   Causes a global economic meltdown
5.   Increases likelihood of bankruptcy
6.   Causes unemployment




7.
8.   http://www.youtube.com/watch?v=SwRFoxgEcHc&feature=rel
     ated (VIDEO)
Practice Opinions




                    45
 Assume the following facts about the auditor:
• The auditor is independent.
• The auditor previously expressed an unqualified opinion on
  the prior year's financial statements.
• Only single-year (not comparative) statements are
  presented.
• The conditions for an unqualified opinion exist unless
  contradicted in the factual situations.
• The conditions stated in the factual situations are material.
• No report modifications are to be made except in response
  to the factual situation.



                                                            46
                   Situation 1
Burgandy's consolidated financial statements show that
during the year just ended, the company incurred a net
loss of $400 million and at year end had a shareholders'
deficit of $125 million. The current ratio has been steadily
declining and is below that required in a loan agreement.
Company officials believe that Burgandy's existing
financial resources are adequate to finance operations
during the next fiscal year, as disclosed in a note to the
financial statements.




                                                               47
             Situation 2

The chief financial officer of Fine
Concrete Company will not permit you to
confirm accounts receivable from a major
customer. You are unable to use
alternative procedures to satisfy yourself.
The amount of the receivable is material
in relation to the financial statements.


                                              48
           Situation 3

Two weeks after year end, Regal
Wholesale, Inc., sold the franchise for
the appliances it has sold for the past
twenty years. Regal plans to dispose
of its appliance inventory and convert
its facility to a retail outlet for pottery.


                                               49
           Situation 4


Management of Marks Corporation has
declined to include a statement of cash
flows among its basic financial
statements. Cash has increased for the
past five years, and Marks's liquidity
exceeds the average of the industry.


                                          50
                      Situation 5
Drug Development Corporation is a defendant in litigation.
The nature of the company's business and its primary product
lines inherently subject the company to the hazards of
product liability litigation. The company is currently a
defendant in several product liability lawsuits. At this time, the
company's legal counsel is unable to determine whether the
outcome of the litigation will have a material impact on the
company. Accordingly, no provision has been made in the
consolidated financial statements for any liability that may
result, but notes include the litigation information.




                                                               51
                 Situation 6
Seigel Corporation has provided for depreciation
primarily by the declining-balance method on
substantially all property acquired prior to the
current year. At the beginning of the period, the
company adopted the straight-line method for
financial statements purposes for all new property
acquired. The new method conforms with that
prevalent in the industry. The effect of the change
for the current year was to increase net earnings by
an amount material in relation to net income.
                                                  52
More Practice




                53
             Situation 7

In auditing the long-term investments
account, an auditor is unable to obtain
audited financial statements for an
investee located in a foreign country. The
auditor concludes that sufficient
competent evidential matter regarding this
investment cannot be obtained.


                                             54
              Situation 8

Due to recurring operating losses and
working capital deficiencies, an auditor has
substantial doubt about an entity's ability to
continue as a going concern for a
reasonable period of time. However, the
financial statement disclosures concerning
these matters are adequate.

                                             55
               Situation 9

A principal auditor decides to take
responsibility for the work of another CPA
who audited a wholly owned subsidiary of
the entity and issued an unqualified opinion.
The total assets and revenues of the
subsidiary represent 17 percent and 18
percent, respectively, of the total assets and
revenues of the entity being audited.

                                             56
              Situation 10

An entity issues financial statements that
present financial position and results of
operations, but it omits the related
statement of cash flows. Management
discloses in the notes to the financial
statements that it does not believe the
statement of cash flows to be a useful
financial statement.
                                             57
             Situation 11

An entity changes its depreciation method
for production equipment from the straight-
line method to a units-of-production
method based on hours of utilization. The
auditor concurs with the change although
it has a material effect on the
comparability of the entity's financial
statements.

                                          58
              Situation 12

An entity is a defendant in a lawsuit
alleging infringement of certain patent
rights. However, the ultimate outcome of
the litigation cannot be reasonably
estimated by management. The auditor
believes there is a reasonable possibility
of a significant material loss, but the
lawsuit is adequately disclosed in the
notes to the financial statements.
                                             59
             Situation 13

An entity discloses in the notes to the
financial statements certain lease
obligations. The auditor believes that the
failure to capitalize these leases is a
departure from generally accepted
accounting principles.


                                             60
 Key Themes of AS No. 5
(1) Audit opinion on only the effectiveness of ICFR.
(2) Consideration of the work of previous audits.
(3) Reliance on the work of others.
(4) Use of a risk-based approach for focusing on risk
    areas.
(5) Use of a top-down approach for focusing on
    materiality and what does matter.
(6) Consideration of size and complexity.
(7) A principles-based approach of reducing unnecessary
    prescriptive audit standards.
(8) More congruence with SEC Interpretive Guidance.

                                                      61
AS No. 2 was criticized for escalating
  Section 404 compliance costs by:
•   Promoting a bottom-up and control-based
    approach to testing ICFR.
•   Requiring extensive control documentation of the
    process-level controls, and less focus on entity-
    level controls and assessment of risk related to
    significant controls.

The top-down, risk-based approach promoted in both
   the SEC’s Interpretive Guidance and AS No. 5 is
   designed to refocus both management and
   auditors on controls that matter and risks that
   threaten the integrity and reliability of financial
   reports.
                                                         62
Definitions
 The SEC’s Interpretive Guidance and AS No. 5 provide the following
 definitions of significant deficiency and material weakness of ICFR:
 • A significant deficiency is a deficiency, or a combination of
 deficiencies, in internal control over financial reporting that is less
 severe than a material weakness, yet important enough to merit
 attention by those responsible for oversight of the company’s financial
 reporting.
 • A material weakness is a deficiency, or a combination of deficiencies,
 in internal control over financial reporting, such that there is a
 reasonable possibility that a material misstatement of the company’s
 annual or interim financial statements will not be prevented or detected
 on a timely basis.[1]
   [1]
     Public Company Accounting Oversight Board (PCAOB). 2007. Auditing Standard No. 5: An Audit of Internal
   Control over Financial Reporting That Is Integrated with an Audit of Financial Statements. Available at:
   www.pcaob.org/Rules/Rules_of_the_Board/Auditing_Standard_5.pdf.

                                                                                                              63
       Conventional Audit                       Integrated Audit




                                                      Integrated Audit
 Mandatory or           Audit of                         of Internal
Voluntary Audit        Financial                        Control over
  of Internal         Statements                          Financial
   Controls                                            Reporting and
                                                          Financial
                                                        Statements



         Integrated                Internal Control
            Audit                       Audit                         Financial
                                                                  Statement Audits




                                                                                     64
65
66
67
Source: Excerpt from PCAOB AS No. 5. Public Company
Accounting Oversight Board (PCAOB). 2007. Auditing
Standard No. 5. An Audit of Internal Control over Financial
Reporting That is Integrated with an Audit of Financial
Statements (May 24). Available at:
pcaobus.org/Rules/Rules_of_the_Board/Auditing_Standard_5
.pdf.                                                    68
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            Materiality and Risk




                                   69

								
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