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BA 427 – Assurance and Attestation Services Lecture 1 Introduction.

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Presentation on theme: "BA 427 – Assurance and Attestation Services Lecture 1 Introduction."— Presentation transcript:

1 BA 427 – Assurance and Attestation Services Lecture 1 Introduction

2 Lecture 1 – Introduction  Syllabus  Course Requirements  Course Materials and Resources  Corporate Governance

3 Lecture 1 – Grading

4 Lecture 1 – course materials  Gleim’s 2006 CPA Review Guide: Auditing & Attestation, available from the OSU bookstore and from the publisher’s website.  Course Readings Packet, available from the OSU bookstore.  Additional required readings will be distributed in class and others are available on the web.  Optional: Auditing and Assurance Services by Arens, Elder & Beasley, 11 th edition

5 Lecture 1 – course objectives  Help you succeed in your first weeks on the job  Help you pass the CPA exam  Help you in your first two promotions

6 Lecture 1 – course objectives  These objectives have driven the following choices for the course: Gleim as our “textbook” Extensive use of source documents Coverage of topics that will help you advance in your career, but that are not included in the firm’s continuing education training Six outside speakers from the accounting profession

7 Lecture 1 – course objectives  The great issues of our day The detection of fraud The independence of the independent public accountant Corporate governance and aggressive financial reporting Self-regulation by the public accounting profession

8 Lecture 1 – how to succeed  Do not fall behind on the readings.  Understand how to learn from Gleim.  Understand how to skim materials in the readings packet.  Participate in class discussions, particularly when outside speakers are here.

9 Lecture 1 – Introduction  Syllabus  Course Requirements  Course Materials and Resources  Corporate Governance

10 Overview of the Course Corporate Governance & Reporting The Public Audit Regulatory Oversight The Audit Committee Internal Controls Internal Auditing

11 A Framework for everything we do:  Ask five questions: Who When What Why How

12 A Framework for everything we do:  Ask five questions: Who: the private sector, a regulator, a self-regulatory body? When: the sequence of events is important. What: is this a study, a recommendation, a rule, and what is its impact? Why: Motives; what is the economic, legal and political context? How: what provided this entity or person the resources or clout to have an impact?

13 The Players The Private Sector Self-regulatory Bodies Regulators The SEC U.S. Congress The Courts Public Accounting Firms Investors Financial Accounting Standards Board The New York Stock Exchange Auditing Standards Board American Institute of Certified Public Accountants Public Oversight Board Wall Street Companies doing business in the U.S. The PCAOB State Boards The GAO Ethics Division of the AICPA

14 An example:  “Audit Committees: A Call to Action”: Who  Lynn Turner, SEC Chief Accountant from about 1997 to 2001, under SEC Chairman Arthur Levitt When  October 5, 2000 (before the bubble burst; see next slide) What  A public speech delivered in New York Why  To encourage self-regulation and regulatory reform How  The SEC Chief Accountant is a high-profile position

15 An example:  “Audit Committees: A Call to Action” Yet investors and the business community learned a very valuable lesson 70 years ago—that the trust and confidence in markets can be shaken and lost. We learned that liquidity can disappear and capital quickly dry up. Fair and orderly markets can dissolve much more quickly than they are built. An economy that is seemingly the Emerald City of Oz with roads of gold can turn to a bowl of dust overnight.

16 An example:  “Audit Committees: A Call to Action”: Here are all (or most) of the sources that Turner references and quotes in his speech:  The Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees  The Committee of Sponsoring Organizations (COSO) 1999 report “Fraudulent Financial Reporting: 1987 – 1997”  The Panel on Audit Effectiveness  SAS 89 and SAS 90, issued by the APB  Warren Buffett  “New Responsibilities and Requirements for Audit Committees,” by Arthur Andersen

17 Corporate Governance  Key regulatory and self-regulatory events The Foreign Corrupt Practices Act The Treadway Report The Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees

18 The FCPA  The Foreign Corrupt Practices Act In 1976, bribes originating from Lockheed Aircraft led to the arrest of a former Prime Minister of Japan.

19 The FCPA  The Foreign Corrupt Practices Act Signed by President Carter in 1977 Best known for its prohibition against U.S. companies bribing foreign officials  This prohibition is sometimes incorrectly characterized as prohibiting “grease payments” to foreign government bureaucrats. It does not do that. The FCPA also imposes on U.S. public companies internal accounting control and bookkeeping requirements.

20 The FCPA  The Foreign Corrupt Practices Act The increased bookkeeping and internal accounting controls requirements were intended to supplement the anti-bribery provisions, by  increasing corporate accountability;  decreasing the likelihood that illegal payments can be concealed.

21 The FCPA  The Foreign Corrupt Practices Act The bookkeeping requirements:  Every public company shall make and keep books, records, and accounts which, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the issuer.

22 The FCPA  The Foreign Corrupt Practices Act The Act requires companies to devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that:  Transactions are executed in accordance with management’s general or specific authorization.  Transactions are recorded as necessary to permit preparation of financial statements in conformity with GAAP, and to maintain accountability for assets.  Access to assets is permitted only in accordance with management’s general or specific authorization.  The recorded accountability for assets is compared with the existing assets at reasonable intervals and appropriate action is taken with respect to any differences.

23 The FCPA  The Foreign Corrupt Practices Act The Act codified existing concepts and “best practices” The Act is concerned with accounting controls only, not all internal controls. The Act acknowledges that all controls are subject to a cost/benefit test. For the first time, weak internal controls can subject public companies, their officers and employees to civil liability and criminal prosecution under federal law.

24 Corporate Governance  Key regulatory and self-regulatory events The Foreign Corrupt Practices Act The Treadway Report The Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees

25 Treadway  Formally, The Report of the National Commission on Fraudulent Financial Reporting.  Chaired by James Treadway, Jr., Executive V.P. and General Counsel of Paine Webber (and former SEC Commissioner).  The Commission conducted a two-year study of the financial reporting system in the U.S., and issued its report in October, 1987.

26 Treadway  The Commission was sponsored and funded by: The AICPA The American Accounting Association The Institute of Internal Auditors The National Association of Accountants (now the Institute of Management Accountants) The Financial Executives Institute (now Financial Executives International)  These organizations constitute “COSO”, the Committee of Sponsoring Organizations

27 Treadway  Key conclusion: “Fraudulent financial reporting is indeed a serious problem. Infrequent though its occurrence arguably may be, its consequences can be widespread and significant.  The Treadway Report consists primarily of a series of recommendations

28 Treadway  Recommendations to Public Companies: The Tone at the Top: the tone set by top management—the corporate environment or culture within which financial reporting occurs—is the most important factor contributing to the integrity of the financial reporting process.

29 Treadway  Recommendations to Public Companies: Top management must identify, understand, and assess the factors that may cause the company’s financial statements to be fraudulently misstated. Public companies should maintain internal controls that provide reasonable assurance that fraudulent financial reporting will be prevented or subject to early detection. Public companies should develop and enforce written codes of conduct that foster a strong ethical climate and open channels of communication. The Audit Committee should review annually the program that management establishes to monitor compliance with the code.

30 Treadway  Recommendations to Public Companies: Public companies should maintain accounting functions that are designed to meet their financial reporting obligations. Public companies should maintain an effective internal audit function staffed with an adequate number of qualified personnel. Public companies should ensure that their internal audit functions are objective. Internal auditors should consider the implications of their nonfinancial audit findings for the company’s financial statements.

31 Treadway  Recommendations to Public Companies: Management and the audit committee should ensure that the internal auditors’ involvement in the audit of the entire financial reporting process is appropriate and properly coordinated with the independent public accountant. The SEC should require all public companies to establish audit committees composed solely of independent directors. Audit committees should be informed, vigilant, and effective overseers of the financial reporting process and the company’s internal controls.

32 Treadway  Recommendations to Public Companies: All public companies should develop a written charter setting forth the duties and responsibilities of the audit committee. The board should approve the charter and review it periodically. Audit committees should have adequate resources and authority to discharge their responsibilities. The audit committee should review management’s evaluation of factors related to the independence of the company’s public accountant. Both the audit committee and management should assist the public accountant in preserving his independence.

33 Treadway  Recommendations to Public Companies: Before the beginning of each year, the audit committee should review management’s plans for engaging the company’s independent public accountant to perform management advisory services during the coming year, considering both the types of services that may be rendered and the projected fees.

34 Treadway  Recommendations to Public Companies: All public companies should be required by SEC rule to include in their annual reports management reports signed by the CEO and the chief accounting officer and/or the CFO. The report should acknowledge management’s responsibilities for the financial statements and internal control, discuss how these responsibilities were fulfilled, and provide management’s assessment of the effectiveness of the company’s internal controls.

35 Treadway  Recommendations to Public Companies: All public companies should be required by the SEC to include in their annual reports a letter signed by the chairman of the audit committee describing the committee’s responsibilities and activities during the year. Management should advise the audit committee when it seeks a second opinion on a significant accounting issue. The SEC should require public companies that change their independent accountants to disclose the nature of any material accounting or auditing issue discussed with both its old and new auditor during the three-year period prior to the change.

36 Treadway  Recommendations to Public Companies: Audit committees should oversee the quarterly reporting process. COSO should cooperate in developing additional, integrated guidance on internal control.

37 Treadway  Recommendations to CPAs: The ASB should revise standards to restate the independent public accountant’s responsibility for detection of fraudulent financial reporting, requiring the independent accountant to (1) take affirmative steps in each audit to assess the potential for such reporting, and (2) design tests to provide reasonable assurance of detection. Revised standards should include guidance for assessing risks and pursuing detection when risks are identified.

38 Treadway  Recommendations to CPAs: The ASB should establish standards to require independent public accountants to perform analytical review procedures in all audit engagements and should provide improved guidance on the appropriate use of these procedures. The SEC should require independent public accountants to review quarterly financial data of all public companies before release to the public.

39 Treadway  Recommendations to CPAs: The AICPA’s SEC Practice Section should strengthen its peer review program by increasing review of audit engagements involving public company clients new to a firm. For each office selected for peer review, the first audit of all such new clients should be reviewed. Public accounting firms should recognize and control the organizational and individual pressures that potentially reduce audit quality.

40 Treadway  Recommendations to CPAs: The AICPA’s SEC Practice Section requirement for a concurring (second) partner review should be revised to  require the concurring partner’s involvement in the planning stage of the audit,  require the concurring partner to have prior experience with SEC registrants, and familiarity with the client’s industry,  require the concurring partner to consider himself a peer of the engagement partner for purposes of the review.

41 Treadway  Recommendations to CPAs: The ASB should revise the auditor’s standard report  to state that the audit provides reasonable but not absolute assurance that the audited financial statements are free from material misstatements as a result of fraud or error.  to describe the extent to which the independent public accountant has reviewed and evaluated the system of internal accounting control. The ASB also should provide explicit guidance to address the situation where, as a result of his knowledge of the company’s internal accounting controls, the independent public accountant disagrees with management’s assessment as stated in the proposed management report.

42 Treadway  Recommendations to CPAs: The AICPA should reorganize the ASB to afford a full participatory role in the standard-setting process to knowledgeable persons who are affected by and interested in auditing standards but who either are not CPAs or are CPAs no longer in public practice.

43 Treadway  Recommendations to the SEC and regulators The SEC should have the authority to impose civil money penalties in administrative proceedings. The SEC should have the authority to issue a cease and desist order when it finds a securities law violation. The SEC should seek explicit statutory authority to bar or suspend corporate officers and directors involved in fraudulent financial reporting from future service in that capacity in a public company. Criminal prosecution of fraudulent financial reporting cases should become a higher priority.

44 Treadway  Recommendations to the SEC and regulators The SEC should require accounting firms that audit public companies to be members of a professional organization that has peer review and independent oversight functions and is approved by the SEC, such as the SEC Practice Section of the AICPA. The SEC should take enforcement action when a public accounting firm fails to remedy deficiencies cited by the public accounting profession’s quality assurance program. The SEC must be given adequate resources to perform existing and additional functions that help prevent, detect, and deter fraudulent financial reporting.

45 Treadway  Recommendations to the SEC and regulators The Office of the Comptroller of the Currency, the Federal Reserve Board, the F.D.I.C., and the Federal Home Loan Bank Board should adopt measures patterned on the Commission’s recommendations directed to the SEC. The financial institution regulatory agencies and the public accounting profession should provide for the regulatory examiner and the independent public accountant to have mutual access to information they develop about examined financial institutions.

46 Treadway  Recommendations to the SEC and regulators State boards of accountancy should implement positive enforcement programs that periodically would review the quality of services that the independent public accountants they license render. Parties charged with responding to various tort reform initiatives should consider the implications that the perceived liability crisis holds for long-term audit quality and the independent public accountant’s detection of fraudulent financial reporting.

47 Treadway  Recommendations to the SEC and regulators The SEC should reconsider its longstanding position, insofar as it applies to independent directors, that the corporate indemnification of officers and directors for liabilities that arise under the Securities Act of 1933 is against public policy.

48 Treadway  Recommendations to Educators Throughout the business and accounting curricula, educators should foster knowledge and understanding of the factors that may cause fraudulent financial reporting and the strategies that can lead to a reduction in its incidence. The business and accounting curricula should promote a better understanding of the function and the importance of internal controls, including the control environment, in preventing, detecting, and deterring fraudulent financial reporting.

49 Treadway  Recommendations to Educators Business and accounting students should be well- informed about the regulation and enforcement activities by which government and private bodies safeguard the financial reporting system and thereby protect the public interest. The business and accounting curricula should help students develop stronger analytical, problem solving, and judgment skills to help prevent, detect, and deter fraudulent financial reporting when they become participants in the financial reporting process.

50 Treadway  Recommendations to Educators The business and accounting curricula should emphasize ethical values by integrating their development with the acquisition of knowledge and skills to help prevent, detect, and deter fraudulent financial reporting. Business schools should encourage business and accounting faculty to develop their own personal competence as well as classroom materials for conveying information, skills, and ethical values that can help prevent, detect, and deter fraudulent financial reporting.

51 Treadway  Recommendations to Educators Professional certification examinations should test students on the information, skills, and ethical values that further the understanding of fraudulent financial reporting and that promote its reduction. As part of their continuing professional education, independent public accountants, internal auditors, and corporate accountants should study the forces and opportunities that contribute to fraudulent financial reporting, the risk factors that may indicate its occurrence, and the relevant ethical and technical standards.

52 Corporate Governance  Key regulatory and self-regulatory events The Foreign Corrupt Practices Act The Treadway Report The Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees

53 The Blue Ribbon Committee  The Blue Ribbon Committee Instigated by the SEC Sponsored by the NYSE and the NASD 11 committee members Initiated in 1998, issued its report in 1999 At the time, the major exchanges required companies to maintain audit committees, but did not specify their composition or function.

54 The Blue Ribbon Committee  The Blue Ribbon Committee members NYSE Chairman and CEO Richard Grasso NASD Chairman and CEO Frank Zarb E&Y Chairman & CEO Philip Laskawy PwC CEO James Schiro POB board member Charles Bowsher TIAA-CREF Chairman and CEO John Biggs Retired Goldman Sachs Co-Chair Whitehead Four others

55 The Blue Ribbon Committee  The Blue Ribbon Committee issued ten recommendations: Two to improve audit committee independence Three to improve audit committee effectiveness Five to address mechanisms for accountability among the audit committee, the external auditors, and management

56 The Blue Ribbon Committee  Audit committee independence: Directed at NASD and NYSE companies with market capitalization over $200 million. All audit committee members should be independent. Restrictions include:  Not employed by the company within the past five years.  No compensation from the company except for board service or under a retirement plan.  No family member who has served as an executive officer of the company for the past five years.

57 The Blue Ribbon Committee  Audit committee effectiveness: Large companies should have audit committees of at least three members, all of whom are financially literate. At least one member should have accounting or financial management expertise. Audit committees of all companies should have written charters. The SEC should require companies to disclose information related to the audit committee’s charter, and compliance therewith.

58 The Blue Ribbon Committee  Accountability The external auditors are ultimately accountable to the board of directors and the audit committee. The audit committee is responsible for retaining the auditor. The audit committee is responsible for monitoring and ensuring the independence of the external auditor. GAAS should require auditors to discuss with the audit committee the quality, not just the acceptability, of the company’s financial reporting.

59 The Blue Ribbon Committee  Accountability The SEC should require companies to include in its 10K a letter from the audit committee indicating whether the committee has discussed the audited financial statements privately among its members, with management, and with the auditors. The SEC should require interim financial reviews of 10Qs by the external auditors, and the auditors should discuss quarterly results with the audit committee.

60 The Blue Ribbon Committee  The Committee’s “guiding principles” for best practices: Audit committee oversight of the work of others in the financial reporting process; Private communication between the audit committee and the internal auditors; Private communication between the audit committee and the external auditors; Frank discussions with management; Diligent and knowledgeable audit committee members.

61 The Blue Ribbon Committee  In distributing the Blue Ribbon’s report to interested parties, the POB included a cover letter that stated: “The POB believes that corporate America stands on the threshold of sharply increased effectiveness of corporate governance, which hopefully will lead to sounder financial reporting.”

62 The Blue Ribbon Committee  The Blue Ribbon Committee itself stated: “If an audit committee is determined to be diligent in its oversight role, a sure sense of appropriate action will follow; credible diligence is not rocket science.”

63 Robert K. Jaedicke Dean, 1983 – 90, Stanford Graduate School of Business and Director of the Audit Committee at Enron The Blue Ribbon Committee


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