The Role of the Public Accountant in the American Economy

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-2 The Attest Function Management Subject Matter Suitable Criteria The CPA Gathers Evidence Subject Matter* The Attest Report Issues Report *May be management’s assertion about the subject matter.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-3 Attestation Engagements Type of Engagement Level of Assurance Nature of Report Procedures Examination Highest Expresses opinion Sufficient to limit attestation risk to low level

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-4 Attestation Engagements Type of Engagement Level of Assurance Nature of Report Procedures Examination Review Highest Moderate or Limited Expresses opinion Expresses negative assurance Sufficient to limit attestation risk to low level Generally limited to inquiry & analytical procedures

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-5 Attestation Engagements Type of Engagement Level of Assurance Nature of Report Procedures Examination Review Agreed-upon procedures Highest Moderate or Limited Varies with procedures Expresses opinion Expresses negative assurance States findings Sufficient to limit attestation risk to low level Generally limited to inquiry & analytical procedures Procedures agreed- upon with the specified users

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-6 Audit of Financial Statements Management Prepares Financial Statements Criteria (e.g., GAAP) The Auditors Gathers Evidence Financial Statements The Auditors’ Report Issues Report

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-7 What Creates the Demand for Audits? Audits lend credibility to information by reducing information risk, the risk that information is materially misstated Financial statement misstatements arise due to-- Accidental errors Lack of knowledge of accounting principles Unintentional bias Deliberate falsification Audits do not directly address business risk, the risk that a company will not be able to meet its financial obligations due to economic conditions or poor management decisions

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-8 History of the Attest Function PeriodDevelopments Audit Objective Nature of Audit Ancient - Ancient Audits of city states, individuals & ventures Detection of fraud Detailed; No reliance on controls Industrial revolution resulted in the need for corporate audits Detection of fraud & clerical errors Some testing; No reliance on controls Development of stock markets - increased emphasis on earnings Determination of fairness; detection of fraud & errors Increased emphasis on testing; Slight reliance on controls Development of auditing standards Determination of fairness Substantial reliance on controls Criticism by Congress; Increased self-regulation Determination of fairness Internal control determines scope of audit Increased demands for reporting on compliance & internal control Determination of fairness Risk assessment determines audit scope; must assess risk of fraud 1995-Present Panel on Audit Effectiveness; Sarbanes- Oxley Act of 2002 Determination of fairness Business risk approach to audits

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-9 The Accounting Profession’s Credibility Crisis 2000—The Panel on Audit Effectiveness made a variety of suggestions to improve audits. 2001—Enron Bankruptcy 2002—WorldCom Fraud 2002—Sarbanes-Oxley Act 2003—Public Company Accounting Oversight Board began operations

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved Types of Audits Audits of Financial Statements Compliance Audits Operational Audits

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved Types of Auditors External Auditors Internal Auditors GAO Auditors Tax Auditors

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved AICPA’s Traditional Role Establishes Standards Research and Publication Continuing Professional Education Self-Regulation CPA Examination Note: The standards setting and regulation roles have been taken over by the SEC and the PCAOB with respect to auditors of public companies.

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved Types of Professional Services Attestation and Assurance Tax Consulting Accounting Personal Financial Planning Fraud Investigation

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved Typical Structure of a National CPA Firm Partners Managers Seniors Staff