1. Electronic Presentations in Microsoft ® PowerPoint ® Prepared by Brad MacDonald SIAST © 2003 McGraw-Hill Ryerson Limited

2. Copyright © 2003 McGraw-Hill Ryerson Limited Chapte r 1 2 Professional Practice

3. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 1 3 Learning Objective 1 Distinguish auditing from accounting.

4. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 1 4Auditing An independent intermediary provides assurance to users that management’s statements are reliable. –Client – retains the auditor (user) –Auditee – entity whose statements are under review (management) –Auditor – independent intermediary

5. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 1 5Accounting Accounting attempts to record and summarize a company’s transactions into financial statements for the benefit of users. –Function of an organization’s management –Users are removed from accounting due to complexity, remoteness or consequences –Possibility for conflict of interest between users and management.

6. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 1 6 Learning Objective 2 Chronicle the historical development of auditing standards, including the criticisms of the profession and its responses.

7. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 1 7 Brief History of Auditing 1500 BC - Recordkeeping - Linear B script 500 BC - King Darius “King’s ears” 1500 AD - Double-entry bookkeeping - British legislation requires audits (1844, revised 1900) 1844 AD - Accountants’ societies formed Great Britain – 1854, ICAO – 1879, CICA – 1902, CGAAC - 1913 1854 AD - Canadian legislation requires audits Ontario Corporations Act - 1907 Federal Corporation Act - 1917 1907 AD

8. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 1 8 Brief History of Auditing - Stock market crash, Great Depression1929 - US Securities Acts create SEC 1933 - CICA issues standards (handbook)1946 - OSC mandates use of handbook, followed by Ontario Securities Act and Canadian Business Corporations Act 1965 - Estey Commission questions standards 1985 - Macdonald Commission recognizes expectation gap 1988 - Enron and Anderson collapse2002

9. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 1 9 Learning Objective 3 Describe the effects of Enron and related scandals in the profession.

10. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 1 10Enron Following the collapse of energy giant Enron, trust in the North American markets fell to an all-time low. –Other large companies such as those following have contributed to the erosion of trust: Global Crossing, WorldCom, Adelphia Communications, Tyco International… –The accounting profession has become a casualty of Enron.

11. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 1 11 The Post-Enron World Costs from the collapse of Enron include: –Investors lost over $60 billion dollars. –6,000 employees lost their jobs and most of their retirement savings. –Numerous lawsuits resulted against management, the board of directors, financial institutions, and of course, the auditors. –The resulting scandal caused the collapse of the accounting firm Arthur Anderson.

12. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 1 12 Arthur Anderson and Enron At the beginning of 2002, Arthur Anderson employed 85,000 people world wide. –The firm was essentially destroyed by October 2002, when the firm was sentenced for obstruction of justice. –Clients left the firm due to Arthur Anderson’s failing reputation. –Arthur Anderson was seen to lack objectivity in its audit of Enron, due to the extensive consulting work performed for the client.

13. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 1 13 Sarbanes-Oxley Act The Sarbanes-Oxley Act (SOX) was passed into law in the United States on July 30, 2002 –Sped by the failures of Enron and WorldCom –Created a Public Company Accounting Oversight Board Increased penalties for corporate wrongdoers More timely and extensive financial disclosures New options of recourse for aggrieved shareholders Full ramifications yet to be seen

14. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 1 14 Sarbanes-Oxley Act SOX and the financial disasters that led to it have had an impact around the world: –In Canada, the CICA helped organize the Canadian Public Accountability Board to oversee auditors of public companies. –The question of self-regulation or government involvement in the markets is being raised. –Auditors are increasingly finding that their work is being second-guessed by regulators.

15. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 1 15 Learning Objective 4 Define and explain auditing, especially its role in information risk reduction.

16. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 1 16 Definition of Auditing Academic accountants’ definition: Auditing is a systematic process of objectively obtaining and evaluating evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between the assertions and established criteria and communicating the results to interested parties.

17. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 1 17 Audit Objectives “The objective of the audit of financial statements is: to express an opinion whether the financial statements present fairly, in all material respects, the financial position of the company in accordance with generally accepted accounting principles…” CICA Handbook, Section 5090

18. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 1 18 Audit Objectives An audit opinion is not: –an assurance as to future viability –an opinion as to effectiveness and efficiency of operations and controls In performance of an audit, the auditor complies with generally accepted auditing standards (GAAS).

19. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 1 19 A Definition of Auditing Relating to “Risk Reduction” Business risk: –This risk is the chance a company takes that inflation will rise, taxes will increase, customers will buy from competitors, government grants will be lost, employees will strike and the like.

20. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 1 20 A Definition of Auditing Relating to “Risk Reduction” Information risk: –Financial statements will fail to appropriately reflect economic substance of business activities, including business risks and uncertainties. Auditing: –A process of reducing information risk to users of financial statements.

21. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 1 21 Learning Objective 4 Describe the audits and auditors in governmental, internal, and operational auditing.

22. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 1 22 Operational and Internal Auditing Internal auditing –An independent appraisal function established within an organization. Operational auditing –Has the purpose of making recommendations about the economic and efficient use of resources, effective achievement of business objectives, and compliance with company policies.

23. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 1 23 Governmental Auditing Auditor General of Canada (OAG) –The accounting, auditing and investigative agency of Parliament. Public sector audits –Include financial audits, compliance audits, and value-for-money audits.

24. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 1 24 Governmental Auditing Financial statement audits –Determine whether financial statements present fairly the financial position, results of operations in accordance with GAAP Compliance audits –Determine whether an entity has complied with laws and regulations Value-for-money audits –Economy, efficiency, and effectiveness audits

25. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 1 25 Regulatory Auditors Canada Customs and Revenue Agency (CCRA) auditors: –determine taxpayers correspondence with the standards found in the tax regulations –audit for tax fraud and tax evasion Federal and provincial bank examiners: –audit banks, trust companies, and other financial institutions

26. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 1 26 Learning Objective 6 Describe the various public accounting associations, and the organization of public accounting firms, and identify the various services they offer.

27. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 1 27 Accounting Profession Canadian accounting associations have both national and provincial associations: –Canadian Institute of Chartered Accountants –Certified General Accountants Association of Canada –Society of Management Accountants International Federation of Accountants American Institute of Certified Public Accountants

28. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 1 28 Public Accounting Firms Perception of public firms is dominated by the “Big four” firms: –Ernst & Young –Deloitte & Touche –KPMG –PricewaterhouseCoopers Accounting firms are organized as partnerships, or as limited liability partnerships (LLPs).

29. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 1 29 Public Accounting Services Assurance services: –Audit 30% to 40% for large firms (drastic reduction) –Non-auditing accounting and review services - big source of revenue for small firms services in relation to presentations other than financial statements

30. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 1 30 Public Accounting Services Non-assurance services –Taxation services tax planning and preparation –Consulting services all accounting firms handle a great deal of consulting SOX will restrict consulting to audit clients Consulting will remain a large part of most public accounting practices.

31. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 1 31 Regulation of Public Accounting Provincial Accountancy Acts –In Canada, there is a trend to open public accounting to CAs, CGAs, and CMAs. Legal system and regulators under Federal Bank Act Securities commissions

32. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 1 32 Learning Objective 6 Provide an overview of international and US auditing.(Appendix 1a)

33. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 1 33 International Auditing Increased economic integration and rapid globalization –International Federation of Accountants (IFAC) 1977 –International Standards of Auditing (ISAs) International Auditing and Assurance Standards board created and funded April 1, 2002. –CICA policy to adopt ISAs unless Canadian conditions require different standard.

34. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 1 34 US Auditing Standards have been set by the American Institute of Certified Public Accountants (AICPA). –Cohen Commission in the 1970s and the Treadway Commission suggested greater governmental control over the process. –In 1990s concern over independence of auditors was raised. –In 2002, SOX created the Public Company Accounting Oversight Board (PCAOB).

35. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 1 35 US Auditing PCAOB –responsible for inspection and disciplining of public accounting firms –Extent to which this board will follow recommendations of Cohen Commission remains to be seen.

36. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 1 36 Learning Objective 8 Describe alternative theories of the role of auditing in society. (Appendix 1B)

37. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 1 37 Information Hypothesis Auditing is an information risk reducing activity. –Audits are demanded to reduce losses resulting from faulty decisions based on incorrect or incomplete information.

38. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 1 38 Monitoring Hypothesis Based on principal-agent framework of economic theory. –If managers are not monitored, they will not function efficiently. –The market will price securities accordingly. –The audit is seen as a way to monitor management’s opportunistic behaviour.

39. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 1 39 Insurance Hypothesis Auditors are in demand so that they may be sued in the case there is a business failure. –Degree of recourse: Negligence – need to demonstrate that the auditor failed to perform the audit properly. Implied Warranty – need only show that the audit did not uncover material misstatement.

40. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 1 40 Comparison of Theories The theories should be seen as complimentary, rather than exclusive. –Each theory may apply in different degrees in different jurisdictions. Risk of legal action much higher in US (insurance theory) than Canada. –All theories lead to reduction of information risk.

41. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 1 41 Learning Objective 9 List and explain the requirements for becoming a PA.

42. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 1 42 Becoming a Public Accountant Public accountants are governed by provincial regulations. –Four basic requirements -- education, examinations, practical experience, and a provincial certificate and license. –CAs, CGAs, CMAs - see websites

43. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 1 43 Learning Objective 9 Describe the accounting and auditing activities of the professional accounting organizations.

44. Copyright © 2003 McGraw-Hill Ryerson Limited Chapter 1 44 Responsibilities of Accounting Organizations Setting and enforcing standards: qualification, adherence, and enforcement CICA has primary responsibility for setting standards of practice (CICA Handbook). –Regulation 44 of the Canada Business Corporation Act Financial statements of companies must be prepared in accordance with the CICA Handbook.