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0:13
Hello this is Dr. Paz and welcome to our auditing chapter to professional standards
0:20
Lecture if you'll see right here we're going to be discussing Bernie Madoff and he is actually the case that we have for this learning module and you'll see that he actually Embezzled fifty billion dollars from investors in what has been known as our classic Ponzi scheme So let's go over what you're going to learn. We are going to discuss generally accepted auditing standards gasps Generally Accepted Auditing Standards we're also going to discuss the fundamental principles of
0:54
responsibilities and how they apply to the characteristics and the qualifications that auditors must have we're also going to talk about the fundamental principle of performance in the activities that we have to perform during an audit and lastly we're going to talk about the fundamental principles of Reporting, which is the content of our auditors report Which is basically the opinions that we give not only on internal controls
1:21
but also on our financial statements and lastly we're going to discuss the role of quality control and monitoring as they relate to our professional Quality and the appropriate level that we need to have as auditors So let's dive right in and let's start with a little bit of history of our professional standards settings in this course We will talk about the PCAOB the Public Company Accounting
1:50
Oversight
1:54
Board
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And that is pretty much our regulatory bodies from
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2003 to current keep in mind that in 2002 we had a Known as Enron and then we had sarbanes-oxley You can also refer to the statement of auditing standards from the AICPA the American Institute of Certified Public Accountants, so these are the two types of professional standards that you will be kind of citing in your Cases and also just referring to as you learn auditing so the auditing standards that we're looking at as I mentioned for the PCAOB standards and the AICPA
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Statements of auditing standards note that our PCA will be standards Those are the ones that pretty much deal with the audit of public entities. They don't really deal with non public entities So right here is where we're in the external audit phase
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so anytime we're talking about external audit you're gonna be in the PCAOB realm and if you're talking about Non-public or sometimes internal auditing then the AICPA will be relevant So let's go over gas generally accepted accounting principles and here are the three main Fundamental principles that we have that we covered within our learning objectives responsibilities Performance and reporting and then lastly where we're going to talk about the quality of public accounting firms
3:20
so gas pretty much tells us the qualifications and the Characteristics that really guides the auditor and how they conduct their audits now the purpose of generally accepted auditing standards Is basically we're trying to find reasonable assurance that the financial Statements are free of material misstatement. This is a critical This is a critical piece here. So you want to make sure you remember that audits provide?
3:51
Reasonable assurance that the financial statements are free of material misstatement we're not saying that they are free from error and We are not saying that they are free from fraud. All we're saying is that in an audit is that they're free of material misstatement? So the report on the financial statements basically is communicated in what the auditor fine And that report is our audit opinion
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And note we have two opinions we have an opinion on the financial statement and we have an opinion on the internal controls and those opinions are what's known as our Integrated audit which basically means we audit both facets now financial statement and internal controls So now let's talk about just the entire pronouncements, right? So here we have gasp and then here we have the three fundamental
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Principles that we just went over reporting and performance and responsibilities. Then we have our PCAOB Which pretty much gives us? The requirements to support these principles and then lastly we have interpretive publications this is where we focus with the PCAOB and the fundamental principles because remember this is kind of going both ways, right so our PCAOB is what's kind of detailing what we have to do and what's require for the fundamental principles
5:15
So we have then the ten basic standards. This is Happily tested on the CPA exam the audit section. So you want to make sure that you pay extra special attention? So we have general standards that we have to have training and proficiency Auditors have to be independent and they have to have do professional care So basically what that's telling us as auditors is we have to be confident. We have to know what we're doing
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there are some ethical requirements of Independence and that we do care that we're actually saying what we're doing and the key point here is Professional skepticism and professional judgment, so here you have to have an inquisitive mind and you have to question what doesn't make sense?
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Then we have standards of fieldwork So when we're actually out at the client location conducting our audit our audit should be planned and supervised, right? We need to gain an understanding of the entity and we have to assess risk For material misstatement the higher the risk the more you have to audit, right? So if the risk is lower than our fieldwork would be less and maybe the amount of evidence that we need to get is less
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And you'll note that we need to have evidence that is sufficient and appropriate again a very important concept Sufficient and appropriate is our evidence and the ending result is our audit report Which we now know is our audit opinion so that's where we're heading and
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Lastly let's talk about these statements of the standards of reporting, right? So here we're saying that in our audit opinion that the financial statements were Prepared according to GAAP and that gap is applied consistently, so there isn't a departure of GAAP And also we're saying that we need and we have the proper disclosures which is really the footnotes or the notes to the financial statements And then we have to express or disclaim an opinion and there are several types of opinion the
7:17
unqualified opinion is hopefully the most common which is basically the clean opinion which tells you that the financial statements are free of material misstatement Right, so they are not free of error and they are not free of fraud that they are free of material misstatement So the reporting principle states that as an auditor We're going to express an opinion or we're gonna say we don't have sufficient Evidence or our scope has been limited and we cannot express an opinion
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And when we do express an opinion, we say that the financial statements are pretty much applicable to in this case GAAP Right that they're following GAAP
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so we have several stages of the audit and here we first we have to find a client right then we have to plan the engagement and here's where our Engagement letter comes in we have to assess risk. We have to gain evidence which has to be
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sufficient and Appropriate as we mentioned to give us the opinion and then we report which is basically our audit opinion So then we have the responsibilities which we have to be confident and independent
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Right, and then we have to have professional skepticism and we have to exercise professional judgment and we have to have do care that we're actually going to perform the audit and that's where our Performance come in and then our reporting is that of the opinion and we know that we issue an opinion on the financial statements and the internal controls now So those are all the stages of an audit
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so let's talk about responsibilities now So here we are here where we're trying to obtain our engagement and here what we need to do is we need to have competent auditors that have the proper experience we need to be independent most of the audit issues are because there is an independent in fact or Appearance right so we can't have financial manager relationships with our client. We can't own a
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Large or majority of stock we have to have as auditors have to have do care where we are Performing that what a reasonable auditor would perform in a certain circumstance, right? so we're doing the same actions that another auditor would do and then we have to have Skepticism which is our questioning of our evidence and we have to have judgment which is basically our application So this is where critical thinking comes in of what we know in our experience
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And what the evidence is telling us as we are applying these informed decisions throughout our fieldwork, which eventually will be our audit
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So now let's talk about performance So we're now are moving to the engagement planning stage and here the goal is to provide reasonable assurance that the financial statements do not Contain material misstatement. So here what's required is we need to plan. The audit plan is one of the most important phases of the audit and students tend to gloss over that before You accept a client then you need to make sure that you're planning the audit Properly that you have the auditors in place to do
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so you also have to set your threshold for materiality now materiality is basically what would influence Financial statement. So what amount you're gonna set? So this is a dollar amount that If an amount is above this threshold it would be material and it would change the decision of a financial statement user and that Materiality stays with us throughout the entire on it and we pretty much
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Holds any adjustments to that level then we want to assess risk and what they're going to talk about our audit risk We're going to talk about our control risk our inherent risk so this will all come later and here we're understanding the business itself the entity and we're understanding the internal controls and then we want to determine what type of substantive testing we're going to do right we have analytical procedures as
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one type of test then we have substantive tests of details and
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We have tests of account balances so those are the major types of tests that we do when we're out in the field and as I mentioned before Audit evidence needs to be sufficient in amount and appropriate in quality So this is the level of reliability that we need and obviously from the source third-party sources Are higher quality, right? We're getting something from the client that they produce that's lower quality
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But if we're getting a bank confirmation that's coming from the financial institution directly to the auditors. That's of a higher quality source
12:07
So now let's talk about risk assessment and when we're talking about risk We're talking about our effectiveness of internal controls. And then if we have a lower risk than we would have to use less Substantiative procedures which is our testing now if we have a higher risk, then we're gonna have to increase that type of testing
12:27
Now audit evidence, which is our fourth stage in our audit and one of the most critical stages Right, so we have detection risk, which is basically if we're going to detect a material misstatement or not Then we need to discuss the appropriateness and the sufficiency so we have quality and quantity here and Basically when we're talking about appropriateness We see if it's relevant and reliable and where have you seen? relevant and reliable before in our statement of
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Financial Accounting concepts So the SFA see I believe it's number two relevance and reliability are
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qualitative Characteristics That are part of our conceptual framework, which is now also coming into auditing as well
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So when we're talking about quality as I mentioned, we have relevance and reliability Which is our statement of financial accounting concepts and here we have the reliability The auditors direct knowledge and then the external and internal evidence that we obtain if there's external this is higher in that like in our Reliability and if it's internal, it's lower
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So sufficiency of evidence here, we're just talking about how much Right. And so when we talk about how much coverage comes into our discussion how much what percentage of The account balance are we sampling? And what determines how much or how little is the effectiveness of the internal controls? so if we can rely on the internal controls then we don't have to do as much testing if we cannot rely then we would have to do alternative procedures and make and continue and increase
14:30
our sample for our substantive testing and
14:35
lastly our last fundamental principle is reporting and when we talk about reporting there is our fifth stage of our audit and when we're talking about reporting is basically the end result of our audit is the opinion right and there we are going to an express an opinion or we are going to disclaim the opinion and not express it and we're just basically assessing the financial statement and the financial reporting framework and so here what we're using is some type of measurement
15:06
reckon recognition presentation disclosure of material items in the financial statements and so examples here if we're following gap or IFRS or another Framework mostly in the u.s obviously we follow GAAP and so we still haven't converged GAAP and I first but at this point our reporting principle is We're expressing an opinion. And so this is what our Opinion looks like and so here we have the introductory paragraph which tells us that we've audited the financial statements here
15:39
We're talking about a balance sheet and the related income statement stockholders equity Statements in the statement of cash flows for three years, which is very typical of SEC requirements And then we're saying that the auditors are responsible to express an opinion Then the scope paragraph tells us what the auditors did so here we conducted our audit in accordance to the PCAOB And those standards require us to plan and perform the audit which is our early stages and we want to obtain
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Reasonable assurance about whether the financial statements are free of material misstatement Notice the importance of that we are obtaining
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Reasonable assurance about whether the financial statements are free of material misstatement Then we describe what an audit is which is basically we're examining on a test phases or through sampling
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supporting amounts and disclosures keep in mind the financial statements must Have the notes the footnotes in order to be a complete set both these two items of financial statements itself plus the footnote Disclosures all the notes to the angels' so and then we're seeing the audit includes assessment of the accounting principles Which include any estimates that were made by management as well as where as auditors are evaluating the financial statement
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presentation and the audits provide a reasonable Look basis for our opinion Then we move on to the opinion paragraph which is basically saying that they present fairly in all material Respects the financial position of McDonald's in this case. So this is an unqualified opinion
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And Then we have so right here is our opinion of the financial statements So this all of these paragraphs are on the financial statements and then here we have an internal control now you can issue two separate opinions or in this case You can consolidate them into one opinion and then the internal control paragraph is basically again referring to the PCAOB
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Here and we're saying that the internal controls over financial reporting Which is what we're concerned with the internal controls over financial reporting were established according to Co so the committee of sponsoring organization so Co so
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Which is of the Treadwell Commission and they express an unqualified opinion, so in this case McDonald's has two unqualified opinions one on the financial statements which is the first three paragraphs the introductory scope and opinion and Then the second is the internal control paragraph And so this is the Klean opinion and this is the opinion that we all want here We see that Ernst and Young is the auditors and this date at the very bottom is the last date of fieldwork
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So that is the last date of fieldwork So that's the last date that the auditors pulled out went back to the office to compile the report
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So we went through there are other items in the auditor's report So we have that the auditor is stating that it's management's responsibility for financial reporting. So management is responsible and management are the ones that make the assertions such as completeness and accuracy evaluation that the audit is conducted with PCAOB standards the Public Company Accounting Oversight Board and we have our opinion on the financial
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Statements and we have our opinion on the internal controls and they can be two separate opinions or as we saw previously With McDonald's. We have it in one opinion with several paragraphs
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So we just
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So now we have the unqualified which is the opinion that we want which is what we saw with McDonald's, so that everything is according to GAAP. So that's a ok then we have our second opinion, which is a qualified opinion And so this is what we known has been except for so Everything in the financial statements is according to GAAP in as it should be except for one eye
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Except for one item and that one item is usually detailed in a paragraph then we have an adverse opinion Which is basically you're not in conformity with GAAP Which is very detrimental and then when we cannot express an opinion This is your disclaimer and the disclaimer usually comes because your scope was limited So for example, if the client doesn't give you certain transactions in you as an auditor feel that these transactions Could be an issue than you would possibly give a disclaimer
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And then we have here that the unmodified is used for non public companies while the unqualified is used for public companies So you'll see we will normally refer to it as an unqualified opinion
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So when you're evaluating the quality this is now we've gone through all the principles so this is our last
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objective right now We're going to look at the quality of public accounting firms and there's a control system that's in place to also provide reasonable assurance that the actual auditing firm Has you know has some assurance and has some personnel that are calm and independent so here the whole quality control process is to make sure that the auditing firm is Kind of checking the dots that they're following the professional standards and they're following all the regulatory
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And the legal requirements and that they're issuing the correct deport report within the correct circumstances So all the audit evidence is sufficient and appropriate to support the opinion that the auditors gave
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So there are elements of this quality control system, right? So we always at the top right the tone at the top the leadership for the firm. What ethical? Requirements the firm has what acceptance and continuous policies of the clients. The firm's has what about their HR department? How their engagements are performed and then there's a monitoring the peer review process. So the PCAOB Says that monitoring public accounting firms is done through inspections
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And if your firms audit greater than 100 public entities, it's done. Annually if you're doing less it's every three years So most of the big four are doing over a hundred public entities So they would be about annually and what's interesting is if you go to this link you'll see the inspection reports and the deficiencies that are noted in the audit and all of the big four have some type of deficiency in the expection report
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