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The Audit Market Principles of Auditing: An Introduction to International Standards on Auditing - Ch. 2

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Title: The Audit Market Principles of Auditing: An Introduction to International Standards on Auditing - Ch. 2


1
The Audit Market Principles of Auditing An
Introduction to International Standards on
Auditing - Ch. 2
  • Rick Stephan Hayes,
  • Philip Wallage, and Hans Gortemaker

2
  • Management controls the accounting systems, the
    internal controls, and the financial reports to
    investors.
  • Management is not independent or objective
    because their success depends on positive
    reports.
  • The auditor increases the confidence of the
    report users by giving an independent opinion on
    the fairness of these reports.

3
Demand for audit services explained by several
different theories
  • The Policeman Theory
  • The Lending Credibility Theory
  • The Theory of Inspired Confidence
  • Agency Theory

4
Agency Theory
  • A company is viewed as the result of 'contracts',
    in which several groups make some kind of
    contribution to the company, given a certain
    'price'.
  • Management is seen as the agent, trying to
    obtain contributions from principals such as
    bankers, stockholders and employees.
  • Management tries to do what is best for
    management and has a considerable advantage over
    the principals regarding information about the
    company (information asymmetry).
  • Cost of an agency relationship are monitoring
    costs, bonding costs, and residual loss.

5
Audits Required
  • In most countries, audits are now legally
    required for some types of companies (statutory
    audits)
  • E.g., listed companies, companies receiving
    government money, certain industries
  • Major bourses (including NYSE, NASDAQ, London
    Stock Exchange, Tokyo NIKKEI, and Frankfurt DAX)
    have listing rules that require all companies to
    have an audited annual report.

6
Audit Regulation
  • Although there is regulation around the world,
    two that may be the most influential are
  • The Sarbanes-Oxley Act of 2002 required the U.S.
    Securities and Exchange Commission (SEC) to
    create a Public Company Accounting Oversight
    Board (PCAOB).
  • European Union Eighth Council Directive
    84/253/EEC and EU Directive 2006/43/EC

7
Independent Oversight
  • International Forum of Independent Audit
    Regulators (IFIAR),
  • In Australia - Financial Reporting Council,
  • In the UK -The Review Board,
  • In the Netherlands - Authority for the Financial
    Markets (AFM),
  • France - Autorité des marchés financiers(AMF)
  • USA -Public Company Accounting Oversight Board

8
The International Forum of Independent Audit
Regulators (IFIAR) Core Principles
  • comprehensive and well defined accounting and
    auditing principles and standards
  • legal requirements for the preparation and
    publication of financial statements according to
    those principles and standards
  • an enforcement system for preparers of financial
    statements to ensure compliance with accounting
    standards
  • corporate governance practices that support
    high-quality corporate reporting and auditing
    practice and
  • effective educational and training arrangements
    for accountants and auditors.

9
Who supervises Auditing rules and Auditing Firms?
Public Company Accounting Oversight Board (PCAOB)
Created by the Sarbanes-Oxley Act of 2002
US classes
10
PCAOBs Audit Standards
  • PCAOB has passed 16 audit standards as of
    December 2010.
  • They also enforce as temporary standards the
    existing audit standards by the Audit Standards
    Board called Statements of Audit Standards (SAS)

US classes
11
PCAOBs Audit Standards US classes
  • AS No. 1 References in Auditors Reports to the
    Standards of the Public Company Accounting
    Oversight Board
  • AS No. 3 Audit Documentation
  • AS No. 4 Reporting on Whether a Previously
    Reported Material Weakness Continues to Exist
  • AS No. 5 An Audit of Internal Control Over
    Financial Reporting That Is Integrated with An
    Audit of Financial Statements
  • AS No. 6 Evaluating Consistency of Financial
    Statements
  • AS No. 7 Engagement Quality Review

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12
PCAOBs Audit Standards US classes
  • AS No. 8 Audit Risk
  • AS No. 9 Audit Planning
  • AS No. 10 Supervision of the Audit Engagement
  • AS No. 11 Consideration of Materiality in
    Planning and Performing an Audit
  • AS No. 12 Identifying and Assessing Risks of
    Material Misstatement
  • AS No. 13 The Auditor's Responses to the Risks
    of Material Misstatement
  • AS No. 14 Evaluating Audit Results
  • AS No. 15 Audit Evidence

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13
Communications With Audit Committees (PCAOB Audit
Standard 16)
  • http//pcaobus.org/Rules/Rulemaking/Docket030/Rele
    ase_2012-004.pdf (August 15, 2012)
  • Replaces AU 310 and 380
  • Requires the auditor to record the terms of the
    engagement in an engagement letter, to have the
    engagement letter signed and determine that the
    audit committee has acknowledged and agreed to
    the terms.
  • Adds a requirement for the auditor to communicate
    to the audit committee significant unusual
    transactions that are outside the normal course
    of business for the company or that otherwise
    appear to be unusual and to communicate the
    auditor's understanding of the business rationale
    for such transactions.
  • improves and enhances current auditor
    communication requirements (pages 9-12)

14
PCAOB Audit Standard 1 References in Auditors
Reports to the Standards of the Public Company
Accounting Oversight Board
  • adopted as interim standards, on an initial,
    transitional basis, GAAP in AICPAs Auditing
    Standards Board's Statement on Auditing Standards
    No. 95
  • the auditor in their opinion must refer to "the
    standards of the Public Company Accounting
    Oversight Board (United States)."

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15
Report of independent Registered Public
Accounting Firm The Board of Directors and
Shareholders of Wal-Mart Stores, Inc. We have
audited the accompanying consolidated balance
sheets of Wal-Mart Stores, Inc. as of January 31,
2010 and 2009, and the related consolidated
statements of income, shareholders equity, and
cash flows for each of the three years in the
period ended January 31, 2010. These financial
statements are the responsibility of the
Companys management. Our responsibility is to
express an opinion on these financial statements
based on our audits.
We conducted our audits in accordance with the
standards of the Public Company Accounting
Oversight Board (United States). Those standards
require that we plan and perform the audit to
obtain reasonable assurance about whether the
financial statements are free of material
misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit
also includes assessing the accounting principles
used and significant estimates made by
management, as well as evaluating the overall
financial statement presentation. We believe that
our audits provide a reasonable basis for our
opinion.
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In our opinion, the financial statements referred
to above present fairly, in all material
respects, the consolidated fi nancial position of
Wal-Mart Stores, Inc. at January 31, 2010 and
2009, and the consolidated results of its
operations and its cash flows for each of the
three years in the period ended January 31, 2010,
in conformity with U.S. generally accepted
accounting principles. As discussed in Note 8 to
the consolidated financial statements, effective
February 1, 2007, the Company changed its method
of accounting for uncertainty in income taxes. We
also have audited, in accordance with the
standards of the Public Company Accounting
Oversight Board (United States), Wal-Mart Stores,
Inc.s internal control over financial reporting
as of January 31, 2010, based on criteria
established in Internal Control Integrated
Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission and our
report dated March 30, 2010 expressed an
unqualified opinion thereon. Ernst
Young Rogers, Arkansas March 30, 2010
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17
PCAOB Audit Standard 3 Audit Documentation
  • This standard establishes general requirements
    for documentation the auditor should prepare and
    retain in connection with engagements
  • Audit documentation is the written record of the
    basis for the auditor's conclusions that provides
    the support for the auditor's representations,
    whether those representations are contained in
    the auditor's report or otherwise
  • The auditor must retain audit documentation for
    seven years from the date the auditor grants
    permission to use the auditor's report in
    connection with the issuance of the company's
    financial statements ( report release date ),

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PCAOB Audit Standard 4 Reporting on Whether a
Previously Reported Material Weakness Continues
to Exist
  • Establishes requirements and provides direction
    that apply when an auditor is engaged to report
    on whether a previously reported material
    weakness in internal control over financial
    reporting continues to exist as of a date
    specified by management

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19
Report of Independent Registered Public
Accounting Firm We have previously audited and
reported on management's annual assessment of XYZ
Company's internal control over financial
reporting as of December 31, 200X based on
Identify control criteria, f or example,
"criteria established in Internal
Control-Integrated Framework issued by the
Committee of Sponsoring Organizations of the
Treadway Commission (COSO)." .  Our report,
dated date of report , identified the
following material weakness in the Company's
internal control over financial reporting
Describe material weakness We have audited
management's assertion, included in the
accompanying title of management's report, that
the material weakness in internal control over
financial reporting identified above no longer
exists as of date of management's assertion
because the following control(s) addresses the
material weakness Describe control(s) In
our opinion, the material weakness described
above no longer exists as of date of
management's assertion . ..
US classes
20
PCAOB Audit Standard 5 An Audit of Internal
Control Over Financial Reporting That Is
Integrated with An Audit of Financial Statements
  • This standard establishes requirements when an
    auditor is engaged to perform an audit of
    management's assessment of the effectiveness of
    internal control over financial reporting ("the
    audit of internal control over financial
    reporting") that is integrated with an audit of
    the financial statements.
  • If one or more material weaknesses exist, the
    company's internal control over financial
    reporting cannot be considered effective.
  • The audit of internal control over financial
    reporting should be integrated with the audit of
    the financial statements.

US classes
21
Report of Independent Registered Public
Accounting Firm on Internal Control Over
Financial Reporting The Board of Directors and
Shareholders of Wal-Mart Stores, Inc. We have
audited Wal-Mart Stores, Inc.s internal control
over financial reporting as of January 31, 2010,
based on criteria established in Internal Control
Integrated Framework issued by the Committee
of Sponsoring Organizations of the Treadway
Commission (the COSO criteria). Wal-Mart Stores,
Incs management is responsible for maintaining
effective internal control over financial
reporting, and for its assessment of the
effectiveness of internal control over financial
reporting included in the accompanying
Managements Report to Our Shareholders. Our
responsibility is to express an opinion on the
Companys internal control over financial
reporting based on our audit. We conducted our
audit in accordance with the standards of the
Public Company Accounting Oversight Board (United
States). Those standards require that we plan and
perform the audit to obtain reasonable assurance
about whether effective internal control over
financial reporting was maintained in all
material respects. Our audit included obtaining
an understanding of internal control over
financial reporting, assessing the risk that a
material weakness exists, testing and evaluating
the design and operating effectiveness of
internal control based on the assessed risk, and
performing such other procedures as we considered
necessary in the circumstances. We believe that
our audit provides a reasonable basis for our
opinion. A companys internal control over
financial reporting is a process designed to
provide reasonable assurance regarding the
reliability of financial reporting and the
preparation of financial statements for external
purposes in accordance with generally accepted
accounting principles. A companys internal
control over financial reporting includes those
policies and procedures that (1) pertain to the
maintenance of records that, in reasonable
detail, accurately and fairly reflect the
transactions and dispositions of the assets of
the company.
US classes
22
(2) provide reasonable assurance that
transactions are recorded as necessary to permit
preparation of financial statements in accordance
with generally accepted accounting principles,
and that receipts and expenditures of the company
are being made only in accordance with
authorizations of management and directors of the
company and (3) provide reasonable assurance
regarding prevention or timely detection of
unauthorized acquisition, use or disposition of
the companys assets that could have a material
effect on the financial statements Because of
its inherent limitations, internal control over
financial reporting may not prevent or detect
misstatements. Also, projections of any
evaluation of effectiveness to future periods are
subject to the risk that controls may become
inadequate because of changes in conditions, or
that the degree of compliance with the policies
or procedures may deteriorate. In our opinion
Wal-Mart Stores, Inc. maintained, in all material
respects, effective internal control over
financial reporting as of January 31, 2010, based
on the COSO criteria. We also have audited, in
accordance with the standards of the Public
Company Accounting Oversight Board (United
States), the consolidated balance sheets of
Wal-Mart Stores, Inc. as of January 31, 2010 and
2009, and related consolidated statements of
income, shareholders equity and cash flows for
each of the three years in the period ended
January 31, 2010 and our report dated March 30,
2010 expressed an unqualified opinion
thereon. Ernst Young Rogers, Arkansas March 30,
2010
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23
PCAOB Audit Standard 6 Evaluating Consistency
of Financial Statements
  • This standard establishes requirements for the
    auditor's evaluation of the consistency of the
    financial statements.
  • The auditor should recognize the following
    matters in an explanatory (matter of emphasis)
    paragraph a relating to the consistency of the
    company's financial statements in the auditor's
    report if those matters have a material effect on
    the financial statements
  • A change in accounting principle
  • An adjustment to correct a misstatement in
    previously issued financial statements.

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24
Auditing Standard 7  Engagement Quality Review
  • An engagement quality review and concurring
    approval of issuance are required for each audit
    engagement and for each engagement to review
    interim financial information
  • The objective of the engagement quality reviewer
    is to perform an evaluation of the significant
    judgments made by the engagement team and the
    related conclusions reached in forming the
    overall conclusion on the engagement in order to
    determine whether to provide concurring approval
    of issuance
  • An engagement quality reviewer must have
    competence, independence, integrity, and
    objectivity

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25
Auditing Standard 8 Audit Risk
  • This standard discusses the auditor's
    consideration of audit risk
  • Risk of material misstatement at the assertion
    level consists of the following components
    Inherent risk and Control risk
  • The auditor uses the assessed risk of material
    misstatement to determine the appropriate level
    of Detection risk for a financial statement
    assertion.

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26
Auditing Standard 9 Audit Planning
  • Establishes requirements regarding planning an
    audit.
  • The engagement partner is responsible for
    planning the audit
  • Planning the audit includes establishing the
    overall audit strategy for the engagement and
    developing an audit plan, which includes, in
    particular, planned risk assessment procedures
    and planned responses to the risks of material
    misstatement.

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27
Auditing Standard 10 Supervision of the Audit
Engagement
  • This standard establishes requirements regarding
    supervision of the audit engagement, including
    supervising the work of engagement team members.
  • The engagement partner is responsible for the
    engagement and its performance including PCAOB
    standards and the work of engagement personnel,
    specialists, other auditors, internal auditors,
    and others who are involved in testing controls

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28
Auditing Standard 11 Consideration of
Materiality in Planning and Performing an Audit
  • establishes requirements regarding the auditor's
    consideration of materiality in planning and
    performing an audit.
  • the Supreme Court of the United States - a fact
    is material if there is "a substantial likelihood
    that the fact would have been viewed by the
    reasonable investor as having significantly
    altered the 'total mix' of information made
    available.

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29
AS 11 (cont)
  • To obtain reasonable assurance about whether the
    financial statements are free of material
    misstatement, the auditor should plan and perform
    audit procedures to detect misstatements that,
    individually or in combination with other
    misstatements, would result in material
    misstatement of the financial statements.

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30
Auditing Standard No. 12 Identifying and
Assessing Risks of Material Misstatement
  • Establishes requirements regarding the process of
    identifying and assessing risks of material
    misstatement of the financial statements.
  • The auditor should perform risk assessment
    procedures that are sufficient to provide a
    reasonable basis for identifying and assessing
    the risks of material misstatement, whether due
    to error or fraud.

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31
AS 12 Continued
  • This standard discusses the following risk
    assessment procedures
  • Obtaining an understanding of the company and its
    environment (paragraphs 7-17)
  • Obtaining an understanding of internal control
    over financial reporting (paragraphs 18-40)
  • Considering information from the client
    acceptance and retention evaluation, audit
    planning activities, past audits, and other
    engagements performed for the company (paragraphs
    41-45)
  • Performing analytical procedures (paragraphs
    46-48)
  • Conducting a discussion among engagement team
    members regarding the risks of material
    misstatement (paragraphs 49-53)
  • Inquiring of the audit committee, management, and
    others within the company about the risks of
    material misstatement (paragraphs 54-58)

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Auditing Standard No. 13 The Auditor's Responses
to the Risks of Material Misstatement
  • Establishes requirements regarding designing and
    implementing appropriate responses to the risks
    of material misstatement.
  • Responses that have an overall effect on how the
    audit is conducted ("overall responses"),
    (paragraphs 5-7) - e.g., appropriate staff
    assignment, supervision, unpredictable audit
    procedures
  • Responses involving the nature, timing, and
    extent of the audit procedures to be performed,
    (paragraphs 8-46).

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Auditing Standard No. 14 Evaluating Audit Results
  • Establishes requirements regarding the auditor's
    evaluation of audit results and determination of
    whether he or she has obtained sufficient
    appropriate audit evidence which should include
    evaluation of the following
  • The results of analytical procedures performed in
    the overall review of the financial statements
    ("overall review")
  • Misstatements accumulated during the audit,
    including, in particular, uncorrected
    misstatements
  • The qualitative aspects of the company's
    accounting practices
  • Conditions identified during the audit that
    relate to the assessment of the risk of material
    misstatement due to fraud ("fraud risk")
  • The presentation of the financial statements,
    including the disclosures
  • The sufficiency and appropriateness of the audit
    evidence obtained.

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34
Auditing Standard No. 15 Audit Evidence
  • Explains what constitutes audit evidence and
    establishes requirements regarding designing and
    performing audit procedures to obtain sufficient
    appropriate audit evidence.
  • Audit evidence is all the information, whether
    obtained from audit procedures or other sources,
    that is used by the auditor in arriving at the
    conclusions on which the auditor's opinion is
    based.

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35
AS 15 Sufficient Appropriate Audit Evidence
  • Sufficiency is the measure of the quantity of
    audit evidence affected by the following
  • Risk of material misstatement or the risk
    associated with the control (risk increase ?
    amount of evidence increases)
  • Quality of the audit evidence obtained.
  • Appropriateness is the measure of the quality of
    audit evidence, i.e., its relevance and
    reliability.

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36
List of PCAOB Temporary Standards
  • AU Section 100 - Statements on Auditing Standards
    -- Introduction
  • AU Section 200 - The General Standards
  • AU Section 300 - The Standards of Field Work
  • AU Section 400 - The First, Second, and Third
    Standards of Reporting
  • AU Section 500 - The Fourth Standard of Reporting
  • AU Section 600 - Other Types of Reports
  • AU Section 700 - Special Topics AU Section 800 -
    Compliance Auditing
  • AU Section 900 - Special Reports of the Committee
    on Auditing Procedures

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Big Four Firms Non-Big Four
  • Deloitte, Ernst Young, KPMG, PricewaterhouseCoop
    ers
  • Second Tier Grant Thornton BDO Seidman
    McGladrey Pullen Moss Adams Myer, Hoffman
    McCann Crowe Group, American Express, BKD

38
Legal liability of the auditor
  • varies from country to country, district to
    district.
  • based on one or more of the following
  • common law,
  • civil liability under statutory law,
  • criminal liability under statutory law, and
  • liability for members of professional accounting
    organizations.

39
Common Law Ultramares - Touche case (Ultramares
Corporation v Touche et al.)
  • the accountants were negligent for not finding
    that a material amount of accounts receivable had
    been falsified when careful investigation would
    have shown it to be fraudulent,
  • not liable to a third party bank because the
    creditors were not a primary beneficiary, or
    known party,
  • called the Ultramares doctrine, that ordinary
    negligence is not sufficient for a liability to a
    third party because of lack of privity of
    contract between the third party and the auditor.

40
Caparo Industries, PLC v Dickman
  • The question in Caparo was the scope of the
    assumption of responsibility of the auditor if a
    clean opinion was given for negligent accounts,
    and what the limits of liability ought to be.
  • The House of Lords of the UK, following the Court
    of Appeal, set out a "three-fold test for an
    obligation (duty of care) to arise from
    negligence
  • harm must be reasonably foreseeable
  • the parties must be in a relationship of
    proximity and
  • it must be fair, just and reasonable to impose
    liability.

41
Civil Liability Under Statutory Law
  • The Securities Act of 1933 established the first
    U.S. statutory civil recovery rules for third
    parties against auditors.
  • Original purchasers have recourse against the
    auditor for up to the original purchase price if
    the financial statements are false or misleading.
  • The auditor has the burden of demonstrating that
    reasonable investigation was conducted or that
    all the loss of the purchaser of securities
    (plaintiff) was caused by factors other than the
    misleading financial statements.

42
Sarbanes Oxley Act of 2002 Civil Penalties for
CEOs and CFOs
  • If there is a material restatement of a companys
    reported financial results due to the material
    noncompliance of the company, as a result of
    misconduct, the CEO and CFO shall reimburse the
    company for any bonus or incentive or
    equity-based compensation received within the 12
    months following the filing with the financial
    statements subsequently required to be restated
    (Section 304)
  • Financial statements filed with the SEC by any
    public company must be certified by CEOs and
    CFOs. If all financials do not fairly present the
    true condition of the company CEOs and CFOs may
    receive fines of up to 1 million. If
    certifications are made knowing the statements
    are incorrect, the fine can be up to 5 million.

43
Criminal Liability Under Statutory Law
  • The Securities Exchange Act of 1934 in the United
    States sets out (Rule 10b-5) criminal liability
    for the auditor to employ any device, scheme or
    artifice to defraud or intentionally or
    recklessly misrepresent information for third
    party use.
  • Not In Text Cases In United States v. Natelli
    (1975) United States v. Weiner (1975) ESM
    Government Securities v. Alexander Grant Co.
    (1986).

44
Sarbanes Oxley Act of 2002 Criminal Penalties for
CEOs, CFOs and Auditors
  • To knowingly destroy, create, manipulate
    documents and/or impede or obstruct federal
    investigations is considered felony, and
    violators will be subject to fines or up to 20
    years imprisonment, or both
  • All audit reports or related workpapers must be
    kept by the auditor for 7 years. Failure to do
    this may result in 10 years imprisonment.
  • CFOs and CEOs who falsely certify financial
    statements or internal controls are subject to 10
    years imprisonment. Willful false certification
    may result in a maximum of 20 years imprisonment

45
Liabilities as Members of Professional
Organizations
  • Nearly all national audit professions have some
    sort of disciplinary court.
  • The disciplinary court makes its judgment and
    determines the sanction. It may be
  • a fine
  • a reprimand (either oral or written)
  • a suspension for a limited period of time (e.g. 6
    months) or
  • a lifetime ban from the profession.

46
In order to hold the auditor successfully legally
liable in a civil suit, the following conditions
have to be met - US Classes
  • An audit failure/neglect has to be proven
    (negligence issue).
  • The auditor should owe a duty of care to the
    plaintiff (due professional care).
  • The plaintiff has to prove a causal
    relationship between her losses and the alleged
    audit failure (causation issue)
  • The plaintiff must quantify her losses
    (quantum issue).

47
financial risks resulting from litigation for
audit firms
  • European Union Commissioner Charlie McCreevy has
    said
  • We have concluded that unlimited liability
    combined with insufficient insurance cover is no
    longer tenable. It is a potentially huge problem
    for our capital markets and for auditors working
    on an international scale. The current conditions
    are not only preventing the entry of new players
    in the international audit market, but are also
    threatening existing firms.

48
Suggested Solutions to Auditor Liability
  • Some countries (e.g. Germany) have put a legally
    determined cap on the liability of auditors (to
    the client in the case of Germany)
  • A system of proportionate liability - an audit
    firm is not liable for the entire loss incurred
    by plaintiffs but only to the extent to which the
    loss is attributable to the auditor.
  • In order to protect the personal wealth of audit
    partners, some audit firms are structured as a
    limited liability partnership (e.g. in the UK).

49
Suggested Solutions to Auditor Liability (cont)
  • To make insurance of all liability risks
    compulsory using new legislation was one of the
    recommendations of a EU commission.
  • Exclude certain activities with a higher risk
    profile from the auditors' liability. A mechanism
    to achieve this outcome would be to introduce
    so-called safe harbour provisions by legislation.

50
Audit Expectations with regard to the following
duties of auditors giving an opinion on
  • the fairness of financial statements
  • the company's ability to continue as a going
    concern
  • the company's internal control system
  • the occurrence of fraud and
  • the occurrence of illegal acts.

51
The Fairness Of Financial StatementsThe
Company's Ability To Continue As A Going Concern
  • A large part of the financial community (users of
    audit services) expects that financial statements
    with an unmodified (unqualified) audit opinion
    are completely free from error. The inherent
    limitations of auditing not accepted.
  • In most national regulations, auditors need to
    determine whether the audited entity is able to
    continue as a going concern.

52
Opinion on the Companys Internal Control System
  • The objective of the auditor is to identify and
    assess the risks of material misstatement
    through understanding the entity and its
    environment, including the entitys internal
    control.
  • The United States Sarbanes-Oxley Act of 2002
    requires that company officers certify that
    internal controls are effective and requires that
    an independent auditor verify managements
    analysis

53
Company's Internal Control
  • Section 404 of the Sarbanes-Oxley Act requires
    each annual report of a company to contain an
    internal control report which should
  •   (1) state the responsibility of management
    for establishing and maintaining an adequate
    internal control structure and procedures for
    financial reporting, and
  • (2) contain an assessment, as of the end of
    the fiscal year, of the effectiveness of the
    internal control structure and procedures for
    financial reporting.
  • (3) Companies must select suitable criteria
    (COSO-based) against which it may evaluate the
    effectiveness of internal controls for
    authorization, safeguarding assets, and properly
    recording of transactions.
  • (4) An independent auditor attests to any
    difference between managements assertions under
    404 and the audit evidence on internal controls

US classes
54
Opinion on the Occurrence of Fraud
  • Both governments and the financial community
    expect the auditor to find existing fraud cases
    and report them.
  • Audit history as gone from the fraud detection as
    the objective of an audit to not taking any
    responsibility for fraud, to the current position
    that the auditor is responsible for obtaining
    reasonable assurance the financial statements are
    free from material statement, whether caused by
    fraud or error.

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The Occurrence of Fraud
  • ISA 240- the responsibility for the prevention
    and detection of fraud and error rests with both
    those charged with the governance and the
    management.
  • ISA 210 states that when planning and performing
    audit procedures and in evaluating and reporting
    the results, auditors should consider the risk of
    misstatements in financial statements resulting
    in fraud.
  • In planning the audit, the auditor must assess
    the risk that material fraud or error has
    occurred.

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US Fraud Standard US Classes
  • Auditing Standard Number 99 (SAS 99)
  • The standard requires that as part of the
    planning process the audit team must consider how
    and where the clients financial statements may
    be susceptible to fraud.
  • Gather information by inquiring of management and
    consider ing fraud risk factors

US classes
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The Occurrence of Illegal Acts
  • Both ISA 250 and most national regulators state
    that the auditors responsibility in this area is
    restricted to designing and executing the audit
    in such a way that there is a reasonable
    expectation of detecting material illegal acts
    which have a direct impact on the form and
    content of the financial statements.
  •  The professional regulations in some countries
    require the auditor to inform members of the
    audit committee or board of directors

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Responses to Accounting Controversies
  • In response to the controversies there have been
    in two landmark studies (the COSO Report and the
    Cadbury Report which lead to the Combined Code
    and the Turnbull Report) and most recently have
    been legislated into the US
  • accounting profession by the
  • Sarbanes-Oxley
  • Act of 2002.

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COSO Report
  • The COSO report was published by the Committee of
    Sponsoring Organizations of the Treadway
    Commission. The COSO report envisaged
  • 1 harmonizing the definitions regarding internal
    control and its components
  • 2 helping management in assessing the quality of
    internal control
  • 3 creating internal control benchmarks, enabling
    management to compare the internal control in
    their own company to the state-of-the-art and
  • 4 creating a basis for the external reporting on
    the adequacy of the internal controls.

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Combined Code UK
  • In 1998 London Stock Exchange published a new
    Listing Rule together with related Principles of
    Good Governance and Code of Best Practice (called
    the Combined Code).
  • The combined code combines the recommendations
    of the so-called Cadbury, Greenbury, and Hampel
    committees on corporate governance.

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The Sarbanes-Oxley Act of 2002 Restrictions on
Auditors
  • Auditors must report to the audit committee
  • The lead audit partner and audit review partner
    must be rotated every five years.
  • A second partner must review and approve audit
    reports.
  • It is a felony with penalties of up to 20 years
    in jail to willfully fail to maintain all audit
    or review work papers for seven years.
  • Auditors are  prohibited from offering certain
    information system and accounting services.

62
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