Notesale: Turn your study into money

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Pro Forma Earnings: earnings “as if” (vs
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to make themselves look better

Who fought FASB and SEC efforts to enhance transparency?
•
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Congress- Because of Lobbying
Ex: treatment of stock options, stock comp used to not be recognized

How did audit firms expand their services?
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Consulting

Issue of peer review
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Big 5 at the time would cover for each other

What reforms are still needed according to Lynn Turner?

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How to audit
Do not confuse auditing standards with accounting standards
Audit Standards
AIPCA (ASB): Private Auditors, AU-C, nonissuers
PCAOB: Public Audits, AS, issuers

Accounting Standards: FASB- issues accounting standards- private sector
➢ ASC
➢ GAAP

Requirements for Issuers of Financial Statements (Public)
➢
➢
➢
➢
➢
➢

Must make an annual assessment of the effectiveness of internal controls (§404a)
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Cooling off period of 1 year before hiring former auditor as CEO, CFO, CAO
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May not extend loans to directors or corporate officers
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Must establish complaint procedures about accounting and auditing matters
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“Financial expert” member of audit committee must be disclosed
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➢ Must receive regular updates from auditor on:
o

Accounting treatments

o

Discuss alternative GAAP treatments

o

Discuss auditor’s preference

o

Accounting disagreements btwn auditor and management

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➢ Must register with the board and pay fees to the board
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➢ Must:
o comply with auditing and professional standards
o comply with quality control standards
o submit to quality control inspections by PCAOB
➢ Must retain documents for 7 years – 5 year felony imposed for failure to maintain “all audit or
review work papers”
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May NOT provide 9 specific non-audit services to their issuer clients (§201)
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Must use a second/concurring partner review
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Must obtain audit committee pre-approval for services (any services)
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Common reasons include:
Failure to exercise professional skepticism
Ignoring contradictory evidence
Poor audit planning
Lack of training of personnel
Tight deadlines
•

These are all factors the firms can control (and fix)
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This comes with severe sanctions and disciplinary orders
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What
do you think of this?

POGO believes PCAOB is too lenient on enforcing actions against firms and individuals
Financial penalties way too low

•

The Financial Reporting Council (U
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equivalent of PCAOB) has asked the Big Four in the U
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to separate their consulting businesses
from their audit businesses (to be completed by 2024)
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•

The new proposal is to create the Audit, Reporting and Governance Authority (ARGA) – apparently to be more like the US regulator
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Another reform discusses limiting the Big 4’s share of FTSE 350 audits

PCAOB Approves Rule for Naming Audit Partner
Form AP is called the “middle ground approach” – filed with PCAOB

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Form AP filed with PCAOB no more than 35 days after audit report filed with SEC
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Form AP will require disclosure of other firms that participate in public company audits
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Audit Tenure – passed and is now part of the new standard on the auditors report

New PCAOB Standard Requires:
o
o
o
o
o

The auditor to state the year the auditor began serving consecutively as the company’s
auditor (auditor tenure requirement)
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The phrase, “Whether due to error or fraud” – to be included in the audit report when
describing responsibility for misstatements
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At least one CAM most of the time

Challenges for Auditors related to CAMs:
◦

PCAOB did not provide a list of what might constitute a CAM
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◦

Auditors may be tempted to use boilerplate language
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The new standard requires specific language to be added to the report that precedes the communication of CAMs – basically an
introductory paragraph
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Implementation of CAM’s

AS 3101 is a principles-based standard
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But the PCAOB staff has given some guidance:
◦

A potential loss contingency for which management has recorded an accrual and/or
made a disclosure could be a CAM, but if a contingency is remote (and therefore, not
recorded or disclosed), it would not be a CAM
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Different auditors could come up with different CAM’s
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Significant deficiencies or material weaknesses in internal controls cannot, in and of themselves, be CAMs
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Companies are also required to discuss critical accounting estimates in their MD&A’s, but CAMs is a much broader concept than this, although
there could be some overlap

PCAOB (Issuers)
➢
➢
➢
➢

AS
Explanatory Language - Required
Emphasis Paragraph- Optional
CAM’s- Required

AIPCA – ASB (Non-Issuers)
➢
➢
➢
➢
➢

AU-C aka
SAS aka
GAAS
KAM’s – optional
Emphasis of Matter Paragraph

Unqualified (Issuer)
➢ Qualified- material
➢ Disclaimer- pervasively material Scope limitation
➢ Adverse- pervasively material GAAP issues

Unmodified (non-issuer)
➢ Qualified- material
➢ Disclaimer- pervasively material Scope limitation
➢ Adverse- pervasively material GAAP issues
IMMATERIAL- Still unqualified

Week 4 Review
Audit Reports
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AS: Audits of Issuers; PCAOB (Public)

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Significant related party transactions

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Catastrophic subsequent events

•

Entity is a component of a large business enterprise

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Audit Issues: auditor is unable to obtain sufficient evidence to conclude the FS are fairly stated;
SCOPE LIMITATION; Imposed By:
a
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By the client
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i
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AS 3105: Departure from Unqualified Opinions
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When there are audit issues, the auditor would issue either a qualified opinion or a Disclaimer of
opinion

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When there are financial statement issues, the auditor would issue either a Qualified Opinion or
an Adverse opinion
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In the case of an audit issue, this paragraph would explain
the nature of the scope limitation

AS 3105: Disclaimer of Opinion/ Adverse Opinion
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In a disclaimer of opinion the auditor does not express an opinion

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In an adverse opinion, the auditor states that the financial statements do not present fairly, in
accordance with GAAP or another framework

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An additional paragraph is added in the Opinion section of the report explaining the reasons for
the departure from GAAP

AS 3105: Scope Limitations
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Restrictions on the timing of the auditor’s work

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Inability to gather sufficient evidence

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Inadequate accounting records

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Inability to observe physical inventories

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Inability to obtain audited F/S of an investee

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Restrictions on the ability to apply other audit procedures

SAS: Unmodified Reports (Non-Issuers)
The basic elements of the new unmodified auditor’s report include (in order):
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Title (Independent Auditor’s Report)

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Addressee

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Opinion (name the F/S, give opinion, according to GAAP)

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Basis for Opinion (followed GAAS, we’re independent)

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Going Concern paragraph (if applicable)

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Key Audit Matters (only when auditor is engaged to communicate KAM’s)

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Management Responsibility (who is responsible for the F/S?)

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Auditor Responsibility (describe the objective of an audit – reasonable assurance,
issue an opinion, etc
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SAS: Unmodified Reports
Important Notes on the ASB Unmodified Report
o

Key Audit Matters (KAM’s) – those matters that, in the auditor’s professional judgment,
were of most significance in the audit of the financial statements of the current period
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o

Remember, KAM’s are NOT required
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o

Auditors discuss how KAM’s were selected, and how they were addressed in the audit
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Unmodified Report (Nonissuers)
According to GAAS, some situations require an emphasis-of-matter paragraph be added to the
auditor’s report
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Subsequently discovered facts lead to a change in audit opinion
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AICPA standards (GAAS) do not specify where the emphasis-of-matter paragraph is located in the
report
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An emphasis-of-matter paragraph does not affect the auditor’s opinion, and this should be
explicitly stated
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Audit Issues – the auditor is unable to obtain sufficient evidence to conclude the F/S are
fairly stated
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It can be imposed by (a) circumstances or (b) by
the client
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Financial Statement Issues – the financial statements as a whole are materially
misstated
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Qualified Opinion (Non-Issuers) (MATERIAL BUT NOT PERVASIVE)

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The opinion paragraph includes the phrase, “except for”
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This paragraph should also quantify the misstatement, if practicable
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Basis for Disclaimer of Opinion Paragraph, is added immediately after the opinion
section and describes the reasons the auditor was not able to obtain sufficient
evidence to express an opinion
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The opinion paragraph includes the phrase, “do not present fairly”
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The auditor has no responsibility to carry out auditing procedures subsequent to
that date
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Review for Subsequent Events
in an Audit of Financial Statements
Type 1 Event: Conditions existed before the BS date and affect estimates that are part of FS
Requires adjustment of the FS

BS date

Type 2 Event: Conditions did not exist at the balance sheet date and do not affect the accuracy of the FS
Requires disclosure and possible pro forma FS

Know the audit opinions- had to put what the opinion would be based on a scenario

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