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Browse Location: United States\PwC Material\Montgomery's Auditing, Twelfth Edition\Part 1: The Audit Environment
Publish Date: 25 June, 2001
2
Organization and Structure of the Auditing Profession
2.1 TYPES OF ASSURANCE SERVICES
(a) Financial Audits,
(b) Compliance Audits,
(c) Performance Audits,
(d) Reviews of Financial Information,
(e) Attest Engagements,
(f) Other Assurance Services,
2.2 TYPES OF AUDITORS
2.3 ORGANIZATION OF AN ACCOUNTING FIRM
(a) Assurance Services,
(i) Audits,
(ii) Reviews,
(iii) Agreed-Upon Procedures
Engagements,
(iv) Attest Engagements,
(v) Other Assurance Services,
(b) Nonassurance Services,
(i) Compilations,
(ii) Tax Services,
(iii) Consulting Services,
(c) Firm Structure,
(d) Audit Engagement Team,
(i) Partner,
(ii) Manager,
(iii) Other Personnel,
2.4 ORGANIZATION OF THE AUDITING PROFESSION
(a) American Institute of CPAs,
(b) State Societies of CPAs,
(c) Institute of Internal Auditors,
(d) Other Organizations,
2.5 PROFESSIONAL CERTIFICATION AND LICENSING
(a) Certified Public Accountant (CPA),
(b) Certified Fraud Examiner (CFE),
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(c) Certified Internal Auditor (CIA),
(d) Certified Information Systems Auditor (CISA),
2.6 ASSURANCE STANDARDS AND STANDARD-SETTING BODIES
(a) Generally Accepted Auditing Standards,
(b) International Auditing Standards,
(c) Role of the SEC and the Courts,
(d) Standards for Internal Auditing,
(e) Standards for Government Auditing,
(f) Attestation Standards,
(g) Statements on Standards for Accounting and
Review Services,
2.1 TYPES OF ASSURANCE SERVICES
Although the focus of this book is on audits of historical financial statements, the auditing profession provides other types of assurance services, some of which are described in this section. Some of these services continue to be referred to as "audits," while others-particularly some of the newer ones-are called "attest engagements." Still other services in which CPAs provide assurance to their clients and others are referred to in this book as "other assurance services."
(a) Financial Audits
In a financial audit, an auditor seeks evidence about assertions related mainly to financial
information, usually contained in a set of financial statements or some component thereof. The established criteria against which that financial information is measured are generally
accepted accounting principles or some other specified basis of accounting (such as might be stipulated in a rental agreement). Generally, the information will be used by parties other than the management of the entity that prepared it. Sometimes, however, the information is
intended to be used primarily by management for internal decision-making purposes. In that event, it may include nonfinancial as well as financial data. While most often financial audits are associated with independent auditors whose work results in an opinion on financial
statements, both internal auditors and government auditors also perform financial audits, often in conjunction with compliance or performance audits.
(b) Compliance Audits
Compliance audits are intended to determine whether an entity has complied with specified policies, procedures, laws, regulations, or contracts that affect operations or reports. Examples of compliance audits include auditing a tax return by an Internal Revenue Service agent, auditing components of financial statements to determine compliance with a bond indenture, auditing a researcher's expenditures under a government grant to determine compliance with the terms of the grant, and auditing an entity's hiring policies to determine whether it has complied with the Equal Employment Opportunity Act. As with all audits, a compliance audit
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requires established criteria (such as those contained in a law or regulation) to measure the relevant assertions against. Compliance audits are performed by independent auditors and by internal and government auditors (often as part of a performance audit).
If a policy, contract, law, or regulation has a direct and material effect on the entity's financial statements, determining the extent of compliance with it usually will be an integral part of a financial statement audit. For example, an auditor reviews an entity's conformity with the restrictive covenants in a long-term debt agreement to ascertain that a violation of the
covenant has not made the entire bond issue due and payable at the lender's option, which might require that the debt be reclassified as a current liability. Independent auditors do not, however, plan their audits of financial statements to provide assurance about an entity's compliance with policies, contracts, laws, and regulations that do not have a direct and
material effect on the financial statements. Chapter 4 describes the auditor's responsibilities when a possible illegal act is detected. Compliance audits are discussed further in Chapter 32. (c) Performance Audits1
Performance audits, also referred to as operational audits, include economy and efficiency audits and program audits. Government Auditing Standards, issued by the U.S. General Accounting Office and revised most recently in 1994, defines those audits as follows:
Economy and efficiency audits include determining (1) whether the entity is acquiring, protecting, and using its resources (such as personnel, property, and space)
economically and efficiently, (2) the causes of inefficiencies or uneconomical practices, and (3) whether the entity has complied with laws and regulations concerning matters of economy and efficiency.
Program audits include determining (1) the extent to which the desired results or
benefits established by the legislature or other authorizing body are being achieved, (2) the effectiveness of organizations, programs, activities, or functions, and (3) whether the entity has complied with significant laws and regulations applicable to the program. Using resources economically means achieving a specified output or performance level at the lowest possible cost. An entity that met or exceeded the specified level at the lowest cost would be using its resources economically. Using resources efficiently means attaining the highest possible output or performance level at a specified cost. If output or performance can be increased without incurring additional costs, the implication is that a more efficient use of resources is possible. The achievement of desired results or benefits refers to the extent to which a program meets objectives and goals that are proper, suitable, or relevant. Results that are consistent with established objectives and goals indicate that the program is being carried out effectively.
Objectives and goals may be established by federal or state legislatures or granting agencies, or they may be set by an entity's management. As noted in Chapter 1, the subject matter of auditing usually is quantifiable information about economic actions and events. Some
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quantifiable objectives and goals may not relate to economic actions and events, however, which raises the question of whether their evaluation falls within the definition of auditing. For example, in an audit of program results in a state's prison system, program objectives and goals almost surely will not be stated in terms of economic actions or events; instead, they may be stated in terms of the number of prisoners rehabilitated and released, the number of repeat offenders, or the percentage of prison capacity utilized. While such program audits may at times stretch the definition of auditing, they are widely performed, particularly by
government auditors, and are almost always referred to as audits.
(d) Reviews of Financial Information
A review engagement consists of applying certain limited procedures to financial statements as a basis for expressing limited assurance that there are no material modifications that should be made to them. That limited assurance is less than the assurance provided by an audit. (e) Attest Engagements
An attest engagement is defined in Statement on Standards for Attestation Engagements, Attestation Standards (), as "one in which a practitioner is engaged to issue or does issue a written communication that expresses a conclusion about the reliability of a written assertion that is the responsibility of another party." The scope of services covered by this definition is similar, if not identical, to that in the American Accounting Association's
definition of auditing, which was discussed in Chapter 1. Examples of attest services include testing and reporting on representations about the characteristics of computer software, investment performance statistics, internal control, prospective financial information, and historical occupancy data for hospitals.
The profession has not yet reached a consensus about which services should be called audits and which attest engagements. For the foreseeable future, however, it is clear that attest services related to historical financial statements will continue to be called audits. Also, the term "attest engagement" will be limited to an engagement in which the practitioner issues a written opinion about a written assertion.
(f) Other Assurance Services
Many of the services CPAs in public practice currently perform do not fall into any of the categories previously described. These services-as well as new services that are not being provided currently-are best described as "other assurance services." They may include providing assurance on performance measures, such as the effectiveness of health care providers, or on an entity's compliance with its human resource policies or operating policies. The AICPA Special Committee on Assurance Services considered the potential scope of assurance services, which the Committee defined broadly as "independent professional services that improve the quality of information, or its context, for decision makers," and identified and developed detailed business plans for six new assurance services. Those services are risk assessment, business performance measurement, information systems
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reliability, electronic commerce, health care performance measurement, and assessing the quality of providers of elder care. In addition, the Committee considered, but did not develop business plans for, seven other assurance services.
2.2 TYPES OF AUDITORS
Auditors can be classified into three categories: independent, internal, and government. Independent auditors, also referred to as external auditors, and frequently as CPAs, CPAs in public practice, public accountants, or "outside" auditors, are never owners or employees of the entity that retains them to perform an audit, although they receive a fee for their services. Independent auditors perform financial statement audits to meet the needs of investors and creditors and the requirements of regulatory bodies like the Securities and Exchange Commission (SEC). The audits typically result in an opinion on whether the financial
statements are fairly stated, in all material respects, in conformity with generally accepted accounting principles. Occasionally, CPAs perform compliance and performance audits. Increasingly, they perform attest engagements and provide other assurance services.
Internal auditors are employed by the entity they audit. The Institute of Internal Auditors has defined internal auditing as "an independent appraisal function established within an organization to examine and evaluate its activities as a service to the organization. The
objective of internal auditing is to assist members of the organization in the effective discharge of their responsibilities. . . . The internal auditing department is an integral part of the
organization and functions under the policies established by management and the board [of directors]." The primary function of internal auditors is to examine their entity's internal control and evaluate how adequate and effective it is. In performing that function, internal auditors often conduct performance (or operational) audits that are broadly designed to accomplish financial and compliance audit objectives as well.
The independence of internal auditors is different from that of independent (i.e., external) auditors. Internal auditors' independence comes from their organizational status-essentially, their function and to whom they report-and their objectivity. For external auditors,
independence derives instead from the absence of any obligation to or financial interest in the entity they were retained to audit, its management, or its owners.
Government auditors are employed by agencies of federal, state, and local governments. When the audit is of the government agency or department that employs the auditors, they function as internal auditors; when they audit recipients of government funds (including other government agencies), they act as external auditors. For example, auditors employed by the U.S. Department of Agriculture may audit the internal operations of that department; they also may audit the economy, efficiency, and program results of research funded by the Department of Agriculture but performed by others, such as colleges and universities. Most audits performed by government auditors are performance audits of economy, efficiency, and
programs, which include determining whether the entity being audited has complied with laws and regulations concerning economy and efficiency as well as those applicable to the program. 2
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Some audits, such as those by the Internal Revenue Service, are performed almost exclusively for compliance purposes.
There are many different groups of government auditors; virtually every level of government and every government agency has its own auditors. One group in particular warrants further discussion-the General Accounting Office (GAO). A nonpolitical agency headed by the
Comptroller General of the United States, it was created by and reports directly to Congress. The GAO has the authority to audit virtually every federal agency and expenditure. The GAO formulated the notion of and standards for economy, efficiency, and program audits, which are the major part of its activities.
2.3 ORGANIZATION OF AN ACCOUNTING FIRM
Accounting firms range in size from an individual CPA in business as a sole practitioner to large firms with an international practice, hundreds of offices worldwide, and thousands of partners and employees. In between these two extremes are numerous small and
medium-sized firms of professional accountants. In general, the larger firms offer a broader range of services than do the smaller ones. The majority of medium-sized and large
accounting firms are multicapability firms, meaning that they serve clients in several major practice areas, including assurance, taxation, consulting, and human resources advisory services. Although the structure of individual firms varies, it is possible to make some generalizations about the services typically offered by the majority of accounting firms. (a) Assurance Services
The most basic practice area of a CPA firm, assurance services consist primarily of performing independent audits of entities' financial statements. CPAs also perform reviews, engagements based on agreed-upon procedures, attest engagements, and other assurance services.
(i) Audits. An audit requires personnel with a blend of skills and technical expertise. For example, if the engagement is extremely complex technically, the audit team may require members who have industry expertise, a high level of knowledge of computer systems, tax expertise, and the ability to understand difficult actuarial computations. A team with such expertise frequently will find and recommend ways to improve the entity's financial and operating policies, a client service that is derived from the audit process.
In addition to audits, accounting firms generally offer a number of audit-related services, either in conjunction with an audit or as separate engagements. One of these services is a
communication to management containing recommendations for improvements in internal control relating to financial reporting and other matters, such as comments on operating efficiencies and profitability. Additional audit-related services include acquisition audits of
entities that clients are contemplating acquiring, and issuing letters reporting whether an entity is in compliance with the covenants of debt instruments.
(ii) Reviews. CPAs also perform review services. Review services for nonpublic entities are
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defined by the American Institute of Certified Public Accountants (AICPA) in the first of a series of Statements on Standards for Accounting and Review Services (SSARSs). Those statements resulted from the AICPA's recognition of the need for professional services that are less than an audit, but that provide some assurance about the reliability of a nonpublic entity's financial statements. Reviews are discussed further in Chapter 30.
(iii) Agreed-Upon Procedures Engagements. Accountants sometimes are engaged to perform agreed-upon procedures to specified elements, accounts, or items of a financial statement. In these engagements, the parties agree on the procedures to be performed, and use of the resulting report is limited to those parties. These agreed-upon procedures
engagements are discussed further in Chapter 30. Other types of agreed-upon procedures engagements fall under the attestation standards and are discussed in Chapter 31. (iv) Attest Engagements. In an attest engagement, the accountant provides written
assurance about an assertion or assertions made by another party. The definition of an attest engagement is broad and covers a variety of assertions. For example, an accountant may be engaged to examine or review, and report on insurance claims data or enrollment and attendance data for a college. While attest engagements typically are undertaken by audit personnel, at times they are performed by personnel specializing in some of the
"nonassurance services" offered by accounting firms, as described below. (Attest
engagements are described further in Chapter 31.)
(v) Other Assurance Services. In an engagement to provide assurance services beyond those currently defined in the authoritative professional literature, the objective is to improve the quality of information, or its context, for decision makers. Since the particular set of
information that is used by a specific decision maker to make a specific decision will vary with the circumstances, the assurance provider must be able to identify what information is relevant and determine how and when to develop and present that information to the decision maker. The AICPA plans to develop measurement and reporting criteria to assist the assurance provider that will be sufficiently broad so that they can be customized to fill the needs of
individual decision makers. While assurance services may be undertaken by audit personnel, they also may be performed by personnel specializing in some of the "nonassurance services" offered by accounting firms, as described below, particularly since those individuals may have the competencies appropriate for providing those services.
(b) Nonassurance Services
Accounting firms provide nonassurance services to their clients in the form of compilations, tax services, and consulting services.
(i) Compilations. A service performed by CPAs that is related to assurance services but does not result in the expression of assurance is a compilation. A compilation consists of presenting information in the form of financial statements without expressing any opinion on them. Compilations are discussed further in Chapter 30.
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(ii) Tax Services. A major service provided by accounting firms is in the area of taxation-tax and business planning and compliance services offered to businesses and individuals. Tax services offered to businesses by accounting firms cover a broad spectrum, including
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