Page 32 replacement, beginning with AICPA Generally Accepted Auditing Standards (GAAS)

AICPA Generally Accepted Auditing Standards
What are the standards developed by the public accounting profession through the AICPA?  The AICPA has set forth the basic framework in the following 10 generally accepted auditing standards (emphasis added).

            The 10 standards set forth by the AICPA include such subjective terms of  measurement as “adequate plan,” “sufficient understanding of the entity,” and “sufficient appropriate evidence.”  To decide under the circumstances of each audit engagement what is adequate, sufficient and appropriate requires the exercise of professional judgment.  Auditing cannot be reduced to rote; the exercise of judgment by the auditor is vital at numerous points in every engagement.  However, the formulation and publication of carefully worded auditing standards are of immense aid in raising the quality of audit work, even though these standards require professional judgment in their application. 

General Standards—Auditor Qualifications and Quality of Work
The general standards are personal in nature in that they deal with auditor training and proficiency, auditor independence, and the need for due professional care.  These standards apply to all parts of the audit, including fieldwork and reporting.

Training and Proficiency
How does the independent auditor achieve the “adequate technical training and proficiency” required by the first general standard?  This requirement is usually interpreted to mean college or university education in accounting and auditing, participation in continuing education programs, and substantial public accounting experience.  A technical knowledge of the industry in which the client operates is also part of the personal qualifications of the auditor.  It follows that a CPA firm must not accept an audit engagement without first determining that members of its staff have the proficiency needed to function effectively in the particular industry.

Independence
An opinion by an independent public accountant as to the fairness of a company’s financial statements is of questionable value unless the accountant is truly independent. Consequently, the auditing standard that states “in all matters relating to the assignment an independence in mental attitude is to be maintained by the auditor” is perhaps the most essential factor in the existence of a public accounting profession.
If auditors own shares of stock in a company that they audit, or if they serve as members of the board of directors, they might subconsciously be biased in the performance of auditing duties. An auditor should therefore avoid any relationship with a client that would cause an outsider who had knowledge of all the facts to doubt the CPA’s independence. It is not enough that auditors be independent; they must conduct themselves in such a manner that informed members of the public will have no reason to doubt their independence. Independence is a key element of professional ethics and will be described in detail in Chapter 3.

Due Professional Care
The third general standard requires due professional care in the conduct of the audit and in the preparation of the audit report. This standard requires the auditors to plan and carry out every step of the audit engagement in an alert and diligent manner. Full compliance with this standard would rule out any negligent acts or material omissions by the auditors. Of course, auditors, as well as members of other professions, inevitably make occasional errors in judgment.

Standards of Fieldwork—Planning, Accumulating and Evaluating Evidence
The three standards of fieldwork relate to planning the audit, obtaining an understanding of the client and its environment, and obtaining sufficient appropriate audit evidence.  Audit planning involves developing an overall strategy relating to collecting and evaluating the evidence to be obtained.  By obtaining an understanding of the entity and its environment, including internal control, the auditors can assess whether it offers assurance that the financial statements will be free from material errors and fraud.  These assessments enable the auditors to evaluate the risks of material misstatement of the financial statements.  To address these risks, the auditors will perform procedures to substantiate the amounts on the financial statements being audited.  Examples of such evidence include written confirmations from outsiders and firsthand observation of assets by the auditors.  The gathering and evaluating of evidence lies at the very heart of the audit process and is a continuing theme throughout this textbook.

Adequate Planning and Supervision
Adequate planning is essential to a satisfactory audit. Some portions of the audit can be performed prior to the end of the year under audit; some information may be compiled by the client’s staff and made available for the auditors’ analysis. The appropriate number of audit staff of various levels of skill and the time required of each need to be determined in advance of fieldwork. These are but a few of the elements of planning the audit.
Most of the fieldwork of an audit is carried out by staff members with limited experience. The key to successful use of relatively new staff members is close supervision at every level. This concept extends from providing a specific written audit program to staff members all the way to an overall review of the work by the partner in charge of the engagement.
Sufficient Understanding of the Entity, and its Environment, including its Internal Control
The auditors’ understanding of the client and its environment, including internal control, allows the auditors to determine what can go wrong to cause the financial statements to be materially misstated. In areas where risk is high the auditors must plan and perform more extensive audit procedures. Such procedures may be tests of internal controls or procedures to substantiate financial statement amounts.
  Effective internal control provides assurance that the client’s records are reliable. When the auditors find this type of internal control, the quantity of other evidence required is much less than if controls are weak. Thus, the auditors’ assessment of internal control has a great impact on the nature of the audit process.
Sufficient Appropriate Audit Evidence
The third standard of fieldwork requires that the auditors gather sufficient appropriate evidence to have a basis for expressing an opinion on the financial statements. The term appropriate refers to the quality of the evidence; some forms of audit evidence are stronger and more convincing than others. In Chapter 5, we explore at length the meaning of this standard.

Standards of Reporting
The four reporting standards establish some specific directives for preparation of the auditors’ report. The report must specifically state whether the financial statements are in conformity with generally accepted accounting principles. The report must contain an opinion on the financial statements as a whole, or must disclaim an opinion. Consistency in the application of generally accepted accounting principles and adequate informative disclosure in the financial statements is to be assumed unless the audit report states otherwise. These basic reporting standards are considered more fully in the later part of this chapter.

AICPA Statements on Auditing Standards (SASs)
[Learning Objective 2]
Statements of Auditing Standards are serially numbered pronouncements issued by the AICPA’s Auditing Standards Board (ASB).  The first in the series, SAS 1, is a codification of 54 Statements previously issued over many years by the Committee on auditing Procedure, a predecessor of the ASB.  Since SAS 1 was released in 1972, many additional statements on specific topics have been issued to provide more detailed guidance than is available from the 10 generally accepted auditing standards.
The SASs are codified within the framework of the 10 generally accepted auditing standards.  They are the most authoritative references that auditors can utilize to resolve problems encountered during the audit of a nonpublic company.  The term auditing standards is often used in practice to refer to the SASs, to the generally accepted auditing standards , or to both.  The authoritative status of the SASs is derived from the AICPA Code of Professional Conduct (Rule 202).  The code requires auditors to adhere to these pronouncements.
When describing auditor responsibility, the exact wording of the pronouncement is extremely important.  SAS No. 102 (AU 120),  “Defining Professional Requirements in Statements on Auditing Standards” provides the appropriate guidance.  In some cases the standard establishes an unconditional requirement that auditors must follow in all circumstances and in others it provides matters to be considered, but not necessarily performed.  Figure 2.2 provides a summary of the most relevant wording.  Thus, for example, if a pronouncement states that an auditor “must” perform a particularly procedure there are no exceptions—the procedure must be performed on an audit.  If a pronouncement says a procedure “should,” be performed, there may be circumstances in which alternate procedures may be performed instead.  These terms are used in essentially an equivalent manner in Public Company Accounting Oversight Board pronouncements.
[Figure 2-2 about here]
Figure 2.2  Terminology in Statements on Auditing Standards

---
Data input—Have to be careful here.

• Make sure you keep Figure 2.1 that is on page 34.
• Pages 33 and 35 have been replaced completely.
• Now return to old text at page 36.  The only difference is that Figure 2.2 in 15th is now Figure 2.3 at page 36.