📚Ethics in Accounting Unit 4 – Auditing and Assurance Services

Key Concepts and Definitions

• Auditing involves examining financial statements and related disclosures by an independent party to express an opinion on their fairness and compliance with applicable standards
• Assurance services aim to improve the quality and reliability of information for decision-makers, including auditing, review, and agreed-upon procedures
• Independence requires auditors to maintain an unbiased mental attitude and avoid situations that could impair their objectivity
• Materiality refers to the significance of an item or error in the context of financial statements, influencing the economic decisions of users
• Audit risk is the possibility that an auditor expresses an inappropriate opinion when the financial statements are materially misstated
  • Consists of inherent risk, control risk, and detection risk
• Sufficient appropriate audit evidence should be obtained to support the auditor's opinion and reduce audit risk to an acceptably low level
• Audit procedures include tests of controls, substantive tests of transactions, and analytical procedures to gather evidence
• An unmodified opinion indicates that the financial statements are presented fairly in all material respects, while a modified opinion suggests departures from the applicable framework

Ethical Framework in Auditing

• Auditors must adhere to fundamental principles of integrity, objectivity, professional competence and due care, confidentiality, and professional behavior
• The AICPA Code of Professional Conduct and IESBA Code of Ethics for Professional Accountants provide guidance on ethical responsibilities
• Threats to compliance with fundamental principles include self-interest, self-review, advocacy, familiarity, and intimidation threats
• Safeguards, such as firm-wide policies, engagement-specific measures, and regulatory oversight, help mitigate threats to an acceptable level
• Auditors should maintain a questioning mind, exercise professional skepticism, and apply professional judgment throughout the audit process
• Ethical dilemmas may arise from conflicts of interest, pressure from clients or superiors, or personal relationships with client personnel
• Auditors should consult with appropriate parties, document their decisions, and prioritize the public interest when faced with ethical challenges
• Continuous training and awareness of emerging ethical issues are crucial for maintaining high standards of professional conduct

Auditor's Responsibilities and Independence

• Auditors are responsible for planning and performing the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement
• Detecting and reporting fraud, evaluating the entity's ability to continue as a going concern, and communicating significant deficiencies in internal control are key responsibilities
• Independence in appearance and independence of mind are essential for maintaining public trust and confidence in the auditing profession
• Financial, business, employment, and personal relationships with the client can pose threats to independence
• Auditors should comply with relevant independence rules, such as partner rotation, non-audit service restrictions, and cooling-off periods
• Regular communication with those charged with governance (TCWG) about independence matters helps maintain transparency and accountability
• Documenting independence assessments, consultations, and conclusions demonstrates compliance with ethical requirements
• Auditors should decline or withdraw from engagements when independence cannot be maintained or threats cannot be reduced to an acceptable level

Risk Assessment and Materiality

• Auditors perform risk assessment procedures to identify and assess the risks of material misstatement at the financial statement and assertion levels
• Understanding the entity and its environment, including internal control, is crucial for effective risk assessment
• Inherent risk factors, such as the nature of the entity, complexity of transactions, and susceptibility to fraud, influence the likelihood of misstatements
• Control risk is the risk that a misstatement will not be prevented, detected, or corrected by the entity's internal control system
• Auditors design and perform further audit procedures in response to assessed risks, considering the nature, timing, and extent of procedures
• Materiality judgments are based on quantitative (monetary thresholds) and qualitative factors (nature and circumstances of misstatements)
  • Materiality levels are set for the financial statements as a whole (overall materiality) and for particular classes of transactions, account balances, or disclosures (performance materiality)
• Auditors reassess risk and materiality throughout the audit and modify their approach as necessary based on new information or changes in circumstances

Audit Evidence and Procedures

• Audit evidence is information used by the auditor to draw conclusions and support the audit opinion
• Evidence should be sufficient (quantity) and appropriate (quality, relevance, and reliability) to reduce audit risk to an acceptably low level
• Audit procedures include inspection, observation, inquiry, confirmation, recalculation, reperformance, and analytical procedures
• Tests of controls evaluate the operating effectiveness of controls in preventing, detecting, or correcting material misstatements
• Substantive procedures, such as tests of details and substantive analytical procedures, detect material misstatements at the assertion level
• External confirmations (accounts receivable) and physical inspection (inventory observation) provide direct evidence from independent sources
• Auditors should consider the source, comparability, nature, and understandability of available evidence when evaluating its appropriateness
• Professional skepticism should be exercised when assessing the reliability of evidence, especially when contradictory evidence exists or fraud risk is high

Reporting and Communication

• The auditor's report expresses an opinion on whether the financial statements are presented fairly in accordance with the applicable financial reporting framework
• Unmodified opinions indicate that the financial statements are free from material misstatement and comply with the framework
• Modified opinions, such as qualified, adverse, or disclaimer of opinion, are issued when misstatements or scope limitations are identified
• Key audit matters (KAMs) and critical audit matters (CAMs) highlight areas of significant auditor attention or judgment in the auditor's report
• Emphasis of matter and other matter paragraphs draw users' attention to important disclosures or other relevant information without modifying the opinion
• Auditors communicate significant findings, deficiencies in internal control, and other relevant matters to TCWG through written reports or oral discussions
• Management representation letters confirm management's responsibilities and provide written representations on specific matters requested by the auditor
• Auditors should report suspected or actual non-compliance with laws and regulations to appropriate authorities, considering confidentiality and legal implications

Regulatory Environment and Standards

• Auditing standards, such as International Standards on Auditing (ISAs) and Generally Accepted Auditing Standards (GAAS), provide guidance for conducting high-quality audits
• Regulatory bodies, such as the Public Company Accounting Oversight Board (PCAOB) and the International Auditing and Assurance Standards Board (IAASB), set and enforce auditing standards
• Securities and Exchange Commission (SEC) and other regulatory agencies oversee financial reporting and auditing practices for public companies
• Sarbanes-Oxley Act (SOX) introduced stricter requirements for auditor independence, internal control reporting, and corporate governance in response to accounting scandals
• Quality control standards (ISQC 1 and SQCS) require audit firms to establish policies and procedures for engagement performance, ethical requirements, and monitoring
• Peer reviews and regulatory inspections assess audit firms' compliance with professional standards and identify areas for improvement
• Auditors should stay informed about changes in regulations, standards, and best practices through continuous professional development and engagement with professional organizations

Practical Applications and Case Studies

• Enron scandal highlighted the importance of auditor independence and the consequences of unethical behavior, leading to the collapse of Arthur Andersen
• WorldCom fraud involved the manipulation of financial statements and the failure of auditors to detect and report the misstatements
• Lehman Brothers case raised questions about auditors' responsibilities in evaluating going concern assumptions and disclosing off-balance sheet transactions
• Olympus accounting scandal demonstrated the challenges of cross-border audits and the need for effective communication between group and component auditors
• Parmalat fraud exposed weaknesses in the regulatory environment and the role of auditors in detecting and reporting fraudulent activities
• Satyam Computer Services scandal underscored the importance of professional skepticism and the risks of over-reliance on management representations
• Case studies can be used to analyze ethical dilemmas, apply professional judgment, and develop critical thinking skills in real-world scenarios
• Discussing practical applications and case studies in training sessions, workshops, and classroom settings helps auditors understand the complexities and challenges of the profession