Practitioners guide to gaas 2016 covering all sass ssaes ssarss pcaob auditing standards and interpr

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Practitioner’sGuideto

GAAS

CoveringallSASs, SSAEs,SSARSs, PCAOBAuditing Standards,and Interpretations

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Practitioner’sGuideto

GAAS

CoveringallSASs, SSAEs,SSARSs, PCAOBAuditing Standards,and Interpretations

JoanneM.Flood

Copyright  1992through2015bytheAmericanInstituteofCertifiedPublicAccountants,Inc.

Reprintedwithpermission.

ThebookcontainsnumerousexcerptstakenfromtheStatementsonAuditingStandards,theStatementson StandardsforAttestationEngagements,andtheStatementsonStandardsforAccountingandReviewServices,and interpretationsofthesestatements.ThesearenotedbyreferencetothespecificstandardorAICPACodification section,exceptfordefinitionswhichappearunderaseparateheadingatthebeginningofeachsection.These standardsarecopyrightedbytheAmericanInstituteofCertifiedPublicAccountants,Inc.andreprintedwith permissionoftheAICPA.

ThisbookcontainsdefinitionstakenfromStatementofFinancialAccountingConcepts2, QualitativeCharacteristicsofAccountingInformation;andStatementofFinancialAccountingConcepts7, UsingCashFlow InformationandPresentValueinAccountingMeasurements,arecopyrightedbytheFinancialAccounting StandardsBoard,401Merritt7,POBox5116,Norwalk,Connecticut06856-5116,USA.Portionsarereprinted withpermission.CompletecopiesofthesedocumentsareavailablefromtheFASB.

Thisbookisprintedonacid-freepaper. ♾

Copyright  2016byJohnWiley&Sons,Ltd.Allrightsreserved.

PublishedbyJohnWiley&Sons,Ltd,Chichester

PublishedsimultaneouslyinCanada.

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ISBN978-1-119-10759-0(paperback)ISBN978-1-119-10761-3(ebk) ISBN978-1-119-10762-0(ebk)ISBN978-1-119-23351-0(ebk)

PrintedintheUnitedStatesofAmerica 10987654321

AU-C200 OverallObjectivesoftheIndependentAuditorandtheConductofan AuditinAccordancewithGenerallyAcceptedAuditingStandards

AU-C210 TermsofEngagement

AU-C220 QualityControlforanEngagementConductedinAccordancewith

AU-C230

AU-C240

AU-C250

AU-C540 AuditingAccountingEstimates,IncludingFairValueAccounting EstimatesandRelatedDisclosures

AU-C570 TheAuditor’sConsiderationofanEntity’sAbilityto ContinueasaGoingConcern

AU-C580 WrittenRepresentations

AU-C585 ConsiderationofOmittedProceduresAftertheReportReleaseDate

AU-C600 SpecialConsiderations AuditsofGroupFinancialStatements (IncludingtheWorkofComponentAuditors)

AU-C705 Modifi cationstotheOpinionintheIndependentAuditor’sReport

AU-C706 Emphasis-of-MatterParagraphsandOther-MatterParagraphsinthe

AU-C800 SpecialConsiderations AuditsofFinancialStatementsPreparedin AccordancewithSpecialPurposeFrameworks

AU-C805 SpecialConsiderations AuditsofSingleFinancialStatementsand Speci ficElements,Accounts,orItemsofaFinancialStatement

AU-C806 ReportingonCompliancewithAspectsofContractualAgreementsor RegulatoryRequirementsinConnectionwithAuditedFinancial

AU-C810 EngagementstoReportonSummaryFinancialStatements

AlertThatRestrictstheUseoftheAuditor ’sWrittenCommunication

AU-C910 FinancialStatementsPreparedinAccordancewithaFinancial ReportingFrameworkGenerallyAcceptedinAnotherCountry

AU-C915 ReportsonApplicationofRequirementsofanApplicable

PREFACE

TheAICPA’sClarityProject

AuditingStandards

FollowingthecreationofthePublicCompanyAccountingOversightBoard(PCAOB),the AICPA ’sAuditingStandardsBoard(ASB)reassesseditsmission.TheASBdevelopedaplanto convergeUSgenerallyacceptedauditingstandards(GAAS)withtheInternationalStandardson Auditing(ISAs)issuedbytheInternationalAuditingandAssuranceStandardsBoard(IAASB). Thus,theASB’sClarityProjectbeganworkto:

• Redrafttheauditingstandardsforclarity tomakethestandardseasiertoread,understand,andapply

• ConvergeUSstandardswiththeISAs

TheASBhascompleteditsproject.Whileclarityandconvergence,notchange,werethe goalsoftheClarityProject,theProjectdidcreatesomechangesthatrequireauditorstomake changesinpractice.Foreaseofuse,thisbookarrangesinformationaccordingtothesectionsofthe AICPA ’sauditingstandardscodifi cation.

Preparation,Compilation,andReviewStandards

InMay2010,theAICPA’sAccountingandReviewServicescommittee(ARSC)approveda clarityprojectwiththepurposeofaligningtheconventionsofitsstandardswiththeASB standardsandmakingthecompilationandreviewstandardseasiertoread,understand,andapply. OnedivergencefromtheASBapproachisthatARSCdecidednottoincludeapplicationguidance forgovernmentalandsmaller,lesscomplexentities.Otherwise,theformatsaresimilarand include:

• Objectives definesthecontextinwhichtherequirementsareset

• Definitions explains,whererelevant,specifi cterms

• Requirements whatthepractitionersmustdotomeettheobjectivesofthestandard

• ApplicationandOtherExplanatoryMatters providefurtherguidanceforcarryingout therequirementsofthestandard.Theseparagraphsusean “A” prefi xandareinaseparate sectionthatfollowstherequirementssection.

AsaresultoftheARSCclarityproject,anewsectionidenti fier, “AR-C,” wasestablishedfor theclari fiedstandardsinordertoavoidconfusionwithreferencestotheextant “AR” sections.

SSARSNo.21

StatementonStandardsforAccountingandReviewServices(SSARS)No.21, Statementson StandardsforAccountingandReviewServices:ClarificationandRecodification,isaproductof theSSARSclarityproject.Therehavelongbeenpracticeproblemsaroundwhenanaccountantis associatedwithorinvolvedinthepreparationof financialstatements.Questionscircledaroundthe accountant’sresponsibilitiesandtheusers’ perceptionsofthemeaningoftheaccountant’s involvement.Withtheadvent firstofcomputersandthenthecloud,theseissuesbecameeven morecomplex.

Inanefforttoclarifytheaccountant’sroleundervariousscenarios,theAICPA’sAccounting andReviewServicesCommittee(ARSC)undertookaprojectandinJune2012issuedthree proposedSSARSmeanttoclarifyandcommunicatetheaccountant’sresponsibilityregarding compilationengagementsandassociationwithunaudited financialstatements.Laterthatyear,in November,SSARSissuedtwoproposalsonreviewengagements.

During2012,2013,and2014,ARSCsolicitedcommentsandmetwithconstituencies.It issuedrevisedproposalsandarigorousprocesstoensuretheintegrityandacceptanceofthe final product.InAugust2014,ARSCvotedtoissuethe fi nalstandard.

InOctober2014,theAICPAreleasedstatementonSSARSNo.21.Thisnewstandard signifi cantlyaffectspublicpractitionerswhoprepared fi nancialstatementsandiseffectivefor reviews,compilations,andpresentationof financialstatementsforperiodsendingonorafter December15,2015,withearlyimplementationallowed.

SSARSNo.21supersedesallextantARsections,exceptforARsection120.Thelastwillbe thesubjectofafutureclari fiedstandard.SSARSNo.21eliminatesallexistingSSARS interpretationsandincorporatesthemintotheclari fiedguidance.SSARSNo.21contains substantivechangestostandardsforcompilationsandengagementstoprepare financialstatements.ThosechangesarehighlightedintheTechnicalAlertsectionsandincorporatedinthe relevantchaptersofthisbook.

SSARSNo.21resultsinthefollowingstructure:

• Section60, GeneralPrinciplesforEngagementsPerformedinAccordanceWithStatementsonStandardsforAccountingandReviewServices

• Section70, PreparationofFinancialStatements

• Section80, CompilationEngagements

• Section90, ReviewofFinancialStatements

NextSteps

TheARSCisworkingonclari fiedstandardsonprospectiveandproforma financial information.Exposuredraftsareexpectedin2015with finalstandardsin2016.Thatwill completetheclarityprojectforSSARSengagements.

Resources

WileyGAAScontainsrobusttoolstohelpauditorsimplementtheclari fiedstandards.Each chapterbeginswiththesourceofthecodesection,theclari fiedobjectives,anddefinitions, followedbypracticeguidance.Exhibitsandillustrationsareintegratedinthechapterandclearly identi fied.Clari fiedstandardreferencesareprecededby “AR-C.”

TheAICPAhasdedicatedapageonitssitetotheSSARSclarityproject,withlinksto additionalresourcesthatmaybehelpfulinimplementingthechanges: http://www.aicpa.org/SSARSClarity

PCAOB

ThePCAOBissuedanewaccountingstandard,ASNo.18, RelatedParties.Thechapteron PCAOB18detailsthestandard’srequirements.

ABOUTTHEAUTHOR

JoanneM.Flood, CPA,isanauthorandindependentconsultantonaccountingandauditing technicaltopicsande-learning.Shehasexperienceasanauditorinbothaninternational firmanda local fi rmandworkedasaseniormanagerintheAICPA’sProfessionalDevelopmentgroup. ShereceivedherMBASummaCumLaudeinAccountingfromAdelphiUniversityandher Bachelor’sdegreeinEnglishfromMolloyCollege.

Whileinpublicaccounting,Joanneworkedonmajorclientsinretail,manufacturing,and financeandonsmallbusinessclientsinconstruction,manufacturing,andprofessionalservices. AttheAICPA,Joannedevelopedandwrotee-learning,text,andinstructor-ledtrainingcourseson USandInternationalStandards.Shealsoproducedtrainingmaterialsinawidevarietyofmedia, includingprint,video,andaudio,andpioneeredtheAICPA ’se-learningproductline.Joanne residesonLongIsland,NewYorkwithherdaughter,Elizabeth.Joanneistheauthorofseveral articlesforandcontributortoWileyInsightIFRSandthefollowingWileypublications:

FinancialDisclosureChecklist

WileyGAAP2016:InterpretationandApplicationofGenerallyAcceptedAccounting Principles

WileyPractitioner’sGuidetoGAAS2016:CoveringallSASs,SSAEs,SSARSs,and Interpretations

WileyGAAP:FinancialStatementDisclosuresManual(WileyRegulatoryReporting), comingsoon

WileyRevenueRecognition,comingsoon

AndthefollowingAICPAonlineandliveCPEprograms:

AuditStaffEssentials,Level1 NewHire

AuditStaffEssentials,Level2 ExperiencedStaff

AuditStaffEssentials,Level3 AuditSenior/In-Charge

ORGANIZATIONANDKEYCHANGES

ThisbookreducestheofficiallanguageofStatementsonAuditingStandards(SASs), StatementsonStandardsforAttestationEngagements(SSAEs),StatementsonStandardsfor AccountingandReviewServices(SSARSs),PublicCompanyAccountingOversightBoard (PCAOB)AuditingStandards,andtheinterpretationsofthosestandardsintoeasy-to-readand understandableadvice.ItisdesignedtohelpCPAsintheapplicationof,andcompliancewith, authoritativestandards.Thisyearmarksthefullimplementationoftheclari fiedstandards resultingfromtheAICPA ’sClarityProject.ThePrefacecontainsadditionalinformationon theClarityProject.

ThisbookfollowsthesequenceofsectionsoftheAICPA CodificationofStatementson AuditingStandards,the CodificationofStatementsonStandardsforAttestationEngagements, andthe CodificationofStatementsonStandardsforAccountingandReviewServices.Sectionsare dividedintothefollowingeasy-to-understandparts:

OriginalPronouncement. Ahandy,briefidenti ficationoftheoriginalstandardforthe section.

De finitionsofTerms. Aglossaryofofficialdefinitionsthatgathersinoneplace explanationsoftermsthatareordinarilyscatteredthroughoutastandard.

ObjectivesofSection. Abehind-the-scenesexplanationofthereasonsforthepronouncementandacapsuleexplanationofthemostbasicideasofthesection. FundamentalRequirements. Conciselistinganddescriptionsofthosethingsspecificallymandatedbythesection.

Interpretations. Abriefsummaryofeachinterpretation. TechniquesforApplication. Helpfultechniquesforcomplyingwiththefundamental requirementsofthesection.

Illustrations. Examplesoftheapplicationofthefundamentalrequirementsofthe section.

AICPAAuditingStandards

TheAICPA ’sAuditingStandardsBoard(ASB)establishesstandardsfornonissuers.The ASBissuesStatementsonAuditingStandards(SASs)andinterpretativepublicationsforauditsof nonissuers.Interpretativepublicationincludes:

• Auditinginterpretationsand

• AuditingguidanceinAICPAAuditandAccountingGuidesandinStatementsofPosition (SOPs)

AU-C200requirestheauditortoconsiderinterpretativeguidanceinplanningandperforming theaudit.

PCAOBStandardsandRelationshiptoAICPAStandards

FollowingthepassageoftheSarbanes-OxleyActof2002,auditorsofpubliccompaniesmust followthePCAOBstandards.ThePCAOBestablishesstandardsonauditingandrelated attestation,qualitycontrol,andethicsandindependenceforusebyregisteredpublicaccounting firmsinthepreparationandissuanceofauditreportsforissuers.

Initiallyin2003,thePCAOBadoptedonaninterimbasistheAICPA’sauditing,attestation, andqualitycontrolstandards.Intheensuingyears,thePCAOBhasissuedsomeofitsown standards.Thosestandardsaredescribedinthisvolume.

Aswithallaccountingandauditingpublications,thisbookismerelyaguide.Itisnota substituteforprofessionaljudgment.Itcan,however,beavaluablereferencetool.

The2016editionofthisbookiscurrentthroughSAS129, AmendmenttoSASNo.122 Section920, LettersforUnderwritersandCertainOtherRequestingParties,asAmended; SSAE 17, ReportingonCompiledProspectiveFinancialStatementsWhenthePractitioner’sIndependenceisImpaired;SSARS21, StatementsonStandardsforAccountingandReviewServices: Clari ficationandRecodification;andPCAOBAuditingStandard1, RelatedParties.

OntheHorizon

SSARSNo.21supersedesallexistingARsectionsexceptforARSection120, Compilation ofProFormaFinancialInformation,whichisexpectedtobeexposedforpubliccommentin clari fiedformatin2015

TheAuditingStandardsBoardisworkingonaprojecttoclarifytheAttestationStandards. Theclari fi cationisexpectedtobereleasedasSSAE18.Nodefinitivedateforissuancehasbeen released.

ThePCAOBhasissuedaproposaltoreorganizethePCAOBauditingstandardsandrelated amendmentstothePCAOBAuditingStandardsandRules.Theproposalistoreorganizethe standards,butthePCAOBhasstatedthattheproposedamendmentwillnotincludesubstantive changes.

JoanneM.Flood

August2015

AU-C200 OverallObjectivesofthe IndependentAuditorandthe

AU-CORIGINALPRONOUNCEMENTS

OriginalPronouncements StatementsonAuditingStandards(SASs)122,123,and128.

AU-C200DEFINITIONSOFTERMS

Source:AU-C200.14

Applicable fi nancialreportingframework. The financialreportingframeworkadoptedby managementand,whenappropriate,thosechargedwithgovernanceinthepreparationandfair presentationofthe fi nancialstatements,thatisacceptableinviewofthenatureoftheentityandthe objectiveofthe financialstatements,orthatisrequiredbylaworregulation.

Auditevidence. Informationusedbytheauditorinarrivingattheconclusionsonwhichthe auditor’sopinionisbased.Auditevidenceincludesbothinformationcontainedintheaccounting recordsunderlyingthe financialstatementsandotherinformation. Sufficiencyofauditevidence is themeasureofthequantityofauditevidence.Thequantityoftheauditevidenceneededisaffected bytheauditor’sassessmentoftherisksofmaterialmisstatementandalsobythequalityofsuch auditevidence. Appropriatenessofauditevidence isthemeasureofthequalityofauditevidence; thatis,itsrelevanceanditsreliabilityinprovidingsupportfortheconclusionsonwhichthe auditor’sopinionisbased.

Auditrisk. Theriskthattheauditorexpressesaninappropriateauditopinionwhenthe financialstatementsaremateriallymisstated.Auditriskisafunctionoftheriskofmaterial misstatementanddetectionrisk.

Auditor. Thetermusedtorefertothepersonorpersonsconductingtheaudit,usuallythe engagementpartnerorothermembersoftheengagementteam,or,asapplicable,the firm.When anAU-Csectionexpresslyintendsthatarequirementorresponsibilitybefulfi lledbythe engagementpartner,theterm engagementpartner ratherthan auditor isused. Engagement partner and firm aretobereadasreferringtotheirgovernmentalequivalentswhenrelevant. Detectionrisk. Theriskthattheproceduresperformedbytheauditortoreduceauditriskto anacceptablylowlevelwillnotdetectamisstatementthatexistsandthatcouldbematerial,either individuallyorwhenaggregatedwithothermisstatements.

Financialreportingframework. Asetofcriteriausedtodeterminemeasurement, recognition,presentation,anddisclosureofallmaterialitemsappearinginthe financialstatements;forexample,USgenerallyacceptedaccountingprinciples,InternationalFinancial ReportingStandards(IFRSs)promulgatedbytheInternationalAccountingStandardsBoard (IASB),oraspecialpurposeframework.

Theterm fairpresentationframework isusedtorefertoa financialreportingframeworkthat requirescompliancewiththerequirementsoftheframeworkand:

1.Acknowledgesexplicitlyorimplicitlythat,toachievefairpresentationofthe financial statements,itmaybenecessaryformanagementtoprovidedisclosuresbeyondthose specifi callyrequiredbytheframework;or

2.Acknowledgesexplicitlythatitmaybenecessaryformanagementtodepartfroma requirementoftheframeworktoachievefairpresentationofthe financialstatements.Such departuresareexpectedtobenecessaryonlyinextremelyrarecircumstances.

A financialreportingframeworkthatrequirescompliancewiththerequirementsofthe frameworkbutdoesnotcontaintheacknowledgmentsin1or2isnotafairpresentationframework. Financialstatements. Astructuredrepresentationofhistorical financialinformation, includingrelatednotes,intendedtocommunicateanentity’seconomicresourcesandobligations atapointintimeorthechangesthereinforaperiodoftimeinaccordancewitha fi nancialreporting framework.Therelatednotesordinarilycompriseasummaryofsignificantaccountingpolicies andotherexplanatoryinformation.Theterm financialstatements ordinarilyreferstoacomplete setof financialstatementsasdeterminedbytherequirementsoftheapplicable fi nancialreporting framework,butcanalsorefertoasingle financialstatement.

Historical financialinformation. Informationexpressedin financialtermsregardinga particularentity,derivedprimarilyfromthatentity’saccountingsystem,abouteconomicevents occurringinpasttimeperiodsorabouteconomicconditionsorcircumstancesatpointsintimein thepast.

Interpretivepublications. Auditinginterpretationsofgenerallyacceptedaccountingstandards(GAAS),exhibitstoGAAS,auditingguidanceincludedintheAmericanInstituteof Certi fiedPublicAccountants(AICPA)AuditandAccountingGuides,andtheAICPAAuditing StatementsofPosition(SOPs).

Management. Theperson(s)withexecutiveresponsibilityfortheconductoftheentity’s operations.Forsomeentities,managementincludessomeorallofthosechargedwithgovernance; forexample,executivemembersofagovernanceboardoranowner-manager.

Misstatement. Adifferencebetweentheamount,classifi cation,presentation,ordisclosureof areported financialstatementitemandtheamount,classi fication,presentation,ordisclosurethat isrequiredfortheitemtobepresentedfairlyinaccordancewiththeapplicable financialreporting framework.Misstatementscanarisefromfraudorerror.

Otherauditingpublications. Publicationsotherthaninterpretivepublications;theseinclude AICPAauditingpublicationsnotdefi nedasinterpretivepublications;auditingarticlesinthe JournalofAccountancy andotherprofessionaljournals;continuingprofessionaleducation programsandotherinstructionmaterials,textbooks,guidebooks,auditprograms,andchecklists; andotherauditingpublicationsfromstatecerti fi edpublicaccountant(CPA)societies,other organizations,andindividuals.

Premise,relatingtotheresponsibilitiesofmanagementand,whenappropriate,those chargedwithgovernance,onwhichanauditisconducted(thepremise). Managementand,

whenappropriate,thosechargedwithgovernancehaveacknowledgedandunderstandthatthey havethefollowingresponsibilitiesthatarefundamentaltotheconductofanauditinaccordance withGAAS;thatis,responsibility:

1.Forthepreparationandfairpresentationofthe fi nancialstatementsinaccordancewiththe applicable financialreportingframework;

2.Forthedesign,implementation,andmaintenanceofinternalcontrolrelevanttothe preparationandfairpresentationof fi nancialstatementsthatarefreefrommaterial misstatement,whetherduetofraudorerror;and

3.Toprovidetheauditorwith

a.Accesstoallinformationofwhichmanagementand,whenappropriate,thosecharged withgovernanceareawarethatisrelevanttothepreparationandfairpresentationofthe financialstatements,suchasrecords,documentation,andothermatters;

b.Additionalinformationthattheauditormayrequestfrommanagementand,when appropriate,thosechargedwithgovernanceforthepurposeoftheaudit;and

c.Unrestrictedaccesstopersonswithintheentityfromwhomtheauditordeterminesit necessarytoobtainauditevidence.

Thepremise,relatingtotheresponsibilitiesofmanagementand,whenappropriate,those chargedwithgovernance,onwhichanauditisconductedmayalsobereferredtoasthepremise. Professionaljudgment. Theapplicationofrelevanttraining,knowledge,andexperience withinthecontextprovidedbyauditing,accounting,andethicalstandards,inmakinginformed decisionsaboutthecoursesofactionthatareappropriateinthecircumstancesoftheaudit engagement.

Professionalskepticism. Anattitudethatincludesaquestioningmind,beingalertto conditionsthatmayindicatepossiblemisstatementduetofraudorerror,andacriticalassessment ofauditevidence.

Reasonableassurance. Inthecontextofanauditof financialstatements,ahigh,butnot absolute,levelofassurance.

Riskofmaterialmisstatement. Theriskthatthe financialstatementsarematerially misstatedpriortotheaudit.Thisconsistsoftwocomponents,describedasfollowsattheassertion level:

• Inherentrisk. Thesusceptibilityofanassertionaboutaclassoftransaction,account balance,ordisclosuretoamisstatementthatcouldbematerial,eitherindividuallyorwhen aggregatedwithothermisstatements,beforeconsiderationofanyrelatedcontrols.

• Controlrisk. Theriskthatamisstatementthatcouldoccurinanassertionaboutaclassof transaction,accountbalance,ordisclosureandthatcouldbematerial,eitherindividually orwhenaggregatedwithothermisstatements,willnotbeprevented,ordetectedand corrected,onatimelybasisbytheentity’sinternalcontrol.

Thosechargedwithgovernance. Theperson(s)ororganization(s)(forexample,acorporate trustee)withresponsibilityforoverseeingthestrategicdirectionoftheentityandtheobligations relatedtotheaccountabilityoftheentity.Thisincludesoverseeingthe financialreportingprocess. Thosechargedwithgovernancemayincludemanagementpersonnel;forexample,executive membersofagovernanceboardoranowner-manager.

OBJECTIVESOFAU-CSECTION200

AU-CSection200.12statesthat:

...Theoverallobjectivesoftheauditor,inconductinganauditof financialstatements,areto

a.obtainreasonableassuranceaboutwhetherthe financialstatementsasawholearefree frommaterialmisstatement,whetherduetofraudorerror,therebyenablingtheauditor toexpressanopiniononwhetherthe financialstatementsarepresentedfairly,inall materialrespects,inaccordancewithanapplicable financialreportingframework;and

b.reportonthe financialstatements,andcommunicateasrequiredbyGAAS,inaccordance withtheauditor’ s findings.

FUNDAMENTALREQUIREMENTS

OBJECTIVEOF ORDINARY AUDIT

Thepurposeofanauditistoprovideuserswithanopinionbytheauditoronthefairness,inall materialrespects,withwhichthe financialstatementspresent financialposition,resultsof operations,andcash flowsinconformitywiththeapplicable financialreportingframework. (AU-C200.04)

AUDITOR RESPONSIBILITIES

Ineveryaudit,theauditorhastoobtainreasonableassurance1 aboutwhetherthe fi nancial statementsarefreeofmaterialmisstatement,whetherduetoerrorsorfraud.(AU-C200.06)

Materialityistakenintoaccountwhenplanningandperformingtheaudit.Misstatementsare consideredmaterialwhentheyinfluenceeconomicdecisionsby financialstatementusers. Materialityconsidersqualitativeandquantitativeelementsandshouldbeviewedincontext. (AU-C200.07)

Theauditor’soverallobjectivesarenotonlytoobtainreasonableassuranceaboutwhetherthe financialstatementsarefreeofmaterialmisstatementinordertoformanoption,buttoissuea reportandcommunicateasrequiredbyGAAS.(AU-C200.12)Ifreasonableassurancecannotbe obtained,theauditormusteitherdisclaimanopinionorwithdraw,whenpossible.(AU-C200.13)

INDEPENDENCE

Theauditormustbeindependent.Ifnotindependent,theauditorcannotissueareportunder GAAS.TheonlyexceptionisifGAASprovidesotherwiseorlaworregulationrequiresthe auditortoaccepttheengagementandreportonthe financialstatements.(AU-C200.15)

PROFESSIONAL SKEPTICISMAND JUDGMENT

Theauditormustperformtheauditwithprofessionalskepticismandexerciseprofessional judgmentinplanningandperforminganauditof financialstatements.(AU-C200.17-18)

1 SeeDefinitionsofTerms.

MANAGEMENTRESPONSIBILITIES

Financialstatementsarepreparedbymanagementwithoversightfromthosechargedwith governance.GAASdonotimposerequirementsonmanagementorthosechargedwithgovernance.However,anauditisconductedonthepremisethatmanagementandthosechargedwith governanceunderstandtheirresponsibilities.(AU-C200.05)

DEFININGPROFESSIONALREQUIREMENTSINSTATEMENTSON AUDITINGSTANDARDS

AuditorsmustcomplywithandunderstandAU-Csections.AU-CSection200.25-26clari fies thattheSASsusetwocategoriesofprofessionalrequirementstodescribethedegreeof responsibilitythestandardsimposeonauditors.

• Unconditionalrequirements. Theauditorisrequiredtocomplywithanunconditional requirementinallcasesinwhichthecircumstancesexisttowhichtheunconditional requirementapplies.SASsusetheword must toindicateanunconditionalrequirement.

• Presumptivelymandatoryrequirements. Theauditorisalsorequiredtocomplywitha presumptivelymandatoryrequirementinallcircumstanceswherethepresumptively mandatoryrequirementexistsandapplies.However,inrarecircumstances,theauditor maydepartfromapresumptivelymandatoryrequirement.Thedepartureshouldonly relatetoaspeci ficprocedurewhentheauditorsdeterminethattheprocedurewouldbe ineffectiveinthespecificcircumstances.Theauditorsmustdocumenttheirjustifi cation forthedepartureandhowthealternativeproceduresperformedinthecircumstanceswere sufficienttoachievetheobjectivesofthepresumptivelymandatoryrequirement.GAAS usetheword should toindicateapresumptivelymandatoryrequirement.

(AU-C200.25-.26)

Theterm “shouldconsider” meansthattheconsiderationoftheprocedureoractionis presumptivelyrequired,whereascarryingouttheprocedureoractionisnot.

AU-CSection200alsoclari fiesthatexplanatorymaterialisintendedtoexplaintheobjective oftheprofessionalrequirements,ratherthanimposingaprofessionalrequirementfortheauditorto perform.

GAAS ANDTHE GAASHIERARCHY

Theauditorisresponsibleforplanning,conducting,andreportingtheresultsofanaudit accordingtoGAAS.2

AuditorsarerequiredtocomplywithGAAS.EachAU-Csectioncontainsobjectivesthat providealinkbetweentherequirementsandtheoverallobjectivesoftheauditors.GAASprovide thestandardsfortheauditors’ workinful fillingtheirobjectives.Auditorsshouldhavesuffi cient knowledgeoftheAU-Csectionstodeterminewhentheyapplyandshouldbepreparedtojustify departuresfromthem.

2 GenerallyacceptedauditingstandardsareissuedintheformofStatementsonAuditingStandardsand codifiedintoAU-CsectionsintheAICPA’sProfessionalStandards.

InterpretivePublications

Interpretivepublicationsarenotauditingstandards,butarerecommendations,issuedunder theauthorityoftheASB,onhowtoapplytheSASsinspeci ficcircumstances,including engagementsforentitiesinspecializedindustries.Interpretivepublicationsarenotauditing standards.Theyconsistofthefollowing:

• AuditingInterpretationsofSASs,listedineachchapterofthisbookthathasarelated Interpretation.

• AICPAAuditandAccountingGuidesandStatementsofPosition,listedinAppendixCof thisbook.

(AU-C200.A81)

Auditorsshouldbeawareofandconsiderinterpretivepublicationsthatapplytotheiraudits.

OtherAuditingPublications

Otherauditingpublicationsarenotauthoritativebutmayhelpauditorstounderstandand applySASs.Anauditorshouldevaluatesuchguidancetodeterminewhetheritisboth(1) relevant foraparticularengagementand(2) appropriate fortheparticularsituation.Whenevaluating whethertheguidanceisappropriate,theauditorshouldconsiderwhetherthepublicationis recognizedashelpfulinunderstandingandapplyingSASs,andwhethertheauthorisrecognized asanauditingauthority.(AICPAauditingpublicationsthathavebeenreviewedbytheAICPA AuditandAttestStandardsstaffarepresumedtobeappropriate.)(AU-C200.A84)

INDEPENDENCE

To be independent,theauditormustbeintellectuallyhonest;tobe recognized as independent,heorshemustbefreefromanyobligationtoorinterestintheclient,its management,oritsowners.Forspeci fi cguidance,theauditorshouldlooktoAICPAandthe statesocietycodesofconductand,ifrelevant,therequirementsoftheSecuritiesandExchange Commission(SEC).3

PROFESSIONAL SKEPTICISM

TheauditorshouldobserveGAAS,possesst hedegreeofskillcommonlypossessedby otherauditors,andshouldexercisethatskillwithreasonablecareanddiligence.Theauditor shouldalsoexercise professionalskepticism ,thatis,anattitudethatincludesaquestioning mindandacriticalassessmentofauditevidenc e.Auditorsshouldbealertforcontradictory evidence,indicationsoffraud,unusualcircumstances,andevidencethatcallsintoquestionthe reliabilityofdocuments,andresponsestoinquiries.(AU-C200.A22-A23)However,the auditorisnotaninsurer,andtheauditreportdoesnotconstituteaguaranteebecauseitisbased on reasonableassurance.Thus,anauditconductedinaccordancewithGAASmaynotdetecta

3 Section201oftheSarbanes-OxleyActof2002andtherelatedSECimplementingrulescreatedsignificant newindependencerequirementsforauditorsofpubliccompanies.Forexample,theSECprohibitscertain nonauditservicessuchasbookkeeping,internalauditoutsourcing,andvaluationservices.Allauditand nonauditservicesperformedbytheauditor,includingtaxservices,mustbepreapprovedbythecompany’ s auditcommittee.InMarch2003,theSECissued finalrulesimplementingSection201oftheAct.Therules, StrengtheningtheCommission’sRequirementsRegardingAuditorIndependence, canbefoundat www. sec.gov/rules/final/33-8183.htm

materialmisstatement.Theauditorshouldbealerttothepossibilityofcollusionwhen performingtheauditandhowmanagementmayoverridecontrolsinawaythatwould makethefraudparticularlydif fi culttodetect.

INTERPRETATIONS

Therearenointerpretationsforthissection.

TECHNIQUESFORAPPLICATION

MANAGEMENT’S RESPONSIBILITIES

Manytimes,clientsdonotunderstandtheirresponsibilitiesfortheaudited financial statements.The financialstatementsare management’ s. Theycontainmanagement’srepresentations.Theformandcontentofthe fi nancialstatementsaremanagement’sresponsibility,even thoughtheauditormayhavepreparedthemorparticipatedintheirpreparation.TheSEChas stated:

Thefundamentalandprimaryresponsibilityfortheaccuracyofinformation filedwiththe Commissionanddisseminatedamongtheinvestorsrestsuponmanagement. Management doesnotdischargeitsobligationsinthisrespectbytheemploymentofindependentaccountants, howeverreputable. (AccountingSeriesReleaseNo.62;emphasisadded)

Managementalsoisresponsibleforimplementingandmaintaininganeffectivesystemof internalcontrol.

AUDITOR’S RESPONSIBILITIES

Theauditor’sresponsibilityforthe financialstatementsheorsheauditsisconfinedtothe expressionofanopiniononthosestatements.Inperformingtheaudit,theauditorisresponsible forcompliancewithGAAS,includingtheSASs.

UnderGAAS,theauditorhasaresponsibilitytoconsiderAU-Csectionsandinterpretive publicationsinallaudits.Ifsuchguidanceisnotfollowed,anauditormustbeprepared:

• ForAU-Csections,tojustifyadeparturefromGAAS

• Forinterpretivepublications,toexplainthatanalternativeapproachachievedthe objectivesofGAAS

Toprovidereasonableassurancethatitisconformingwithgenerallyacceptedauditing standardsinitsauditengagements,anaccounting firmshouldestablishqualitycontrolpolicies andprocedures.Thesepoliciesandproceduresshouldapplynotonlytoauditengagementsbut alsotoattestandaccountingandreviewservicesforwhichprofessionalstandardshavebeen established.(AU-C200.A20)TheAICPA’sQualityControlStandardsdetailthe firm’sresponsibilityforestablishingandmaintainingasystemofqualitycontrolforauditors.SeeQCSection 10, AFirm’sSystemofQualityControl,formoreinformation.

Independence,Integrity,andObjectivity

Policiesandproceduresshouldprovidereasonableassurancethatpersonnelmaintain independencewhenrequiredandperformallresponsibilitieswithintegrityandobjectivity.

1.Independenceisanimpartialitythatrecognizesanobligationforfairness.

2.Integritypertainstobeinghonestandcandid,andrequiresthatserviceandpublictrustnot besubordinatedtopersonalgain.

3.Objectivityisastateofmindthatimposesanobligationtobeimpartial,intellectually honest,andfreeofcon flictsofinterest.

(SeetheAICPA ’sCodeofProfessionalConduct,Section300.)

AU-C210 TermsofEngagement

AU-CORIGINALPRONOUNCEMENT

OriginalPronouncement StatementonAuditingStandards(SAS)122and128.

APPLICABILITY

Thissectionstatestherequirementsandprovidesapplicationguidanceontheauditor’s responsibilitiesinagreeingupontermsofengagementwithmanagementandthosechargedwith governance.Itestablishespreconditionsforanaudit,forwhichmanagementisresponsible.AU-C 220, QualityControlforanEngagementConductedinAccordancewithGenerallyAccepted AuditingStandards,addressesthoseaspectsofengagementacceptancethattheauditorcan control.AU-C580, WrittenRepresentations,discussesmanagement’sresponsibilities.(AU-C 210.01)

DEFINITIONSOFTERMS

Source:AU-C210.04

Preconditionsforanaudit. Theusebymanagementofanacceptable fi nancialreporting frameworkinthepreparationandfairpresentationofthe financialstatementsandtheagreementof managementand,whenappropriate,thosechargedwithgovernance,tothepremiseonwhichan auditisconducted.

Recurringaudit. Anauditengagementforanexistingauditclientforwhomtheauditor performedtheprecedingaudit.

OBJECTIVES

AU-CSection210.03statesthat:

...theobjectiveoftheauditoristoacceptanauditengagementforaneworexistingauditclient onlywhenthebasisuponwhichitistobeperformedhasbeenagreeduponthrough

a.establishingwhetherthepreconditionsforanauditarepresentand b.confirmingthatacommonunderstandingofthetermsoftheauditengagementexists betweentheauditorandmanagementand,whenappropriate,thosechargedwith governance.

FUNDAMENTALREQUIREMENTS

ENGAGEMENT ACCEPTANCE

PRECONDITIONS

Unlessrequiredtodosobylaworregulation,anauditorshouldnotacceptanengagement whenthepreconditions(see “DefinitionsofTerms” sectionabove)arenotmet.(AU-C210.08)To assesswhetherthosepreconditionsaremet,theauditorshould:

a determinewhetherthe financialreportingframework1 tobeappliedinthepreparationof the financialstatementsisacceptableand

b obtaintheagreementofmanagementthatitacknowledgesandunderstandsits responsibility

i.forthepreparationandfairpresentationofthe financialstatementsinaccordance withtheapplicable financialreportingframework;

ii.forthedesign,implementation,andmaintenanceofinternalcontrolrelevanttothe preparationandfairpresentationof financialstatementsthatarefreefrommaterial misstatement,whetherduetofraudorerror;and

iii.toprovidetheauditorwith

(1)accesstoallinformationofwhichmanagementisawarethatisrelevanttothe preparationandfairpresentationofthe financialstatements,suchasrecords, documentation,andothermatters;

(2)additionalinformationthattheauditormayrequestfrommanagementforthe purposeoftheaudit;and

(3)unrestrictedaccesstopersonswithintheentityfromwhomtheauditor determinesitnecessarytoobtainauditevidence.

(AU-C210.06)

Ifmanagementlimitsthescopeoftheauditor’sworksothattheauditorwillhavetodisclaim anopinion,theauditorshouldnotaccepttheengagement.Theexceptiontothisiswhen managementisrequiredbylaworregulationtohaveanauditandthedisclaimerofopinion isacceptableunderlaworregulation,forexamplewithauditsofemployeebene fitplans.Then,the auditorcanaccepttheengagement,butisnotrequiredtodoso.(AU-C210.07)

Theauditorshouldestablishanunderstandingwithmanagementorthosechargedwith governance 2 abouttheservicestobeperformedforeachaudit,reviewofapubliccompany’s financialstatements,oragreed-uponproceduresengagement.Theunderstandingshouldinclude:

1.Theengagement’sobjectivesandscope

2.Management’sresponsibilities

1 Acceptablereportingframeworkscontainestablishedaccountingprinciplespromulgatedbyabody designatedbytheCounciloftheAICPAunderRule203intheAICPACodeofProfessionalConduct. ThesebodiesincludeFASB,FASAB,IFRS,GASB,AICPA,andPCAOB.

2 Inthischapter,referencestomanagementshouldbereadas “managementand,whenappropriate,those chargedwithgovernance,” unlessthecontextsuggestsotherwise.Thosechargedwithgovernanceare those “withresponsibilityforoverseeingthestrategicdirectionoftheentityandobligationsrelatedtothe accountabilityoftheentity,” includingthe financialreportingprocess.(AU-CGlossaryofTerms)

3.Auditor’sresponsibilities

4.Theaudit’slimitations,theinherentlimitationsofinternalcontrol,andriskthatsome misstatementsmaynotbedetected

5.Financialreportingframework

6.Expectedformandcontentofthereport

Theauditorshoulddocumenttheunderstanding,inwriting.Iftheauditorfailstoestablishan understanding,theauditorshoulddeclinetheengagement.(AU-C210.09-.10)

Asampleengagementletterisincludedattheendofthischapter.

InitialAudits,Reaudits,andRecurringAudits

Inquiryofthepredecessorauditorisrequiredbecausethepredecessormayprovide informationthatwillassistthesuccessorauditorindecidingwhethertoaccepttheengagement. Thecommunicationmaybeeitherwrittenororal.Boththepredecessorandsuccessorauditors shouldtreatanyinformationobtainedfromeachotherasconfidentialinformation.

Thesuccessorauditorshouldrequestpermissionfromtheprospectiveclienttomakean inquiryofthepredecessor priorto finalacceptanceoftheengagement.However,thesuccessor auditormaymakeaproposalforanauditengagementbeforehavingpermissiontoinquireofthe predecessorauditor.Thesuccessorauditorshouldasktheprospectiveclienttoauthorizethe predecessortorespondfullytothesuccessorauditor’sinquiries.Ifaprospectiveclientrefusesto permitthepredecessorauditortorespondorlimitstheresponse,thesuccessorauditorshould inquireastothereasonsandconsidertheimplicationsofthatrefusalindecidingwhethertoaccept theengagement.(AU-C210.11)

Forarecurringaudit,theauditorshouldevaluatewhetherthetermsoftheengagement needtobechanged.Theauditorshouldalsoremindtheclientabouttheexistingtermsof engagement.Iftheclientrequestsachangeintheterms,theauditormustensurethatthereis areasonablejusti fi cationforthechange.So,too,ifpriortocompletionofanaudit,the clientrequestsachangetoanengagementwithalowerlevelofassurance,theauditormust besatis fi edthatareasonablejusti fi cationfordoingsoexists.Ifthetermsarechanged,the auditorandmanagementshoulddocumentthemutuallyagreeduponchangeinwriting.(AU-C 210.13-16)

If,however,theauditorconcludesthereisnoreasonablejusti ficationforachangeinterms andmanagementdoesnotallowtheauditortocontinuetheoriginalaudit,theauditormusttake thesesteps:

1.Withdrawfromtheengagement.

2.Communicatethesituationtothosechargedwithgovernance.

3.Determinewhethertheauditorhasanylegal,contractual,orotherobligationtoreportthe circumstancestoowners,regulators,orotherparties.

(AU-C210.17)

INTERPRETATIONS

Therearenointerpretationsforthissection.

TECHNIQUESFORAPPLICATION

EngagementLetter

Inadditiontotheengagementletterguidancediscussedearlier,theauditormaywantto:

1.Elaborateonthescopeoftheauditbyreferencingregulations,laws,GAAS,ethicalcodes, pronouncementsofprofessionalbodies,asapplicable.

2.Identifyanycommunicationsinadditiontotheauditor’sreport.

3.Discussauditplanningandperformanceincludingcompositionoftheauditteam.

4.Remindmanagementabouttheexpectationofwrittenrepresentation,theagreementto makeavailabledraft financialstatementsonatimelybasis,theagreementformanagement toinformtheauditorofsubsequenteventsorfactsdiscoveredafterthedateofthe fi nancial statementsthatmayaffectthe financialstatements.

5.Detailfeesandbillingarrangements.

6.Requestmanagementtoacknowledgereceiptoftheengagementletterandtoagreetothe termsbysigningtheletter.

Theauditormayalsochoosetoaddressarrangementsconcerningtheinvolvementofother auditors,specialists,internalauditorsandotherentitystaff,andpredecessorauditors.Restrictions onauditor’sliability,whennotprohibited,auditdocumentationtobeprovidedtootherparties, additionalservices,arrangementswithcomponentauditors,andanyotheragreementswiththe entitymaybeincludedintheengagementletter.(AU-C210.A23-.A26)

InquiriesofthePredecessorAuditor

Thesuccessorauditorshouldmakespecifi candreasonableinquiriesofthepredecessorabout:

1.Informationaboutmanagement ’sintegrity

2.Disagreementswithmanagementaboutaccountingprinciples,auditingprocedures,or othersignificantmatters

3.Communicationstothosechargedwithgovernanceandresponsibilityregardingfraud, noncompliancewithlawsorregulations,andinternalcontrol-relatedmatters

4.Thepredecessorauditor’sunderstandingofthereasonsforthechangeofauditors (AU-C210.A31)

Thepredecessorauditorshouldrespondpromptly,fully,andfactually.However,ifthe predecessordecides,duetounusualcircumstancessuchasimpending,threatened,orpotential litigation;disciplinaryproceedings;orotherunusualcircumstances,nottorespondfully,heorshe shouldindicatethattheresponseislimited.Also,ifmorethanoneauditorisconsideringaccepting theaudit,thepredecessorauditdoesnothavetorespondtoinquiriesuntilanauditorhasbeen selectedbytheentityandacceptedtheengagement.Anyinformationexchangedbetweenthe predecessorandsuccessorauditorshouldbeconsideredconfidential.(AU-C210.A28-A30)

Ifthesuccessorauditorreceivesalimitedresponse,thatauditorshouldconsiderthe implicationsofthelimitedresponseindecidingwhethertoaccepttheengagement.

RevisingTerms

Certainfactorsmaywarrantachangeinthetermsofengagementforarecurringengagement. Thesemightinclude,forexample,changesinmanagementorownership,inlegalorregulatory requirements,inthesizeoftheentity,orinthe financialreportingframework.(AU-C210.A33)

ILLUSTRATION

EXAMPLEOFAN AUDIT ENGAGEMENT LETTER (FROM AU-C210.A42)

Thefollowingisanexampleofanauditengagementletterforanauditofgeneralpurpose financial statementspreparedinaccordancewithUSGAAP.Thisletterisintendedonlytobeaguidethatmaybe usedinconjunctionwiththeconsiderationsoutlinedinAU-CSection210.Theletterwillvaryaccording toindividualrequirementsandcircumstancesandisdraftedtorefertotheauditof financialstatementsfor asinglereportingperiod.Theauditormayseeklegaladviceaboutwhetheraproposedletterissuitable.

Auditor’sletterhead

Addressedtothe appropriaterepresentative ofthosechargedwith governance

Theobjectiveandscopeof theaudit

SmithandJones Certi fiedPublicAccountants October,7,20XX

BrockWarner Plainsmen,Inc. 2320TigerBlvd. Lancaster,Pennsylvania19701

Youhaverequestedthatweauditthe financialstatementsof Plainsmen,Inc.,whichcomprisethebalancesheetasofDecember31, 20XX,andtherelatedstatementsofincome,changesinstockholders’ equity,andcash flowsfortheyearthenended,andtherelatednotestothe financialstatements.Wearepleasedtoconfirmouracceptanceandour understandingofthisauditengagementbymeansofthisletter.Ouraudit willbeconductedwiththeobjectiveofourexpressinganopiniononthe financialstatements.

Theresponsibilitiesofthe auditor

Wewillconductourauditinaccordancewithauditingstandards generallyacceptedintheUnitedStatesofAmerica(GAAS).Those standardsrequirethatweplanandperformtheaudittoobtainreasonable assuranceaboutwhetherthe financialstatementsarefreefrommaterial misstatement.Anauditinvolvesperformingprocedurestoobtainaudit evidenceabouttheamountsanddisclosuresinthe financialstatements. Theproceduresselecteddependontheauditor’sjudgment,includingthe assessmentoftherisksofmaterialmisstatementofthe financial statements,whetherduetofraudorerror.Anauditalsoincludes evaluatingtheappropriatenessofaccountingpoliciesusedandthe reasonablenessofsignificantaccountingestimatesmadebymanagement, aswellasevaluatingtheoverallpresentationofthe financialstatements.

Becauseoftheinherentlimitationsofanaudit,togetherwiththe inherentlimitationsofinternalcontrol,anunavoidableriskexiststhat somematerialmisstatementsmaynotbedetected,eventhoughtheaudit isproperlyplannedandperformedinaccordancewithGAAS.

Inmakingourriskassessments,weconsiderinternalcontrolrelevant totheentity’spreparationandfairpresentationofthe financialstatements inordertodesignauditproceduresthatareappropriateinthe circumstancesbutnotforthepurposeofexpressinganopiniononthe effectivenessoftheentity’sinternalcontrol.However,wewill communicatetoyouinwritingconcerninganysignificantdeficienciesor materialweaknessesininternalcontrolrelevanttotheauditofthe financialstatementsthatwehaveidentifiedduringtheaudit.