Auditing Standards

06/02/2010

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Auditing Standards
Teaching auditing has become considerably more complicated now that we have two sets of auditing standards – ASB standards for audits of private companies and PCAOB standards for audits of public companies. I present the ASB version of the 10 generally accepted auditing standards because I like the revised wording better than the old wording retained by the PCAOB. The temptation is to use ASB standards to talk about the financial statement audit and mention PCAOB standards only when talking about the S-Ox 404 requirement to report on internal controls. But this could create the impression that auditing the financial statements and auditing the internal controls are two separate processes while PCAOB AS No. 5 specifically requires an integrated audit. Therefore, I prefer to describe the entire audit process in terms of PCAOB standards. 

Because my students have studied differences between US GAAP and IFRS in their accounting classes, they often ask me if significant differences exist between US GAAS and international auditing standards. I point them to the WebCPA (August 21, 2009) article cited below and explain that the differences are minor at this time. The Lindberg & Seifert (CPA Journal, April 2011) article describes five principal differences between US GAAS, PCAOB auditing standards, and International Standards on Auditing.

U.S. GAAS:
“Clarified Auditing Standards: The Quiet Revolution,” Jan Taylor Morris & C. William Thomas, Journal of Accountancy (June 2011): 24-28. This article describes significant changes arising from the ASB’s Clarity Project including changes in the status of the 10 generally accepted auditing standards, the wording of the auditor’s report, and standards for group audits.

“Federal Oversight Board Wants to Write Auditing Standards,” Carrie Johnson, Washington Post (April 17, 2003): E1. The PCAOB decides to take standard-writing duties from the AICPA.

“U.S. Accounting Group to Focus on Private Audits,” Reuters News (April 28, 2003). The AICPA will continue to write standards for audits of private companies after the PCAOB takes over writing standards for public company audits.

“AICPA Expands Membership on Auditing Standards Board,” Business Wire (October 20, 2003). Membership on the ASB expands to 19 members and includes federal regulators and financial statement users.

International Auditing Standards:
“International Auditing Standards Spread to 126 Countries,” WebCPA (November 3, 2009). IFAC reports that International Standards of Auditing (ISAs) have been adopted or used as the foundation for national auditing standards in 126 countries.

“Auditing Standards Don’t Have Far to Converge,” WebCPA (August 21, 2009). A recent study of US GAAS and International Standards of Auditing (ISA) concludes that differences are minor except for the PCAOB requirement that auditors report on internal controls over financial reporting.

“A Comparison of U.S. Auditing Standards with International Standards on Auditing,” Deborah Lindberg & Deborah Seifert, CPA Journal (April 2011): 17-21. This article describes five principal differences between US GAAS, PCAOB auditing standards, and International Standards on Auditing.
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Future of Auditing

06/02/2010

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Future of Auditing

I like to spend about 30 minutes on the last day of class discussing the future of auditing. Eventually, investors will demand that companies post weekly (or real-time) financial data on their websites in the same manner that investors 100 years ago demanded annual financial statements and investors 40 years ago demanded quarterly statements. Auditors, in the future, will have to provide continuous assurance by testing data as it is processed.

Monographs:
Global Capital Markets and the Global Economy: A Vision from the CEOs of the International Audit Networks (November 2006). Samuel DiPiazza (PwC), David McDonnell (Grant Thornton), William Parrett (Deloitte), Mike Rake (KPMG), Frans Samyn (BDO), James Turley (EY). Suggestions from the leaders of the six largest public accounting firms for restoring investor confidence, improving financial reporting, and strengthening the audit function.

Articles:
“Twenty-First Century Assurance,” Robert K. Elliott, Auditing: A Journal of Practice & Theory (March 2002): 139-146. Bob Elliott predicts that auditing will move toward continuous assurance of real-time financial and non-financial information with greater emphasis on fraud prevention and detection.

 
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History of Auditing

06/02/2010

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History of Auditing

Despite the widespread perception that history is boring, I find auditing students reasonably receptive to brief lessons about the history of auditing. The Samson et al. case (Issues in Accounting Education, 2006) is very useful for reinforcing the concept that audits help companies raise capital. The Stone article (Accounting Review, 1969) is easy to read and describes how audits have been around for centuries. Articles about classic frauds such as Ivar Kreuger and McKesson & Robbins enliven class discussions and demonstrate that American auditors have struggled for decades to uncover financial crime.

Cases:
“Corporate Governance and External and Internal Controls: The Case of the Baltimore and Ohio Railroad, Circa 1831,” William Samson, Dale Flesher & Gary Previts, Issues in Accounting Education (February 2006): 45-62. This case describes how B&O Railroad had to reform its board of directors, internal controls, and financial reporting practices to attract British investors.

Articles:
“The Greatest Frauds of the (Last) Century,” Paul Clikeman, New Accountant (August 2003): 7-9. This article describes how the Kreuger & Toll and McKesson & Robbins frauds of the 1930s led to passage of the Securities Acts of 1933 and 1934 and the introduction of new auditing standards.

“The Development of ‘The Big Eight’ Accounting Firms in the United States, 1900 to 1990,” Charles Wootton & Carel Wolk, Accounting Historian’s Journal (June 1992): 1-27. This paper describes the major political, economic, and social events that influenced the American public accounting profession from 1900 to 1990.

“Antecedents of the Accounting Profession,” Williard E. Stone, Accounting Review (April 1969): 284-291. This easy-to-read article traces the history of auditing to the ancient Greek, Roman, and Babylonian empires. Also mentions the auditors who oversaw Christopher Columbus’s voyages to the new world and the Pilgrims’ colonization of Massachusetts. 

“Changing Audit Objectives and Techniques,” R. Gene Brown, Accounting Review (October 1962): 696-703. Another easy-to-read article that explains the trend toward greater reliance on internal controls and decreased detailed testing.

Books:
Called to Account: Fourteen Financial Frauds That Shaped the American Accounting Profession, Paul M. Clikeman, Routledge (2009). The history of public accounting in the U.S. can be described as a series of scandals followed by voluntary or mandated reforms. This book describes how accounting frauds from Kreuger & Toll (1932) through Enron and WorldCom (2002) shaped contemporary auditing practices.
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Demand for Auditing

06/02/2010

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Demand for Auditing

Holman Jenkins in his article “Abused Accountants Say ‘Take This Job and …’” (Wall Street Journal, January 19, 2000) asked: “What exactly is the purpose of the federal make-work project known as the public audit? That question never has really been answered.”

I distribute Mr. Jenkins’ article on the first day of class and ask the students why we have audits. Many students share Mr. Jenkins’ belief that audits exist only because of government mandate. Discussing three research articles helps correct this misperception. Chow (Accounting Review, 1982) documents that 80 percent of NYSE firms were audited before Congress passed the Securities Acts of 1933 and 1934. Minnis (Journal of Accounting Research, 2011) presents evidence that audited companies are able to borrow at lower interest rates than unaudited companies. Rennie et al. (Research in Accounting Regulation, 2003) found that more than 70 percent of large private Canadian companies chose to retain their auditors even after the Canadian government rescinded the law requiring them to be audited.

By the end of the first day of class, my students know that the purpose of a financial statement audit is to reduce information risk, protecting investors and reducing the auditee’s cost of capital. We have the next 14 weeks to discuss whether U.S. auditors are fulfilling this role at an acceptable level of quality.

Articles:
“Audits Add Shine to Firms,” Angus Loten, Wall Street Journal (January 13, 2011): B5. A University of Chicago research study found that small private firms save $6,900 per $1 million of debt annually if they have audited financial statements.

“The Economic Role of the Audit in Free and Regulated Markets: A Look Back and a Look Forward,” Wanda Wallace, Research in Accounting Regulation (2004): 267-298. An update of Wallace’s 1980 monograph discussing the purpose and value of audits. Discusses various explanations for auditing including the stewardship (monitoring) hypothesis, the information hypothesis, and the insurance hypothesis.

Classroom Exercises:
“A Classroom Experiment on the Benefit of Auditing in Financial Markets,” Scott Boylan, Issues in Accounting Education (May 2004): 189-209. Students participate in an experimental market that demonstrates that auditing can influence security prices and investment portfolio compositions in a way that benefits investors and lowers the cost of capital for firms.

“Using Experimental Asset Markets to Illustrate the Value of Auditing,” Scott Boylan, Issues in Accounting Education (February 2000): 43-65. A two-day experimental market demonstrating how auditing improves overall market performance.

Research Studies:
“Deregulation of the Private Corporation Audit in Canada: Justification, Lobbying, and Outcomes,” Morina Rennie, David Senkow, Richard Rennie & Jonathan Wong, Research in Accounting Regulation (2003): 227-241. After Canada rescinded a law requiring large, private companies to be audited, 73% of companies continued having their financial statements audited. The most common explanations for audit continuance were lender and owner requirements.

“The Value of Financial Statement Verification in Debt Financing: Evidence from Private U.S. Firms,” Michael Minnis, Journal of Accounting Research (May 2011): 457-506. Audited firms’ interest rates are, on average, more than 50 basis points lower than those of unaudited firms. Audits reduce information risk to lenders, resulting in lower cost of capital for borrowers.

“The Demand for External Auditing: Size, Debt and Ownership Influences,” Chee W. Chow, Accounting Review (April 1982): 272-291. Roughly 80 percent of NYSE firms were audited in 1926. Audited firms were larger and had more debt and more debt covenants than unaudited firms.


 
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