Clarified Auditing Standards—Principles and Objectives of Audits

This is the first article in a new series focusing on the Clarified Auditing Standards issued by the Auditing Standards Board (ASB) of the AICPA.  The first 39 standards were issued in SAS No. 122; other numbered standards have been issued subsequently.  The content of each of the standards will be outlined and most articles will include a discussion of practical considerations related to the application of the SASs.  The first Clarified Auditing Standard was issued in two parts:

·      Statement on Auditing Standard (SAS): Preface to Codification of Statements on Auditing Standards, Principles Underlying an Audit Conducted in Accordance With Generally Accepted Auditing Standards, and

·      SAS: Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance With Generally Accepted Auditing Standards. 

Changes from Previous Standards

These standards supersede SAS No. 95, as amended, which contained the general, field work, and reporting standards (the 10 standards).

The Ten Generally Accepted Auditing Standards (GAAS) were considered by the ASB in formulating this SAS as follows.

SASs are codified within the framework of the 10 standards, viewed as the historical basis for generally accepted auditing standards (GAAS). The clarity drafting conventions adopted by the ASB include establishing an objective or objectives for each SAS.

The SAS establishes the overall objectives of the auditor, which are to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, thus, enabling the auditor to express an opinion on whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework; and to report on the financial statements, or otherwise as required by the SASs, in accordance with the auditor’s findings.

Each SAS contains an objective, or objectives that provide a link between the requirements and the overall objectives of the auditor. The SASs taken together provide the standards for the auditor’s work in fulfilling the overall objectives of the auditor.

If an auditor fulfills the overall objective of the audit and meets applicable ethical requirements, such as the AICPA Code of Professional Conduct, the ASB believes that the auditor will have fulfilled the requirements currently stated in the 10 standards. For this reason, the SAS does not contain 10 unconditional requirements that are the direct equivalent of the 10 standards.

Replacement of the 10 standards with principles

To preserve the functions of the 10 standards, the ASB has developed the Principles Governing the Conduct of an Audit in Accordance With Generally Accepted Auditing Standards (referred to as the principles).

The principles identified in the SAS have been drafted in the present tense, are not requirements and do not carry any authority. They are the fundamental principles that govern an audit and are supported by the objectives and requirements of the individual SASs.

Structure of the Principles

·      The purpose of an audit (purpose). To provide financial statement users with an opinion by the auditor on whether the statements are presented fairly, in all material respects, in a manner that conforms to an applicable financial reporting framework

·      Personal responsibilities of the auditor (responsibilities).  These include competence and capabilities, compliance with appropriate ethical standards and approaching the work with appropriate professional skepticism and judgment.

·      Auditor actions in performing the audit (performance).  Perform the work necessary to be reasonably, but not absolutely, sure that the financial statements are free from material misstatement due to fraud or error.

·      Reporting (reporting).  Based on the results of the performance of the audit, express an opinion or state that an opinion cannot be expressed on the financial statements.

Definitions of Financial Reporting Frameworks

Financial reporting framework. A set of accounting principles that are used to determine measurement, recognition, presentation, and disclosure of all material items for preparing financial statements in accordance with principles generally accepted in the U.S.(GAAP), International Financial Reporting Standards (IFRSs), issued by the International Accounting Standards Board (IASB), or a special purpose framework prepared on a comprehensive basis of accounting other than GAAP (OCBOA– now referred as Special Purpose Framework). Note: The AICPA’s Financial Reporting Framework for Small- and Medium-Sized Entities is a special purpose framework.

Applicable financial reporting framework— The financial reporting framework adopted by management in the preparation and presentation of its financial statements.

Fair-presentation framework— Refers to a financial reporting framework that requires compliance with the requirements of the framework and acknowledges explicitly or implicitly that, to achieve fair presentation of the financial statements, it may be necessary for management to provide disclosures beyond those specifically required by the framework; or acknowledges explicitly that it may be necessary for management to depart from a requirement of the framework to achieve fair presentation of the financial statements. Such departures are expected to be necessary only in extremely rare circumstances. Current reporting requirements do not permit departures from GAAP unless they can be justified under Rule 203-1 of the AICPA Code of Professional Conduct, i.e, when the application of an accounting standard causes financial statements to be misleading.

Regulatory and contractual-based framework—Refers to a financial reporting framework that requires compliance with the requirements of the defined framework. This type of framework is referred to in the International Standards of Auditing (ISAs) as a compliance framework; the term was changed for purposes of GAAS to regulatory or contractual-based framework to avoid confusion with the term compliance audit.

Practical Considerations

Underpinning the principles in this standard, the concepts of professional skepticism and professional judgment are discussed in the application material.  Professional skepticism includes being alert for contradictory audit evidence, information that brings doubt as to the reliability of documents and managements responses to inquiries and errors or fraud that indicate the need for additional substantive procedures. 

Professional judgment is necessary on every engagement when considering audit risk and materiality, the nature, extent and timing of audit procedures, evaluating the appropriateness and reasonableness of financial statement assertions and the applicable financial reporting framework.  Professional judgment is defined as the application of training, knowledge and experience, and knowledge of professional standards, in decision-making about actions necessary in any accounting or auditing engagement.

The auditor’s professional skepticism and professional judgment applied in planning, performing and completing an audit must be clearly documented in engagement files.  Many auditors use a Planning Document or Planning Memo to document the exercise of professional judgment and professional skepticism applied in planning an audit, developing a cost-efficient audit strategy and modifying audit programs.  An illustrative Planning Document will be present in the next article.

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