15h) Chhipten 2) xpacei > A See Examination on a surprise basis of General..Union Bank, Emphasis placed on verification of cash, marketable securities, and loans receivable and on consistent observation of the banking code. 6. Analysis of the accounting system of a small business with the objective ‘of making recommendations concerning installation of a computer-based system. Determination of fairness of financial statements for public distribution by a corporation that has professional-level internal auditing staff, 8. Review of the activities of the receiving department of a large manufacturing company, with special attention to efficiency of materials ingpection and promptness of reports issued. 9. Review aftthe tax return of the corporate president fo determine whether charitable contributions are adequately substantiated. 10, Review of daily attendance during the first semester at Blue Ridge Public School to ascertain whether payments received from the government were substantiated by pupil-lay data and whether disbursements hy the school were within authorized limits. 11. Review of transactions of a government agency to determine whether disbursements under the Cash Transfer program of the Department of Social Welfare followed the intent of Congress. 12. Compilation of quarterly financial statements for a small business that does not have any aecounting personnel capable of preparing financial statements. Chapter THE PUBLIC ACCOUNTING PROFESSION ENVIRONMENT Expected Learning Outcomes After studying this chapter, you should be able to: 1. Defi lic aane the practice of public accountancy as provided for in RA Know who is a Certified Public Accountant (CPA). 3, Enumerate the requirements Paueae dss to enter the accountancy profession 4, Deseribe the characteristics, capabil ie , Capabilities and competer SA degree holder must possess as requited by CHED. a 5, Understand the CPA Licensure Examination requirements. 6 Know the need for the professional accountant to conti develop cay Sate ce abilities and competence after admission to the 7 Dae i core values and competency requirements for CPAs iy Saat ens yates at nsec He ecvemting cessor © tabliyiataGPAmaybocemonadea nt eT Rea teia onic u nina uicre Speman 11. Understand the challenge and credi i ibility crists faced by accountng profession ard how ta address hems WBSCHAPTER 3 THE PUBLIC ACCOUNTING PROFESSION ENVIRONMENT PRACTICE OF PUBLIC ACCOUNTANCY DEFINED Article I, Section 4 of the Philippine Accountancy Act (RA 9298) describes the scope of the praetice of public accountancy as follows: "Practice of Public Accountancy shall constitute in a person, be it in his/her individual capacity, or as a partner or as a staff member in an accounting or auditing firm, holding out himselffherself as one skilled in the knowledge, science and practice o! ‘a qualified person to render professional services as a céitified public accountant; or offering ot rendering, or both, to more than one client on a fee basis or otherwise, services such as the audit or verification of financial transaction and accounting, records; or the preparation, signing, or certification for clients of reports of audit, balance sheet, and other financial, accounting and related schedules, exhibits, statements or reports NOM] are to be used for publication or for credit purposes, or to be filed with a court or government agency, or to be used for any other purpose; or the design, installation, and revision of accounting system; of the preparation of income tax returns when related to' accounting procedures; or when he/she represents clients before government agencies on tax and other matters related to accounting or renders professional assistance in ‘matters relating to accounting procedures and the recording and presentation of financial facts or data.” Article IV, Section 26 of the same law provides: ""No person shall practice accountancy in this country, or use the title "Certified Public Accountant”, or use the abbreviated title "CPA" or display or use any title, sign, card, advertisement, or other device to indicate that such person practices or offers to practice accountancy, or is a certified public accountant, unless ‘stich person shall have received from the Board a certificate of registration!professiohal license and be issued a professionat identification card ‘or a valid temporary/special permit duly issued to him/her‘by the Board and the Commission.” ‘The Public Accounting Profession Environment _ 38 CERTIFIED PUBLIC ACCOUNTANT A certified publie accoutitant (GPA) is a person who, after obtaining the required education passes an extensive examination and is licensed by the country to practice as a nt Most young professionals aspiring to become CPAs usually would like start their careers working for a CPA firm. After they become CPAS, many leave the firm to work in industry, government or education. These people may continue to be CPAs but often give up theirright to practice as independent auditors. CPAs who practice as independent auditors must meet registration requirements to exercise their right to practice. It'is common therefore, for accountants to be CPAs who do not practice as independent auditors REQUIREMENTS TO ENTER THE ACCOUNTANCY PROFESSION Meeting the expectations of diverse groups requires considerable expertise. Because of the inereasing complexity of the business environment, the demands ‘made on the professional accountants have certainly increased. To be able to enter the professional accountancy profession in.the Philippines, an individual should be able to satisfy all of the following requisites: (@) Be a holder of a degree of Bachelor of Science in Accountancy (BSA) conferred by @ school, college or institute duly recognized and/or accredited by the Commission on Higher Education (CHED) or other authorized government office; (b) Qualify as a professional accountant by passing the CPA. Licensure Board Examination administered by the Professional Regulatory Board of Accountancy; and (©) Satisfy all other legal and regulatory requirements before the individual takes on the role of a professional accountant. A, Pre-Qualification Education Requirements An individual aspiring to be a professional accountant should meet the pre-qualification education requirement that requires possession of a Bachelor of Science in Accountancy (BSA) degree.36 Chapter 3 The Public Accounting Profession Environment _ 37. The BSA program should’ provide a foundation of professional 7 [CAPABILITIES AND COMPETENCIES |. PERFORMANCE INDICATOR] Knowledge, professional skills, and professional values, ethics and j ‘© Propare individual and conporate attitudes that enable them to continue to learn and adapt to change, 5 income tax retums and conduct throughout. their professional lives, These capabilities will enable basi tax planning in compliance professional accountants to identify problems, kiow where to find this with relevant legislations and knowledge and know how to apply it in an ethical manner to acl regulations. appropriate solutions. The balance of these elements may vary but what ‘© Perform cost-benefit araysis for ig required is to develop the knowledge base, strong skills and ethical ‘ < values in order to produce competent professional accountants with ot Oesan paar ferincleniert cw ‘appropriate values, ethics and attitudes. rea The BSA Curriculum under the CHED Memo No. 27, Series of 2017, © Communicate effeotively the consists of the following components: elie ier pee sean um Di ‘ 2. Conduct accounfaney research | + Design an appropriate research Gourses Proseribod through independent studies of plan’ 7 ion (GE) Courses a relgvant literature and | Prepare a critical review of related 2. National Service Training Progrem (NSTP) oe ‘appropriate use of accounting literature [3 Physical Eduoation (PE) courses: “ theory and methodologies. © Analyze vesulls uf study and = Gonmon Business. and Management Education Courses = . (eo ae [5__Cote Accouniing Education Courses | FasaaaT | contributions to body of 6. Cognais / Major Professional Courses ae ici ‘ oe at ‘© Present findings and conclusions ABSA degree holder under CHED Memo No. 27, Series of 2017, should of the study possess the following characteristics, capabilities and competencies with fed Coanaeeaeerecivale fe specific measurable performance indicators recommendations, CAPABILITIES AND COMPETENCIES] PERFORMANCE INDICATOR —_| 3. Employ technology as a| » Customize an accounting T4. Resolve business -issues and | » Record financial transactions in business fool in. capturing software to a particular business | problems, with a global and Conplence vi PSs financial and non-financial entity strategic perspective using accounting and reporting standards information, generating reports | » Develop a financial model using a knowledge ad technical (both global and focal) for sole ‘and making decisions. ‘spreadsheet software m he areas of | (proprietorships, partnerships, + Analyze the performance of a | and ations, government and not. paticular business entity using ting and jons. ‘appropriate accounting software wunting and | » Prepare Accountancy reports such tools and functions. and accounting as budgets and business plans 4,” Apply knowledge and skills that |" Perform ting cpa arewer, | wil “successfuly respond to] ~ in cin ee natn * Conduct financial and operational various types of assessmenis reset cerita audits of all types of business {including professional licensure | Pass licensure examinations or i and not-for-profit and certifications). qualify for ~—_ professional | im ee 7a _aocteditationsicertficatons.B, CPA 38 Chapter 3 ‘CAPABILITIES AND COMPETENCIES %, Confidently maintain a | Promote me | ‘commitment to good corporate Pe acre izenship, social responsibility ofan organization. Shi etiical pracice in| « Communicate imitations or ther performing functions @s an constraints fe woud eae responsible judgment or ‘aocountant See ect snsure Examination ir i 8) Article II, Sections, 13 to ‘The "Philippine Accountancy Act" (RA 9298) A ns. 13 TE provide for the requirements for the Examination, Registration and Licensure for the Practice of Accountancy as follows L - Qualification of Applicants for the Licensure Examinations, rmination shall establish the following ‘Any person applying for examination i pre-requisites to the Satisfaction of the Board that he/she: (a) # a joa holder of the degree of Bachelor of Science in Accountancy ‘conferred. by a school, college, academy or institute duly Tecognized and/or accredited by the CHED other authorized jovernment offices; and - see (@) fas not been convicted of any criminal offense involving moral turpitude. IL. Scope of Examination 2, xf 2015, the licensure [As per PRC-BOA Resolution No. 262, Series of 2015, examination for certified public accountants shall cover, but are ot limited to, the following six (6) subjects: 1) Financial Accounting and Reporting 2) Advanced Financial Accotinting and Reporting, 3), Management Advisory Services 4) Audi 5) Taxation , 8 Regulatory Framework for Business Transaction The Public Accounting Profession Environment _39 The foregoing changes in the examination subjects shall be applied starting May 2016 schedule of the Board Licensure Examination for Certified Public Accountant (BLECP) The resolution was published in the Official Gazette on February 22, 2016 with date of effectivity of March 9, 2016. MI. Rating in the Licensure Examination To be qualified as having passed the licensure examination for ‘accountants, a candidate must obtain a general average of seventy- five percent (75%), with no grades lower than sixty-five percent (65%) hi any given subject. In the event a candidate obtains the rating of seventy-five percent (75%) and above in at least majority of the subjects as provided for in this Act, he/she shall receive a conditional credit for the subjects passed: Provided, That a candidate shall take an examination in the remaining subjects within two (2) ‘years from the preceding examination: Provided, further, That if the candidate fails to obtain at least a general average of seventy-five Percent (75%) and a rating of at least sixty-five percent (65%) in ‘each of the subjects reexamined, he/she shall be considered as failed ill the entire examination ", Other Legal and Regulatory Requirements Oath All successful candidates in the examination shall be required to take an oath of profession before any member of the Board or before any ‘govemment official authorized by the Commission or any person authorized by law to administer caths upon presentation of proof of his/her qualification, prior to entering upon the practice of the profession. IL Issuance of Certificates of Registration and Professionat Identification Card A certificate of registration shall be issued to examinees who pass the licensure examination subject to payment of fees prescribed by the Commission. The Certificate of Registration shall bear the signature of the chairperson of the Commission and the chairman ‘and members of the Board, stamped with the official seal of the Commission and of the Board, indicating that the person named40__Chapter 3 therein ‘is entitled fo the practice of the profession with all the privileges appurtenant thereto. The said certificate shall: remain in full foree and: effeet until withdrawn, suspended or revoked in accordance with this Act. A Professional Identification Card bearing the registration number, date of issuance, expiry date, duly signed by the chairperson of the Conall 8 8 every regan renewable every three (3) years. IIL Indication of Certificate of Registration, Identification Card and Professional Tax Receipt The certified public accountant shall be required to. indicate hisfher certificate of registration numiber and date of issuance, the duration of validity, including the Professional Tax Receipt number on the documents he/she signs, uses or issues in connection with the practice of his/her profession, IV. For CPAs in Public Practice an accreditation from the Board of Accountancy is required. Such acereditation shall be renewed every three (3) years. DEVELOPING CAPABILITIES AND COMPETENCE AFTER ADMISSION TO THE PROFESSION The requirements of those entering the auditing profession are demanding. Audits are performed in teams where each auditor is expected to complete tasks requiring considerable technical knowledge and expertise, along with leadership, teamwork and professional skills. In terms of technical knowledge and expertise, auditors must understand accounting. and auditing authoritative literature, develop industry and client-specific knowledge, develop and apply computer skills, evaluate internal controls, and assess and respond to fraud risk. In terms of leadership, teamwork, and professional skills, auditors make presentations to management and audit committee members, exercise logical reasoning, communicate decisions to users, manage and supervise others by ing meaningful feedback, act with integrity and ethics, interact in a team environment, collaborate with others, and maintain a professional personal presence. While external auditors at all types of audit firms need these skills, the ‘work environment at larger versus smaller audit firms differs, The Public Accounting Profession Environment, At —_______ Publie Accounting Profession Emirorment, at To acquire the capabilities and competence required of professional accountants, individuals may need further education and development beyond that needed to qualify as professional accountants. Education and development for acquiring and maintaining the capabilities of professional accountants can include: (@) Advanced professional education pursued at academic institutions or through the programs of professional bodies; (b) On-the-job-training and experience programs; ~ (©) Off-the-job training; and (@) Continuing professional development (CPD) courses and activities, ‘The sustainability of the accounting profession depends on the quality of services provided by its members and the profession's capacity to respond effectively and efficiently to the demands of economy and society. Recent developments in technology, globalization, ethics and governance have dramatically altered the business environment and the nature of the professional activities of accountants. The liberalization of services requires that the academic and professional qualifications of the accountant be at par with other countries to enable him/her to perform competently in the workplace and at the same time to be recognized internationally 1 Professional accountants in public practice are bound by professional and accounting standards and reporting requirements in so far as the public interest is concerned. They are likewise bound by the regulatory and professional ethics framework as to their conduct of the work, Similarly, professional accountants in business who use their accounting background and their work in private practice are responsible to management and must exert all efforts to provide exemplary accounting-based business, analysis, projections and interpretations. Employers are demanding a broad range of professional and general business skills which, if developed, improves the versatility of the professional accountant. All professional accountants are obliged to engage in lifelong learning to keep up-to-date on developments influericing the profession and the quality of the services they provide42_ Chapter 3 CORE VALUES AND COMPETENCY REQUIREMENTS FOR CPAs IN PUBLIC PRACTICE ‘The Accounting Profession requires CPA’s to possess the following Core Values and Competencies which reflect the foundation of the unique strengths and quali s that will continue to drive and di .guish the profession in the coming decades. Core Values > Core values of the CPA profession are the essential and enduring beliefs that it upholds over time. Core values enable CPAs to retain their unique character and value as they embrace the changing dynamics of the global economy, . it i PAS Conduct. themselves with intspty and honesty, holing themselves to rigorous standards of professional ethics. © Competence CPAs demonstrate superior technical proficiency by performing with a high level of expertise and knowledge + Lifelong Learning ‘ : CPAs highly value education beyond certification and continually pursue new and broad skills and knowledge. © Objectivity CPAs maintain impartiality and intellectual honesty by remaining free of personal bias and conflicts of interest. © Commitment to Excellence F CPAs continually deliver exemplary, high-quality services. © Relevance in the Globial Marketplace : CPAs enhance their value by mecting the ever-changing needs of the world around them. ‘The Public Accounting Profession Environment 43 Core Competencies > Core competencies are a unique combination of Huinan skills, knowledge and technology that provides value and results to the user. Enhancing the profession's core competencies is a key to sustaining a competitive and differential advantage in the marketplace. © Communication Skills CPAs are able to effectively exchange reliable and meaningful information, using appropriate context and interpersonal skills, © Leadership Skills: CPAs are adept at influencing, inspiring and motivating others to facilitate change and achieve excellence. * Critical-Thinking and Problem-Solving Skills CPAs are skillful in evaluating facts, challenging assumy applying judgment to develop relevant solutions, + Anticipating and Serving Evolving Needs CPAs are adept in identifying strategic directions and opportunities to meet the evolving needs of those they serve. © Synthesizing Intelligence to Insight CPAs are expert in connecting data, performing analysis and using business acumen to provide astute guidance for better business decision making. ‘© Integration and Collaboration CPAs are effective at building strategic alliances and ‘working collaboratively to provide multidisciplinary solutions to complex problems. os44 Chaper 3 REGULATORY AND PROFESSIONAL ORGANIZATIONS THAT INFLUENCE THE PROFESSION A. Regulatory Government Agencies Professional Regulation Commission (PRO) PRC administers, implements and enforces the regulatory policies of the National Government with respect to the regulation and licensing of the various professions under its jurisdiction including the maintenance of professional standards and ethics and the enforcement of the rules and regulations relative thereto, ‘This Commission has the overall jurisdiction over the regulatory, boards in the Philippines among which is the Board of Accountancy. It derives its authority from the PRC Modernization Act of 2000. Professional Regulatory Board of Accountancy (BOA) This board, consisting of a chairman and six members, is the agency that is empowered to administer the Accountancy Law. As a licensing agency of the government, the board is the only body that may issue and revoke CPA certificates and grant licensés to practice. Its functions are provided for in the Philippine Accountancy Act of 2004, Securities and Exchange Commission (SEC) ‘This is the government agency that regulates the registration and operations ‘of corporations, partnership and other forms of associations in the Phitippines, The overall objective of the Securities and Exchange Commission, an agency of the national government, is to assist in providing investors with reliable information upon which to make investment decisions, To this end, ‘companies planning to issue new securities to the public must submit a registration statement to the SEC for approval. They are required to file detailed “annual reports with the Commission. The Commission examines these statements for completeness and adequacy before permitting the company to sell its securities through the stock exchange. Public Accounting Profession Environn ‘The SEC has considerable influence in setting financial reporting standards and disclosure requirements for financial statements as a result of its authority for specifying reporting requirements considered necessary for fair disclosure to investors. It is represented in standard-setting bodies such as the Philippine Financial Reporting Standards Council (PFRSC), Auditing Standards and Auditing and Assurance Standards Council (AASC) and in the Philippine Interpretations Committee (PIC). The SEC has power to establish rules for any CPA associated with audited financial statements submitted to the Commission Because large CPA firms usually have clients that must file accounting reports and the rules and regulations affecting filings with the SEC are extremely complex, most CPA firms have specialists who spend a large portion of their time ensuring that their clients satisty all SEC requirements, ‘Commission on Audit (COA) -- This is the agency that audits or determines whether government units handle their funds according to existing laws and whether their program are being conducted efficiently and economically. Bureau of Internal Revenue (BIR) The Bureau of Internal Revenue is responsible for enforcement of the tax laws, rules and regulations. Its agents conduct compliance audits, examines and reviews income tax retums of individuals and corporations to determine that income has been computed and taxes paid as required by the National Internal Revenue Code: . Professional Organizations Philippine Institute of Certified Public Accountants (PICPA) PICPA is the accredited national professional organization of CPAs. It serves all members in the different sectors of the accounting profession, namely, public practice, education, government and commerce and industry, through a set of technical and social services, Year-round professional development programs (seminars, technical sessions, symposium and dialogues) and regular fellowship and sport activities are sponsored by the association for its members. PICPA publishes the Accountants Journal that contains technical and formal papers, bulletins and pronounceients released by the Financial46 Chapter 3 Reporting Standards Council (FRSC) and the Auditing and Assurance Standards Council (AASC).. ‘Sectoral Organizations \ ‘The other professional organizations that complement PICPA’s objectives ‘and provide the specific professional development and other requirements of CPAs in the different sectors are: Association of CPAs in Public Practice (ACPAPP) Association of CPAS in Education (ACPAE) ‘Association of CPAs in Commerce and Industry (ACPACI) Government Association of CPAs (GACPA) C. Standard-Setting Bodies International Federation of Accountants (IFA) IFAC was formally approved in Munich in 1977 and has as its mission the development and enhancement of the profession to enable it to provide services of consistently high quality in the public interest. It is a non-profit, non-governmental, non-political international organization of accountancy “bodies, Membership in IFAC is open to accountancy bodies recognized by law or ‘general consensus within their countries as substantial national organizations ‘ef good standing within the accountancy profession (e.g, PICPA). Membership in IFAC automatically includes membership in the International ‘Accounting Standards Board (IASB). The Assembly, consisting of one representative from each member accountaney body elects the members of Council. The work programs of the \., Couneil are implemented primarily by smaller working groups, or standing " technical committees which include: Education: Ethics; Financial and Management Accounting; Information Technology; Membership; and Public Sector. ‘The Public Accounting Profession Environment _47 International Accounting Standards Board (IASB) The International Accounting Standards Board (IASB), based in London, began operations in 2001. It is funded by contributions from the major accounting firms, private financial institutions and industrial companies throughout the world, central and development banks, and other international and professional organizations. The 14 Board members (12 of whom are full= time) reside in nine countries and have a variety of functional backgrounds. The Board is committed to developing, in the public interest, a single set of high quality, global accounting standards that require transparent and comparable information in general purpose financial statements. In pursuit of this objective, the Board cooperates with national accounting standard-setters to achieve convergence in accounting standards around the world. Financial Reporting Standards Councit The Financial Reporting Standards Council (FRSC) is tasked to ass Board in carrying out its powers and functions particularly the adoption of Incernational Financial Reporting Standards inthe Philippines. International Auditing Practices Committee (IAPC) The International Auditing Practices Committee (IAPC) is a standing committee of the Council of IFAC and is responsible for the development and issuance on behalf of the Council, standards and statements on a variety of audit and attests functions in order to improve the degree of uniformity of auditing practices and "related services throughout the world. IAPC issues the International Standards on Auditing (ISAS) that are to be applied in the audit of financial statements, audit of other information and related services. Auditing and Assurance Standards Council (AASQ) Auditing and Assurance Standards Council (AASC) is the body that is assigned to assist the Board in carrying out its powers and functions particularly the adoption of auditing and assurance standards in the Philippines.$8 Chapters CPA'S LEGAL LIABILITY Potential litigation is a major concern to auditors. Professionals have always had ‘duty to provide a reasonable level of care while performing work for those they serve. Audit professionals have a responsibility under common law to fulfil expressed and implied contraets with clients. They are liable to their clients fot negligence and/or breach of contracts should they fail to provide the.services or not exercise due care in their performance. Lawsuits against auditors typically involve alleged misstatements, that the auditors did not detect in the financial statements. These misstatements are usually: 1) ‘an improper or inadequate disclosure, or 2) an inappropriate valuation. Other typical lawsuits brought by clients against CPA firms involve claims that the auditor (1) did not discover an employee defaleation (theft of assets) as a result of negligence in,the conduct of the an ‘the agreed on date; and (3) inappropriate withdrawal from an audit. Public accounting firms have developed procedures that some characterize as defensive auditing to minimize risk. Also, understanding how and when auditors can be liable will be helpful. LEGAL CONCEPTS RELATED TO AUDITOR'S LIABILITY Concepts basic to an understanding of auditors’ liability include Due professional care Sources of responsibility Degree of wrongdoing, Lack of privileged communication Liability for acts of others Due Professional Care : ‘There is agreement within the profession and the courts that the auditor is not 4 guarantor of the statements! accuracy. Auditors are not infallible and can make efrors in judgment. But auditors are expected to exercise the same reasonable care'with which others in the profession would perform in similar circumstances. This is frequently referred to as exercising due professional : 2) did not complete the audit on , ‘The Public Accounting Profession Environment _49. caresThis standard of dye care to which the-auditor is expected to be held is often referred to as the prudent person concept. Sources of Responsibility The auditor’s legal responsibilities to others are established by either common law or statutory law. ‘ Common laws are laws that have been developed through court decisions rather than through government statutes. An example is an auditor's liability to a bank related to the auditor's failure to discover material misstatements in financial statements that were relied on in issuing a loan, Statutory laws refer to the body of laws passed by legislative bodies such as Congress. For example, auditors for an entity selling securities under the Securities Act owe a statutory duty to a purchaser of those securities. Degree of Wrongdoing Figure 4.1 illustrates the degree of an audite?’s wrongd 1g oF failure to fulfill their responsibilities. Figure 4.1 Degree of Wrongdoing Degree of Wrongdoing Gross negligence oF None Negligence | Constructive Fraud Fraud ‘Auditor perform ‘Audiors issue appropriate audit and report on financial issue appropriate statements with the report. intent to deceive. At one extreme, auditors perform an appropriate audit and issue an appropriate report, Hence, the auditors have no’ degree of wrongdoing, Auditors who commit fraud are at the other extreme because they know the financial statements are misstated but do.not take appropriate action to report the misstatements, Courts consider fraud as the maximum wrong that auditors can do. Courts traditionally use the legal concept of sciemter or the knowledge of the falsity on the part of the person making the statement, to differentiate fraud from other degrees of wrongdoing.‘The courts have. identified two degrees of wrongdoing — negligence (ordinary) and gross negligence. Ordinary negligence implies absence of reasonable care that can be expected of a person in a set of circumstances. Auditors are guilty of ordinary negligence if they do not do what reasonably prudent auditors should do in the circumstances. Auditors are guilty of gross negligence if they consistently fail to follow the standards of the profession ‘on an engagement, Courts distinguish between these two degrees of wrongdoing depending on the particular circumstances of the case or the pertinent legal precedent. LEGAL LIABILITY OF THE INDEPENDENT AUDITOR Auditor's liability to clients A CPA is obliged to exercise due professional care during the engagement including adherence to professional standards and ethics. Failure by the CPA to ‘exercise this degree of care may constitute negligence and breach of contracts to render professional sorvice. An-honest error does not vonstilute negligence OW he ppart of a CPA so Jong as he has exercised due professional care. While the basic purpose of an audit is to render an opinion on the fairness of the financial statements and not to detect fraudulent acts by employees, if an undetected fraud is so widespread and of such magnitude as to cause the financial statement to be materially misstated, the argument may be advanced that the ‘auditor's procedures were clearly inadequate and that the auditor was negligent. In the event that the auditor is found negligent, a client is entitled to recover any losses to which the auditor's negligence was proximate cause, The client may also recover the audit fee because of the auditor's breach of contract. Auditor's liability to third parties Creditors, investors and other third parties also rely upon the auditor's work when they place confidence in audited financial statements. Independent auditors are liable to all foreseeable third parties for losses which are caused by the auditor's fraud or gross negligence. Auditor's expression of an opinion on financial statement when, in fact, he has no basis for an opinion is considered gross negligence. Failure of the auditor to detect a widespread fraud also constitutes negligence. The Public Accounting Profession Environment _ 51 LIMITATION ON AUDITOR'S RESPONSIBILITY An independent auditor satisfies his or her detection responsibility by planning to search for material errors or irregularities and exercising due skill and care. PSA 240 (Redrafted) states that: If circumstances indicate the possible existence of fraud or errors, the auditor should consider the potential effect on the financial information. If the auditor believes that the suspected fraud or error could have a material effect on the financial statements, he should perform such modified and additional procedure as he determines appropriate to confirm or dispel such suspicion. It's further provided that ‘The auditor should communicate his fin igs (0 management on a timely bas @) he believes fraud may exist even if the potential effect on the financial information would be immaterial, or Y). fre or significant error is actially found wo exist In the event the auditor fails to detect fraud and is found negligent, a client is entitled to recover any losses occurring since the auditor’s negligence was proximate cause. Also the client may recover the audit fee because of the ‘auditor's breach of contract. AUDITOR'S DEFENSES AGAINST CLIENT SUITS Under common law, CPA firms can use one or a combination of five defeises when there are legal claims by clients. These are: 1) The CPA firm can claim there was no implied or expressed contact to perform the service. This is referred to as lack of auty-to perform the service. 2) The audit was performed using reasonable care or the lack of reasonable care did not cause damages. 3) The reliance on the financial statements did not cause the loss. This is also referred to as absence of causal connection. 4) In cases'in which a tort is involved, auditors in some jurisdiction can claim contributory negligence (that the client's own actions contributed to the loss). 5) The statute of limitations on the action has expired.52_Chapter 3 AUDITOR'S DEFENSES AGAINST THIRD-PARTY LAWSUITS ‘Auditors have four defenses in third-party lawsuits. These are: 1) The preferred defense in third-party suits is nonmegligent performance. If the audit was conducted in actotdanice with Standards of Auditing, the other defenses are unnecessary. 2) A lack of duty defense can also be used. This defense contends lack of privity of contract. Privity of contract means limitations of liability to the parties to a given contract. Under privity, the CPA is not liable to third parties for ordinary negligence. 3) Absence of causal connection: ‘This means that third party must be able to prove that there is a close causal connection Between the auditor's breach of the standard of due care and the damages suffered by the third party. This could also be construed as nonreliance on the financial statements by the user. 4) The statute of limitations on the action has expired. Contributory negligence is ordinarily not available in third-party -lawsuits because a third-party is not in a position to contribute to misstated financial statements. MINIMIZING EXPOSURE TO LEGAL LIABILITY In the light of the auditor's extensive exposure to obligation, public accounting firms must take positive action to withstand the threat of legal liability. Among these actions are: 1) Emphasize compliance with standards of auditing, the Code of Professional Ethics and where appropriate Financial Reporting Standards 2) Thoroughly investigate prospective clients. Avoid taking on clients when ‘there are indications of deliberate management mistepresentation. Evaluate whether a client has the necessary integrity. 3) Avoid companies and industries in which the risk of litigation is high. 4) Bxercise extreme care in the audit of clients in financial difficulties. 5) Establishing and following appropriate quality control procedures over all audit work. ‘The Public Accounting Profession Environment $3 6) Use engagement letters which clearly point out to the client the scope of the auditor's services and responsibilities on a particular engagement. 7) Conduct the audit with appropriate professional skepticism. 8) Provide the opportunity for auditor to consult with more experienced auditors about difficult issues. 9) Maintain adequaté professional liability insurance coverage. This is however not a common practice in the Philippines. 10) Seek legal counsel whenever serious problems oceur. SOCIETY'S PXPECTATIONS AND AUDITOR'S RESPONSIBILITIES It is important to remember that while auditors have important responsibilities, management is primarily responsible for maintaining effective internal control and for ensuring the fairness of the company’s financial statements. The auditor’s responsibility to provide reasonable assurance with respect to eiors, fraud and Illegal acts clearly shapes the auditor’s environment and the work the he or she performs. CHALLENGES FACED BY THE PUBLIC ACCOUNTING PROFESSION As a pfofession, we are in a period of change in which auditors and accountants are called upon to make professional judgments that best reflect the economics, transactions or current states of economic holdings. Further, audit firms need professional staffs that make consistent judgments across a wide variety of companies, countries, and types of transactions. Thus, professional judgment and processes with which to make such judgments consistently across both the breadth of a firm, as well as time, are critical to the future success of each auditing firm, ‘Among the significant challenges faced by the profession are: |. Aecounting in highly complex often iti part because companies are entering into, increasingly complex transaction and organizational standard. 2. Audit procedures must be designed to attest material fraud and assure users that the financial statement are free from fraud54. Chapter 3 3, Computer systems are complex. When used properly, they provi ‘opportunities for effective contracts, but when not used properly, they ‘create additional risks. 4. Many companies are global. The audit firm must operate in multiple countries that require consistent high quality audits wherever the audit takes place. 5, There is time pressure to get the audit done and to report more quickly than ever before, 6. There is anced to generate audit fees sufficient to both (a) attract new people to the profession and (b) retain managers and partners, who often operate under having stress to fulfill this most important obligation. This could meet resistance from clients who may believe that price changes are not warranted. ‘The public accounting profession has been one of the most highly regarded professions in the country. But the audits is only as good as the next engagement Which must be executed well and within the fules of the profession. The new public practitioner must be more than a “rules person”. He or she must be able to meet the challenges of professional judgment and adhere to standards of professional excellence and ethics. ‘THE ACCOUNTING PROFESSION’S CREDIBILITY CRISIS ‘A recent survey of users .of financial statements particularly the investors, provides evidence that a gap has existed between what auditors attempt to do in ‘an audit and the user's expectations of the audit. This phenomenon, referred to as the expectation gap, has existed in some form since: the inception of modem auditing, Although CPAs have historically enjoyed a high degree of credibility, users of audit reports expect auditors to detect both intentional and unintentional ‘material misstatements and to report when an entity is not likely to survive. ‘Although audits are not designed for these tasks, changes in audit standards and practices have been made to better recognize auditor’s responsibility’ for detecting fraudulent financial reporting and to improve the communication of the work done by the auditor. The Public Accounting Profession Environment _ 55 To address the current issues on the expectation gap of the CPA’s performance, public regulations and. tel the flora ‘regulations within the firm have been adopted to include ‘+ Setting requirements to ensure that only people are admitted to the accounting practice through the accredi See igh tation by the Board of Establishing and: complying with internat i onal stand unt reporting and auditing services. alae ed rae ys Adopting the Revised Code of Ethies for Professional Accountants, Developing a program for quality control of public accounting pra Requiring practicing accountants to comply wit i Sao aot oeete comply with continuing professional Requiring regular, periodic reviews peri s of auditor’s compliance with professional standards through it vi profesional standards through the quality assuranes review (QAR) by the ‘+ Penalizing those found guilty of unacceptable practices. ‘* Monitoring adequate competition among CPA’s56 Chapter 3 ‘REVIEW QUESTIONS Questions: 10. Deseribe briefly the practice of public accountancy as provided for in the Philippine Accountancy Act of 2004. How does one become a CPA? What are the qualification requirements that a prospeotive examinee ‘must satisfy before taking the CPA Licensure examination? What are the requirements that a CPA if public practice must comply with before he is issued a'certificate of accreditation by the Board of Accountancy? What are the major components of the BSA Curriculum? What are the qualification requirements that an individual must meet to be able to take the CPA licensure examination? How may a professional accountant develop and sustain the required capabilities and competence after admission to the profession? Explain briefly the competency requirements for professional ‘accountants in business. Name the core competencies required in. the public accounting profession. Comment upon each of the following statements you heard in a conversation between two newly hired staff auditors. a) “Of course, I'm qualified to be assigned to this engagement. | have ‘an’ accounting degree from a top university and was an honors graduate. I know some of the accounting ritles have changed since I graduated, but I'l be able to figure that out as we go through the audit”, The Public Accounting Profession Environment 57 ©) “It doesn’t really matter what other think ... I'm completely independent of Chiva Industries and should be a member of the audit ‘team. While I own some stock, itis small amount and I’m holding it fora long terin, anyway”, 11, Deseribe the role of the various organizations that affect the practice of the accounting professionals in the Philippines. and explain briefly at least five (5) initiatives to address the credibility crisis in the accountaney profession, 13, Under what conditions may a foreigner be allowed to practice ‘accountaney in the Philippines? 14. What factors have caused litigations against auditors to inerease? 15. What is due care? How does it affect auditors” liability’? 16. Under what circumstances can an auditor be criminally liable for the results of an audit? 17, Identify specific actions an auditor can undertake to reduce the potential for litigation. 18. How does the prudent person concept affect the liability of the auditor? 19. What is the body that issues international pronouncements providing auditing procedural and reporting guidance? 20. Who has the primary responsibility for the adequacy of disclosure in the financial statements of a publicly held company?58_Chapter 3 Multiple Choice Questions In the auditing environment, failure to meet auditing standards is often a. an accepted practice. b. a suggestion of negligence. c. conclusive evidence of negligence. 4d. tantamount to criminal behavior. ‘The prudent person concept establishes in law that a, the CPA firm is not expected to be infallible, b, an audit in accordance with Standards on Auditing is subject to limitations and cannot be relied upon for complete assurance that all, ‘errors and irregularities will be found. ©. the courts do not require that the auditor become the insurer or ‘Buarantor of the accuracy of the statements. 2 4. all three of the above are true. To succeed in an action against the auditor, the client must be able to show that a. the auditor was grossly negligent the auditor was fraudulent . there is a close causal connection between the auditor’s breach of the standard of due care and the damages suffered by the client, 4d. there was a written contract. The standard of due care to which the auditor is expected to be held is, referred to as the ‘a, prudent person concept. ¢. due care concept. b. common law doctrine. d._reckless regard doctrine. ‘The existence of extreme or unusual negligence, even though there was no intent to deceive or do harm, is a. fraud c. gross fraud b. constructive fraud 4d. ordinary fraud Most lawsuits against CPAs are filed by a. client cc, third party beneficiaries b. third parties d. government agencies, such as SEC The Public Accounting Profession Environment 9 7. The Commission on Audit (COA): is primarily concemed with rapid processing of all accounts payable incurred by the national government. b. Responsibilities include conducting operational audits to ensure spending meets Congress's requirements. ¢. is a multinational organization of professional accountants, 4 & primarily concerned with budgets and forecasts approved by the 8 The risk associated a. Information risk. b. Inherent risk, ce. Relative risk. d. Business risk, ith survivability and profitability is referred to as 9. Which of the following attributes is more essential for an auditor than of management? ‘ a. Integrity, b. Competence, ©, Independence. 4. Keeping informed on current professional developments, 10. Attestation risk is limited fo a low level in which of the following, engagement(s)? a, Both examinations and reviews: b. Examinations, but not reviews. ©. Reviews, but not examinations, d. Neither examinations nor reviews.‘G0 Chapter $e Cases Case 1 You and a colleague are carrying on a heated discussion. The makes a number of statements about the public accounting profession that you believe are in error. Weleoming an opportunity for rebuttal, you are ready to reply. Required: (@) For each of the following colleague statements, develop a brief response indicating, erroneous assumptions made by the colleague or your agreement with the statements, "6 (0) Cite relevant evidence in support of your response. Colleague's Statements 1. “Auditing neither creates goods nor adds utility to existing goods and therefore does not add value to business. Auditing exists only because it has been legally mandated.” 2. “The' failure of the public accounting profession to warn us of the problems that existed in the economy is an example of a profession not adding utility to society.” 3. “The only reason [ would hire an auditor is with the expectation that the auditor search for and find any fraud that might exist within my company. Searching for fraud should be the primary focus of an audit.” 4, “Auditors cannot legitimately serve the public when they are hired and fired by the management of the company being audited.” 5. “Auditors cannot add significant value to financial statements as long, as PERS allow such diversity in accounting principles. How, for example, can the same auditor issue unqualified opinions on identical companies one that uses FIFO and the other weighted average to account for the same set'of transactions recognizing that the reported income and statenient of financial positions will be ‘materially different? How can, both be fairly presented?” 6.° “Auditing is narrow’ - just nitpicking and challenging the ‘organization in an atteript to find mistakes. 1 would rather pursue @ ‘career where I really understand a company’s business and would be in a position to make recommendations that would improve it.” ‘The Public Accounting Profession Evironment 64 “Auditing would add greater value if er analyzed company Performance and presented a report on coi rf . ‘vith the audited financial statements a? Perermanee along 8. “If auditors make recommendations to clients based on weaknesses in the company operations, the auditors ought to make those recommendations public, This would help increase the public trust by. providing ‘more accountability by both management and ditors 9. “Adding reports on the quality of internal il t intemal control will value of the audit function fo society.” ea Crise 2 In their review of the public accountin iecounting profession, LouyMar and Associates warn that an audit report too often is viewed as a “cert 4 a “certifi ” ‘company. The report states: fetes The most ious consequences steunning from such a misunderstanding are that the independent auditor can quickly be portrayed as the force that represents all good in financial accounting and the guarantor of anythin Positive anyone wants to feel about a given company. i Required: (@) Why is public accounting often viewed as a guarantor of results or even ‘as a provider of assurance that one’s investment is of high quality? (b) To what extent. is it reasonable to view the audi é view the auditor ‘organization’s financial Quality? Explain, Sirus (©) To what extent do you believe that user expectati lo li expectations of the publi accounting professions appear to you to be unwarranted? Explain, a Case 3 Various organizations develop standards for audits s its and regulate Cl s. Compare and contrast the roles of the PICPA, the SEC and the osha Accountancy along the following dimensions: a) Standard setting b)_ Regulation of CPA firms. ©) Source of authority.62_Chapter 3. Case 4 Michael Diaz, owner of Diaz Company, applied for a bank loan and was informed by the banker that audited financial statements of the business had to be submitted before the bank could consider the loan application. Michael then retained Arnold Benamer, CPA, to perform an audit. Michael informed Amold that audited financial statements were required by the bank and that the audit must be completed within three weeks. Michael also promised to pay Amold a fixed fee plus a bonus if the bank approved the loan. Arnold agreed and accepted the engagement ‘The first step taken by Arnold was to hire two accounting students to conduct the audit. He spent several hours telling them exactly what to do. Amold told the students not to spend time reviewing controls but instead to concentrate on proving the mathematical accuracy of the ledger accounts and summarizing the data in the accounting records that support Diaz Company's financial statements. The students followed Arnold's instructions and after two weeks gave Arnold the financial statements, which did not include any notes Arnold reviewed the statements and prepared an unqualified audit report. The report, however, did not refer to Financial Reporting Standards. Required: Indicate how the actions of Arnold resulted in a failure to comply with the Standards of Auditing, Case 5 Generic Corporation is a large multinational audit client of your CPA firm. One of Generic's subsidiaries, Ultra Ltd., is a sticcessful electronics. assembly company that operates in a small Caribbean country. The country in which Ultra operates has very strict laws governing the transfer of funds to ‘other countries. Violations of these laws may result in fines or the ‘expropriation of the assets of the company. During the current year, you discover that $500,000 worth of foreign curreney was smuggled out of the Caribbean country by one of Ultra's employees and deposited in one of Generie's bank accounts. Ultra's ‘management generated the funds by selling company automobiles, which ‘were fully depreciated on Ultra’s books, to company employees. ‘You are concerned about this illegal act committed by Ultras management ‘and decide to discuss the matter with Generic's management and board of directors‘sgem to be unconcerned with the matter and express the opinion The Public Accounting Profession Environment 63 that you are making far too much of a situation involving an immaterial peso amount, They also believe that it is necessary to take any steps to prevent Gites management from engaging in illegal activities in the future. Genes tga counsel indicates that the probability is remote that such an legal act would not be material to the client's dat es: to the client's consolidated financial Your CPA firm is ready to issue the inte it is ready to issue the integrated audit report on Generic’ {trying to decide on the appropriate course of action regarding the illegal act. Required: ° Pee the implications ofthis legal act by Uitte managetnen, scribe the courses of action that afe av: Desist ilable to. your CPA firm ©) State your opinion as to the course of action that is appropriate. Explain, Case 6 Alice Borromeo, a partner in the CPA firm of Jay i E 5 i y and Dee, following memorandum from Jenny Gomez, president ap aes ‘Manufacturing Corporation, an audit client of many years. Dear Alice: Thave a new type of engagement for you. You are familiar with how mu eliminate the air and water pollution caused by our manufacturing plant, We have changed our production process to reduce discharge of gases; we hhave changed to more expensive fuel sources with less pollution potential: and we have discontinued some products because we couldn't produce them without causing considerable pollution, z | don't think the stockholders and the public are aware of the efforts we have made, and I want to inform them of our accomplishments in avoidi danger to the envirinment. We will devote a major part of our annust Teport to this topic, stressing that our company is the leader of the entire industry in combating pollution. To make this publicity more convincing, 1 would like to retain your firm to study what we have done and to attest as independent accountants that our operations are the best in the industry as far as preventing pollution is concerned.64 Chapter 3 To justify your statement, you are welcome to investigate every aspect of cour opefations as fully as you wish, We will pay for your services at your regular audit rates and will publish your "pollution opinion” in our annual report to stockholders immediately following some pictures and discussion ‘of our special equipment and processes for preventing industrial pollution. We may put this section of the annual report in a separate cover and distribute it free to the public. Please let me know at once if this engagement is acceptable to you. Sincerely, Jenny Gomez Required: Put yourself in Alice's position and write a reply to this client's request Indicate clearly whether you are willing to accept the engagement and explain your attitude toward this proposed extension of the auditor's attest function. Chapter MANAGEMENT OF A PUBLIC ACCOUNTING PRACTICE Expected Learning Outcomes After studying this chapter, you should be able to: 1. Understand the forms of organization of accounting firms. , 2. Learn the specific duties and responsibilities of partners as well as the professional staff in as audit firm. 3. Describe the acceptable means of marketing or advertising an accounting practitioner's professional services. 4. Name the sources of audit clients: 5. Understand the basis of charging professional fees and methods of billing the olient. 6. Understand the implication: of auditing in a globalized environment. 7. Know the nature of a quality control System that audit firms should adopt. * 8, Enumerate and describe the elements, objectives and corresponding policies and procedures of a quality control system, BULBS