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CHAPTER 2
Professional Standards
LEARNING OBJECTIVES
Review
Checkpoints
Exercises, Problems,
and Simulations
1. Name the various practice standards for
internal, governmental, and independent
auditors and accounting firms and identify
their sources.
1 51
2. Understand generally accepted auditing
standards (GAAS) and explain how GAAS
affect the audit team’s responsibilities.
2, 3
3. Describe how the audit examination is
affected by the fundamental principles of
responsibilities and performance.
4, 5, 6, 7, 8, 9,
10, 11, 12, 13,
14, 15, 16
46, 47, 48, 49, 50, 55
(partial), 56 (partial),
59, 61 (partial), 62
4. Understand the principle of reporting and
identify the basic contents of the auditors’
report.
17, 18, 19, 20 52, 53, 55 (partial),
56 (partial), 61
(partial)
5. Identify the need for attestation standards and
explain how attestation standards differ from
generally accepted auditing standards.
21, 22 54
6. Understand the role of a system of quality
control and monitoring efforts in enabling
accounting firms to meet appropriate levels
of professional quality.
23, 24, 25, 26,
27
57, 58, 60
Chapter 02 – Professional Standards
2-2
SOLUTIONS FOR REVIEW CHECKPOINTS
2.1 For independent (external) auditors of financial statements, practice standards are issued by the AICPA
Auditing Standards Board (in the form of Statements on Auditing Standards) and the Public Company
Accounting Oversight Board (in the form of Auditing Standards). Statements on Auditing Standards are
appropriate for the audits of nonpublic entities, while Auditing Standards are appropriate for the audits of
public entities.
For governmental auditors, the Government Accountability Office issues Government Auditing Standards
(also known as the “Yellow Book”).
For internal auditors, the Institute of Internal Auditors issues Statements of Internal Auditing Standards
(also known as the “Red Book”).
For fraud auditors, the Association of Certified Fraud Examiners issues Professional Standards and
Practices for Certified Fraud Examiners.
For auditors in other countries, the IFAC International Auditing and Assurance Standards Board issues
International Standards on Auditing and Assurance.
2.2 Generally accepted auditing standards are standards that identify necessary qualifications and
characteristics of auditors and guide the conduct of the audit examination.
Generally accepted accounting principles represent the requirements for the preparation and presentation
of financial statements and accompanying footnote disclosures.
These two types of standards are related to one another because a primary objective of a GAAS audit is to
allow auditors to conclude whether an entity’s financial statements are prepared and presented in
conformity with GAAP.
2.3 The three fundamental principles are:
1. Responsibilities, which involves having appropriate competence and capabilities, complying with
relevant ethical requirements, maintaining professional skepticism and exercising professional
judgment.
2. Performance, which requires auditors to obtain reasonable assurance about whether the financial
statements as a whole are free of material misstatement by: (1) planning the work and properly
supervising assistants; (2) determining and applying appropriate material levels; (3) identifying
and assessing the risk of material misstatement; and, (4) obtaining sufficient appropriate audit
evidence.
3. Reporting, which requires the auditor to express an opinion as to whether the financial statements
are prepared in accordance with the applicable financial reporting framework.
Auditing procedures relate to acts to be performed during the engagement. Auditing standards deal with
measures of the quality of performance of those acts and the objectives to be attained. Auditing standards
are less subject to change and provide the criteria for rejecting, accepting, or modifying auditing procedures
in a given circumstance.
An example of the relative stability of standards and procedures is found in the change from
non-computerized information systems to computerized information systems. New auditing procedures
were required to evaluate computerized information systems, but auditing standards remained unchanged
and were the criteria for determining the adequacy of the new auditing procedures.
Chapter 02 – Professional Standards
2-3
2.4 Independence in fact represents auditors’ mental attitudes (do auditors truly act in an unbiased and
impartial fashion with respect to the client and fairness of its financial statements?). Independence in
appearance relates to financial statement users’ perceptions of auditors’ independence.
Auditors can be independent in fact but not perceived to be independent. For example, ownership of a small
interest in a public client would probably not influence auditors’ behavior with respect to the client.
However, it is likely that third-party users would not perceive auditors to be independent.
2.5 Due care reflects a level of performance that would be exercised by reasonable auditors in similar
circumstances. Auditors are expected to have the skills and knowledge of others in their profession (known
as that of a prudent auditor) and are not expected to be infallible.
2.6 Professional skepticism is a state of mind that is characterized by appropriate questioning and a critical
assessment of audit evidence.
Professional judgment is the auditors’ application of relevant training, knowledge, and experience in
making informed decisions about appropriate courses of action during the audit engagement.
Auditors are required to demonstrate professional skepticism and professional judgment throughout the
entire audit process.
2.7 Reasonable assurance recognizes that a GAAS audit may not detect all material misstatements and
auditors are not “insurers” or “guarantors” regarding the fairness of the company’s financial statements.
The following characteristics of an audit do not permit auditors to provide absolute assurance:
Mistakes and misinterpretations may occur
Management judgments and estimates affect financial reporting
Audit procedures cannot always be relied upon to detect misstatements
Audit engagements must be conducted within a reasonable period of time and so as to achieve a
balance between benefit and cost.
2.8 Three elements of planning and supervision considered essential in audit practice are:
A written audit plan.
An understanding of the client’s (auditee’s) business.
Policies to allow an audit team member to document disagreements with accounting or auditing
conclusions and disassociate him or herself from the matter.
2.9 The timing of the auditors’ appointment is important because auditors need time to properly plan the audit
and perform the necessary work without undue pressure from tight deadlines.
2.10 Materiality is the dollar amount that would influence the lending or investing decisions of users; this
concept recognizes that auditors should focus on matters that are important to financial statement users.
Materiality should be considered in planning the audit, performing the audit, and evaluating the effect of
misstatements on the entity’s financial statements.
2.11 Auditors obtain an understanding of a client, including its internal control, as a part of the control risk
assessment process primarily in order to plan the nature, timing and extent of substantive audit procedures.
A secondary purpose is because of auditors’ responsibilities for reporting on client’s internal controls under
Auditing Standard No. 5.
2.12 As the client’s internal control is more effective (a lower level of control risk), auditors may use less
effective substantive procedures (a higher level of detection risk). Conversely, when the client’s internal
control is less effective (a higher level of control risk), auditors must use more effective substantive
procedures (a lower level of detection risk).
Chapter 02 – Professional Standards
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2.13 Audit evidence is defined as the information used by auditors in arriving at the conclusion on which the
audit opinion is based.
2.14 External documentary evidence is audit evidence obtained from another party to an arm’s-length transaction
or from outside independent agencies. External evidence is received directly by auditors and is not
processed through the client’s information processing system.
External-internal documentary evidence is documentary material that originates outside the bounds of the
client’s information processing system but which has been received and processed by the client.
Internal documentary evidence consists of documentary material that is produced, circulates, and is finally
stored within the client’s information processing system. Such evidence is either not circulated to outside
parties at all or is several steps removed from third-party attention.
2.15 In general, evidence that is completely external in nature is most reliable, because the client has not
influenced its processing. In contrast, evidence that is completely internal in nature is least reliable, as it
may represent a fictitious transaction created or modified by client personnel to enhance perceptions of the
client’s financial statements.
2.16 As auditors need to achieve lower levels of detection risk, more appropriate evidence needs to be obtained.
Thus, auditors should gather higher quality evidence (more reliable evidence). For example, auditors may
choose to obtain evidence from external sources rather than internal sources.
In addition, for lower levels of detection risk, auditors need to gather more sufficient evidence. Because
sufficiency relates to the quantity of evidence, a greater number of transactions or components of an
account balance should be examined.
2.17 A financial reporting framework is a set of criteria used to determine the measurement, recognition,
presentation, and disclosure of material items in the financial statements. The financial reporting
framework is related to auditors’ reporting responsibilities because this framework serves as the basis
against which the financial statements are evaluated and the auditors’ opinion on the financial statements is
expressed.
2.18 Four types of opinions and their conclusions:
Type Conclusion
Unqualified opinion Financial statements are presented in conformity with GAAP.
Adverse opinion Financial statements are not presented in conformity with GAAP.
Qualified opinion Financial statements are presented in conformity with GAAP,
except for one or more departures or issues of concern.
Disclaimer of opinion An opinion cannot be issued on the financial statements.
2.19 The auditors’ report is dated at the point when all significant procedures have been completed by auditors
and auditors have gathered sufficient appropriate evidence. This date is referred to as the audit completion
date.
2.20 Public accountants should issue a report when they are associated with financial statements because users
may mistakenly assume that an audit has been conducted and that the entity’s financial statements are fairly
presented according to GAAP.
Chapter 02 – Professional Standards
2-5
2.21 The purpose served by the attestation standards is to guide work in attestation areas and engagements other
than audits of financial statements.
2.22 The major differences between attestation standards and generally accepted auditing standards (GAAS) lie
in the areas of practitioner competence, materiality and the risk of material misstatement, and reporting.
GAAS presume knowledge of accounting and require competence and capabilities as auditors (meaning
auditors of financial statements). The attestation standards are more general, requiring training and
proficiency in the “attest function” and knowledge of the “subject matter of the assertions.”
The attestation standards have no specific requirement for determining materiality levels or obtaining and
understanding of the entity and its environment to assess the risk of material misstatement. Because
attestation engagements may cover information not confined to accounting and financial assertions, these
activities may not be appropriate for all attest engagements.
Reporting is different because attestations on nonfinancial information do not depend upon generally
accepted accounting principles. In addition, GAAS do not address two reporting issues (stating significant
reservations about the engagement and indicating that the report is only intended for specified parties) that
are important reporting aspects for attestation engagements.
2.23 A system of quality control provides firms with reasonable assurance that the firm and its personnel (1)
comply with professional standards and applicable regulatory and legal requirements and (2) issue reports
that are appropriate in the circumstances.
The six elements of a system of quality control are:
1. Leadership responsibilities for quality within the firm (“tone at the top”)
2. Relevant ethical requirements
3. Acceptance and continuance of clients
4. Human resources
5. Engagement performance
6. Monitoring
2.24 In deciding whether to accept or continue an engagement with a client, firms should consider:
The integrity of the client and the identity and business reputation of its owners, key management,
related parties, and those charged with governance.
Whether the firm possesses the competency, capability, and resources to perform the engagement.
Whether the firm can comply with the necessary legal and ethical requirements.
If firms decide to withdraw from an engagement, the firm should document significant issues,
consultations, conclusions, and the basis for any conclusions related to the decision to withdraw.
2.25 Typically, firms that audit nonpublic companies have peer reviews conducted through the AICPA’s Center
for Public Company Audit Firms Peer Review Program. While firms that are subject to PCAOB review
requirements can elect to have peer reviews conducted under this program, most choose not to do so.
2.26 The PCAOB’s monitoring role for firms providing auditing services to public entities includes registering
public accounting firms and conducting inspections of registered public accounting firms (similar to peer
reviews).
2.27 The frequency of PCAOB inspections depends upon the number of audits conducted by member firms. For
firms performing audits for more than 100 public companies, inspections are required on an annual basis.
For those performing audits for fewer than 100 public companies, inspections are conducted every three
years.
Chapter 02 – Professional Standards
2-6
SOLUTIONS FOR MULTIPLE-CHOICE QUESTIONS
2.28 a. Correct Gathering audit evidence is a component of the performance principle.
b. Incorrect While reasonable assurance is related to gathering audit evidence, this is not one
of the categories of principles
c. Incorrect The reporting principle relates to the contents of the auditors’ report
d. Incorrect The responsibilities principle relates to the personal integrity and professional
qualifications of auditors.
2.29 a. Incorrect This practice relates to accountants’ competence and capabilities, not due care.
b. Incorrect This practice relates to the reporting principle.
c. Incorrect Sufficiency of evidence relates to the performance principle and not due care.
d. Correct These practices are a part of due care.
2.30 a. Incorrect GAAS relates to the conduct of audit engagements and not overall professional
services.
b. Correct Standards within a system of quality control are firm- (rather than auditor-)
related.
c. Incorrect GAAP relates to accounting and financial reporting, rather than auditing
practices.
d. Incorrect International auditing standards govern the conduct of audits conducted across
international borders.
2.31 a. Incorrect Relying more extensively on external evidence is related to the appropriateness
(or quality) of evidence.
b. Incorrect Focusing on items with more significant financial effects on the financial
statements is related to materiality.
c. Correct Professional skepticism is characterized by appropriate questioning and a critical
assessment of audit evidence.
d. Incorrect Financial interests are most closely related to auditors’ independence.
2.32 a. Correct Auditors study internal control to determine the nature, timing, and extent of
substantive tests.
b. Incorrect Consulting suggestions are secondary objectives in an audit.
c. Incorrect Information about the entity’s internal control is, at best, indirect evidence about
assertions in the financial statements.
d. Incorrect Information about the entity’s internal control provides auditors with little
opportunity to learn about changes in accounting principles.
2.33 a. Incorrect External evidence is considered to be relatively reliable.
b. Correct Management representations should least affect auditors’ conclusions, as they
have not been validated or corroborated by external parties.
c. Incorrect Auditor-prepared evidence is considered to be the most reliable form of
evidence.
d. Incorrect Although a representation of a client employee, inquiry of the entity’s legal
counsel is considered more reliable than that of entity management.
2.34 a. Incorrect Inquiry of management should least affect auditors’ conclusions.
b. Incorrect Although very persuasive, auditors’ personal knowledge (choice d) provides the
most persuasive evidence
c. Incorrect Observation of a client’s procedures provides evidence on the effectiveness of
the client’s internal control, but not the existence assertion for newly-acquired
computer equipment.
d. Correct Auditors’ personal knowledge provides the most persuasive evidence.
Chapter 02 – Professional Standards
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2.35 a. Incorrect Inquires of client personnel are the least reliable form of evidence.
b. Incorrect While more reliable than inquiries (choice a), inspection of internal documents
is relatively low in terms of reliability.
c. Incorrect While sales invoices are documents created by external parties, the fact that
these documents were received from client personnel decreases their reliability.
d. Correct Because the statements were received directly from outside parties, this is a
more reliable form of evidence than choice (c).
2.36 a. Incorrect Documentation of this nature would not be related to independence.
b. Incorrect While the quality of the documentation and the conclusions included in the
documentation might provide information about competence and capabilities,
choice (c) is more appropriate.
c. Correct Initials of the preparer and reviewer provide evidence that the documentation
was reviewed, which relates to planning and supervision.
d. Incorrect While the quality of the documentation and the conclusions included in the
documentation might provide information about sufficient appropriate evidence,
choice (c) is more appropriate
2.37 NOTE TO INSTRUCTOR: Since this question asks students to identify the requirement that is not
included in attestation standards, the response labeled “correct” is not included in attestation standards
and those labeled “incorrect” are included in attestation standards.
a. Incorrect Attestation standards require adequate knowledge of the subject matter.
b. Correct An understanding of the client’s environment (including internal control) is not
required under attestation standards, because internal control may not always be
relevant to the subject matter of the attestation.
c. Incorrect Attestation standards require sufficient evidence to be gathered.
d. Incorrect Attestation standards require independence in mental attitude.
2.38 NOTE TO INSTRUCTOR: Since this question asks students to identify the concept that is least related to
due care, the response labeled “correct” is least related to due care and those labeled “incorrect” are
more related to due care.
a. Incorrect Due care requires the level of skills and knowledge of others in the auditors’
profession, which would require independence in fact.
b. Incorrect See choice (a) above.
c. Incorrect Due care refers to the performance of a “prudent” auditor.
d. Correct Due care recognizes that mistakes and misinterpretations may occur during the
audit.
2.39 a. Incorrect Internal documents are a relatively low quality of evidence.
b. Incorrect Management representations (and the related verbal inquiries) are the lowest
quality of evidence.
c. Incorrect While direct, external evidence is of reasonable quality, it is of lower quality
than direct personal knowledge of the auditor (choice d).
d. Correct Direct, personal knowledge of auditors is the most appropriate form of evidence.
2.40 a. Incorrect While it may increase auditors’ knowledge about the client, obtaining an
understanding of a client’s internal control does not directly influence auditors’
competence and capabilities.
b. Incorrect Obtaining an understanding of a client’s internal control does not directly
influence auditors’ independence.
c. Incorrect Obtaining an understanding of a client’s internal control does not directly help
satisfy the quality control standard about audit staff professional development.
d. Correct The primary purpose of obtaining an understanding of a client’s internal control
is to plan the nature, timing, and extent of substantive audit procedures on an
engagement.
Chapter 02 – Professional Standards
2-8
2.41 d. Correct Independence confirmations would ensure that all firm personnel are
independent with respect to that firm’s clients, which is related to the “Relevant
Ethical Requirements” element of a system of quality control. It would not relate
to acceptance and continuance of clients (a), engagement performance (b), or
monitoring (c).
2.42 b. Correct Government auditing standards are issued by the Government Accountability
Office (GAO). Governmental accounting standards are issued by the
Governmental Accounting Standards Board.
2.43 a. Correct Consultation with a specialist demonstrates due care if auditors do not have
expertise in the area in question.
b. Incorrect Auditors are experts in financial matters, not areas of art (and other collectibles)
valuation.
c. Incorrect GAAS applies to all audit engagements, including audit engagements for not-
for-profit organizations.
d. Incorrect Since (a) is correct, (d) cannot be correct.
2.44 NOTE TO INSTRUCTOR: Since this question asks students to identify the topic that is not been addressed
in the auditors’ report, the response labeled “correct” is not addressed in the auditors’ report and those
labeled “incorrect” are addressed in the auditors’ report.
a. Incorrect The responsibilities of the auditor and management are provided in the
introductory paragraph.
b. Correct Auditors provide reasonable (but not absolute) assurance in an audit engagement
(this is noted in the scope paragraph of the auditors’ report).
c. Incorrect A description of the audit engagement is provided in the scope paragraph of the
auditors’ report.
d. Incorrect The auditors’ opinion on internal control over financial reporting is provided in
the internal control paragraph of the auditors’ report.
2.45 a. Correct Attestation standards differ from generally accepted auditing standards in that
they apply to engagements other than those on historical audited financial
statements.
b. Incorrect Attestation standards require that the practitioner be independent.
c. Incorrect Attestation standards may apply to prospective “what if” financial statements.
d. Incorrect Attestation standards include requirements related to evidence.
Chapter 02 – Professional Standards
2-9
SOLUTIONS FOR EXERCISES AND PROBLEMS
2.46 Audit Engagement Independence
a. Auditors should not follow clients’ suggestions about the conduct of an audit unless the
suggestions clearly do not conflict with their professional competence, judgment, honesty,
independence, or ethical standards. Where there is no disagreement about the results to be
accomplished and the client’s suggestions represent good ideas, auditors can consider these
suggestions. Within professional bounds, mutual agreement with the client is acceptable. Auditors
must never agree to any arrangement that violates generally accepted auditing standards or the
AICPA’s Code of Professional Conduct.
b. The reasons that would not support dividing the assignment of audit work solely according to
assets, liabilities and income and expenses include the following:
1. Work should be assigned to staff members by considering the degree of difficulty in
relation to the technical competence and experience of individual staff members.
2. Sequence of work performed on an examination should be in accordance with an overall
audit plan.
3. It is impossible to segregate work areas by major captions because often a close
relationship exists among a number of accounts in more than one category. For example,
interest and dividend income are normally based on an asset (investments) and interest
expense is normally based on a liability (long-term debt).
4. Often a single form of audit documentation is desirable to provide evidence with respect to
balances in accounts of various types, such as an insurance analysis supporting premium
disbursements, the insurance expense portion, and the prepaid insurance balance.
5. Duplication of staff effort would be more likely to occur if assignments were made on such
a basis.
6. Frequently, the scope of work regarding a single account requires simultaneous
participation by the staff, such as in the observation of inventories.
Many audit operations are not susceptible to division by category, as for example studying and
evaluating internal control, testing transactions, and preparing the report.
c. The audit staff member whose uncle owns the advertising agency should not be assigned to
examine the client’s advertising account. The firm is responsible for avoiding relationships which
might suggest a conflict of interest. Regardless of whether this staff member could be independent
and unbiased in such a situation (independence in fact), external parties will likely be influenced in
their thinking by the fact that the uncle is the owner of the advertising agency (the staff member
would not have independence in appearance). Even if a problem of ethics were not involved, it
would be unwise for the firm to assign this staff member because the client’s attitude could change
significantly and the firm’s position would be jeopardized if difficulties later arose in connection
with the contract. Any situation in which bias exists or might arise should be avoided.
Chapter 02 – Professional Standards
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2.47 Performance Principle
The important elements of the performance principle and their relation to the C. Reis Company audit are:
1. Auditors must plan the work and appropriately supervise any assistants. Fulfilling this element
would include the preparation of an audit plan for accounts receivable and reviewing it with the
assistant prior to beginning the examination. These tasks were not done. Also, the completed audit
documentation should have been reviewed to determine whether an adequate examination was
performed. The illustration states that this procedure was followed.
2. Auditors must determine and apply appropriate materiality levels throughout the audit. This
scenario did not address the process through which materiality levels were determined, so
potential strengths and weaknesses related to materiality cannot be assessed.
3. Auditors must identify and assess risks of material misstatement. This element requires auditors to
obtain a sufficient understanding of the entity and its environment, including its internal control, to
assess the risk of material misstatement of the financial statements whether due to error or fraud,
and to design the nature, timing, and extent of further audit procedures. The case presented did not
reference any work on the internal control. Complete reliance upon prior-year audit documentation
in lieu of an evaluation of the existing internal control is improper, because changes may have
been implemented to the system and controls by the client.
4. Auditors must obtain sufficient appropriate audit evidence. The assistant’s preparation of audit
documentation, confirmation requests, and other procedures seem to fulfill the requirements of this
standard if the audit work is properly performed and is of sufficient scope.
2.48 Time of Appointment and Planning
From a theoretical viewpoint (and, in fact, from a practical viewpoint as well) such short notice of a request
for an audit causes difficulties with planning the audit work, establishing staffing requirements, and
reviewing the work; all of these features are important elements in the exercise of due care. The December
26 – January 20 period is a serious time constraint for an initial audit engagement. The greatest difficulties
involve due care as well as the ability to appropriately perform the engagement (planning and supervision,
determining materiality levels, identifying and assessing risks of material misstatement, and obtaining
sufficient appropriate evidence). In view of the short notice and the time constraint, there may be some
question as to whether an audit could be adequately completed by January 20.
Chapter 02 – Professional Standards
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2.49 GAAS in a Computerized Environment
With respect to the responsibilities principle, auditors are required to (1) have appropriate competence and
capabilities to perform the audit, (2) comply with relevant ethical requirements, and (3) maintain
professional skepticism and exercise professional judgment.
1. In an audit of a computerized accounting system, competence and capabilities must be directly
related to information technology and controls in a computerized environment. In particular,
auditors should be knowledgeable of the functions performed by computer systems, methods of
testing the operations of a computerized accounting system, and methods of documentation unique
to a computerized accounting system.
2. In complying with ethical requirements, auditors must maintain independence, just as in any type
of engagement. In order to demonstrate due care, auditors must possess similar levels of skill and
knowledge of others in the profession; in this environment, some of the knowledge in (1) above
would be important to permit the engagement to be conducted using due care.
3. Professional skepticism and professional judgment must be demonstrated. It would not be unusual
for auditors to be less knowledgeable about many elements of the client’s computerized
accounting system and the evidence produced by that system compared to the level of knowledge
in a manual system. This would generally lead to heightened levels of professional skepticism.
With respect to the performance principle, auditors are require to (1) plan the work and properly supervise
any assistants, (2) determine and apply appropriate materiality levels, (3) identify and assess risks of
material misstatements, and (4) obtain sufficient appropriate evidence.
1. As it relates to planning and supervision, some knowledge of computerized accounting systems
auditing is necessary for planning access to computerized records and programs and conducting
appropriate audit procedures. The planning should provide for an early examination of the
computerized accounting system so that further procedures involving non-computer controls and
accounting features may be planned should they depend upon computer control activities.
2. The effect of computerized processing has very limited effects on the auditors’ ability and process
of determining materiality levels. This aspect of the audit is least affected by the extent of
computerized processing used by the client.
3. When assessing the risk of material misstatement, the use of a computerized accounting system
will impact both the risks of material misstatements as well as the type of controls implemented by
the client. Computer controls need to be evaluated and tested to determine that they are operating
effectively.
4. As the auditors obtain sufficient appropriate audit evidence, the type of evidence in a
computerized accounting system will differ from that in a non-computerized system. Documentary
evidence relating to a computerized accounting system includes program flowcharts, logic
diagrams, and decision tables that are not normally used in non-computerized systems. Since these
types of documentation are types of evidence, they must be understood by auditors.
Chapter 02 – Professional Standards
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2.50 Independence
a. Independence in fact relates to the auditors’ “state of mind” and reflects an unbiased and
impartial perspective with respect to the financial statements and other information they audit.
Independence in appearance relates to others’ (particularly financial statement users’)
perceptions of the auditors’ independence.
b. The two general types of relationships that compromise auditors’ independence are financial
relationships (owning shares of stock or having an outstanding loan to or from a client) and
managerial relationships (acting in a decision-making capacity on behalf of a client or providing
advice on systems or information that will be audited).
c. 1. While auditors might still be independent in fact with respect to the audit of the client, the
large revenues resulting from these services create a financial interest that many users
would find to be troubling. For example, consider the possibility that clients might use
the revenues from these services as a bargaining tool with auditors if an issue arises
during the audit engagement. Currently, no prohibitions exist on the extent of consulting
services or revenues, other than the prohibition of certain types of services and the
required approval of non-audit services by the client’s audit committee.
2. This would clearly pose a compromise to auditors’ independence and would not be
permitted under current guidelines. The issues in this case are (1) the fact that the auditor
is directly involved with the engagement and (2) the executive-level position occupied by
his or her spouse with a client.
3. This introduces a similar issue to (2), but would be less likely to compromise the
auditors’ independence. The major differences in this scenario are (1) the auditor is not
directly involved with the engagement, (2) the level of position held by the auditor’s
relative is not at the executive level, and (3) the relationship between the auditor and
other individual is not as close. Professional standards would likely not conclude that this
situation would compromise the auditor’s independence.
4. This represents a direct financial interest in a client. The issue is whether the fact that the
staff member is not a part of the engagement team compromises his or her independence.
While professional guidelines would not conclude that this situation compromises the
independence of the staff member, many firms have adopted the practice of not
permitting any of their professional staff to hold financial interests in their audit clients.
