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The COVID-19 crisis and related economic uncertainty present a unique  set of challenges for companies and their auditors. While U.S.  regulatory authorities, such as Securities and Exchange Commission  (“SEC”) and Public Company Accounting Oversight Board (“PCAOB”), have  been diligent in providing resources and guidance on reporting, auditors  still have an obligation to comply with auditing standards and rules,  and other applicable regulatory and professional requirements in all  circumstances. This assignment provides an opportunity for you to apply  your knowledge obtained in Lesson 2 in the current situation and think  about how the global pandemic has changed the auditing environment  (Note: For this assignment, we will focus on overall auditing  environment, rather than specific audit procedures, as details of audit  procedures are covered in later chapters).

ACCT 461/561 – Prof. Kim READ THE INSTRUCTION CAREFULLY!!!

Auditing Implications of COVID-19

The COVID-19 crisis and related economic uncertainty present a unique set of challenges for companies

and their auditors. While U.S. regulatory authorities, such as Securities and Exchange Commission

(“SEC”) and Public Company Accounting Oversight Board (“PCAOB”), have been diligent in providing

resources and guidance on reporting, auditors still have an obligation to comply with auditing standards

and rules, and other applicable regulatory and professional requirements in all circumstances. This

assignment provides an opportunity for you to apply your knowledge obtained in Lesson 2 in the current

situation and think about how the global pandemic has changed the auditing environment (Note: For this

assignment, we will focus on overall auditing environment, rather than specific audit procedures, as

details of audit procedures are covered in later chapters).

Requirements:

1. Part I*

a. The coronavirus pandemic has posed operational challenges for all companies, causing

the vast majority of the workforce to work remotely. Discuss how the new working

environment (for both clients and auditors) might affect the auditors’ 1) responsibility

and 2) performance principles discussed in Chapter 2. You should address the effects of

the change on one or more specific elements of each principle.

b. Many companies have experienced economic fallouts from the coronavirus pandemic.

Some struggling companies have gone through downsizing, layoff, or even bankruptcy.

Discuss how the environment of continued economic uncertainty and turbulence might

affect the auditors’ 1) responsibility and 2) performance principles discussed in Chapter

2. You should address the effects of the economy on one or more specific elements of

each principle.

* While you can use any resource, as long as it is authoritative information, to address these

questions, I recommend starting from Center for Audit Quality’s Audit Profession Resources on

COVID-19 (https://www.thecaq.org/profession-resources/).

2. Part II

a. We will observe an example of an audit report that discusses the impact of COVID-19 on

financial reporting and auditing. Obtain the annual report (10-K) of News Corporation

for the fiscal year ended June 30, 2020, and find the independent auditor report written by

Ernst & Young (EY). In Critical Audit Matters (CAM) section of the auditor report, EY

discussed two auditing-related matters that arose during the 2020 audit and how they

addressed the matters.

i. Briefly explain how economic uncertainties due to COVID-19 affected financial

reporting of News Corporation and EY’s audit.

ii. Both matters require estimation of the future performance of the business. What

are 1) general challenges and 2) COVID-specific challenges that can arise when

auditing these accounts that involve subjective judgments? You can refer to your

earlier discussion in Part I to make an argument for this question but your

discussion should specifically address News Corporation’s CAM.

Auditing Profession Resources

ACCT 461/561 – Prof. Kim READ THE INSTRUCTION CAREFULLY!!!

Note: The list above does not present a complete list of issues related to the topic. You may additionally

discuss other issues relevant to impacts of the pandemic on auditing in your paper.

Due Date

Monday, March 1. You should submit an electronic version to SafeAssign by the due date.

Format

• Length for the essay: minimum 1500 words (no more than 1800) (on double-spaced pages)
PLUS a list of references (make sure you follow an appropriate introduction, conclusion and

reference format).

• Follow APA formatting guidelines: The guidelines are described at
https://owl.english.purdue.edu/owl/resource/560/01/

• Margins: 1” (Left justification ONLY).

• Font: Times New Roman, 12 point.

• Headings and Subheadings: Use them as appropriate.

• Do not forget Page Numbers.

References

You must provide proper citations for all references used to avoid plagiarism. Any direct quotes must be

indicated as such. You must include at least THREE unique references (IN ADDITION TO the

textbook, and 10-Ks of News Corp). Wikipedia.com, random blogs, and class lecture notes do NOT

count as references! Include references in your paper using the author/year (e.g. Smith 2015)

parenthetical citation method with the full citation listed in the reference section (i.e., do not use

footnotes to list your references). A wealth of excellent resources exists at your disposal. I encourage

you to use popular and business press articles (New York Times, Wall Street Journal, Financial Times,

Business Week, The Economist, etc.), practitioner journals (Journal of Accountancy, CPA Journal,

Accounting Today, etc.), and academic journals (The Accounting Review, Accounting Horizons,

Auditing, etc.) to inform your research. You have access to these and many more through George Mason

University’s Library website.

Grading

You will be graded on content, grammar, and compliance with instructions. Your paper should be

professional in tone and free from grammatical errors.

Writing*: 20 points

Content: 15 points

Submission Total: 35 points

*Note: If your grade for writing is below 60%, you will be asked to rewrite.

Other Instructions/Suggestions

• Write a clear, concise Introduction: Your introduction should summarize your arguments and
conclusion.

• Show your analytical skills. This assignment is not about how well you summarize what you
read.

https://owl.english.purdue.edu/owl/resource/560/01/

ACCT 461/561 – Prof. Kim READ THE INSTRUCTION CAREFULLY!!!

• Do not use lists, bullet points, contractions or the second person (e.g., “you”) in your writing
(Note: The first person (“I”) is allowed).

• Be clear and direct! Professional writing must be as unambiguous as possible.

• A paragraph needs at least three sentences.

• You may only use up to two (2) SHORT direct quotes, which should be properly anchored in
your paper (i.e., quotes should not disrupt the flow of your essay).

• Use passive voice sparingly.

Remember, you must submit a paper that is unique to this class. If you have written about this topic in a

prior class, you must either write a completely new paper or ask me for a new topic.

Students who want additional help with their writing should visit one of the writing center locations on

campus. Visit http://writingcenter.gmu.edu for more information.

http://writingcenter.gmu.edu/

Auditing & Assurance Services 8e
Chapter 2

Copyright 2020 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. .

©McGraw-Hill Education

1

Chapter 02
Professional Standards

“In today’s regulatory environment, it’s virtually impossible to violate rules.”

– Bernard Madoff, money manager, approximately one year prior to being arrested for embezzling $50 billion from investors in a Ponzi scheme.
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©McGraw-Hill Education

2

History of Professional Standards-Setting
AICPA Auditing Standards Board: Non-issuers (Nonpublic entities)
Statements on Auditing Procedure (1939 – 1972)
Statements on Auditing Standards (1972 – current)
PCAOB: Issuers (Public entities)
Auditing Standards

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©McGraw-Hill Education.

Overview
GAAS and Principles
Responsibilities
Performance
Reporting
Quality of Public Accounting Firms’ Practices

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©McGraw-Hill Education.

Generally Accepted Auditing Standards
Identify necessary qualifications and characteristics of auditors and guide the conduct of the audit
Purpose of GAAS is to achieve the following objectives of an audit examination
Obtain reasonable assurance about whether financial statements are free of material misstatement
Report on the financial statements and communicate in accordance with auditor’s findings

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Watch more detailed explanation on these standards (Video 2-A)

©McGraw-Hill Education.

5
In this chapter, we look at Generally Accepted Auditing Standards, or GAAS in short. It sounds similar to GAAP, only that the second A in GAAP is accounting whereas in GAAS, it is auditing. When management prepares financial statements, their reporting should conform to GAAP. When auditors conduct an audit of those financial statements, auditors should conform to GAAS.
As you saw on page 3, there are two organizations that write these auditing standards. For decades, AICPA Auditing Standard Board had been the only one who write these standards, but in 2002, a new agency called PCAOB was founded to oversee the audits of public companies, and they started to write auditing standards for public company audits. That means an auditor has to conform to AICPA standards when they audit a private company and follow PCAOB standards when they audit a public company.

Components of GAAS

Fundamental Principles
(Guide general conduct of audits)
PCAOB Auditing Standards and ASB Statements on Auditing Standards
(Requirements supporting principles)
Interpretive Publications
(Guide application of GAAS)

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©McGraw-Hill Education.

I will let you read about the overview of GAAS on your own, but I wanted to explain these fundamental principles of GAAS further in this video. These are concepts that are very important, and will come up frequently throughout the course.

6

Engagement Overview and Principles

OBTAIN
(OR RETAIN)
CLIENT

RISK
ASSESSMENT

AUDIT
EVIDENCE
REPORTING
ENGAGEMENT
PLANNING

Responsibilities: Professional skepticism, Professional judgment, Due care
Performance
Reporting
Responsibilities: Competence and capabilities, Independence
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©McGraw-Hill Education.

7

Overview
GAAS and Principles
Responsibilities
Performance
Reporting
Quality of Public Accounting Firms’ Practices

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©McGraw-Hill Education.

Fundamental Principles of GAAS consists of three components: Responsibilities, Performance, and Reporting. Let’s start with responsibilities.

8

Responsibilities Principle
Competence and capabilities
Experience and expertise
Independence
Independence in fact vs. independence in appearance
Financial and managerial relationships
Due care
Level of performance by reasonable auditor in similar circumstances
Professional skepticism and judgment
Skepticism: Appropriate questioning and critical assessment of evidence
Judgment: Application of training, knowledge, and experience in making informed decisions during audit

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©McGraw-Hill Education.

9
These are the responsibilities of individuals who performs financial statement audits.
First, the individuals should be equipped with competence and capabilities that are necessary for auditors. That is why auditors can be licensed only when they have passed CPA exams and have a certain amount of relevant experiences.
Second, auditors should be independent. Remember the purpose of auditing we discussed in chapter 1? Information users have auditors examine financial statements because they need an independent body to assure that these financial statements are not materially misstated. If auditors are not independent from the client company or the management of the company, the assurance auditors provide does not mean anything. When we say independence, we are not only talking about auditors’ actual mindset toward clients, but also whether auditors do not have any ties to the client and ‘look’ independent. We will talk about this more next week in Lesson 3, Module B, Professional Ethics.
And auditors have to adhere to the required audit process and deliver a certain level of performance expected from a reasonable auditor, and exercise professional skepticism and judgements. We talked about the concept of professional skepticism last week in chapter 1.

Overview
GAAS and Principles
Responsibilities
Performance
Reporting
Quality of Public Accounting Firms’ Practices

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©McGraw-Hill Education.

Next principle to see, performance.
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Performance Principle
Goal is to provide reasonable assurance that financial statements do not contain material misstatements
Planning and supervision
Preparation of audit plan
Materiality
Influences decisions of financial statement users
Considered throughout the audit
Risk assessment
Understand entity and environment (including internal control)
Determine necessary effectiveness of substantive tests
Audit evidence
Sufficient = quantity (How many transactions or components?)
Appropriate = quality (What level of reliability needed? Source?)

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©McGraw-Hill Education.

11
The goal of any audit is to provide reasonable assurance. What does that mean? You can compare this with ‘absolute assurance’. If auditors were to provide absolute assurance, auditors should chase every misstatement to a dollar. But unfortunately, auditors do not have that kind of time or resources. And clients would not want to pay for that much of auditors’ time either. And no company would be able to meet the filing deadline.
So auditors provide reasonable assurance by making a plan to conduct an audit, focusing on areas that are especially risky, meaning that there is a higher probability of misstatements in those areas, and auditors focus on discovering ‘material’ misstatements. This is where I want you to refer to the vignette we watched last week, ‘Auditing is a People Business’. There, auditors and the client both talked about how they wanted to resolve this marketing expense issue before the earnings announcement call, although the amount is ‘not material’. Remember?
Whether something is material in financial reporting is decided by whether that issue makes any difference in decision making of an information user. I will use Microsoft’s 10-K, that we looked at last week, as an example.

[MS’s income statement]
This is this year’s income statement of Microsoft. It looks like they reported the total revenue of 143 billion dollars. So what if it turns out that they actually overstated the revenue by 1 million and the true amount of revenue should have been 1 million dollars less than what we see in this report? It would make absolutely no difference for investors. Right? What is 1 million when the total number is 143 billions? In this case, we can say 1 million dollars of misstatement is NOT MATERIAL, and auditors would not insist that the management should adjust the revenue balance.

[MS audit report]
This is the auditor’s report of Microsoft we saw last week. So when auditors say they believe the financial statements of Microsoft is not materially misstated, they are saying there could be some immaterial misstatements that have not been corrected. Auditors are only responsible to detect material misstatements.
Also, while we are at it, let’s look at the second section once more. Here we can see that auditors conform to PCAOB auditing standards. If this was an audit report for a private company, this sentence would have said that ‘We conducted our audit in accordance with GAAS’ and wouldn’t have mentioned PCAOB.

[Go back to page 11]
Lastly, when conducting audit procedures, auditors should obtain sufficient and appropriate audit evidence. Remember in chapter 1, when I was explaining professional skepticism, I said that auditors must always obtain evidence and not take the client’s words for anything?

Overview of Evidence

Detection Risk
Sufficiency (Quantity of Evidence)
Relevance (What Does Evidence Tell the Auditor?)
Reliability (Can the Auditor Trust the Evidence?)
Appropriateness (Quality of Evidence)
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©McGraw-Hill Education.

But actually how sufficient and appropriate each evidence should be can vary depending on clients, accounts, or assertions. We will talk about this detection risk and others in Lesson 6, chapter 4, when we look at audit risk, so I won’t be explaining this in too much detail here. Just keep in mind that auditors should consider both quantitative and qualitative aspect of audit evidence.

12

Sufficient evidence
Related to quantity (number of transactions or components examined)
Influenced by effectiveness of entity’s internal control

Effective internal control Lower level of control risk Evaluate less evidence

Ineffective internal control Higher level of control risk Evaluate more evidence

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©McGraw-Hill Education.

Quantitative aspect is about how many observations auditors should obtain. Let’s say auditors want to examine whether revenue transactions were properly recorded. Auditors should decide how many transactions they want to look at, because it is usually impossible to look at all transactions occurred that year. And when the auditors already know that the client has good internal control system in place, auditors can decide to examine fewer observations because they know that this client is not that risky and the probability of misstatements is relatively low.

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Appropriate Evidence
Relates to the quality of evidence
Relevance: Does evidence address assertion(s) of interest?
Reliability: Source of evidence
Auditors’ direct personal knowledge
External documentary evidence
Internal documentary evidence

High

Low
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©McGraw-Hill Education.

Appropriateness of evidence is about relevance and reliability. How does this piece of evidence directly support the transaction auditors want to examine? That is relevance. How do auditors know the evidence is not fake? That is reliability.
Usually, evidence auditors obtained directly from external parties, like the client’s bank, is more reliable than a sales invoice created ‘by’ the client.
Also, if auditors calculated the investment losses by directly obtaining market value of investment securities from Wall street journal, that would be the most reliable compared to any other evidence that supports that loss amount.

14

Summary: Appropriateness of Evidence

Effective internal control Lower level of control risk Use less effective substantive procedures

Ineffective internal control Higher level of control risk Use more effective substantive procedures

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©McGraw-Hill Education.

Similarly to quantitative aspect of evidence, how relevant and reliable the audit evidence should be can vary depending on how good the client’s internal control system is and therefore, how risky the client is. We will revisit this relationship between controls and the type of evidence in lesson 6, chapter 4.

15

Overview
GAAS and Principles
Responsibilities
Performance
Reporting
Quality of Public Accounting Firms’ Practices

2-16

©McGraw-Hill Education.

Reporting Principle
Express an opinion (or indicate that an opinion cannot be expressed) on entity’s financial statements
Assess financial statements against financial reporting framework
Set of criteria used to determine the measurement, recognition, presentation, and disclosure of material items in the financial statements
Examples include GAAP, IFRS, or special purpose framework

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17

Independent Auditors’ Report NEW! (AS3101 – Click HERE)

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Title (Report of Independent Registered Public Accounting Firm)
Addressee: Board of Directors and Shareholders
Opinion on the Financial Statements
Conducted audits of financial statements and internal control over financial reporting
Opinions on financial statements and internal control over financial reporting
Basis for Opinion
Responsibility of management and auditors for financial statements
Description of audit conducted under PCAOB standards
Critical audit matters
Material accounts and disclosures
Challenging, subjective, or complex judgments
Other
Signed by firm
Identify office of firm and date audit completed
Identify auditor tenure
Watch more detailed explanation on auditors’ reports and audit opinions (Video 2-B)

©McGraw-Hill Education.

18
In this video, we will talk about what the standard auditor’s report looks like and deviations auditor’s reports can take from this standard form, and when that deviation takes place.
What you see on this page is how an audit report is structured for an issuer, a public company. The private company’s audit report looks a little different, because it follows AICPA auditing standards.
This structure is relatively new. PCAOB issued an auditing standard, AS 3101 that includes a number of changes and new requirements for audit reports. This week, you have an assignment related to that. Read more detailed instruction on the Blackboard lesson page, but basically you’ll need to compare an audit report issued for the fiscal year ended before December 2017 to another audit report that is issued for the fiscal year ended after June 2019, and discuss the differences. The length of the write-up does not affect your grade as long as you discuss all the significant changes.
This section ‘critical audit matters’ in particular is a requirement only for ‘large accelerated filer’ companies at this point, and the rest of the public companies ‘will’ include this paragraph from fiscal years ending on or after Dec. 15, 2020. So make sure you use one of the largest companies as an example so that the critical audit matters paragraph is included in the 2019 audit report that you are using for this assignment.

Types of Audit Opinions (click each opinion for an example)

Unmodified (unqualified)
F/S are in conformity with GAAP
Qualified
(due to non-conformity with GAAP or Scope Limitation)

Except for limited items, F/S are in conformity with GAAP

Adverse

F/S are not in conformity with GAAP

Disclaimer

Auditors do not express an opinion

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Now we will look at different types of audit opinions. The most common type of audit opinion is unmodified or unqualified standard opinion. It means the opinion paragraph is not modified from the standard form. I found that a lot of students hear ‘unqualified’ opinion and automatically think that it is a negative opinion, but here, unqualified is a merely synonym for unmodified. So unqualified opinion is a good thing. It means auditors did not find any material misstatement. The opinion in the Microsoft audit report I showed you in the previous video is an example of an unmodified/unqualified opinion.
But if there was a material misstatement, or there was a section of the financial statements that auditors could not examine, maybe because the records had been damaged or for some other reasons, auditors issue a qualified opinion. If you click on these two links for qualified opinions, you can see examples.

[Go to qualified opinion for departure from GAAP example]
You can recognize that it is a qualified opinion by finding this ‘except for’ clause in the opinion. Basically, auditors are saying most of the financial statements looked fine, except for one particular area. Here, auditors claim that the uncollectible receivables should have been included as 2019 loss rather than 2020 loss and that is a material misstatement.

[Go to qualified opinion for scope limitation example]
And as I said, auditors can issue a qualified opinion for a different reason. Here auditors had to issue a qualified opinion because auditors could not participate in a physical inventory count for some reason. Inventory count is one of the most important audit procedure on inventory, and without that procedure, auditors might not be able to provide assurance on inventory balance, which was the case here. So auditors are saying that, on other areas of financial statements, they are providing am unqualified opinion, but for this particular account of inventory, auditors are refusing to issue either a positive or negative opinion.

[Back to page 19]
Also, it is not that departure from GAAP always results in a qualified opinion. When the misstatement can be isolated to a certain area and the issue is not that pervasive, auditors issue a qualified opinion. But, if the problem affects a large area of financial statements, auditors cannot say, anymore, everything is fine except for this one thing. In that case, the opinion to issue is an ‘adverse opinion’. If the auditors decide to issue an adverse opinion…

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