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Explain the nature and functions of auditing.
Relate your explanation to the audit functions in your organization, or an organization with which you are familiar. :An audit is a dynamic concept that begins where accountancy ends. Auditing is concerned with making and analytical and critical examination of books of account, checking & verification of evidence in support of entries appearing in the books of account, and ascertaining the authenticity of assertions in the financial statements. It is the scrutiny of accounts of the business with the help of vouchers & documents provided to the auditor.

We have the same experience that has been narrated here. Vouchers are same, accounting is same and audit is same.

ââ?¬¢ Describe the elements of the Generally Accepted Auditing Standards (GAAS).:

1) General standards:-
a) The auditor must have adequate technical training & proficiency to perform the audit.
b) The auditor must maintain independence (in fact and appearance) in mental attitude in all matters related to the audit.
c) The auditor must exercise due professional care during the performance of the audit and the preparation of the report. The auditor must diligently perform the audit and report any misleading statements in the report

2) Standards of fieldwork:
i) The auditor must adequately plan the work and must properly supervise any assistants.
ii) The auditor must 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.
iii) The auditor must obtain sufficient appropriate audit evidence by performing audit procedures to afford a reasonable basis for an opinion regarding the financial statements under audit.

3) Standards of reporting

1) The auditor must state in the auditor's report whether the financial statements are presented in accordance with generally accepted accounting principles.
2) The auditor must identify in the auditor's report those circumstances in which such principles have not been consistently observed in the current period in relation to the preceding period.
3) When the auditor determines that informative disclosures are not reasonably adequate, the auditor must so state in the auditor's report.
4) The auditor must either express an opinion regarding the financial statements, taken as a whole, or state that an opinion cannot be expressed, in the auditor's report. When the auditor cannot express an overall opinion, the auditor should state the reasons therefore in the auditor's report. In all cases where an auditor's name is associated with financial statements, the auditor should clearly indicate the character of the auditor's work, if any, and the degree of responsibility the auditor is taking, in the auditor's report.

ââ?¬¢ Describe how these standards apply to financial, operational, and compliance audits.

Financial statement audits are performed in coordination with GAAP and other established criteria when obtaining evidence about a companyââ?¬â?¢s presentation of its financial position. Evidence evaluated includes results of operations and cash flows for the purpose of conveying an opinion for users of the financial data. To ensure independence in mental attitude, as noted under GAAS general standards, most states have enacted laws so that only certified public accountants (CPAs) can perform financial statement audits. To further enforce this GAAS element, many corporations hire an external audit firm.

An operational audit evaluates a company's efficiency and effectiveness in regard to operational activities in relation to specified objectives. The standards of field work area of auditing plays an important role in operational audits. A high degree of importance is placed on the auditor's efficiency and effectiveness reports and the auditor's recommendations for improvement by the entity.

A compliance audit determines if a company is acting in accordance with rules and regulations in financial and operational activities. This type of audit demonstrates standards of reporting element of GAAS and a requirement under SOX. "The Sarbanes-Oxley Act of 2002 requires companies to have a dual-purpose audit that audits both the financial statements and management's assertion as to whether it has complied with criteria regarding an adequate system of internal control over financial reporting".

Sarbanes-Oxley Act and the Public Company Accounting Oversight Board
SOX greatly affect how auditors are to perform their jobs. Most notably, specific procedures must be followed when obtaining evidence to opine on. In addition, SOX outlines how internal controls are audited, as the auditor's job is to offer an opinion on the effectiveness of the entityââ?¬â?¢s internal control over financial reporting.
In effort to enhance the efficiency and effectiveness of audits, auditing techniques used by many industry professionals prior to SOX, were no longer deemed acceptable

ââ?¬¢ Explain the effect that the Sarbanes-Oxley Act of 2002, and the Public Company Accounting Oversight Board (PCAOB), will have on audits of publicly traded companies. Sarbanes-Oxley Act and the Public Company Accounting Oversight Board

SOX greatly affect how auditors are to perform their jobs. Most notably, specific procedures must be followed when obtaining evidence to opine on. In addition, SOX outlines how internal controls are audited, as the auditor's job is to offer an opinion on the effectiveness of the entityââ?¬â?¢s internal control over financial reporting.
In effort to enhance the efficiency and effectiveness of audits, auditing techniques used by many industry professionals prior to SOX, were no longer deemed acceptable

ââ?¬¢ Discuss the additional requirements that are placed on auditors from this act and the actions of the PCAOB.

In addition to PCAOB Auditing Standard No. 6, auditors must comply with other requirements, such as: auditing internal controls over financial reporting that is integrated with an audit of financial statements, presenting specific documentation to provide a written record of the basis for the auditorââ?¬â?¢s conclusions, and reporting on previously documented materials. Additional requirements by SOX include restricting auditing companies from providing additional, non-auditing, services.

The need for improved regulation over publicly traded corporations forced new laws to be passed and procedures to be followed by both management and auditors of an entity. Many of the standards required by auditors today are due to newly established criteria by the GAAS, the SOX act passing into law, and PCAOB standards.

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An audit is a dynamic concept that begins where accountancy ends. Auditing is concerned with making and analytical and critical examination of books of account, checking & verification of evidence in support of entries appearing in the books of account, and ascertaining the authenticity of assertions in the financial statements. It is the scrutiny of accounts of the business with the help of vouchers & documents provided to the auditor.

Schlosser defined auditing as a ââ?¬Å"systematic examination of financial statements records and related operation to determine adherence to generally accepted accounting principals, management policies or stated requirements. The definition extends the scope of auditing to include allied operations in addition to verification of accounting statements. Scope of audit now includes cost audit, management audit, internal audit& quality audit etc. However, based on the purpose of examination, an audit can be broadly classified into:
ââ?¬¢ Independent
ââ?¬¢ Internal
ââ?¬¢ Government
Primary: To examine reliability & validity of financial statements so as to render an opinion on the truth and fairness of the presentation on those statements ââ?¬"An auditor is required to state whether in his opinion (a) Balance Sheet gives a fair view of the state of the companyââ?¬â?¢s affairs at the end of its financial year & (b) profit & loss account gives a true & fair view for its financial year.

Secondary: Detection and prevention of frauds & errors ââ?¬" An error may be defined as any unintentional mistake or incorrect description in the books of account or records whether by way of (a)mathematical or clerical mistakes in the record or data ;(b) oversight or misinterpretation of facts; or (c) misapplication of accounting policies. An error is generally taken to be innocent & not deliberate. Where it appears to be willfully made, it takes the character of a fraud.

Organizations carry out various types of audit, for virtually every function and department, to ensure compliance with regulatory and internal policies. Thus, we have a specialized audits such as quality ...

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Practical Research - New Approaches for Fraud Deterrence - Opinion on significance

Here is an article on a fraud deterrence, please read it , give us your opinion and make any comments you may have on its likely significance.


New Approaches for Fraud Deterrence
It's time to take a new look at the auditing process.
by Joseph T. Wells, CFE, CPA
"If we always do what we've always done,
we'll always get what we've always gotten."
- Anonymous
Call me a skeptic. Maybe it's because I've investigated a couple of thousand fraud cases over a career now
entering its fourth decade. Perhaps it's because questioning is one of a CPA's most valuable talents. While I
believe that as a profession we're moving in the right direction, I'm convinced we still have miles to go. The
auditing profession's current approach to fraud detection-as well-intended as it is-won't have the impact
the public expects until auditors and their firms are willing to invest in improved fraud deterrence and
detection skills and resources.
In my view, even with SAS no. 99, Consideration of Fraud in a Financial Statement Audit, we're still doing
much of what we've always done. This article should provoke thought and debate among CPAs on how we
might consider different approaches in the way audits are conducted in order to give the public what it
really wants: business enterprises with integrity.
In considering new solutions, it becomes necessary for us to critically examine our current thinking. Over
the years, I personally have trained thousands of CPAs in antifraud matters. One question that I frequently
ask is, "How do we prevent fraud?" The answer: "Internal control."
Oh, really? Under that theory, organizations with adequate controls won't experience fraud. But they do-
time and time again. Part of the reason is that no controls exist that provide absolute assurance against
fraud. Those who are sufficiently motivated to override or circumvent them usually can find a way. Don't
get me wrong: Controls are a vital part of fraud deterrence. However, they need to be considered in a
larger context.
Exhibit 1 Exhibit 2
Source: "Key Crime & Justice Facts at a Glance,"
U.S. Department of Justice, Office of Justice Programs, Bureau of Justice Statistics.
Fraud is not an accounting problem; it is a social phenomenon. If you strip economic crime of its
multitudinous variations, there are but three ways a victim can be unlawfully separated from money: by
force, stealth or trickery. While the first two are on the wane, the third is not (see exhibits 1, 2 and 3). And
the reasons have little to do with accounting controls.
Robbery, theft and other street crimes are the bailiwick of the young and undereducated. According to the
FBI, these kinds of offenses are at a 30-year low. Why? First, our society-because of baby boomers-is
aging: There are fewer young people in our population, the net result of which is that there are fewer
potential offenders. Second, because of mass media, that smaller pool of young people has learned a very
valuable lesson: The best way to rob a bank is to own one.
To understand the risk/reward equation, consider just one anecdote from the go-go '90s: Junk-bond king
Michael Milkin's earnings, largely illegal, amounted to about $1.2 billion. The government fined him $600
million and he spent 20 months in a federal prison. A thug with a gun holding up a financial institution
usually will net less than $5,000 and typically will serve at least five years behind bars. Anyone can perform
the simple arithmetic involved in that crime formula.
The Confusing Issue of Criminal Justice
But before you jump to the conclusion that increasing penalties for crime is the answer, consider another
counterintuitive fact: The United States has some of the harshest criminal penalties in the modern world-
coupled with the highest crime rates. Criminologists almost universally understand why: Punishment-based
deterrence simply doesn't work very well. Nearly 75% of incarcerated inmates are rearrested within three
years of their being released, usually for more serious offenses (see exhibit 4).
If you are thoroughly confused, you should be. That's because classic criminological theory says there are
three related factors involved in deterrence: the certainty, swiftness and severity of punishment. Of those
factors, the first is by far the most important-if punishment is certain and swift, it doesn't need to be
severe. As a matter of fact, the longer the prison sentence, the more likely it is the miscreant will offend
Regrettably, under our system of justice, there is nothing certain about being punished. Exacerbating the
problem, I believe, is the "get tough" mentality that politicians must use to get elected to office. It is one
thing to pass a law but quite another to appropriate the funds to enforce it. Under Sarbanes-Oxley, the
criminal penalties for mail fraud were quadrupled, from five to twenty years per offense.
But there has been no corresponding quadrupling of funds for prosecutors, investigators and prisons. If the
penalties go up and the money devoted to enforcement stays the same, then the certainty of punishment
actually goes down. Our prisons are bursting at the seams, so prosecutors and judges are forced to make
very unattractive choices of who is prosecuted and who isn't. When it comes to making those decisions,
they almost invariably choose to jail those who commit violent crimes-not the people who rip us off.
Exhibit 3
Association of Certified Fraud
So when a potential fraud offender thinks he or she can commit a
crime and get away with it, that assessment usually is correct. What
is society to do, then, about the current wave of fraud that seems to
have engulfed us?
First, we need to understand that our problems cannot be solved by
government intervention. Prosecution of offenders, although
necessary in a civilized society is akin-as we might say here in Texas
-to closing the barn door after the horses are gone. Second, we
must acknowledge the private sector has a responsibility to cure its
own ills. Third, we must commit the resources necessary to find
solutions that work.
Understanding Fraud Prevention
If you accept the postulate that fraud prevention and internal control
are not exactly the same-and they aren't-then the accounting
profession needs to learn more about preventing fraud.
Factors Affecting
Occupational Fraud: A
Partial List
Financial condition
of the organization.
Pressure to show
profits in the
Internal accounting
The state of the
Integrity level of
corporate leaders
and employees.
Commitment to the
organization's value
Personal traits and
characteristics of
executives and
Reward systems for
ethical behavior.
culture and
Peer pressure.
The perception of
The swiftness,
certainty and
severity of
Unfortunately, no one has studied this issue in any great detail,
especially when it comes to occupational fraud. We know some of the
answers, but not nearly enough. For example, when presented with
seemingly identical opportunities and motives, why does one person
or organization turn to fraud and another does not? No one really
knows. Besides internal control, what factors go into preventing
fraud? Again, we're short on answers.
But there is hope. This year, the AICPA and the Association of
Certified Fraud Examiners established and funded the Institute for
Fraud Studies (IFS). Other interested organizations and government
agencies are being invited to participate, too. The IFS will operate
under the auspices of the University of Texas at Austin, where I teach
on fraud subjects in the graduate school of business.
The purpose of the institute is simple: to conduct multidisciplined
research into the causes of and cures for fraud. It will reach out to
academics and researchers in a variety of fields such as behavioral
sciences, the law, accounting and criminal justice. And although the
IFS has a simple mission, achieving its goals will not be easy. One of
the first projects will be to help entities find workable solutions to the
fraudulent financial reporting dilemma.
A Different Tactic
One of the most difficult issues facing the profession is that there are
no auditing procedures that can provide absolute assurance in
detecting all fraudulent financial reporting. As a result auditors have
historically attempted to avoid, albeit unsuccessfully, the responsibility
for fraud detection. In the current environment, the public holds
expectations of auditors with respect to fraud that simply cannot be
fulfilled. The auditing profession could be better served by adopting a
more holistic approach to the deterrence of fraud. This concept,
called the Model Organizational Fraud Deterrence Program (the
model), employs a "best practices" approach to fraud prevention.
Using this model, researchers would identify the factors present in
organizations-both accounting and otherwise-that affect
occupational fraud (see "Factors Affecting Occupational Fraud: A
Partial List"). They then would develop a model deterrence program
based on those factors. Thereafter, instead of opining that the entity
is essentially free of material fraud, the auditor would disclose the
client's degree of compliance to the model.
Although this is a shift in the way audits are conducted, it has three distinct advantages. First, it would
move the emphasis away from an unwinnable strategy of detecting fraud to an achievable one-preventing
it. Second, it would encourage entities to adopt prevention strategies. Third, it could solve the liability
dilemma that plagues the auditing profession
But we don't have to wait until we have all the answers in order to do something different. Two ideas are
worth debating now: the use of antifraud specialists on public audits, and financial transparency for
Anti-Fraud Specialists on Public Audits
Accepting that fraud deterrence and accounting are related but distinctly different disciplines, the auditing
profession could utilize the unique skills of antifraud specialists on public audits. Virtually all of the major
accounting firms currently employ such specialists. However, they are now being used reactively instead of
Rather than using their talents exclusively to investigate allegations of fraud once they have been reported,
antifraud specialists also should be involved during the audit itself to help identify key risk areas, which then
can be furnished to the auditors for further consideration. Moreover, the mere presence of antifraud
specialists during audits could have a significant impact on increasing the perception that illegal activity will
be detected. This is similar to the strategy of reducing crime by putting more cops on the beat. Although
punishment after the fact doesn't work very well, criminologists have thoroughly documented that more
vigilance to stop crime before it happens is the most effective deterrent.
Considering my background, it might be expected that I would
advocate the use of antifraud experts on audits. But, alas, I can't
claim credit for the idea. A number of years ago, I videotaped an
interview with legendary fraudster Barry Minkow while he was
serving an eight-year sentence in a federal prison in Colorado.
(Minkow, a high school dropout with no accounting skills, fooled his
independent auditors in a $100 million financial statement fraud
scheme.) When I asked him how auditors could cope with his ilk,
Minkow said: ""I'll tell you what I would do: I'd send in trained
fraud examiners before the auditors arrive. And I'd tell the client,
"You know, I really want your business, but I want to make sure
you're not committing fraud, too. So I'm sending the examiners in
first. They're going to be looking at everything and asking the tough
questions.' Would that stop a lot of fraud, or what? It certainly
would have stopped me."
Financial Transparency Where It Counts
From the study of a long list of financial statement frauds,
beginning with the classic Equity Funding fraud in the 1970s and
continuing through today's multibillion dollar accounting scandals, a
distinct pattern has emerged: Corporate managements-executives,
insiders and board members-have lined their pockets at the
expense of the shareholders. Their methods vary and are often
cloaked behind complex transactions not readily apparent to the
entity's auditors.
Exhibit 4
Source: "Reentry Trends in the United States"
U.S. Department of Justice
Office of Justice Programs, Bureau of Justice Statistics
Corporate insiders have a fiduciary duty to act in the best interests of the shareholders. A part of this duty
should include their financial transparency. Auditors could be given access to any financial information that
bears on this issue. That would include, but not be limited to, personal tax returns and detailed banking
records. By having such access, two important objectives could be accomplished. First, it would make it
more difficult for insiders to conceal ill-gotten gain. Second, financial transparency could be a significant
and powerful deterrent.
The ideas contained here are not the complete solution. Even if all of them would be adopted in some form,
we still would have to recognize that there is no mechanism that could prevent all financial statement fraud.
Still, traditional accounting approaches have failed so far to solve these difficult problems. But if we do what
we've always done, we'll get what we've always gotten.
The Excesses of Executives
Prosecutors accused Dennis Kozlowski and Mark Swartz of Tyco of stealing another $140 million
from the company. Their salaries, respectively, were $106 million and $54 million.
Andrew Fastow, former CFO of Enron, funneled $30 million to himself from off-balance-sheet
partnerships that he created. Another $17 million was paid to his wife, Lea.
Federal prosecutors say that Adelphia founder John J. Rigas and two of his sons used the company
as their "personal piggy bank, purportedly looting over $300 million, which included more than $50
million in cash advances, money for luxury apartments and a $13 million golf course."
A jury determined that Mickey Monus, responsible for the $500 million Phar-Mor fraud, embezzled
at least $10 million to fund the now-defunct World Basketball League.

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