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Chapter 1

MGMT 138 Chapter Notes - Chapter 1: Public Company Accounting Oversight Board, Auditing Standards Board, Net Income

Course Code
MGMT 138
Patricia Wellmeyer

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Chapter 1:
Auditing: process of reviewing the financial information prepared by the management of the company to
determine that it conforms to a particular standard
The person doing the audit is hired to verify the fairness and completeness of the decisions recorded by the firm
so that outsiders have accurate information to make decisions
Principal-agent relationships: principal is the stockholder. Agent is management
oExists because the owners of the company (principals) are not involved in the daily management of the
oThey hire an agent (management) to run the company for them and to make decisions for the company
Financial statements for public companies are filed with the Public Company Accounting Oversight Board
(PCAOB) and the Securities and Exchange Commission (SEC)
Audit function: involves having the auditor assess whether the financial statements are presented in accordance
with the applicable financial reporting framework
Attest services: the auditor typically attests or authenticates the accuracy of some type of information
Management of public companies typically prefers higher net income to lower net income
oNet income can be increased by either reducing expenses or increasing revenue
Growth in revenue is also an important factor for many companies
The principal reason to misstate financial statements is to keep the company’s stock price from falling
Three standard setting organization are involved in establishing auditing standards:
oThe Auditing Standards Board (ASB)
Committee of 19 members
Authorized to issue auditing standards related to the performance of the audit and the issuance of
audit reports for private companies, also referred to as non-issuers stock
Issues new auditing standards as Statements on Auditing Standards (SASs)
Generally accepted auditing standards (GAAS)
oThe Public Company Accounting Oversight Board (PCAOB)
Five member board created with the passage of the Sarbanes-Oxley Act in 2002
Private sector, nonprofit organization created to oversee auditors of public companies
Overseen by SEC
Sarbanes-Oxley Act (SOX) requires accountants who audit public companies in the US to follow
PCAOB’s auditing standards
Receives its authority from US federal law
oThe International Auditing and Assurance Standards Board (IAASB)
Formed in 1978 as an independent standard setting board
18 members serve part-time for three years
Develops and issues auditing standards under its own authority
Audit evidence: information used by the auditor to determine which audit opinion to use. Includes the
information in the accounting records
Auditor is responsible for gathering sufficient (enough), appropriate (relevant and reliable) evidence to
determined that management has prepared the financial statements in accordance with the applicable financial
reporting framework
Types of gathered evidence:
oSubstantive evidence: describes whether the transactions and balances listed in the financial statements
are represented fairly according to the applicable financial reporting framework
Substantive test of transactions: conducted to gather evidence on income statement accounts
Substantive test of balance: performed to gather evidence on balance sheet accounts
oInternal control evidence: determines whether internal controls can be relied on to detect or prevent
misstatements in the financial statements
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