Page 66 - Encyclopedia of Business and Finance

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Auditing

intellectual honesty and candor; and objectivity, a state of directors is responsible for selecting and hiring the exter-
mind of judicial impartiality that recognizes an obligation nal auditors. In this role, the audit committee also acts as
of fairness to management and owners of a client, credi- a liaison with the auditors who are performing the finan-
tors, prospective owners or creditors, and other stakehold- cial statement audit.
ers. To be independent in appearance, the auditor must
not have any obligations or interests (in the client, its THE SECURITIES AND EXCHANGE
management, or its owners) that could cause others to
COMMISSION
believe the auditor is biased with respect to the client, its
The Securities and Exchange Commission (SEC) was
management, or its owners.
established by Congress in 1934 to enforce the Securities
Internal auditors are employees of individual organi-
Exchange Act of 1934. The act requires publicly held
zations. To increase internal auditors’ objectivity, typically,
companies to file annual audited financial statements (on
internal auditors report to the audit committee of the
Form 10-K) with the SEC. While not required by the act,
board of directors, rather than to the management. Inter-
nonpublic companies may also have their financial state-
nal auditors are primarily involved in completing opera- ments audited for several reasons. For example, the com-
tional and compliance audits, although some perform pany may be planning to go public in the near future for
financial audits of segments of their companies. The Insti- which it will need audited financial statements for several
tute of Internal Auditors (IIA) is an international profes- previous years. Banks or other creditors may also require
sional organization representing the internal auditing audited financial statements annually. Finally, a business
profession. The IIA publishes materials, encourages local may voluntarily hire an auditor to provide the owners
chapter activities, offers certification as a certified internal
with some assurance that its financial statements are reli-
auditor, and provides general support for practicing inter-
able.
nal auditors.
Government auditors are employed by a particular
SARBANES-OXLEY ACT OF 2002
agency of local, state, or federal government. Government
A significant number of high-profile business scandals
auditors are primarily involved in performing compliance
audits. Internal Revenue Service (IRS) auditors and Gov- (e.g., Enron, Tyco, and WorldCom in the United States,
ernment Accountability Office (GAO) auditors are the and Parmalat and Royal Ahold in Europe) that resulted in
most visible government auditors. IRS auditors examine the restatement of previously issued financial statements
tax returns to ensure that organizations and individuals early in the twenty-first century eroded investor confi-
report their information in compliance with the Internal dence worldwide. Consequently the U.S. Congress
Revenue Code. The GAO is an arm of the U.S. Congress responded by passing the Sarbanes-Oxley Act (SOX) of
that responds to Congressional requests for oversight, 2002 in an attempt to restore investor confidence.
review, and evaluation of federal agencies and recipients of An important aspect of SOX is that it increases the
federal funds. Thus, GAO auditors often determine regulation of the external auditors at publicly traded com-
whether the agency being audited has spent the money in panies. In addition, SOX has designated the SEC as the
a manner that is consistent with Congressional mandates. body to enforce the provisions of the act. The SEC has
delegated the oversight of external auditors to the newly
created Public Company Accounting Oversight Board
MANAGEMENT AND AUDITOR (PCAOB). According to Section 103 of SOX, the
RESPONSIBILITY
PCAOB shall:
When preparing the financial statements, management
must follow GAAP, which are the principles and practices (1) register public accounting firms; (2) establish,
that govern financial reporting. Formal statements on or adopt, by rule, “auditing, quality control,
financial accounting standards are issued by the Financial ethics, independence, and other standards relating
Accounting Standards Board, an independent standards- to the preparation of audit reports for issuers;”
setting organization in the United States. When financial (3) conduct inspections of accounting firms;
statements of an entity are presented to the external audi- (4) conduct investigations and disciplinary pro-
tor for a financial audit, the entity’s management asserts ceedings, and impose appropriate sanctions;
that the financial statements are prepared in accordance (5) perform such other duties or functions as nec-
essary or appropriate; (6) enforce compliance with
with GAAP. Based on their audit, the auditors are respon-
the Act, the rules of the Board, professional stan-
sible for rendering an opinion on whether the financial dards, and the securities laws relating to the prepa-
statements have been presented in accordance with GAAP ration and issuance of audit reports and the
in all material respects. To promote independence and obligations and liabilities of accountants with
objectivity, the audit committee of the company’s board of respect thereto; (7) set the budget and manage the

ENCYCLOPEDIA OF BUSINESS AND FINANCE, SECOND EDITION 43