Role_of_the_Cpa

CPA Report November 20, 2010 MEMO To: William Bailey, Manager From: Mary McGuire, CPA Date: November 20, 2010 Subject: CPA Responsibilities/Reviews vs. Audits CPA Responsibilities As professionals, certified public accountants have many roles in society. First as a group CPAs are held to a high standard of ethical principles and professional standards in all their activities. Second CPAs have the responsibility to their profession to maintain and enhance the traditions of the profession (CPA Responsibilities, 2004). Third they must maintain the public and financial statement users’ confidence in their work performance. The AICPA regulates the activities and standards of the CPA through the Principles of Professional Conduct, which outlines the qualities a CPA must possess to protect competently the investors right of information. The six principles as presented in the Principles of Professional Conduct are (AICPA ppt, 2010): 1. responsibility as professional members to exercise professional and moral judgment in all activities 2. commitment to serve the public interest and honor public trust 3. strive continually to improve competence and quality of services with due care 4. to perform all professional responsibilities with the highest sense of integrity 5. maintain objectivity and be free of conflicts of interest in performing professional responsibilities 6. observe the Principles of the Code of Professional Conduct in the scope and nature of services provided Audits versus Reviews As CPA’s strive to maintain the Code of Professional Conduct some of the services provided by professionals include tax returns and accounting services, independent assurance services, auditing, accounting and reporting for governmental, nongovernmental, public, and private companies. CPAs engage in two main types of services these include auditing and attestation services. The audit is the accumulation and evaluation of evidence about information to determine and report on the degree of correspondence between the information and established criteria (Arens et al, 2006). The auditor or CPA gathers and reviews evidence to determine whether information meets the specific chosen criteria. Companies use CPAs to verify the economic events in an accounting period are recorded properly in the accounting period. For each audit, CPAs set criteria based on GAAP therefore auditors must be familiar with generally accepted accounting principles. The objective of the audit is to provide a reasonable basis for expressing an opinion whether the financial statements are fairly stated in accordance with GAAP (Knowledge to solutions, 2007). The verification and substantiation procedures of the audit include visual inspections and tests of accounting records, risk control assessment, and internal control procedures. The CPA must have knowledge of internal controls to verify procedures are in place. The audit report expresses the CPAs highest level of assurance that financial statements, the company’s financial position and results of operations are presented fairly. The audit and the review objective differ in that the audit requires the CPA to express an opinion regarding the financial statements as a whole, but the review opinion states the CPA did not become aware of any material modifications that should be made in order for the statements to be in conformity with GAAP (Knowledge to solutions, 2007). This level of assurance is known as “limited assurance.” A review does not require that the CPA obtain an understanding of the internal control structure, assess control risk, test accounting records or review evidence through inspection, or verification. Method for deferred taxes Companies often use generally accepted accounting standards for preparing financial reports for creditors and investors, however to file income tax returns corporations must use the guidelines established by the Internal Revenue Service. Differences in GAAP and tax reporting regulations may cause tax expenses reported on the financial statements to be different from the amount of taxes payable to the IRS. To understand the differences one must first understand the difference between pretax financial income and taxable income. Pretax financial income is the amount calculated for financial reporting purposes. Taxable income is the tax accounting term used to compute income taxes payable. The difference between these two amounts is a temporary difference. A temporary difference is the difference between the tax basis of an asset or liability and its reported amount in the financial statements, which will result in taxable amounts or deductible amounts in the future (Kieso et al, 2007). Once the company has established the temporary difference, the amount is shown on the books as a deferred tax liability or a deferred tax asset. A taxable temporary difference is a deferred tax liability that will increase taxes payable in futures years whereas a deductible temporary difference is a deferred tax asset that will be a refundable amount in taxes payable for future years. Using deferred tax methods can be useful, an obligation can be spread over a period or a refund can be applied to an obligation in a future year. Procedures for Changes and Error Correction According to the FASB three types of changes occur in accounting. These changes require a change or a restatement of financial reporting: a change in accounting principle; a change in accounting estimate; a change in reporting entity. The change in accounting principle applies to a change in generally accepted accounting principles. The company may choose to report the change using a cumulative effect. This does not change prior-year financial statements rather it presents the current years income with cumulative totals for the years affected by the change. Another way of reporting the change is retrospective application. An adjustment to the prior year statements is made as if the new principle was always in effect. The retained earnings show an adjustment to the earliest year using the cumulative effect. The third way a company may choose to show a change in accounting principle is prospectively. This approach does not affect previously reported years, but reports that a new principle was used for the current year. The FASB requires that companies use the retrospective approach to report changes in accounting principle. Changes in accounting estimate are done using prospectively reporting. The FASB views changes in estimates as the natural result or normal recurring corrections and adjustments to the accounting process (Kieso et al, 2007). Reporting a change in entity is done in the year that the company changes. The financial statements should disclose the reason for change, the periods presented, effect of the change on income before extraordinary items, net income, and earnings per share. Subsidiary Corporations A subsidiary exists when a corporation known as the parent corporation owns all or at least the majority of shares of another corporation. A subsidiary is formed when a corporation purchases the controlling interest in an existing company or creates a new corporation. A subsidiary is preferable to a merger when the option to acquire controlling interest is a smaller investment than a merger would be. A merger requires the approval of stockholders of the acquired firm where acquiring stock does not. The liability of a corporation is limited when connected to a new risky business because the parent and subsidiary are separate legal entities. A parent corporation however can be sued and in some instances be held liable if the subsidiary becomes financially insecure. A multinational corporation may choose to create a subsidiary for favorable tax treatment in a country that requires local subsidiaries for business opportunities. A disadvantage of the subsidiary corporation is multiple taxation. The responsibility of the parent corporation is to maintain a separate corporate identity. If the parent corporation fails to promote the subsidiary’s corporate interest or act in its best interest, the courts may perceive the subsidiary as only used for liability purposes. References AICPA Code of Professional Conduct, (Power point) Retrieved from: www.cob.niu.edu/faculty/m20det1/codecond.ppt, November 20, 2010 Arens, Alvin, Elder, Randal J., Beasley, Mark S., (2006), Auditing and Assurance Services: An Integrated Approach, (11ed), Upper Saddle River, NJ: Pearson Colsen, Robert, The CPA Journal, CPA Responsibilities (Editorial), Retrieved from: http://www.nysscpa.org/cpajournal/2004/104/text/p80/htm, November 20, 2010 Kieso, D.E., Weygandt, J.J., Warfield, T.D. (2007) Intermediate Accounting (12ed), Hoboken, NJ: Wiley Knowledge to Solutions (K2S) Certified Public Accountants and Advisors. (2007). What's the Difference Between an Audit, Review and Compilation. Retrieved from: http://www.k2scpa.com/knowledge-sharing/2007/07/whats-the-difference-between-an- audit-review-and-compilation Maurer, Lotar, Certified General Accountant, Retrieved from: http: //www.islandcga.com/pdf/AudtvsReviewsCompilation_Simple.pdf, November 20, 2