Chapter PROFESSIONAL PRACTICE OF ACCOUNTANCY: AN OVERVIEW Expected Learning Outcomes After studying the chapter, you should be able to 1 2. 3. Explain the attributes of a profession Describe who a professional accountant is. Enumerate and explain the scope of the practice of professional accountants in the Philippines. Describe the nature of assurance, attest, and auditing services of accounting professionals. Describe the relationship among assurance, attest and auditing services. Distinguish between external auditors, internal auditors, government auditors and forensic auditors, Explain the nature of other audit services such as internal audit, compliance audits, operational audits and forensic audits Describe the most sought-after non-assurance services such as Agreed upon procedures Tax preparation and planning services Management advisory services Compilation, accounting and processing system services QU YS eee.CHAPTER 2 PROFESSIONAL PRACTICE OF ACCOUNTANCY: AN OVERVIEW ACCOUNTANCY AS A PROFESSION In our society, professions are generally recognized as elite occupational classifications. Ernest Greenwood in his article Attributes of a Profession (1957) sets forth five major characteristics of an ideal profession. These are (1) systemati¢ body of theory, (2) professional authority, (3) community sanction, (4) regulative code and (5) a culture. Professional accountants satisfy these said attributes of a profession. © Systematic Theory The underlying theory of the public accounting profession consists of accounting theory — financial accounting and reporting standards and practices and auditing standards - a science of validation. Knowledge in systematic theory can be achieved best through formal college-level education in an academic environment. « Professional Authority Clients who use the service of a professional often do not really understand their own needs. The professional thus determines what is good or bad for the client and the client accedes to this professional judgment. The basis for the professional accountants (CPA's) authority is his expertise in the systematic theory of accounting and auditing. © Community Sanction Admission to the public accounting profession is controlled. To become @ professional accountant (CPA), a candidate must satisfy government educational and ‘experience requirements and pass the CPA Licensure Board Examinations. This licensing system is controlled by the Professional Regulation Commission through the Board of Accountancy. Also, although professional accountants (CPAs) are responsible to the community for theit actions, it is generally accepted that a professional's performance should be judged by standards established by a profession itself.Professional Practice of Accountancy: An Overview 13 * Regulations Code The powers and privileges granted to the public accounting profession by the community effectively constitute a monopoly. To prevent abuse of this monopoly and to discipline its members, the Rules of Professional Conduct or Code of Ethics have been promulgated and made legally binding through the Accountancy Law. * A Culture The CPA is a member of a time-honored profession and the status of the profession and the responsibilities that accompany this status affect his/her behavior in society. Accounting has developed a professional.culture as evidenced by such factors as the formal norms of the code of ethies, the informal rules that guide relationships among practitioners and the traditions and myths that have arisen conceming the CPA examinations. The most recent revi ion in the Code of Ethics for Professional Accountants in the Philippines made effective on April 6, 2016 states “A profession is distinguished by certain characteristics including: * Mastery of a particular intellectual skill, acquired by training and education; © Adherence by its members to a common code of values and conduct established by its administering body, including maintaining an outlook which is essentially objective; and © Acceptance of a duty to society as a whole (usually in return for restrictions in use of a title or in the granting of a qualification)." WHO IS A PROFESSIONAL ACCOUNTANT? A professional accountant is an individual who holds a valid certificate issued by the Board of Accountancy (i.e., Certified Public Accountant), whether he/she be in public practice, industry, commerce, the public sector or education. This professional accountant may belong to any of the following sectors: Professional Accountant in Public Practice. A professional accountant, irrespective of functional accountant in classification (for example, audit, tax or consulting) in a firm that provides professional services. This term is also used to refer to a firm of professional accountants in public practice.14 Chapter 2 Professional Accountant in Business. A professional accountant employed or engaged in an executive or non-executive capacity In such areas as commerce, industry, service, the public sector, education, the not-for-profit sector, regulatory bodies o professional bodies, or a professional accountant contracted by such entities. The professional accountant in this group may be in any of the following sub-sectors: (a) commerce and industry; (b) education; and (c) government. Scope of Practice The Philippine Accountancy Act of 2004 (RA. 9298) Article 1, Section 4, paragraphs (a) to (d) spell out the scope of the practice of accountancy as follows: (a) Practice of Public Accountancy. This shall constitute in a person, be it in his/her individual capacity, or as a partner or as a staff member in an accounting or auditing firm, holding out himself/herself as one skilled in the knowledge, science and practice of accounting, and as a qualified person to render professional services as a certified public accountant; or offering or rendering, or both, to more than one client on a fee basis or otherwise, services such as the audit or verification of financial transaction and accounting records; or the preparation, signing, or certification for clients of reports of audit, statement of financial position, and other financial, . accounting and related schedules, exhibits, statements or reports which are to be used for publication or for credit purposes, or to be filed with a court or government agency, or to be used for any other purpose; or the design, installation, and revision of accounting system; or the preparation of income tax returns when related to accounting procedures; or when he/she represents clients before government agencies on tax and other matters related to accounting of renders professional assistance in matters relating to accounting procedures and the recording and presentation of financial facts or data. (b) Practice in Commerce and Industry. This shall constitute in a person involved in decision making requiring professional knowledge in the science of accounting, or when such employment or position requires that the holder thereo! must be a certified Public accountant.Professional Practice of Accountancy: An Overview _\5 (©) Practice in Education/Academe. This shall constitute in a person in an educational institution which involves teaching, of accounting, auditing, Management advisory services, finance, business law, taxation, and other technically related subjects, (d) Practice in the Governme! ; ‘nt. This shall constitute in a person who holds, ot is appointed to, position in the accounting professional group in government or in a government-owned and/or controlled corporation, including those performing proprietary functions, where decision making Fequires professional knowledge in the science of accounting, ot where a civil service eligibility as a certified public accountant is a prerequisite. ASSURANCE, ATTEST, AND AUDITING SERVICES DEFINED Accounting professionals can perform various services that provide assurance about the reliability and relevance of information given by one party to another. The broadest category of such services is simply called assurance services. Attest Services are a subset of assurance services, and auditing is a type of attest service. Many times these terms are used interchangeably because they are related, and at a general level, they encompass the same process: the evaluation of evidence to determine whether information has been recorded and presented in accordance with a predetermined set of criteria, together with the issuance of a report that indicates the degree of correspondence. Assurance Services In the late 1990s, the accounting profession expanded the potential breadth of auditors’ activities beyond auditing and attest services to include a broader set of assurance services, Extending auditors’ activities to assurance services allows reporting not only on the reliability and credibility of information but also on the relevance and timeliness of that information, Assurance services are defined as follows: Assurance services are independent professional services that improve the quality of information, or its context, for decision makers. The definition captures some important concepts. First, the definition focuses on decision making. Making good decisions requires quality information, which, in the context of the broad set of assurances services, can be financial or nonfinancial. Second, it relates to improving the quality of information or its context. An assurance service engagement can improve quality through increasing confidence in the information’s reliability and relevance. Context can be improved by clarifying the format and background with which the information16 Chapter 2 is presented. Third, the definition includes “independence”, which relates to the objectivity of the application of professional judgment and due care by the provider. To summarize, assurance services can include almost any servigg provided by accounting professionals that involves capturing information, improving its quality, or enhancing its usefulness for decision makers, Attest Services Auditors have a reputation for independence and objectivity. As a result, various parties frequently request that auditors attest to information beyond: historical financial information. However, professional standards did not allow for such services until the profession established a separate set of attestation standards in 1986, These standards provide the following definition for attest services: Attest services occur when a practitioner is engaged to issue ,.. a report on subject matter, or an assertion about subject matter, that is the responsibility of another party. Notice that this definition is broader than the one previously discussed for auditing because it is not limited to economic events or actions. The subject matter of attest services can take many forms, including prospective information, analyses, systems and processes, and even the specific actions of specified parties. Note that financial statement auditing is a particular, specialized form of an attest service. Audit Services Auditing is a systematic process of objectivity obtaining and evaluating evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between those assertions and established criteria and communicating the results to interest users. The phrase “systematic process” implies that there should be a well-planned and thorough approach for conducting an audit. This approach involves “objectivity in obtaining and evaluating evidence”. In other words, the auditor must search ‘for audit evidence and objectively evaluate the relevance and validity of th ‘evidence he or she finds. The type, quantity, and reliability of evidence will va" between audits, but the process of obtaining and evaluating evidence makes up most of the auditor’s activities on any audit.Professional Practice of Accountancy: An Overview _17 As our analogy of auditi relate to relevant asserti ing illustrates, the evidence gathered by the auditor must ions, which in auditing ‘pertain to economic actions and events. The auditor compares the evidence gathered to management's financial statement assertions in order to asses “the degree of correspondence between those assertions and established criteria.” While different types of “criteris might be available in various settings, financial accounting and reporting standards principles usually serve as the basis for evaluating management's assertions in the context of a financial statement audit. RELATIONSHIP AMONG ASSURANCE, ATTEST, AND AUDITING SERVICES It is important to understand the relationship among the range of services that are offered by CPAs, because different professional standards apply to each type of service. Figure 2-1 illustrates the universe of services that may be offered by CPAs and the relationships among these services. As shown, CPAs provide both assurance and non assurance services but a few, specially of the management consulting type, overlap. Certain management consulting services have assurance aspects. It also illustrates that attestation services are only a portion of the assurance services that are offered by CPAs. This textbook focuses primarily on financial statements auditing because it represents the major type of assurance service offered by most public accounting firms. In addition, in many instances, the approach, concepts, methods, and techniques used for financial statement audit also apply to other attest and assurance service engagements.18 Chapter 2 Figure 2-1: The Relationship among Assurance, Auditing, Attest, and Services | ASSURANCE SERVICES | NONASSURANCE SERVICES Attestation Services Audits of Financial Statements ‘+ Examination of Intemal Control ‘+ Trust Services, e.g., WebTrust and SysTrust ‘+ Reviews of Financial Statements (or Other Information '* Agreed-Upon Procedures Engagements Management Consulting Services « Fraud Investigations « Information Technology Consulting Other Nonassurance Services Other Assurance Services CPA ElderCarePrime Plus Services © Compilation, Accounting and Data © CPA Performance View Services Processing System Services © CPA Risk Advisory Services © Others © Others TYPES OF AUDITORS J. External Auditors CPA firms have as their primary responsibility the performance of audits of the published historical financial statements of all publicly traded- companies, most other reasonably large companies and many smaller companies and noncommercial organizations. Because of the widespread use of audited financial statements, it is common to use the terms CPA firms, independent auditor, or auditor, synonymously. CPA firms can perform operational auditing as well as compliance auditing as part of their management consultancy services.Professional Practice of Accountancy: An Overview _19 2. Internal Auditors Internal auditors could be CPA firms hired by the entity as consultants or employees of individual companies who perform independent appraisal activity within the organization such as review of accounting, financial and other operations as a basis for service to management. They provide management with valuable information for making decisions concerning effective operation of its business, The internal auditor is therefore concerned with all kinds of financial and other data generated for both internal and external users. Likewise, the internal auditor is also engaged in evaluating the efficiency of resource utilization (operational auditing), the effectiveness with which entity objectives are attained (management or performance auditing and routine compliance auditing). To be able to operate effectively, an internal auditor must be independent of the line functions in an organization and may report directly to the audit committee or board of directors. 3. Government Auditors Several government agencies perform a significant number of audits. These include the Commission on Audit (COA) and the Bureau of Internal Revenue COA Auditors Government auditors from COA determine whether the government agencies and other entities that use public funds: (1) present their financial statements fairly in accordance with Financial Reporting Standards and applicable laws and regulations, (2) conduct the programs with economy and efficiency, (3) desired results are achieved. Many of the COA's audit responsibilities are the same as those of a CPA firm. But since the authority for expenditures and receipts of governmental agencies is defined by law, there is considerable emphasis ‘on compliance in these audits. Also, an increasing effort of the COA's audit efferts has been devoted to evaluating the’ operational efficiency and effectiveness of various government programs. As a result of their great responsibility for auditing government expenditures, their eligibility to be CPAs, their opportunities for performing operational20 Ch 2 _ japter - $$ audit, their use of advanced auditing concepts, COA auditors are highly regarded in the auditing profession. BIR Examiners BIR audits affect individuals as well as businesses. A form of compliance auditing, BIR audits or examinations are designed to determine whether the taxpayers have complied with the tax laws. These audits can be regarded solely as compliance audits i An auditor involved in these areas must have considerable tax knowledge | and auditing skills to conduct an effective audit. Regulatory Auditors Other auditors include SEC, Bangko Sentral ng Pilipinas, Cooperative Commission, Office of Insurance Commission and other government agency examiners who check on the solvency and compliance of the various institutions and business firms with appropriate laws and regulations. 4. Forensic Auditors Forensic auditors are employed by corporations, government agencies, public accounting firms, and specialized consulting and investigative services firms. They are specially trained in detecting, investigating, and deterring fraud and white-collar crime (see the discussion of forensic auditing later in this chapter). Some examples of situations where forensic auditors are often involved include | « Reconstructing incomplete or damaged accountitig records to settle an insurance claim over inventory valuation. «Probing money-laundering activities by tracking and reconstructing cash transactions. . Identify and investigating transactions and assets in business oF marital disputes. Investigating and documenting embezzlement allegations and negotiating insurance settlements.Professional Practice of Accountancy: An Overview 21 TYPES OF OTHER AUDIT SERVICES In addition to the financial st audits: a) b) °) d) a statement audit, there are four (4) major types of Internal audits Compliance audits Operational audits Forensic audits Internal Audit Nature Internal au ing is an independent, objective assurance and consis!"iig activity designed to add value and improve an organization's operations It helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness f risksmanagement, control, and government processes. Objective and Scope The objective of internal auditing is to assist all members of management in the effective discharge of their responsibilities, by furnishing them with analyses, appraisals, recommendations, and pertinent comments concerning the activities reviewed. The internal auditor is concerned with any phase of business activity where he or she can be of service to management. This involves going beyond the accounting and financial records to obtain a full understanding of the operations under review. The attainment of this overall objective involves such activities as: © Reviewing and appraising the soundness, adequacy, and application of accounting, financial, and other operational controls, and promoting effective control at reasonable cost. o Ascertaining the extent of compliance with established policies, plans, and procedures. © Ascertaining the extent to which company assets are accounted for and safeguarded from losses of all kinds. © Ascertaining the reliability of management data developed within the organization. © Appraising the quality of performance in carrying out assigned responsibil © Recommending operating improvements.22 Chapter 2_ b) Compliance Auditins $e 1g, — which is the examination, audit and settlement in accordance with law and regulation. A compliance audit determines the extent to which rules, policies, lays, covenants, or government regulations are followed by the entity being audited. For example, a university may be required to obtain an audit to ensure that applicable rules and policies are being followed with respect to the granting of student loans. Another example of compliance auditing is the examination of tax returns of individuals and companies by the Internal Revenue Service for compliance with the tax laws. Operational audit This is «a future-oriented, independent and systematic evaluation performed by the internal auditor for management of the operational activities controlled by top-, middle-, and lower-level management for the purpose of improving organizational profitability and increasing the attainment of the other organizational objectives. An operational audit involves a systematic review of part or all of an organization’s activities to evaluate whether resources are being used effectively and efficiently. The purpose of an operational audit is to provide assurance, assess performance, identify areas for improvement, and develop recommendations with respect to operational effectiveness and efficiency. Sometimes this type of audit is referred to as @ performance audit or management audit. Operational audits present different challenges than financial statement audit or compliance audits because operational audits often require the auditor to identify or create objective, measurable criteria against which to assess effectiveness and efficiency. Some operational audits, such a information technology (IT) or cybersecurity audits, require specialized skills and expertise. Operational auditing has increased in importance in recent years, and this trend will likely continue. An example of an operational audit is when a" entity auditors to assess the efficiency and effectiveness of its use of information technology resourcesProfessional Practice of Accountancy: An Overview _23 d) Forensic Audits The purpose of a forensic audit is to detect a deter fraudulent activities Forensic auditing has increased significantly in recent years. As we mentioned above in discussing forensic auditors, some examples of where a forensic audit might be conducted include business or employee fraud, various other types of criminal investigations where money or other assets are involved, and matrimonial disputes involving division of assets. TYPES OF OTHER ATTEST SERVICES Auditors can provide numerous types of attest services regarding almost any subject matter. For example, an auditor might be asked to attest to the nature and quantity of inventory stored in an entity’s warehouse so that the entity can obtain a bank loan with the inventory as collateral. A promising new area of attestation services relates to assertions companies make about sustainability-claimed reductions in carbon emissions or appropriate handling of hazardous waste. OTHER NON-ASSURANCE SERVICES In addition to audit, attest, and assurance services, many public accounting firms perform other broad categories of non-assurance services. Agreed-Upon Procedures An agreed-upon procedures engagement, in which the party engaging the professional accountant or the intended user determines the procedures and the professional accountant provides a report of factual findings as a result of undertaking those procedures. This is not an assurance engagement. Tax Preparation and Planning Services Many public accounting firms have tax professionals that assist clients in preparing and filing tax returns, providing advice on tax and estate planning, and representing clients on tax issues before the Internal Revenue Service or tax courts,24 Chagiter 2 Management Advisory Services Management advisory services (MAS) involve providing advice ang assistance concerning an entity's organization, human resources, finances, operations, IT systems, or other activities. Another significant MAS service area is helping public companies implement effective internal control over financial reporting in preparation for an integrated audit to be performed by a different public accounting firm. Due to independence requirements, CPA firms perform MAS primarily for private entities or for public companies for whom they do not provide a financial statement audit. The large public accounting firms all have very robust MAS consulting practices for nonaudit clients. Compilation, Accounting and Data Processing System Services Public accounting firms perform a number of accounting-related services for their nonpublic or nonaudit clients. These services include bookkeeping, payroll processing, and preparing financial statements. When a public accounting firm prepares the financial statements of companies, the services are known as compilations. These forms of services provide less assurance than a financial statement audit.