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Why take Auditing, Why is there a need?

• Required of you-Degree, CPA exam, career• Development of Accounting and Auditing

– Absentee Owners• Free Enterprise, Capitalism does not work without

this service• Difficulty with this course or discipline

– Cannot make you an auditor– Conceptual in nature– Must be more than an accountant

• Superheroes of the business community

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Chapter 1

Auditing and Assurance Services

"If you want to be successful, it's just this simple: Know what you're doing. Love what you're doing.

And believe in what you're doing." -- Will Rogers

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Chapter 1 Objectives1. Define information risk and explain how auditing and assurance

services play a role in reducing this business risk.2. Define and contrast auditing, attestation, and assurance services.3. Describe and define the management assertions embodied in

financial statements, and explain why auditors use them as a focal point of the audit.

4. Explain some characteristics of professional skepticism.5. Describe the organization of public accounting firms and identify the

various services they offer.6. Describe the audits and auditors in governmental, internal, and

operational auditing.7. List and explain the requirements for becoming a certified

information professional.

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User Demand for Reliable Information• User demand for reliable, relevant • 4 Environmental conditions increase user demand:

• Complexity• Remoteness• Time sensitivity• Consequences

• Information risk is the risk (probability) that the information (mainly financial) disseminated by a company will be materially false or misleading.

• Demand for Auditing and Assurance Services

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Definition of AuditingAuditing is a systematic process of objectively obtaining and evaluating evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between the assertions and established criteria and communicating the results to interested users.

Financial Statements(including footnotes)

GAAP

Auditor's Report/Other ReportsPersons who rely on

the financial reports•Creditors•Investors

Source: American Accounting Association Committee on Basic Auditing Concepts. 1973. A Statement of Basic Auditing Concepts, American Accounting Association (Sarasota, FL).

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Different Types of Auditors

• External vs. Internal and all other• Internal Auditors• Governmental Auditors• Assertions vs. operational efficiency

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More Specific Definition of Financial Stmt. Audit

• The objective of the ordinary examination of financial statements by the independent auditor is the expression of an opinion on the fairness with which they present, in all material respects, financial position, results of operations and cash flows in conformity with GAAP. The auditors report is the medium through which they express their opinion or if circumstances require, disclaim an opinion. Page 6

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Exhibit 1.1Overview of Financial Statement Auditing

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Exhibit 1.2The Relationships Among Auditing, Attestation, and Assurance Engagements

Assurance ServicesAny Information

Attestation ServicesPrimarily Financial Information

AuditingFinancial Statements

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Assurance Services

• Assurance services are independent professional services that improve the quality of information, or its context, for decision makers.

• Examples• CPA WebTrust (http://www.cpawebtrust.org)• Systrust• Performance View• PrimePlus Services (formerly known as ElderCare)• Can you think of others?

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Attestation Engagements• An attestation engagement is one “in which a practitioner is

engaged to issue or does issue a report on subject matter or an assertion about the subject matter that is the responsibility of another party.”

• Some financial attestation engagements (other than audits)• Supplementary financial statistics• Pro forma financial information• Financial forecasts and projections

• Some non-financial attestation engagements• Compliance with contractual requirements• Effectiveness of internal control systems• Inventory quantities and locations

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Management Assertions (SAS 31) PERCV

• Existence (assets) or occurrence (transactions)• Rights and obligations – owning/owing• Valuation or allocation-Is inventory valued properly, ie:

lower of cost or market based on FIFO etc., obsolete, damaged goods not included

• Completeness – Is everything recorded that should have been and based on cutoff. Income manipulation.

• Presentation and disclosure-footnotes, disclose inventory methods used etc. Mgmt asserts that all transx have been presented correctly and all relevant info has been disclosed.

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Bike Shop example• The 5 Mgmt assertions: We will want to

gather evidence that:– Inventory exists, that it is owned, completely

recorded, properly valued and properly disclosed.

– We develop our audit program based from the assertions and the nature, timing and extent of our program will be based on:

• Mgmt integrity• Clients internal control• Company’s competition• Materiality

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Exhibit 1.4Example Assertions and their Relationshipsto the Financial Statements

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Professional Skepticism

• Professional skepticism is an auditor’s tendency not to believe management’s assertions without sufficient corroboration.• A potential conflict of interest always exists between

the auditor and the client.• Management wants to portray the company and its operations

in the best possible light.• Auditors want to portray the company and its operations fairly.

• Ask questions, get answers, then verify the answers.• What do I need to know? How well do I know it? Does

it make sense?

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Exhibit 1.5Professional Service Firm Organization

Executive CommitteeManaging Partner

Practice OfficesPartners-in-Charge

Consulting Services

Audit, Assurance and Business Advisory

Services

Tax ConsultingServices

Partner

ManagerManager Manager

Senior (In-charge) AccountantsStaff Accountants (or Associates)

Partner

ManagerManager Manager

Senior (In-charge) AccountantsStaff Accountants (or Associates)

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The Public Accounting Profession

• Assurance services• Audit engagements• Assurance engagements• Attestation engagements• Compilations• Reviews

• Tax consulting services• Consulting services

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Sarbanes-Oxley Act of 2002

• Congress passed the Sarbanes-Oxley Act in an attempt to address a number of weaknesses found in corporate financial reporting in the wake of the recent accounting scandals. The Act’s major provisions include:– Requirement of CEO/CFO certification of financial statements– Requirement of auditor examination of company internal controls– Creation of the Public Company Accounting Oversight Board

(PCAOB) to serve as an auditing profession “watchdog.”– Prohibition of certain client services by firms conducting a client’s

audit.

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Sarbanes-Oxley: Management’s Responsibility For Financial Reporting

One of its most important provisions (Section 302) states that the key company officials must certify the financial statements. Certification means that the company CEO and CFO must sign a statement indicating:

1. They have read the financial statements.

2. They are not aware of any false or misleading statements (or any key omitted disclosures).

3. They believe that the financial statements present an accurate picture of the company’s financial condition.

Source: U.S. Congress, Sarbanes-Oxley Act of 2002, Pub. L. 107-204, 116 Stat/ 745 (2002).

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Prohibited Services to Audit Clients• Sarbanes-Oxley and the PCAOB prohibit professional service firms

from providing any of the following services to an audit client: 1) bookkeeping and related services2) design or implementation of financial information systems3) appraisal or valuation services4) actuarial services5) internal audit outsourcing 6) management or human resources services 7) investment or broker/dealer services 8) legal and expert services (unrelated to the audit)

• Professional service firms may provide client tax services (with some restrictions) and other non-prohibited services to audit clients if the company’s audit committee has approved them in advance.

• In summary, Sarbanes-Oxley prohibits professional service firms from performing any client services in which the auditors may find themselves making management decisions or auditing their own firm’s work.

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Types of Audits and Auditors • Financial (External Auditors/CPAs)

• Ensure that financial statements are accurate.• Operational (Internal Auditors/CIAs)

• Improve operational economy• Improve operational efficiency

• Compliance (Governmental Auditors)• Ensure compliance with company and/or governmental rules and

regulations• Forensic (Fraud Auditors/CFEs)• Most audits are a combination of financial, operational,

and compliance audits.

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Organization of the Profession• “Big Four” Accounting Firms

– D&T, E&Y, KPMG, PwC• National

– Grant Thornton, BDO Seidman• Local/Regional

– Melton & Melton (Houston)– Postlethwaite & Netterville (Louisiana)– Goodman & Company (Virginia)

• Sole Proprietor

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Become Certified!

• Education• Examination• Experience• State Certificate and License for CPA• Skills sets and your education

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The New CPA Exam

• Computerized• Four parts

– Auditing and attestation—4.5 hrs– Financial accounting and reporting—4 hrs– Regulation—3 hrs.– Business environment—2.5 hrs

• Skill sets—research, communication, analysis, judgment and understanding

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Chapter 1 Summary• History of Accounting and Auditing• What drives the need for Auditing • User demand for Reliable Information

– Complexity– Remoteness– Time Sensitivity– Consequences

• Definition of Accounting AAA and the AICPA• 5 Management Assertions• The Concept of professional skepticism• Sox-History, Prohibited services• Assurance, Attest, Audit• Types of Auditors• Types of Certifications and how to achieve

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Engagement Overview

OBTAIN (OR RETAIN)

CLIENT

INTERNALCONTROL

EVALUATION

EVIDENCEGATHERING REPORTING

ENGAGEMENTPLANNING