Intro & Chapter 1-1 Bob Anderson, UCSB INTRO & CHAPTER 1-1 COURSE INTRO & CHAPTER 1 WELCOME TO ECON 132- AUDIT

Bob Anderson, UCSBBob Anderson, UCSB Intro & Chapter 1-Intro & Chapter 1-11INTRO & CHAPTER 1-INTRO & CHAPTER 1-11

COURSE INTRO & COURSE INTRO & CHAPTERCHAPTER

11WELCOME TO ECON 132- WELCOME TO ECON 132-

AUDITAUDIT

Bob Anderson, UCSBBob Anderson, UCSB Intro & Chapter 1-Intro & Chapter 1-22

WHO AM I?WHO AM I?BOB ANDERSONBOB ANDERSON UCSB Graduate of 1992UCSB Graduate of 1992 Senior Manager, KPMG, LLP- 1993-2004Senior Manager, KPMG, LLP- 1993-2004 RAFS, Inc.RAFS, Inc. InterestsInterests


Why are we here?Why are we here?Learn foundation in AUDITING- which is Learn foundation in AUDITING- which is

useful for?useful for?

Doing your JOB!Doing your JOB! CPA ExamCPA Exam

Unfortunately lots of theory!Unfortunately lots of theory!


OVERVIEW OF THE COURSEOVERVIEW OF THE COURSE What is auditing and other services offered by What is auditing and other services offered by

CPA’sCPA’s The current environmentThe current environment Regulation and rules governing auditRegulation and rules governing audit

Sarbanes-Oxley ActSarbanes-Oxley Act Audit EvidenceAudit Evidence Planning an Audit (7 P’s)Planning an Audit (7 P’s) Internal controlInternal control A/R and RevenueA/R and Revenue Operations and completing the auditOperations and completing the audit Auditor’s reportsAuditor’s reports


Course ApproachCourse Approach Mutually well prepared;Mutually well prepared; Lectures to be an expansion of what is in Lectures to be an expansion of what is in

the bookthe book Real WorldReal World Interesting and Layman’s termsInteresting and Layman’s terms


Administrative MattersAdministrative Matters

NOTE: All of the following is in syllabusNOTE: All of the following is in syllabus Web-Page address is Web-Page address is

econ.ucsb.edu/~andersonecon.ucsb.edu/~anderson Student preparation for classesStudent preparation for classes

Class presentations on the web for review/ printing Class presentations on the web for review/ printing before classbefore class

Quizzes and Homework will combine for 10% of Quizzes and Homework will combine for 10% of your course gradeyour course grade

One drop allowedOne drop allowed Grade Posting. You must provide me a Grade Posting. You must provide me a

release form and I will periodically post to the release form and I will periodically post to the webweb

My office: NH 3039. Hours Posted on SyllabusMy office: NH 3039. Hours Posted on Syllabus


PROTECTED CONTENTPROTECTED CONTENT

USERNAME:USERNAME:andersonanderson

PASSWORD:PASSWORD: xxxxxxxxxxxx


POINTSPOINTSEXAMS MAKE UP 83% OF YOUR COURSE EXAMS MAKE UP 83% OF YOUR COURSE

GRADEGRADE Combination of multiple choice, short Combination of multiple choice, short

answer and problem solving;answer and problem solving; Grade allocation (1,000 points):Grade allocation (1,000 points):

Exam #1Exam #1 25.5%25.5% Exam #2 Exam #2 25.5%25.5% Final Exam (25% cumulative)Final Exam (25% cumulative) 32.0%32.0% Homework &QuizHomework &Quiz 12.0%12.0% Simulations Simulations 5.0% 5.0%


LANDSCAPE/ HISTORYLANDSCAPE/ HISTORYENRON, GLOBAL CROSSING, ETC…= PRESSURE ENRON, GLOBAL CROSSING, ETC…= PRESSURE

ON:ON: Financial reporters (management)- certificationsFinancial reporters (management)- certifications Auditors- SOX 404, fraud responsibilitiesAuditors- SOX 404, fraud responsibilities SEC, FASB. Rushing to release.SEC, FASB. Rushing to release.

Sarbanes-Oxley Act of 2002 Created new rules for Sarbanes-Oxley Act of 2002 Created new rules for public company’s and their auditors. The Public public company’s and their auditors. The Public Company Accounting Oversight Board (PCAOB) Company Accounting Oversight Board (PCAOB) is under the SEC and oversees all firms is under the SEC and oversees all firms registered to audit public companies.registered to audit public companies.


KEY NOTESKEY NOTES 90% OF TRANSACTIONS ARE “ROUTINE” AND 90% OF TRANSACTIONS ARE “ROUTINE” AND

CAN BE ACCURATELY REPORTED BY A STRONG CAN BE ACCURATELY REPORTED BY A STRONG “SYSTEM”“SYSTEM” Internal controlsInternal controls

The other 10% is what you read about in the The other 10% is what you read about in the papers.papers. That 10% Does, did and always will require applying That 10% Does, did and always will require applying

JUDGMENT.JUDGMENT. Accounting is NOT the stereotypical “bean Accounting is NOT the stereotypical “bean

counter”. counter”.


Financial statementsFinancial statements

People work very hard for their money. People work very hard for their money. They need to feel “assured” that They need to feel “assured” that information that they are looking at information that they are looking at in making decisions about what to do in making decisions about what to do with that hard earned money is with that hard earned money is reasonably accurate.reasonably accurate.


GAAPGAAPBecause of the importance of quality Because of the importance of quality

financial statements, there are rules financial statements, there are rules which should be adhered to, such that which should be adhered to, such that those statements be reliable, those statements be reliable, reasonable, comparable, etc.reasonable, comparable, etc.

THEREFORE we have generally accepted THEREFORE we have generally accepted accounting principles (GAAP).accounting principles (GAAP).


GAASGAASBecause of the importance of the Because of the importance of the

reliability of financial statements, they reliability of financial statements, they get audited. The auditing profession, get audited. The auditing profession, similarly, is regulated by “Generally similarly, is regulated by “Generally Accepted Auditing Standards”. Which Accepted Auditing Standards”. Which standards are applicable depend on the standards are applicable depend on the type of entity being audited (Public vs. type of entity being audited (Public vs. Non-public entities)Non-public entities)


The Accounting Profession’s The Accounting Profession’s Credibility CrisisCredibility Crisis

2000—The Panel on Audit Effectiveness made a 2000—The Panel on Audit Effectiveness made a variety of suggestions to improve audits.variety of suggestions to improve audits.

2001—Enron Bankruptcy2001—Enron Bankruptcy 2002—WorldCom Fraud2002—WorldCom Fraud 2002—Sarbanes-Oxley Act 2002—Sarbanes-Oxley Act 2003—Public Company Accounting Oversight 2003—Public Company Accounting Oversight

Board began operationsBoard began operations Late 2003- Bob Anderson leaves public Late 2003- Bob Anderson leaves public

accounting!accounting! Auditors- SOX 404, fraud responsibilities and Auditors- SOX 404, fraud responsibilities and

management certificationsmanagement certifications


AICPAAICPAHistorically, and still for non-public companies, Historically, and still for non-public companies,

GAAS determined by the AICPA. The AICPA:GAAS determined by the AICPA. The AICPA: Establishes auditing standards of non-public Establishes auditing standards of non-public

companies (Via its Auditing Standards Board)companies (Via its Auditing Standards Board) Administers the CPA exam (Each state Administers the CPA exam (Each state

licenses)licenses) Promotes continuing professional educ. (CPE)Promotes continuing professional educ. (CPE) Contributes to self regulationContributes to self regulation

Yep, self-regulated! INTEGRITY!!Yep, self-regulated! INTEGRITY!!


INTRODUCING: PCAOBINTRODUCING: PCAOBSarbanes-Oxley Act of 2002 granted extended Sarbanes-Oxley Act of 2002 granted extended

powers to the SEC, creating the Public powers to the SEC, creating the Public Company Accounting Oversight Board (PCAOB) Company Accounting Oversight Board (PCAOB) pronounced “peekaboo”pronounced “peekaboo”. Applies ONLY to . Applies ONLY to firms auditing public companies and the audits firms auditing public companies and the audits of public companies. As you will see below, NO of public companies. As you will see below, NO MORE SELF REGULATION (over public MORE SELF REGULATION (over public companies) Specifically the PCAOB:companies) Specifically the PCAOB:

Registers accounting firms which plan to audit Registers accounting firms which plan to audit public companies.public companies.

Inspects registered accounting firmsInspects registered accounting firms Conducts investigations and disciplinesConducts investigations and disciplines Sanction registered firmsSanction registered firms


What’s an audit? Non-PublicWhat’s an audit? Non-PublicWe have We have auditedaudited the accompanying balance sheets of A Company, Inc. the accompanying balance sheets of A Company, Inc. as ofas of December 31, 20X2 and 20X1, and the relate statements of income, stockholders’ December 31, 20X2 and 20X1, and the relate statements of income, stockholders’ equity and comprehensive income, and cash flows equity and comprehensive income, and cash flows for the years then endedfor the years then ended. . These financial statements are the responsibility of the Company’s managementThese financial statements are the responsibility of the Company’s management. . Our responsibility is to express an opinionOur responsibility is to express an opinion on these financial statements based on on these financial statements based on our audits.our audits.

We conducted our audits We conducted our audits in accordance with auditing standards generally in accordance with auditing standards generally accepted in the United States of Americaaccepted in the United States of America. Those standards . Those standards require that we plan require that we plan and perform the auditand perform the audit to obtain to obtain reasonablereasonable assurance assurance about whether the financial about whether the financial statements are statements are free of free of materialmaterial misstatement misstatement. An . An audit includes audit includes examiningexamining, on a , on a test basistest basis, evidence, evidence supporting the amounts and disclosures in the financial supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.basis for our opinion.

In our opinionIn our opinion, the financial statements referred to above , the financial statements referred to above present fairly, in all present fairly, in all materialmaterial respects respects, the financial position of A Company, Inc. as of December 31, , the financial position of A Company, Inc. as of December 31, 20X2 and 20X1(1), and the results of its operations and its cash flows for the 20X2 and 20X1(1), and the results of its operations and its cash flows for the years then ended years then ended in conformity with accounting principles generally accepted in in conformity with accounting principles generally accepted in the United States of Americathe United States of America..


What’s an audit? PublicWhat’s an audit? PublicReport of Independent Registered Public Accounting Firm

We have audited the accompanying consolidated balance sheets of BOBS MONEY MAKER Corporation and subsidiaries (the Company) as of December 31, 2004 and 2003, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2004. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of BOBS MONEY MAKER Corporation and subsidiaries as of December 31, 2004 and 2003, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2004, in conformity with accounting principles generally accepted in the United States.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of BOBS MONEY MAKER internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 10, 2005 expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.


Auditing: OverviewAuditing: OverviewWhose responsibility is it to present materially accurate financial statements?Whose responsibility is it to present materially accurate financial statements?

MANAGEMENTMANAGEMENT

Whose responsibility is it to “Opine” on the financial statements?Whose responsibility is it to “Opine” on the financial statements?

AUDITORSAUDITORS

What do we call the rules governing how to account for activity?What do we call the rules governing how to account for activity?

GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP)GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP)

What do we call the rules governing performance of an audit?What do we call the rules governing performance of an audit?

GENERALLY ACCETPED AUDITING STANDARDS (GAAS)GENERALLY ACCETPED AUDITING STANDARDS (GAAS)

A public Company & It’s auditors must conform to additional governance, prescribed A public Company & It’s auditors must conform to additional governance, prescribed by?by?

THE SECURITIES & EXCHANGE COMMISSION (SEC) & THE PUBLIC COMPANY THE SECURITIES & EXCHANGE COMMISSION (SEC) & THE PUBLIC COMPANY ACCOUNTING OVERSIGHT BOARD (PCAOB) WHICH IS AN EXTENTION OF THE SECACCOUNTING OVERSIGHT BOARD (PCAOB) WHICH IS AN EXTENTION OF THE SEC


What is an Audit?What is an Audit?Does an audit provide absolute assurance?Does an audit provide absolute assurance?

NONO

Is an audit designed to detect Fraud?Is an audit designed to detect Fraud?

NONO

An audit is designed to provide assurance to the user, An audit is designed to provide assurance to the user, via an opinion from the auditor, that the financial via an opinion from the auditor, that the financial

statements are “free of MATERIAL misstatement from statements are “free of MATERIAL misstatement from GAAP”GAAP”

THINK HARD ABOUT WHAT AN AUDITORS OPINION THINK HARD ABOUT WHAT AN AUDITORS OPINION ACTUALLY SAYS!ACTUALLY SAYS!


AUDITING: WHAT IS IT?AUDITING: WHAT IS IT?Balance Sheet Approach:Balance Sheet Approach:If you test accounts receivable, what are you simulteneously If you test accounts receivable, what are you simulteneously

testing?testing?

SALESSALES

We use a “dual-entry” system- which means that there is a We use a “dual-entry” system- which means that there is a consequence somewhere else to everything you post.consequence somewhere else to everything you post.

Fraudweis, Inc. is being audited. They have fraudulently Fraudweis, Inc. is being audited. They have fraudulently inflated their sales by recording a false entry. If you inflated their sales by recording a false entry. If you create a false entry to sales, then the logical other place create a false entry to sales, then the logical other place is a/r. If we are auditors and are auditing all material a/r, is a/r. If we are auditors and are auditing all material a/r, wouldn’t we wonder why this receivable “ages” as we wouldn’t we wonder why this receivable “ages” as we look at A/R. If they debit something obscure, it will look look at A/R. If they debit something obscure, it will look out-of-place when we are looking there too in our out-of-place when we are looking there too in our “balance sheet” approach. “balance sheet” approach.


SOME TERMINOLOGYSOME TERMINOLOGYGeneral Ledger:General Ledger:A “Ledger” of all of the activity for a specified A “Ledger” of all of the activity for a specified

period of time… very detailedperiod of time… very detailedTrial Balance (or summary trial balance):Trial Balance (or summary trial balance):Takes the “activity” out of the general ledger and Takes the “activity” out of the general ledger and

shows just the ending balances/ activity, as of a shows just the ending balances/ activity, as of a specified date and period.specified date and period.

Sub-Ledger/ Schedules:Sub-Ledger/ Schedules:Some detailed level of presenting an item of the Some detailed level of presenting an item of the

general ledger (accounts receivable aging, or general ledger (accounts receivable aging, or detailed accounts payable listing are examples)detailed accounts payable listing are examples)

Lead-Sheet:Lead-Sheet:Listing of items comprising a single line-item on a trial balance- Listing of items comprising a single line-item on a trial balance-

much like a sub-ledgermuch like a sub-ledger

The Role of the The Role of the Public Accountant in Public Accountant in

the American the American EconomyEconomy


MORE TERMINOLOGYMORE TERMINOLOGYAssurance: Providing some confidence or Assurance: Providing some confidence or

certainty.certainty.

Attestation: Provide assurance.Attestation: Provide assurance.

So an audit, which provides assurance, is So an audit, which provides assurance, is therefore an attestation engagement.therefore an attestation engagement.


Attestation:Attestation:There are three broad categories of attestation:There are three broad categories of attestation:

1.1. Examination= audit where auditor renders an Examination= audit where auditor renders an opinion (called “opining” or to “opine”)opinion (called “opining” or to “opine”)

2.2. Review= Less in scope than an audit. Issues Review= Less in scope than an audit. Issues “negative assurance” which means, nothing “negative assurance” which means, nothing came to the attention of the reviewer.came to the attention of the reviewer.

3.3. Agreed-upon procedures= No opinion or Agreed-upon procedures= No opinion or report, just a summary of findings based on report, just a summary of findings based on applying procedures which were agreed upon applying procedures which were agreed upon at the beginning of the engagement.at the beginning of the engagement.

IMPORTANT NOTE: THESE MUST RESTRICT THE IMPORTANT NOTE: THESE MUST RESTRICT THE DISTRIBUTION!DISTRIBUTION!


ATTESTATION CONT’DATTESTATION CONT’DIn order to “attest” there must be some suitable In order to “attest” there must be some suitable

criteria to compare to. For instance an audit has criteria to compare to. For instance an audit has suitable criteria called GAAP. A review also has suitable criteria called GAAP. A review also has GAAP to look to. Agreed upon procedures will GAAP to look to. Agreed upon procedures will state what the criteria and procedures are.state what the criteria and procedures are.

ALL OF THIS IS TO LEND CREDIBILITY-ALL OF THIS IS TO LEND CREDIBILITY-The purpose of which is to reduce the amount of The purpose of which is to reduce the amount of

“Information Risk” to a user of the underlying “Information Risk” to a user of the underlying data. data.

Some degree of information risk is inherentSome degree of information risk is inherent Audit reduces information risk, but nothing can Audit reduces information risk, but nothing can

ELIMINATE information risk.ELIMINATE information risk.


FRAUDFRAUDWhat does the auditor’s opinion say about fraud?What does the auditor’s opinion say about fraud?

Not explicitNot explicit

So what is the auditor’s responsibility to detect So what is the auditor’s responsibility to detect fraud?fraud?

If it produces a material misstatementIf it produces a material misstatement

BUT! There are rules called Generally Accepted BUT! There are rules called Generally Accepted Auditing Standards (GAAS) which actually Auditing Standards (GAAS) which actually increase the responsibility of an auditor increase the responsibility of an auditor beyond what their opinion states. beyond what their opinion states.


The Attest FunctionThe Attest Function

Management

SubjectMatter

SuitableCriteria

The CPA

Gathers Evidence

SubjectMatter*

The AttestReport

IssuesReport

*May be management’s assertion about the subject matter.


Attestation Engagements

Type ofEngagement

Level ofAssurance

Nature of Report Procedures

Examination Highest Expresses

opinionSufficient to limitattestation risk tolow level



Type ofEngagement

Level ofAssurance

Nature of Report

Procedures

Examination

Review

Highest

Moderate orLimited

Expresses opinion

Expressesnegativeassurance

Sufficient to limitattestation risk tolow level

Generally limited toinquiry & analyticalprocedures



Type ofEngagement

Level ofAssurance

Nature of Report Procedures

Examination

Review

Agreed-upon procedures

Highest

Moderate orLimited

Varies with procedures

Expresses opinion

Expressesnegativeassurance

States findings

Sufficient to limitattestation risk tolow level

Generally limited toinquiry & analyticalprocedures

Procedures agreed-upon with the specified users


Audit of Financial Audit of Financial StatementsStatements

Management

PreparesFinancial

Statements

Criteria (e.g., GAAP)

The Auditors

Gathers Evidence

FinancialStatements

The Auditors’Report

IssuesReport


What Creates the Demand for What Creates the Demand for Audits?Audits?

Credibility, as previously discussed.Credibility, as previously discussed. Financial statement misstatements arise due to--Financial statement misstatements arise due to--

Accidental errorsAccidental errors Lack of knowledge of accounting principlesLack of knowledge of accounting principles Unintentional biasUnintentional bias Deliberate falsification or theftDeliberate falsification or theft

Audits do not directly address business risk, the risk Audits do not directly address business risk, the risk that a company will not be able to meet its financial that a company will not be able to meet its financial obligations due to economic conditions or poor obligations due to economic conditions or poor management decisionsmanagement decisions


Types of AuditsTypes of Audits Audits of Financial StatementsAudits of Financial Statements

Compliance AuditsCompliance Audits

Operational AuditsOperational Audits

NEW: “INTEGRATED AUDIT”NEW: “INTEGRATED AUDIT”

Combines financial statement audit with Combines financial statement audit with

compliance audit.compliance audit.


Types of AuditorsTypes of Auditors

External AuditorsExternal Auditors Internal AuditorsInternal Auditors GAO AuditorsGAO Auditors Tax AuditorsTax Auditors PCAOBPCAOB


AICPA’s Traditional RoleAICPA’s Traditional Role

Establishes StandardsEstablishes Standards Research and PublicationResearch and Publication Continuing Professional EducationContinuing Professional Education Self-RegulationSelf-Regulation CPA ExaminationCPA Examination

Note: The standards setting and regulation Note: The standards setting and regulation roles have been taken over by the SEC and roles have been taken over by the SEC and the PCAOB with respect to auditors of the PCAOB with respect to auditors of public public companiescompanies. .


OBTAINING AND MAINTAINING A CPA LICENSEOBTAINING AND MAINTAINING A CPA LICENSE

TO GET IT:TO GET IT: Bachelors degree (225 quarter units if pathway2)Bachelors degree (225 quarter units if pathway2)

Important note about BS in textbook!Important note about BS in textbook! Pass CPA exam: In order to take exam you need:Pass CPA exam: In order to take exam you need:

36 quarter units of accounting courses 36 quarter units of accounting courses 36 quarter units of business related courses36 quarter units of business related courses

2 years experience (1 if pathway 2)2 years experience (1 if pathway 2) Pass ethics coursePass ethics course

TO KEEP IT:TO KEEP IT: 120 Hours of continuing professional education every 120 Hours of continuing professional education every

3 years.3 years. Firm providing assurance services must have peer Firm providing assurance services must have peer

reviews.reviews.


Types of Professional Types of Professional ServicesServices

Attestation and AssuranceAttestation and Assurance TaxTax ConsultingConsulting Accounting Accounting Personal Financial PlanningPersonal Financial Planning Fraud InvestigationFraud Investigation

If perfoming If perfoming attestation services, attestation services,

then the other then the other forms of services forms of services

may impair may impair independence. In independence. In fact, did you know fact, did you know that a company’s that a company’s

BOD must BOD must specifically approve specifically approve if the firm performs if the firm performs both audit and tax both audit and tax

services?services?


Typical Structure of a National Typical Structure of a National CPA Firm- Responsibility and CPA Firm- Responsibility and

headcountheadcount

Partners

Managers

Seniors

Staff


Compensation Structure of a Compensation Structure of a National National

CPA Firm- per individualCPA Firm- per individual

PARTNERPARTNERSSMANAGERSMANAGERS

SENIORSSENIORS

STAFFSTAFF

Documents

Intro & Chapter 1-1 Bob Anderson, UCSB INTRO & CHAPTER 1-1 COURSE INTRO & CHAPTER 1 WELCOME TO ECON 132- AUDIT