Arens14e ch01 ppt

©2012 Prentice Hall Business Publishing, ©2012 Prentice Hall Business Publishing, Auditing 14/e,Auditing 14/e, Arens/Elder/Beasley Arens/Elder/Beasley 1 - 1 - 11

The Demand for Audit and The Demand for Audit and Other Assurance ServicesOther Assurance Services

Chapter 1Chapter 1

©2012 Prentice Hall Business Publishing, ©2012 Prentice Hall Business Publishing, Auditing 14/e,Auditing 14/e, Arens/Elder/Beasley Arens/Elder/Beasley

Enron story illustrates the importance of the role of auditors and their responsibility to the users of the financial statements.In the aftermath of Enron and other major financial reporting frauds, Congress passed the Sarbanes-Oxley Act


Adelphia

Enron

Tyco

WorldCom

Sarbanes-Oxley ActSarbanes-Oxley Act

The Act established the Public CompanyAccounting Oversight Board.

It also requires auditors to report on the effectiveness of internal control over financial reporting.


Learning Objective 1Learning Objective 1

Describe auditing.Describe auditing.


Nature of AuditingNature of Auditing

Auditing is the accumulation and evaluationof evidence about information to determineand report on the degree of correspondencebetween the information and established criteria.

Auditing should be done by a competent,independent person.

The definition includes several key words and phrases, we’ll now disscuss them


Information and Established Information and Established CriteriaCriteria

To do an audit, there must be information in averifiable form and some standards (criteria)by which the auditor can evaluate the information.

IASBFASBCriteria


Auditors routinely perform audits of quantifiable information, including companies’ financial statementsand individuals’ federal income tax returns.

They also audit more subjective information, such as the effectiveness of computer systems and efficiencyof manufacturing operations


Information and Established Information and Established CriteriaCriteria

The criteria for evaluating The criteria for evaluating information also vary depending on information also vary depending on the information being audited.the information being audited.

In the audit of historical financial In the audit of historical financial statements by CPA firms, the criteria statements by CPA firms, the criteria may be GAAP or IFRSmay be GAAP or IFRS

For more subjective information it is For more subjective information it is more diffucult to establish criteriamore diffucult to establish criteria


Accumulating Evidence and Accumulating Evidence and Evaluating Evidence Evaluating Evidence

Evidence is any information used by the auditorto determine whether the information beingaudited is stated in accordance with theestablished criteria.

Client inquiry

Written andelectronic

Communications with outsiders

Observations

Transaction data


Accumulating Evidence and Accumulating Evidence and Evaluating Evidence Evaluating Evidence

Evidence takes many different forms Evidence takes many different forms including;including;– electronic and documentary data about electronic and documentary data about

transactionstransactions– written communication with outsiderswritten communication with outsiders– observations by the auditorobservations by the auditor– oral testimony of the auditee (client)oral testimony of the auditee (client)


Competent, Independent Competent, Independent PersonPerson

The auditor must be qualified to understand thecriteria used and must be competent to knowthe types and amount of evidence to accumulateto reach the proper conclusion after theevidence has been examined.

The competence of the individual performingthe audit is of little value if he or she is biasedin the accumulation and evaluation of evidence.

The auditor must also have an independent mentalattitude



Judgment and Experience

Evaluation of Evidence

Competence

Proper Conclusion

Independence



Auditors strive to maintain a high level Auditors strive to maintain a high level of independence to keep the confidence of independence to keep the confidence of users relying on their reportsof users relying on their reports

Auditors reporting on company financial Auditors reporting on company financial statements are often called statements are often called independent auditorsindependent auditors

Even though such auditors are paid fees Even though such auditors are paid fees by the company, they are normally by the company, they are normally sufficiently independent to conduct sufficiently independent to conduct auditsaudits


Audit ReportAudit Report

The final stage in the auditing process ispreparing the Audit Report, which is thecommunication of the auditor’s findings to users.

Results differ in nature, but all must inform readersof the degree o correspondence between information and established criteria.


To the Board of Directors and Stockholders ofABC Corporation and SubsidiariesAnywhere, USAWe have audited the accompanying consolidated balance sheets of ABC Corporation and Subsidiaries (the “Company”) as of December 31, 2010 and December 31, 2009, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2010. Our audits also included the financial statement schedule listed in the Index at Item 15. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements and financial statement schedule 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, such consolidated financial statements present fairly, in all material respects, the financial position of ABC Corporation and Subsidiaries as of December 31, 2010 and December 31, 2009, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2010, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2010, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 28, 2011, expressed an unqualified opinion on the Company’s internal control over financial reporting.INTERNATIONAL CPA FIRM LLPAnywhere, USAFebruary 28, 2011

The final step communicates the findings to users.

Audit ReportAudit Report


Audit of a Tax Return Audit of a Tax Return ExampleExample



Distinguish between auditingDistinguish between auditing

and accounting.and accounting.


Distinguish BetweenDistinguish BetweenAuditing and AccountingAuditing and Accounting

Accounting is the recording, classifying,and summarizing of economic eventsfor the purpose of providing financialinformation used in decision making.

Auditing is determining whetherrecorded information properlyreflects the economic events thatoccurred during the accounting period.



Explain the importance of auditingExplain the importance of auditing

in reducing information risk.in reducing information risk.


Economic DemandEconomic Demand for Auditingfor Auditing

Information risk reflects the possibility thatthe information upon which the businessrisk decision was made was inaccurate.

Auditing can have a significant effecton information risk.

To illustrate the need for auditing, considerthe decision of a bank officer in making aloan to a business…(Risk-free interest rate, business risk for the customer,İnformation risk…



List the causes of information risk, and List the causes of information risk, and explain how this risk may be explain how this risk may be

reduced.reduced.


Causes of Information RiskCauses of Information Risk Remoteness of informationWhen information is obtained from others,likelihood of it being intentionally or unintentionally misstated increases Biases and motives of the providerIf information is provided by someone whose goals areİnconsistent with those of the decision maker, the İnformation may be biased in favor of the provider Voluminous dataAs organizations become larger, so does the volume of theirexchange transactions. This increases the likelihood that İmproperly recorded information is included in the records Complex exchange transactions


Reducing Information RiskReducing Information Risk

User verifies information

User shares information risk with management

Audited financial statements are provided


Reducing Information RiskReducing Information Risk User verifies informationThe user may go to the business premises to examine records and obtain information about the reliability of the statements

User shares information risk with managementIf users rely on inaccurate financial statements and as a result incur a financial loss, they may have basis for a lawsuit against managementBut users may not be able to collect on losses

Audited financial statements are providedThe most common way for users to obtain reliable informationİs to have an independent audit


Relationships Among Relationships Among Auditors, Client, and Auditors, Client, and

External UsersExternal Users

Auditor

ClientExternalUsers

Client or auditcommittee hires

auditor

Auditor issuesreport relied

upon by users to reduce information risk

Provides capital

Client provides financial statements to users



Describe assurance services and Describe assurance services and distinguish audit services from other distinguish audit services from other assurance and non-assurance assurance and non-assurance services provided by CPAs.services provided by CPAs.


Assurance ServicesAssurance ServicesAn independent professional service that improves thequality of information for decision makers.

Can be performed by CPAs or by a variety of other professionals

Individuals who are responsible for making businessdecisions seek assurance services to help improve the reliability and relevance of the information used


Assurance ServicesAssurance Services

CPAs have provided many assurance CPAs have provided many assurance services for years, particularly services for years, particularly assurances about historical financial assurances about historical financial statementsstatements

They have also performed assurance They have also performed assurance services related to lotteries and contests services related to lotteries and contests to provide assurance that winners were to provide assurance that winners were determined in an unbiased fashion in determined in an unbiased fashion in accordance with contest rulesaccordance with contest rules


Attestation ServicesAttestation Services

A type of assurance service

CPA reports on the reliability of an assertion

That is the responsibility of another party.


Attestation ServicesAttestation Services

Historical Financial

Statements

1. Audit 3. Review3. Review

2. Internal Control over

Financial Reporting

4. Information 4. Information TechnologyTechnology

5. Other


1. Audit of historical financial statements

The auditor issues a written report The auditor issues a written report expressing an opinion about whether expressing an opinion about whether the financial statements are fairly the financial statements are fairly stated in accordance with the stated in accordance with the applicable accounting standards.applicable accounting standards.


2. Audit of Internal Control over Financial Reporting

Management asserts that internal controls Management asserts that internal controls have been developed and implemented have been developed and implemented following well established criteriafollowing well established criteria

Section 404 of the SOX act requires public Section 404 of the SOX act requires public companies to report management’s companies to report management’s assessment of the effectiveness of controlassessment of the effectiveness of control

The act also requires auditors to attest to The act also requires auditors to attest to the effectiveness of internal control over the effectiveness of internal control over financial reportingfinancial reporting

This evaluation increases user confidence This evaluation increases user confidence about future financial reportingabout future financial reporting


3. Review of Historical Financial Statements

Management asserts that the Management asserts that the statements are fairly stated in statements are fairly stated in accordance with accounting standardaccordance with accounting standard

The CPA provides only a moderate The CPA provides only a moderate level of assurance for reviews of level of assurance for reviews of financial statements, compared to a financial statements, compared to a high level for audits, therefore less high level for audits, therefore less evidence is neededevidence is needed


4. Attestation Services on Information Technology

WebTrust and SysTrust also meet the criteria of attestation service

Management makes various assertions about the reliability and security of electronic information


5. Other Assurance Services

Most of the other assurance services that CPAsprovide do not meet the formal definitionof attestation services.

The CPA is not required to issue a written report.

The assurance does not have to be about thereliability of another party’s assertion aboutcompliance with specified criteria.


Green Initiatives Bring Assurance Opportunities,

Competition

Global interest has triggered a surge in reports.

80% of the Global Fortune 250 released environmental, social, and governance data.

Presented in standalone reports or integrated into annual financial reports.


Other Assurance Services Examples

Assess risks of accumulation, distribution,and storage of digital information…

assessing security risks and relatedcontrols over data and other informationstored electronically, including theadequacy of backup and off-site storage.

including


Other Assurance Services Examples

Compliance with trading policies and procedures

Compliance with entertainment royalty agreements

ISO 900 certification

Environmental audit


Nonassurance Services Nonassurance Services Provided by CPAsProvided by CPAs

1. Accounting and bookkeeping services

2. Tax services

3. Management consulting services


Assurance, Attestation, and Nonassurance Services



Differentiate the three main types of Differentiate the three main types of audits.audits.


Types of AuditsTypes of Audits

Operational

Compliance

Financial Statement


Operational AuditOperational AuditEvaluates the efficiency and effectiveness Evaluates the efficiency and effectiveness

of any part of an organization’s operating of any part of an organization’s operating procedures and methodsprocedures and methods

At the end, management normally At the end, management normally expects recommendations for improving expects recommendations for improving operationsoperations

The reviews are not limited to accounting.The reviews are not limited to accounting.They can include the evaluation of They can include the evaluation of

organizational structure, computer organizational structure, computer operations, production methods…operations, production methods…


Operational AuditOperational Audit

It is impossible to characterize the It is impossible to characterize the conduct of a typical operational auditconduct of a typical operational audit

It is more diffucult to objectively It is more diffucult to objectively evaluate whether the efficiency and evaluate whether the efficiency and effectiveness of operations meets effectiveness of operations meets established criteria than it is for established criteria than it is for compliance and financial statement compliance and financial statement auditsaudits

In this sense operational audit is more In this sense operational audit is more like management consultinglike management consulting


Operational AuditOperational Audit

ExampleEvaluate computerized payroll systemfor efficiency and effectiveness

InformationNumber of records processed, costs ofthe department, and number of errors

EstablishedCriteria

Company standards for efficiency andeffectiveness in payroll department

AvailableEvidence

Error reports, payroll records, andpayroll processing costs


Compliance AuditCompliance Audit

Conducted to determine whether the Conducted to determine whether the auditee is follow,ng specific procedures, auditee is follow,ng specific procedures, rules, or regulations set by some higher rules, or regulations set by some higher authorityauthority

Governmental units, such as school Governmental units, such as school districts are subject to considerable districts are subject to considerable compliance auditing because of extensive compliance auditing because of extensive government regulationgovernment regulation

Results of compliance audit is typically Results of compliance audit is typically reported to managementreported to management


Compliance AuditCompliance Audit

ExampleDetermine whether bank requirementsfor loan continuation have been met

Information Company records

EstablishedCriteria

Loan agreement provisions

AvailableEvidence

Financial statements andcalculations by the auditor


Financial Statement AuditFinancial Statement Audit

Conducted to determine whether the Conducted to determine whether the financial statements are stated in financial statements are stated in accordance with specified criteria accordance with specified criteria (GAAP or IFRS…)(GAAP or IFRS…)

The auditor gathers evidence to The auditor gathers evidence to determine whether the statements determine whether the statements contain material errors or other contain material errors or other misstatementsmisstatements


Audit of Historical Financial Audit of Historical Financial StatementsStatements

ExampleAnnual audit of Boeing’s financialstatements

Information Boeing's financial statements

EstablishedCriteria

Generally accepted accountingprinciples

AvailableEvidence

Documents, records, and outsidesources of evidence


XBRL Electronic Data to Improve Financial Reporting

Extensible Business Reporting Language

Enables sorting and comparing of financial data

Public companies required to provide interactivefinancial statement data



Identify the primary types of Identify the primary types of auditors.auditors.


Types of AuditorsTypes of Auditors

Internal auditors

Independent certified public accounting firms

Internal Revenue agents

Governmental general accounting office auditors



Describe the requirementsDescribe the requirements

for becoming a CPA.for becoming a CPA.


Three Requirements forThree Requirements forBecoming a CPABecoming a CPA

Educational requirement

Uniform CPA examination requirement

Experience requirement


CPA Examination SectionsCPA Examination Sections

Auditing and

Attestation

Financial Accounting

And Reporting

Business Environment

and Concepts

Regulation


CBT-e: The CPA Exam Gets a Makeover

New content and skill specification outline revisions.

Exam structure changes and weighting of individual exam components.

Coverage of international auditing and financialreporting standards.


Three Requirements for Becoming a CPA


End of Chapter 1End of Chapter 1

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Arens14e ch01 ppt

Economy & Finance