Introduction to Auditing

Introduction

• The role of audits is critical in the business environment of the early twenty-first century.

• Important decisions are made on the basis of accounting information.

• Audits reduce the risk that these decisions will be based on inaccurate information.

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An Example

Assume that you are going to purchase a business. • Businesses are frequently valued using a multiple of

earnings. Assume that your business should be valued at five times annual profit.

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How Should Profit be Calculated?

The buyer and seller should agree on the method of calculation of profit.

• GAAP provides a useful guideline.

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How Can We Trust the Financial Information

The seller of the business prepares the financial statements.

– The seller has a natural bias toward increasing income, which will increase the selling price.

– The purchaser may not have the ability to check the accuracy themselves.

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Three-Party Accountability

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SubjectMatter

Auditor Accountable Party

Users

AccountabilityConclusion

Consider financial statements of an Entity

1.Accountable Party

2.Users

3.Auditor

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The Public Interest

Under three-party accountability the auditor is expected to act in the interest of the user of the information.

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Agency Theory and Accountability

When a task is delegated by one party to another (Agent) it can create a problem when three conditions are present:

The Auditor monitors the Agent (management)

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Demand for Reliable Information

Accounting attempts to record and summarize a company’s transactions into financial statements for the benefit of users.

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Auditing

Preparation of financial information by management creates a conflict of interest between users of financial information and management.

• The auditor serves as an independent intermediary who lends credibility to the financial information.

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External Auditor

An external auditor is independent of management and of the production of the financial information.

• This creates three-party accountability.

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Professional Judgement

A professional reaching a complex decision by incorporating standards and ethics in a coherent manner.

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Definition of Auditing

Auditing is a systematic process of:

1.Objectively obtaining and evaluating evidence regarding assertions about economic actions and events

2.In order to ascertain the degree of correspondence between the assertions and established criteria

3.And communicating the results to interested parties.

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Audit Objectives (CAS200)

The purpose of an audit is to enhance the degree of confidence of intended users in the financial statements.

This is achieved by the expression of an opinion by the auditor on whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework.

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Auditing and Risk Reduction

The auditor wants to reduce risk in the audit

What can happen with increased risk?

Business risk:

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Information risk:

Financial statements will fail to appropriately reflect economic substance of business activities, including business risks and uncertainties.

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Auditing: A process of reducing information risk to users of financial statements.•From the auditor’s perspective there are two major categories of information risk.

Audit Risk

The risk of insufficient evidence being gathered on the facts concerning the entity’s economic circumstances.

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Accounting Risk

Risk that errors associated with forecasts used in GAAP accounting estimates are not properly disclosed.

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Internal Auditing

Internal auditing is an independent, objective assurance and consulting activity designed to add value and improve an organization’s operations.

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Internal auditors need to be independent of line managers in an organization.

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Internal auditors have a larger scope of activities than the external auditor.

Operational Auditing

Operational auditing refers to the study of business operations for the purpose of making recommendations about:

The goal is to help managers meet their responsibilities and improve profitability.

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Public Sector(Governmental) Auditing

Governments at all levels make use of public sector auditors.

Public sector audits

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Financial statement audits and the Public Sector

Compliance audits

Value-for-money audits

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Comprehensive governmental audits include:

Regulatory Auditors

Canada Customs and Revenue Agency (CCRA) auditors:

Federal and provincial bank examiners:

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Fraud Auditing and Forensic Accounting

Detection of fraud is not the primary responsibility of the external auditor.

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The Accounting Profession

CPA Canada

Included the following:

Also have:• Certified Internal Auditors• Certified Fraud Examiners

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Public Accounting Firms

Perception of public firms is dominated by the “Big Four” firms:

Accounting firms are organized as partnerships, or as limited liability partnerships (LLPs).

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Organization of Public Accounting Firm

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Public Accounting Services

Assurance services:• Audit:

• Non-audit:

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Public Accounting Services

Taxation services:• Taxation services include:

• A large proportion of practice in small accounting firms is tax practice.

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Public Accounting Services

Consulting services:– All accounting firms handle a great deal of consulting

– PAs compete against non-accountants for these services

– SOX restricts consulting services to audit clients

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International Auditing

The International Federation of Accountants (IFAC) was created in 1977.

• This body mirrors the activities of domestic institutions

• Recommends international standards on auditing

• International convergence of standards

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