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Chapter 1:Auditing, Assurance, and

Internal Control

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Syllabus Course Description Textbooks Course Objectives Exams Research Papers Assignments Class Schedule Performance Evaluation

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Syllabus (cont.) Class Format

Lecture and Discussion In-Class AssignmentsShort Presentations

Blackboard and Class Websitestpt.usf.edu/gkearns/acg6936

Academic Dishonesty Disruption of the Academic Process

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IT AUDITS

IT audits: provide audit services where processes or data, or both, are embedded in technologies. Subject to ethics, guidelines, and standards of the

profession (if certified) CISA Most closely associated with ISACA

Joint with internal, external, and fraud audits Scope of IT audit coverage is increasing Characterized by CAATTs IT governance as part of corporate governance

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FRAUD AUDITS

Fraud audits: provide investigation services where anomalies are suspected, to develop evidence to support or deny fraudulent activities.

Auditor is more like a detective No materiality Goal is conviction, if sufficient evidence of fraud

exists CFE ACFE

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EXTERNAL AUDITS

External auditing: Objective is that in all material respects, financial statements are a fair representation of organization’s transactions and account balances.

SEC’s role Sarbanes-Oxley Act FASB - PCAOB

CPA AICPA

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ATTEST vs. ASSURANCE

ASSURANCE Professional services that are designed to improve

the quality of information, both financial and non-financial, used by decision-makers

IT Audit Groups in “Big Four” (e.g. Final Four) IT Risk Management I.S. Risk Management Operational Systems Risk Management Technology & Security Risk Services Typically a division of assurance services

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ATTEST definition Written assertions Practitioner’s written report Formal establishment of measurement criteria

or their description Limited to:

Examination Review Application of agreed-upon procedures

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THE IT ENVIRONMENT

There has always been a need for an effective internal control system.

The design and oversight of that system has typically been the responsibility of accountants.

The I.T. Environment complicates the paper systems of the past. Concentration of data Expanded access and linkages Increase in malicious activities in systems vs. paper Opportunity that can cause management fraud (i.e.,

override)

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IT Investigative and Forensic Techniques for Auditors

Purpose To assist auditors in developing the

knowledge, skills, and abilities to provide reasonable assurance for the security, availability, integrity and management of information systems and resources.

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The IT Audit

An IT audit is the process of collecting and evaluating evidence of an organization's information systems, practices, and operations. The evaluation of obtained evidence determines if the information systems are safeguarding assets, maintaining data integrity, and operating effectively and efficiently to achieve the organization's goals or objectives.

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The IT Audit

These reviews may be performed in conjunction with a financial statement audit, an internal audit, or other form of attestation engagement.

External auditors can accept the result of an internal audit only if the function reports to the audit committee.

External auditors may use and rely upon a 3rd party IT audit firm.

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IT Audit Process: 8 Steps

1. Plan the audit

2. Hold kickoff meeting

3. Gather data/test IT controls

4. Remediate identified deficiencies (organization)

5. Test remediated controls

6. Analyze and report findings

7. Respond to findings (organization)

8. Issue final report (auditor)

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INTERNAL CONTROL

is … policies, practices, procedures … designed to …

safeguard assets ensure accuracy and reliability promote efficiency measure compliance with policies

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BRIEF HISTORY - SECSEC acts of 1933 and 1934

All corporations that report to the SEC are required to maintain a system of internal control that is evaluated as part of the annual external audit.

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BRIEF HISTORY - CopyrightFederal Copyright Act 1976

1. Protects intellectual property in the U.S.2. Has been amended numerous times since3. Management is legally responsible for violations of

the organization4. U.S. government has continually sought

international agreement on terms for protection of intellectual property globally vs. nationally

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BRIEF HISTORY - FCPAForeign Corrupt Practices Act 1977

1. Accounting provisions FCPA requires SEC registrants to establish and maintain books,

records, and accounts. It also requires establishment of internal accounting controls

sufficient to meet objectives.1. Transactions are executed in accordance with management’s general

or specific authorization.2. Transactions are recorded as necessary to prepare financial

statements (i.e., GAAP), and to maintain accountability.3. Access to assets is permitted only in accordance with management

authorization.4. The recorded assets are compared with existing assets at reasonable

intervals.

2. Illegal foreign payments

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BRIEF HISTORY - COSOCommittee on Sponsoring Organizations - 1992

1. AICPA, AAA, FEI, IMA, IIA

2. Developed a management perspective model

for internal controls over a number of years

3. Is widely adopted

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BRIEF HISTORY – S-OX

Sarbanes-Oxley Act - 20021. Section 404: Management Assessment of Internal

Control Management is responsible for establishing and maintaining

internal control structure and procedures. Must certify by report on the effectiveness of internal control

each year, with other annual reports.

2. Section 302: Corporate Responsibility for Incident Reports Financial executives must disclose deficiencies in internal

control, and fraud (whether fraud is material or not).

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EXPOSURES AND RISK Exposure (definition) Risks (definition)

Types of riskDestruction of assetsTheft of assetsCorruption of information or the I.S.Disruption of the I.S.

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THE P-D-C MODEL Preventive controls Detective controls Corrective controls

Which is most cost effective? Which one tends to be proactive measures? Can you give an example of each?

Predictive controls

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COSO (Treadway Commission)

The five components of internal control are:

The control environmentRisk assessmentInformation & communicationMonitoringControl activities

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SAS 78

The Auditing Standards Board of the American Institute of Certified Public Accountants (AICPA) incorporated the components of internal control presented in the COSO Report in its Statement on Auditing Standards No. 78 (SAS 78), entitled “Consideration of Internal Control in a Financial Statement Audit.”

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SAS 78(#1:Control Environment -- elements) Describe how each one could adversely

affect internal control. The integrity and ethical values Structure of the organization Participation of audit committee Management’s philosophy and style Procedures for delegating

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Management’s methods of assessing performance

External influences Organization’s policies and practices for

managing human resources

SAS 78 (#1:Control Environment -- elements)

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Describe possible activity or tool for each. Assess the integrity of organization’s

management Conditions conducive to management fraud Understand client’s business and industry Determine if board and audit committee are

actively involved Study organization structure

SAS 78 (#1:Control Environment -- techniques)

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Changes in environment Changes in personnel Changes in I.S. New IT’s Significant or rapid growth New products or services (experience) Organizational restructuring Foreign markets New accounting principles

SAS 78 (#2:Risk Assessment)

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Initiate, identify, analyze, classify and record Initiate, identify, analyze, classify and record economic transactions and events.economic transactions and events.

Identify and record all valid economic transactions

Provide timely, detailed information Accurately measure financial values Accurately record transactions

SAS 78 (#3:Information & Communication-elements)

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Auditors obtain sufficient knowledge of I.S.’s to understand: Classes of transactions that are material Accounting records and accounts used Processing steps:initiation to inclusion in

financial statements (illustrate) Financial reporting process (including

disclosures)

SAS 78(#3:Information & Communication-techniques)

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By separate procedures (e.g., tests of controls)

By ongoing activities (Embedded Audit Modules – EAMs and Continuous Online Auditing - COA)

SAS 78(#4: Monitoring)

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SAS 94The Effect of Information Technology on the Auditor’s Consideration of

Internal Control in a Financial Statement Audit

Provides auditors with guidance on IT’s effect on internal control and on the auditor’s understanding of internal control and the assessment of control risk.

Requires the auditor to consider how an organization’s IT use affects his or her audit strategy.

Where a significant amount of information is electronic, the auditor may decide it is not practical or possible to limit detection risk to an acceptable level by performing only substantive tests for one or more financial statement assertions. In such cases, the auditor should gather evidence about the effectiveness of both the design and operation of controls intended to reduce the assessed level of control risk.

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SAS 78(#5: Control Activities)

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Physical Controls (1-3) Transaction authorization

Example: Sales only to authorized customer Sales only if available credit limit

Segregation of duties Examples of incompatible duties:

Authorization vs. processing [e.g., Sales vs. Auth. Cust.] Custody vs. recordkeeping [e.g., custody of inventory vs. DP

of inventory] Fraud requires collusion [e.g., separate various steps in

process]

Supervision Serves as compensating control when lack of segregation

of duties exists by necessity

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Physical Controls (4-6) Accounting records (audit trails; examples) Access controls

Direct (the assets) Indirect (documents that control the assets) Fraud Disaster Recovery

Independent verification Management can assess:

The performance of individuals The integrity of the AIS The integrity of the data in the records Examples

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Operations Data management systems New systems development Systems maintenance Electronic commerce (The Internet) Computer applications

IT Risks Model

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End Ch. 1