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

McGraw-Hill/Irwin

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

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.

1-3

User Demand for Reliable Information

• Today’s information– More complex– Demanded by remote users– Demanded in a more timely manner– Has far reaching consequences

• Information risk – the risk (probability) that the information (mainly

financial) disseminated by a company will be materially false or misleading.

– users demand an independent third party assessment of the information

1-4

Exhibit 1.2Overview of Financial Statement Auditing

1-5

Definition of Auditing

Auditing 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).

1-6

The Relationships Among Auditing, Attestation, and Assurance Engagements

Assurance ServicesAny Information

Attestation ServicesPrimarily Financial Information

AuditingFinancial Statements

1-7

Assurance Services

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

• Examples• Consumer reports• Underwriters laboratories• CPA WebTrust• Performance View• PrimePlus Services

1-8

Attestation Engagements

• An attestation engagement - a practitioner is assesses and reports 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

1-9

Sarbanes-Oxley Act of 2002

• In response to several accounting related corporate scandals Congress passed the Sarbanes-Oxley Act

• 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.

1-10

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.

• 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).

1-11

PCAOB Management Assertions

• Existence or occurrence – Assets included in accounts exists and events that give rise to transactions have taken place

• Rights and obligations- Entity has a legal claim on all assets and revenues reported and has a legal responsibility for all liabilities and expenses

• Completeness - All transactions have been recorded• Valuation or allocation – Transactions are recorded at the

correct amount in the proper period• Presentation and disclosure – All accounts are presented in

the appropriate place and all information required has been disclosed in the statements and footnotes.

1-12

Management Assertions (SAS 106)

Transaction Assertions• Occurrence – Events giving rise to transactions have

taken place

• Completeness and cutoff - All transactions have been recorded and are recorded in the appropriate period

• Accuracy – Transactions are recorded at the correct amount

• Classifications – Transactions have posted to the proper account

1-13

Management Assertions (SAS 106)

Balance Assertions• Existence – Balances include only assets exist

• Rights and obligations – Entity has legal claim on all assets and revenues reported– Entity has a legal responsibility for all liabilities and

expenses

• Completeness – Balances include all items

• Accuracy and valuation –Balances included items recorded in the proper period at the proper amount

1-14

Management Assertions (SAS 106)

Presentation and Disclosure Assertions• Occurrence and rights and obligations – items

presented include information regarding ownership

• Completeness - All accounts are included

• Classification and understandability – All accounts are appropriately grouped – Users can comprehend statements and disclosures

• Accuracy and valuation – Statements include proper measurements

1-15

Exhibit 1.5Example Assertions and their Relationships to the Financial Statements

1-16

Professional Skepticism

• Professional skepticism - auditor’s questioning, evaluative, attitude toward evidence– Management’s assertions without sufficient corroboration.– Financial trends need investigation– Documents are checked for authenticity or alteration– Ask questions, get answers, then verify the answers.

• 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.

1-17

Professional 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)

1-18

The Public Accounting Profession

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

• Tax consulting services• Consulting services

1-19

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.

1-20

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

• Ensure that financial statements are accurate.• Operational (Internal and Governmental

Auditors/CIAs)• Improve operational economy• Improve operational efficiency

• Compliance (Internal and 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.

1-21

Organization of the Profession

• “Big Four” Accounting Firms– D&T, E&Y, KPMG, PwC

• National – Grant Thornton, BDO Seidman

• Local/Regional – Melton & Melton (Houston)– Plante Moran (Michigan/Illinois/Wisconsin)– Goodman & Company (Virginia)

• Sole Proprietor

1-22

Become Certified!

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

1-23

The 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

1-24

Engagement Overview

OBTAIN (OR RETAIN)

CLIENT

RISK ASSESSMENT

EVIDENCEGATHERING

REPORTINGENGAGEMENT

PLANNING

1-25