chapter 1 – the demand for audit and other assurance...

©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

- The opening story involving Cynthia Cooper and WorldCom illustrates the importance of company controls and the role of auditors in detecting fraud.

- In the aftermath of WorldCom and other major financial reporting frauds, Congress passed the Sarbanes–Oxley Act,

- The provisions of the Act apply to publicly held

companies and their audit firms.

- Section 404 of the Act expanded the audit of public companies to include reporting on the effectiveness of the company’s internal control over financial reporting.


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.


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.


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


Information in a Verifiable form means:

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


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


-To satisfy the purpose of the audit, auditors must obtain a sufficient quality and volume of evidence.

-Auditors must determine the types and amount of evidence necessary and evaluate whether the information corresponds to the established criteria. - This is a critical part of every audit and the primary subject of this book.


Competent, Independent Competent, Independent PersonPerson

Judgment and Experience

Evaluation of Evidence

Competence

Proper Conclusion

Independence

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


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 ReportThe final stage in the auditing process is preparing the audit report


Audit of a Tax Return Audit of a Tax Return ExampleExample


Learning Objective 2Learning Objective 2

Distinguish between auditingDistinguish between auditingand 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 auditingin reducing information risk.in reducing information risk.


Economic DemandEconomic Demandfor Auditingfor Auditing

Demand Driver Information risk

Auditing can have a significant effecton information risk.

What is meant by “Information risk”?


Causes of Information RiskCauses of Information Risk Remoteness of information

Biases and motives of the provider

Voluminous data

Complex exchange transactions


Reducing Information RiskReducing Information Risk User verifies information

User shares information risk with management

Audited financial statements are provided


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

External UsersExternal Users

Auditor

Client ExternalUsers

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 Services

An independent professional service

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

Assurance services are independent professional services that improve the quality of information for decision makers.


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 TechnologyTechnology5. Other


Attestation Services on Attestation Services on Information TechnologyInformation Technology

WebTrust and SysTrust also meet the criteria of attestation service

- WebTrust CPA firms assure to the user that the Web site owner has met established criteria related to business practices, transaction integrity, and information processes.- SysTrust CPA firms evaluate and test system reliability in areas such as security and data integrity. -.


Other Assurance ServicesOther 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.


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 proceduresFraud and illegal acts risk assessment ISO 900 certification Environmental audit

The types of assurance services that CPAs can provide are almost limitless, it includes:

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


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 Audit

Example Evaluate computerized payroll systemfor efficiency and effectiveness

Information Number 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


A compliance audit is conducted to determine whether the auditee is following specific procedures, rules or regulations set by some higher authority.

Some examples may include determining whether accounting personnel are following procedures prescribed by the controller, review wage rates for compliance with minimum wage laws, and examine contractual agreements with bankers and other lenders to be sure the company is complying with legal requirements.

Compliance AuditCompliance Audit


Compliance AuditCompliance Audit

Example Determine whether bank requirementsfor loan continuation have been met

Information Company records

EstablishedCriteria Loan agreement provisions

AvailableEvidence

Financial statements andcalculations by the auditor


Audit of Historical Financial Audit of Historical Financial StatementsStatements

Example Annual 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 requirementsfor 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