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Smieliauskas/Bewley, 7e © McGraw-Hill Education, 2016What You Really Need to Know 1-1

W HAT YOU R EALLY NEED TO K NOW

C HAPTER 1: INTRODUCTION TO AUDITING

LO1 Explain the importance of auditing• Auditing is the verification of information by someone other than the one providing it.

Verification reduces the risk of the information being misleading.• The possibility that information is incorrect is known as information risk. When auditors

verify the reliability of financial information, they reduce information risk.• GAAP stands for Generally Accepted Accounting Principles. These are methods that have

been established in a particular jurisdiction by a standard-setting body or by authoritativesupport such as the accounting recommendations in the CPA Canada Handbook.

• Auditors must be perceived as acting in the interest of the financial statement users ( acting inthe public interest ).

• An important distinguishing feature of auditing is known as three party accountability . Thethree parties are: preparers of the information, users of the information, and auditors whowork for the users, checking the work of the preparer.

LO2 Distinguish auditing from accounting• Accounting is the process of recording, classifying, and summarizing transactions into

financial statements.• There are three underlying conditions impacting the users’ demand for accounting

information: complexity, remoteness and consequences. Complexity refers to the increasingnumber and variety of transactions. Remoteness describes how users of financialinformation are usually separated from a company’s accounting records by distance and time,as well as by lack of expertise. Consequences refer to the fact that decisions involving largedollars and efforts are made based on financial information.

• Companies prepare information to be used by financial decision makers in order to obtainloans or sell stock. This is a potential conflict of interest. As a result, users are a naturallyskeptical of the financial information prepared by companies. External professional auditorsare hired to lend credibility to the financial information.

• Professional skepticism is an auditor’s tendency not to believe management assertions but,instead, to find sufficient support for the assertions through appropriate audit evidence.Professional skepticism is an important aspect of professional judgment.

• Lending credibility is also known as providing assurance . Usually when people think offinancial statements, they think of the annual report which includes both the financialstatements prepared by management and the audit opinion prepared by auditors. However,auditing does not include financial report production. That function is performed by acompany’s accountants under the direction of management. The auditor’s role is to determinewhether the information in the financial statements is reliable, and to communicate this to theusers.

• Auditing involves a process of obtaining and evaluating evidence in order to verify theaccuracy of financial information.


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• The purpose of an audit is to enhance the degree of confidence of the users of the financialstatements. Auditors express an opinion on whether the financial statements are prepared,in all material respects, in accordance with an applicable financial reporting framework.

• Professional judgment is widely used in accounting and auditing It refers to the applicationof relevant training, knowledge, and experience in making informed decisions about the

courses of action that are appropriate. Critical thinking is the process of justifying one’sconclusion or decision by providing acceptable reasons.• An attest engagement is an engagement where the PA is hired to perform procedures and

issue a report to affirm the validity of an assertion.• CAS (Canadian Auditing Standard) is the audit standard in Canada using the equivalent

International Standard on Auditing (ISA).• The expectations gap in auditing refers to the difference between what the public and other

financial statement users perceive auditors' responsibilities to be and what auditors believetheir responsibilities entail. It can also refer to difference in understanding regarding natureof audit engagement, i.e. what users believe audit is and what audit actually is. An auditor isrequired to reduce audit risk to an acceptably low level to attain reasonable assurance. But

what is reasonable? This can be different in the eyes of auditor and in the eyes of users offinancial statements and this creates expectation gap.

LO3 Explain the role of auditing in information risk reduction• Business risk is the risk that a company may fail to achieve its objectives. Business risk

results from economic changes, technology changes, poor management decisions, or just badluck.

• Auditors do not influence business risk although they do consider it and must properlydisclose the business risks in the financial statements.

• Information risk is the risk that the financial information fails to reflect economic substanceof business activities. From the auditor’s perspective, information risk is the probability thatthe financial statements distributed by a company will be materially false and misleading to afinancial statement user.

• There are two major categories of information risk: audit risk and accounting risk. Auditrisk is the risk of insufficient evidence being gathered on the facts concerning the auditee’seconomic circumstances. Accounting risk is the risk that errors associated with estimatesused in GAAP are not properly disclosed.

LO4 Describe the other major types of audits and auditors• The Institute of Internal Auditors (IIA) defines internal auditing and its purpose as “an

independent, objective assurance and consulting activity designed to add value and improvean organization’s operations”.

• Some internal auditing activity is known as operational auditing . Operational auditing is thestudy of business operations in order to make recommendations about the economic andefficient use of resources, effective achievement of business objectives, and compliance withcompany policies. The goal of operational auditing is to help managers discharge theirmanagement responsibilities and improve profitability.

• The Office of the Auditor General of Canada (OAG) is an accounting, auditing, andinvestigating agency of Parliament, headed by the Auditor General. Many provinces haveaudit agencies similar to the OAG who answer to provincial legislatures. The OAG is like an


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external auditor, with respect to the government agencies they audit, because they areorganizationally independent. Many government agencies also have their own internalauditors. Audit activities of all levels of government are frequently referred to as publicsector auditing .

• In the public sector you see economy, efficiency, and effectiveness audits called value-for-

money (VFM) audits. VFM audits are a means of improving accountability for the efficientand economical use of resources and the achievement of program goals.• Comprehensive governmental auditing involves financial statements auditing, compliance

auditing, and VFM auditing. It goes beyond an audit of financial reports and compliance withlaws and regulations to include economy, efficiency, and effectiveness audits.

• Fraud is an attempt by one party (the fraudster) to deceive someone (the victim) for gain.Fraud falls under the Criminal Code and includes deception based on manipulation ofaccounting records and financial statements. Recently, auditor responsibilities to detect fraudhave significantly increased. Fraud auditing is a separate engagement, a special in-depthinvestigation of suspected fraud, that might be done by those with specialized training.

LO5 Provide an overview of international auditing and its impact on Canadian AuditingStandards (CAS)• Many of the large public accounting firms are worldwide. Developments such as the

creation of the North American Free Trade Agreement (NAFTA), the evolution of theEuropean Economic Union and other free trade zones, and the pervasive effects oftechnological change are all contributing to increased global harmonization of auditing andaccounting standards. For these reasons the International Federation of Accountants (IFAC)was created in 1977.

• The IFAC publishes its own handbook on auditing standards recommending InternationalStandards on Auditing (ISAs) . ISAs cover basic principles of auditing, auditor’s reports,

professional independence, reliance on other auditors abroad, and professional qualifications.• ISAs are increasingly becoming the dominant standards worldwide. The CPA Canada policy

is to adopt ISAs as is, unless Canadian conditions require a different standard.

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