The Study of Auditing

The study of auditing is different from other accounting courses

Other courses
- Rules, techniques and computations to prepare and analyze financial information
Auditing courses
- analytical and logical skills
- much more conceptual in nature

- accounting is recording transactions, data entry

- auditing is checking the data entry – checking the financial statements
- can’t do auditing without knowing accounting
Publically traded- stock exchange, has shareholders, audit on financial statements and internal
controls – mechanisms placed by management to mitigate financial reporting errors
Private company – not on stock exchange
Cash  capital  investors (equity)  bank (debt)
Principals and agents
- A public company is a company that sells its stocks or bonds to the public, giving the public a
valid interest in the proper use of the company’s resources.
- Managers
o Agents
- Stockholders
o Principals
- Investors  owners/shareholders
- Board of Directors  elected by shareholders and then select the management, hire, fire, and
compensate management
- Audit Committee  hire, fire, compensate, deal with issues that occur during the audit,
separate from BOD and Management
- Corporate veil – principals
- Management  F/S and I/C
Assertions – managements claims about financial statements
Accounts/Events:
1. Occurrence – transactions and events that have been recorded have occurred and pertain to
the entity
2. Completeness – all transactions and events that should have been properly authorized
3. Authorization – all transactions and events that should have been properly authorized
4. Accuracy – amounts and other data relating to recorded transactions and event have been
recorded appropriately
5. Cutoff – transactions and events have been recorded in the correct accounting period
6. Classification – transactions and events have been recorded in the proper accounts
Account Balances:
Disclosures/Presentation:
Audit – needs an independent third party for the audits (no shares, no personal, no business)
Needs evidence for all assertions
Auditor report – the Opinion (Audit is the work that leads to opinion)
Data Analytics Important
3 Opinions – cannot provide 100% assurance – only provide reasonable assurance
A. Unqualified
B. Qualified
C. Adverse
 F) Disclaimer
Fundamental Concepts in conducting a financial statement audit
- Audit risk – issuing an incorrect opinion (lose credibility/reputation – Arthur Anderson )
- Materiality – is an amount that will influence a user of the financial statements to invest or to let
someone borrow (materiality depends)
- Evidence
o Concurring partner does the quality control to check that the product/service meets all
requirements and standards
o Obtain evidence by performing audit procedures
Evidence – assists the auditor in evaluating management’s financial statement assertions consists of
the underlying accounting data and any additional information available to the auditor, where
originating from the client or externally.
- Relevance – is the evidence related to the specific assertion being tested?
- Reliability – Can the evidence be relied upon to signal the true state of the specific
assertion being tested?
Sampling: Inference based on limited observations
Auditors use a sampling approach to examine a subset of the transactions based on previous audits,
an understanding of the company’s internal control system, or knowledge of the company’s industry.
- It would be too costly for auditor to examine every transaction
Major Phases of the Audit:
- Client acceptance/continuance – client to audit, new or continuing, budgeting/reputation
o For new clients – need permission to speak to predecessor to see what happened
- Preliminary engagement activities – do you have resources to allocate
- Plan the audit – based on research and due diligence, plan the audit, notice likely risk
- Consider and audit internal control –managements internal controls need to be tested
- Audit business processes and related accounts (revenue generation) – check processes
- Complete the audit – final touches (contingent liabilities)
- Evaluate results and issue audit report – issue opinion based on audit
Planning Field Work Reporting

Cash
 H/R Revenue
Manufacturing Database
Finance
Fixed Assets Expenditures

Issue the Audit Report - the title line of the audit report includes the word “independent” and usually
the report is addresses to the stockholders of the company.
Types of Auditors:
 External Auditors (only financial statements)
 Internal Auditors (financial documents but not financial statements)
 Government Auditors for much older individuals
 Forensic Auditors (3-5 years of external audit experience – fraud examination)
Controller (CFO) prepares the reports for a company (7 years in external audit, senior manager)
4 Types of Services
Audit Services – internal control audits, compliance audits, operational audits, forensic audits
Attest Services – reporting on nature and quantity of inventory stored in a company’s warehouse so
that the company can obtain a bank loan
Assurance Services – auditing is a specialized form of assurance service
Non-audit Services – tax preparation and planning services, management advisory services, and
compilation and review services
Integrated Audit
F/S + I/S (Financial Statements & Internal Controls)
3 Management Objectives:
 Financial – external auditor
 Operation – efficiently and effectively – internal auditor
 Compliance – internal auditor
GAAP is criterion for F/S ----- COSO is criterion for I/C (Internal Control Framework)
Associate/Staff  Senior/In-Charge (1 client)  Manager (multiple clients)  Partner
Audits are low margin – advisory is high margin
Government Regulation
- In 2002, Congress passed the Sarbanes-Oxley Public Company Accounting Reform and
Investor Protection Act.
- In 2010, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection
Act.
- Cannot perform Audit and Advisory services to same company. Can for tax and audit.
Reasonable vs absolute – wrong expectations (can defend self in court)
- Assigned industry and businesses
A Model of Business
 - Objectives
- Strategies
- Processes (5 broad categories)
- Controls
- Transactions
- Reports
A Model of Business Processes: Five Components
- Financing Process
- Purchasing Process
- Human Resources Management Process
- Inventory Management Process
- Revenue Process
Organizations that Affect the Public Accounting Profession
- Securities and Exchange Commission
- Public Company Accounting Oversight Board
- Financial Accounting Standards Board
-
Chapter 3
The phases of an audit that relate to audit planning
- Client acceptance and continuance
- Preliminary engagement activities
- Plan the audit
Prospective Client Acceptance
1. Obtain and review financial information
2. Inquire of third parties regarding client integrity
3. Consider usual business or audit risks
4. Determine if firm is independent
5. Determine if the firm has the necessary technical skills and knowledge
6. …
Continuing Client Retention
- Evaluate client retention periodically
- Near audit completion or after a significant event
o Conflicts over accounting and auditing issues
o Dispute over fees
Preliminary Engagement Activities
- Determine the Audit Engagement Team Requirements
- Assess Compliance with Ethical and Independence Requirements
Existence Issue – physical count
Does management need to fix material misstatements you found?
- Don’t need to fix, depending on type of mistake and what auditors recommend
 - Every public company is required to have an unqualified opinion – recommendation
(comply) – free of material misstatements, compliance with GAAP, no scope limitation
- Audit committee settles disputes (45-60 days’ time limits)
- Risk of material misstatements is high – sample more, more work
- testing – nature, timing, extent  what type of procedure, when to perform, how big sample size
- RMM X DR Testing
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