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.

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Chapter 1 Objectives
1. 2. 3. Define information risk and explain how auditing and assurance services play a role in reducing this business risk. Define and contrast auditing, attestation, and assurance services. Describe and define the management assertions embodied in financial statements, and explain why auditors use them as a focal point of the audit. Explain some characteristics of professional skepticism. Describe the organization of public accounting firms and identify the various services they offer. Describe the audits and auditors in governmental, internal, and operational auditing. List and explain the requirements for becoming a certified information professional.

4. 5.
6. 7.

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User Demand for Reliable Information

Todays 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

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Exhibit 1.2 Overview of Financial Statement Auditing

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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 GAAP and communicating the results to Auditor's Report/ interested users.
Other Reports

Financial Statements (including footnotes)

Persons 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).

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The Relationships Among Auditing, Attestation, and Assurance Engagements

Assurance Services Any Information

Attestation Services Primarily Financial Information Auditing Financial Statements

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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

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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

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Sarbanes-Oxley Act of 2002

In response to several accounting related corporate scandals Congress passed the Sarbanes-Oxley Act The Acts 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 clients audit.

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Sarbanes-Oxley: Managements 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.
3.

They are not aware of any false or misleading statements (or any key omitted disclosures).
They believe that the financial statements present an accurate picture of the companys financial condition.

Source: U.S. Congress, Sarbanes-Oxley Act of 2002, Pub. L. 107-204, 116 Stat/ 745 (2002).

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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.

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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

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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

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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

Exhibit 1.5 Example Assertions and their Relationships to the Financial Statements

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Professional Skepticism
Professional skepticism - auditors questioning, evaluative, attitude toward evidence
Managements 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.

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Professional Service Firm Organization

Executive Committee Managing Partner Practice Offices Partners-in-Charge

Tax Consulting Services

Partner
Manager Manager

Audit, Assurance and Business Advisory Services

Consulting Services
Partner

Manager

Manager

Manager

Manager

Senior (In-charge) Accountants Staff Accountants (or Associates)

Senior (In-charge) Accountants Staff Accountants (or Associates)

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The Public Accounting Profession

Assurance services
Audit engagements Assurance engagements Attestation engagements Compilations Reviews

Tax consulting services Consulting services

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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 services 2) design or implementation of financial information systems 3) appraisal or valuation services 4) actuarial services 5) 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 companys 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 firms work.

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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.

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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

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Become Certified!
Education Examination Experience State Certificate and License for CPA Skills sets and your education

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The CPA Exam

Computerized Four parts
Auditing and attestation4.5 hrs Financial accounting and reporting4 hrs Regulation3 hrs. Business environment2.5 hrs

Skill setsresearch, communication, analysis, judgment and understanding

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Engagement Overview
OBTAIN (OR RETAIN) CLIENT

ENGAGEMENT PLANNING

RISK ASSESSMENT

EVIDENCE GATHERING

REPORTING