The Demand for

Audit and Other

Assurance Services

Chapter 1

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 1-1

 Learning Objective 1

Describe auditing.

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 Nature of Auditing
Auditing is the accumulation and evaluation of evidence about
information to determine and report on the degree of
correspondence between the information and established
criteria.

Auditing should be done by a competent and independent

auditor, who must be qualified to understand the criteria used.
Such criteria vary depending on the information being audited;
In the audit of historical financial statements, the criteria are
usually Generally Accepted Accounting Principles; GAAP.
For an audit of tax returns , the criteria are found in the Internal
Revenue Code; IRC.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 1-3

 Information and Established
Criteria
To do an audit, there must be sufficient
information and some standards (criteria)
by which the auditor can evaluate the available
information which can take many forms.
Auditors routinely perform audits of quantifiable
information, including companies’ financial
statements and individuals’ income tax returns.
Auditors also perform audits of more subjective
information; i.e. the effectiveness and the
efficiency of manufacturing operations.
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 1-4
Accumulating Evidence and Evaluating Evidence
Evidence is any information used by the auditor
to determine whether the information being
audited is stated in accordance with the established
criteria.
Evidence takes many different forms, including;
Oral testimony of the auditee (client) and
observations by the auditor.
To satisfy the purpose of the audit, auditors must
obtain a sufficient quality and volume of evidence.
Auditors must determine the type and the amount of
evidence necessary and evaluate whether the
information corresponds to the established criteria.
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 1-5
 Competent, Independent Person
The auditor must be qualified to understand the criteria used
and must be competent to know the type & the amount of
evidence needed to accumulate in order to reach the proper
conclusion after the evidence has been examined.

The competence of the individual performing the audit is of

little value if he or she is biased in the accumulation and
evaluation of evidence.

Although absolute independence is impossible, the internal

or external auditor must strive to maintain a high level of
independence to keep the confidence of users relying on
their reports.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 1-6

 Reporting
The final stage in the auditing process is preparing
the Audit Report, which is the communication
of the auditor’s findings to users.
Reports differ in nature , but all must inform readers
about the degree of the correspondence between the
information and established criteria.
Reports also differ in form and can vary from the
highly technical type to the simple report.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 1-7

 Learning Objective 2

Distinguish between
auditing and accounting.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 1-8

 Distinguish Between
Auditing and Accounting
Accounting is the recording, classifying,
and summarizing of economic events
for the purpose of providing financial
information used in decision making.

Auditing is determining whether

recorded information properly
reflects the economic events that
occurred during the accounting period.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 1-9

 Learning Objective 3

List the causes of information

risk, and explain how this
risk may be reduced.

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 Causes of Information Risk

Remoteness of information

Biases and motives of the provider

Voluminous data

Complex exchange transactions

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 Remoteness of information

Information provided by others must be relied upon. When information is

obtained from others, the likelihood of it being intentionally or unintentionally
misstated increases.
Biases and motives of the provider
If information is provided by someone whose goals are inconsistent with those of the
decision maker, information may be biased in favor of the provider & the result is a
misstatement of information. (Ex. the borrower may provides biased financial
statements to the lender to increase the chance of obtaining a loan).
Voluminous data
As organizations become larger, so does the volume of their exchange transactions.
This increase the probability that the recorded information will be included in the
records
Complex exchange transactions
In the last few decades, exchange transactions between organizations have
become increasingly complex and more difficult to record properly.
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 1 - 12
 Reducing Information Risk
User verifies information.
The user may go to the business premises to examine records and obtain
information about the reliability of the statements. Normally, this is
impractical for all users to verify the information individually.

User shares information risk with management.

There is a considerable legal precedent indicating that management is
responsible for providing reliable information to users. If users rely on
inaccurate financial statements and as a result incur a financial loss, they
may have a basis for a lawsuit against management.

Audited financial statements are provided.

The most common way for users to obtain reliable information is to have
an independent audit performed. The decision makers can then use the
audited information on the assumption that it is reasonably complete,
accurate, and unbiased.
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 1 - 13
 Learning Objective 4

Differentiate the three

main types of audits.

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 Types of Audits

It evaluates the efficiency and effectiveness of an organization’s operating

procedures and methods. At the completion of an operational audit,
management normally expects recommendations for improving operations

It is conducted to determine whether the auditee is following specific

procedures , rules or regulations set by higher authority

It is conducted to determine whether the overall financial statements are

stated in accordance with specified criteria. Normally ,the criteria are GAAP.
In determining whether financial statements are fairly stated in accordance
with GAAP, the auditor performs appropriate tests to determine whether the
statements contain material errors or other misstatements.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 1 - 15

 Operational Audit

Evaluate computerized payroll system

Example
for efficiency and effectiveness
Number of records processed, costs of
Information
the department, and number of errors
Established Company standards for efficiency and
Criteria effectiveness in payroll department
Available Error reports, payroll records, and
Evidence payroll processing costs

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 1 - 16

 Compliance Audit

Determine whether bank requirements

Example
for loan continuation have been met

Information Company records

Established
Loan agreement provisions
Criteria
Available Financial statements and
Evidence calculations by the auditor

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 1 - 17

 Financial Statement Audit

Annual audit of Boeing’s

Example
financial statements

Information Boeing's financial statements

Established Generally Accepted Accounting

Criteria Principles
Available Documents, records, and outside
Evidence sources of evidence

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 Learning Objective 5

Identify the primary

types of auditors.

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 Types of Auditors

Certified public accounting firms

They are responsible for auditing the published historical financial
statements of all publicly traded companies

Government accountability office auditors

They are working for the Government Accountability Office

Internal revenue agents

They are responsible for enforcing the tax laws as they have been
defined by the government.

Internal auditors
They are employed by individual companies to audit for management .

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 1 - 20

 Learning Objective 6

Describe the requirements

for becoming a CPA.

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 Introduction

Use of title certified Public

Accountant (CPA) is regulated
by state law through the
licensing departments of each
state.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 1 - 22

 Three Requirements for
Becoming a CPA

Educational requirement: an undergraduate or

Graduate degree with a major in accounting

Uniform CPA examination requirement: computer-based

examination in: Auditing – Accounting – Regulation and
Business environment and concepts.

Experience requirement: varies from no experience to

2 years.

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 1 - 23

 End of Chapter 1

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 1 - 24