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Auditing & Assurance Services, 6e

Chapter 01

Auditing and Assurance Services

“Our system of capital formation relies upon the confidence of millions of savers to invest in companies.

The auditor’s opinion is critical to that trust." -- James R. Doty, Chairman

Public Company Accounting Oversight Board (PCAOB)

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Learning Objectives• Define information risk and explain how the financial statement auditing process

helps to reduce this risk, thereby reducing the cost of capital for a company.• Define and contrast financial statement auditing, attestation, and assurance

services.• Describe and define the assertions that management makes about the recognition,

measurement, presentation, and disclosure of the financial statements and explain why auditors use them as the focal point of the audit.

• Define professional skepticism and explain its key characteristics.• Describe the organization of public accounting firms and identify the various

services that they offer.• Describe the audits and auditors in governmental, internal, and operational

auditing.• List and explain the requirements for becoming a certified public accountant

(CPA) and other certifications available to an accounting professional.

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User Demand for Reliable Information• Today’s information

– More complex– Demanded by remote users– Demanded in a more timely manner– Has far reaching consequences

• Information risk– The risk that the information disseminated by a

company will be materially false or misleading.– Users demand an independent third party assessment of

the information• Business risk

– The risk that an entity will fail to meet its stated business objectives

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Definition of AuditingAuditing 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 and communicating the results to interested users.

Financial Statements(including footnotes)

GAAP

Auditor's Report/Other ReportsPersons 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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Exhibit 1.1: Overview of Financial Statement Auditing

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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)• Financial forecasts and projections • Examination of Management’s Discussion & Analysis• Pro forma financial information

• Some non-financial attestation engagements• Effectiveness of internal control systems • Compliance with environmental regulations• Sustainability reporting engagements

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Exhibit 1.2: Sustainability Report for UPS

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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• XBRL Reporting• Information risk assessment• Customer satisfaction surveys.• Internal audit outsourcing

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Exhibit 1.4: The Relationships Among Auditing, Attestation, and Assurance Engagements

Assurance Services

Attestation Services

Auditing

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Sarbanes-Oxley Act of 2002Management’s Responsibility For Financial Reporting

• One of its most important provisions clearly indicates that the management team is responsible for the financial reporting process and the financial statements.

• In fact, Section 302 of the Act states that the key company officials must certify the financial statements. That is, the company CEO and CFO must sign a statement indicating:

1. They have read the financial statements.2. They are not aware of any false or misleading statements (or any key omitted

disclosures).3. They believe that the financial statements present an accurate picture of the

company’s financial condition.

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

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Management’s Financial Statement Assertions (PCAOB)• Existence or occurrence – Assets and liabilities included in

the accounts exist and recorded transactions are valid and have actually occurred.

• 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 balances and transactions have been recorded in the financial statements

• Valuation or allocation – Assets, liabilities and recorded transactions have been valued in accordance with GAAP

• 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’s Financial Statement Assertions (ASB)

Assertions about Events and Transactions• Occurrence – Events giving rise to transactions are

valid and 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• Classification – Transactions have been posted to the

proper account

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Management’s Financial Statement Assertions (ASB)

Assertions about Account Balances• Existence – Balances include only assets and liabilities that

exist• Rights and obligations – Entity has legal claim on all

assets and revenues reported and has a legal responsibility for all liabilities and expenses

• Completeness – Balances include all items that should be included in accordance with GAAP

• Accuracy and valuation –Balances are reported at the proper amount in accordance with GAAP

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Management’s Financial Statement Assertions (ASB)

Assertions about Presentation and Disclosures• Occurrence and rights and obligations – items presented

have occurred and are either owned by or represent the responsibility of the entity

• Completeness – the proper disclosures have all been made by the entity

• Classification and understandability – accounts in the disclosures have been appropriately grouped and users can comprehend the disclosures

• Accuracy and valuation – the amounts in the disclosures have been properly measured and are valued in accordance with GAAP

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Exhibit 1.6: Assertions and their Relationships to the Financial Statements

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Professional Skepticism• Refers to an auditor’s questioning mindset towards

representations made by management and evidential matter gathered– Inquiry alone is never enough. The auditor must obtain sufficient

corroborative evidence.– Unusual financial trends need investigation– Documents are always checked for authenticity or possible alteration– Ask questions, get answers, then verify the answers.

• Must be skeptical because 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 make sure that this portrayal is fair and accurate.

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A Professional Judgment Process• Clarify the issues and objectives• Consider the possible alternatives• Gather and evaluate the relevant evidence• Reach an audit conclusion• Carefully document rationale for the

professional judgment reached

Source: “Elevating Professional Judgment in Accounting and Auditing: The

KPMG Professional Judgment Framework” (Montvale, NJ: KMPG, 2011).

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The Public Accounting Profession• Assurance services

• Financial Statement Audit engagements• Assurance engagements• Attestation engagements• Compilations• Reviews

• Tax services• Consulting and Advisory services

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Exhibit 1.7: Public Accounting Firm Organization

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Organization of the Profession• “Big Four” Accounting Firms

– Deloitte, EY, KPMG, PwC

• National – Grant Thornton, BDO, McGladrey

• Local/Regional – Melton & Melton (Houston)– Plante Moran (Michigan/Illinois/Wisconsin)– Goodman & Company (Virginia)

• Sole Proprietor

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Exhibit 1.8: Revenues for the Big Four CPA Firms

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Prohibited Professional Services• In summary, Sarbanes-Oxley prohibits professional service firms from

performing any client services for audit clients in which the auditors may find themselves making management decisions or auditing their own firm’s work.

• Specifically, Sarbanes-Oxley prohibits professional service firms from providing any of the following services to an audit client:

1) bookkeeping and related services2) design or implementation of financial information systems3) appraisal or valuation services4) actuarial services5) 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 company’s audit committee has approved them in advance.

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Types of Audits and Auditors • Financial (External Auditors/CPAs)

• Ensure that financial statements are reliable• 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)

• Designed to investigate a crime and will often involve gathering evidence designed to convict a fraudster

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Become Certified!

• Education• Examination• Experience• State Certificate and License• Skills sets and your education

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The CPA Exam

• Significantly Revised in 2011• Computerized• 14 Hours - Four parts

– Auditing and Attestation (AUD)– Financial Accounting and Reporting (FAR)– Regulation (REG)– Business Environment and Concepts (BEC)

• Multiple Choice Questions and Task-Based Simulations

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