Arens14e ch01 ppt

The Demand for Audit and
Other Assurance Services
Chapter 1

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 1-1

Enron story illustrates the
importance of the role of auditors and
their responsibility to the users of the
financial statements.
In the aftermath of Enron and other
major financial reporting frauds,
Congress passed the Sarbanes-Oxley
Act

©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley

Sarbanes-Oxley Act
Enron WorldCom

The Act established the Public Company
Accounting Oversight Board.

It also requires auditors to report on the
effectiveness of internal control over
financial reporting.

Tyco Adelphia

Learning Objective 1

Describe auditing.


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,
independent person.

The definition includes several key words and
phrases, we’ll now disscuss them


Information and Established
Criteria
To do an audit, there must be information in a
verifiable form and some standards (criteria)
by which the auditor can evaluate the information.

Criteria
FASB IASB


Auditors routinely perform audits of quantifiable
information, including companies’ financial statements
and individuals’ federal income tax returns.

They also audit more subjective information, such as
the effectiveness of computer systems and efficiency
of manufacturing operations


Information and Established
Criteria
 The criteria for evaluating information also
vary depending on the information being
audited.
 In the audit of historical financial
statements by CPA firms, the criteria may
be GAAP or IFRS
 For more subjective information it is more
diffucult to establish criteria


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.

Transaction
data Written and
electronic Observations
Communications
with outsiders
Client inquiry


Accumulating Evidence and
Evaluating Evidence
 Evidence takes many different forms
including;
– electronic and documentary data about
transactions
– written communication with outsiders
– observations by the auditor
– oral testimony of the auditee (client)


Competent, Independent Person
The auditor must be qualified to understand the
criteria used and must be competent to know
the types and amount of evidence to accumulate
to reach the proper conclusion after the
evidence has been examined.
The auditor must also have an independent mental
attitude
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.

Judgment and
Competence
Experience

Independence

Evaluation
of Evidence

Proper
Conclusion
©2012 Prentice Hall Business Publishing, Auditing 14/e, Arens/Elder/Beasley 1 - 12

 Auditors strive to maintain a high level of
independence to keep the confidence of
users relying on their reports
 Auditors reporting on company financial
statements are often called independent
auditors
 Even though such auditors are paid fees
by the company, they are normally
sufficiently independent to conduct audits


Audit Report
The final stage in the auditing process is
preparing the Audit Report, which is the
communication of the auditor’s findings to users.

Results differ in nature, but all must inform readers
of the degree o correspondence between information
and established criteria.


Audit Report
To the Board of Directors and Stockholders of
ABC Corporation and Subsidiaries
Anywhere, USA
We have audited the accompanying consolidated balance sheets of ABC Corporation and Subsidiaries (the “Company”) as of December 31, 2010 and December
31, 2009, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended December
31, 2010. Our audits also included the financial statement schedule listed in the Index at Item 15. These financial statements and financial statement schedule
are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements and financial statement schedule
based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of ABC Corporation and Subsidiaries as of
December 31, 2010 and December 31, 2009, and the results of their operations and their cash flows for each of the three years in the period ended December
31, 2010, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule,
when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth
therein.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control
over financial reporting as of December 31, 2010, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission and our report dated February 28, 2011, expressed an unqualified opinion on the Company’s internal
control over financial reporting.
INTERNATIONAL CPA FIRM LLP
Anywhere, USA
February 28, 2011

The final step communicates the findings to users.

Audit of a Tax Return Example



Distinguish between auditing
and accounting.


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.



Explain the importance of auditing
in reducing information risk.


Economic Demand for Auditing
To illustrate the need for auditing, consider
the decision of a bank officer in making a
loan to a business…
(Risk-free interest rate, business risk for the customer,
İnformation risk…

Information risk reflects the possibility that
the information upon which the business
risk decision was made was inaccurate.

Auditing can have a significant effect
on information risk.


List the causes of information risk, and
explain how this risk may be reduced.


Causes of Information Risk
 Remoteness of information
When information is obtained from others,likelihood of it
being intentionally or unintentionally misstated increases
 Biases and motives of the provider
If information is provided by someone whose goals are
İnconsistent with those of the decision maker, the
İnformation may be biased in favor of the provider
Voluminous data
organizations become larger, so does the volume of their
change transactions. This increases the likelihood that
properly recorded information is included in the records
 Complex exchange transactions

Reducing Information Risk

 User verifies information

 User shares information risk with management

 Audited financial statements are provided


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
 User shares information risk with management
If users rely on inaccurate financial statements and as a result
incur a financial loss, they may have basis for a lawsuit
against management
But users may not be able to collect on losses
 Audited financial statements are provided
The most common way for users to obtain reliable information
İs to have an independent audit


Relationships Among Auditors,
Client, and External Users

Client or audit Auditor issues
committee hires report relied
auditor Auditor upon by users to reduce
information risk

Provides capital
External
Client
Users
Client provides financial
statements to users


Describe assurance services and distinguish
audit services from other assurance and
non-assurance services provided by CPAs.


Assurance Services
An independent professional service that improves the
quality of information for decision makers.

Individuals who are responsible for making business
decisions seek assurance services to help improve
the reliability and relevance of the information used

Can be performed by CPAs or by a variety
of other professionals


Assurance Services
 CPAs have provided many assurance
services for years, particularly assurances
about historical financial statements
 They have also performed assurance
services related to lotteries and contests
to provide assurance that winners were
determined in an unbiased fashion in
accordance with contest rules


Attestation Services

A type of assurance service

CPA reports on the reliability of an assertion

That is the responsibility of another party.


Attestation Services

1. Audit 3. Review
Historical
Financial
Statements

2. Internal
Control over 4. Information
Financial 5. Other
Reporting
Technology


1. Audit of historical financial
statements
 The auditor issues a written report
expressing an opinion about whether the
financial statements are fairly stated in
accordance with the applicable accounting
standards.


2. Audit of Internal Control over
Financial Reporting
 Management asserts that internal controls have
been developed and implemented following well
established criteria
 Section 404 of the SOX act requires public
companies to report management’s assessment
of the effectiveness of control
 The act also requires auditors to attest to the
effectiveness of internal control over financial
reporting
 This evaluation increases user confidence about
future financial reporting


3. Review of Historical Financial
Statements
 Management asserts that the statements
are fairly stated in accordance with
accounting standard
 The CPA provides only a moderate level of
assurance for reviews of financial
statements, compared to a high level for
audits, therefore less evidence is needed


4. Attestation Services on
Information Technology
Management makes various assertions
about the reliability and security of
electronic information

WebTrust and SysTrust also meet the
criteria of attestation service


5. Other Assurance Services

Most of the other assurance services that CPAs
provide do not meet the formal definition
of attestation services.

The CPA is not required to issue a written report.

The assurance does not have to be about the
reliability of another party’s assertion about
compliance with specified criteria.

Green Initiatives Bring Assurance
Opportunities, Competition

Global interest has triggered a surge in reports.

80% of the Global Fortune 250 released
environmental, social, and governance data.

Presented in standalone reports or integrated
into annual financial reports.


Examples
Assess risks of accumulation, distribution,
and storage of digital information…

including

assessing security risks and related
controls over data and other information
stored electronically, including the
adequacy of backup and off-site storage.

Examples
 Compliance with trading policies and procedures

 Compliance with entertainment royalty agreements

 ISO 900 certification

 Environmental audit


Nonassurance Services Provided
by CPAs
1. Accounting and bookkeeping services
2. Tax services
3. Management consulting services


Assurance, Attestation, and
Nonassurance Services



Differentiate the three main types of audits.


Types of Audits

 Operational

 Compliance

 Financial Statement


Operational Audit
 Evaluates the efficiency and effectiveness
of any part of an organization’s operating
procedures and methods
 At the end, management normally expects
recommendations for improving operations
 The reviews are not limited to accounting.
 They can include the evaluation of
organizational structure, computer
operations, production methods…


Operational Audit
 It is impossible to characterize the conduct
of a typical operational audit
 It is more diffucult to objectively evaluate
whether the efficiency and effectiveness of
operations meets established criteria than
it is for compliance and financial statement
audits
 In this sense operational audit is more like
management consulting


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

Compliance Audit
 Conducted to determine whether the auditee is
follow,ng specific procedures, rules, or
regulations set by some higher authority
 Governmental units, such as school districts are
subject to considerable compliance auditing
because of extensive government regulation
 Results of compliance audit is typically reported
to management


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

Financial Statement Audit
 Conducted to determine whether the
financial statements are stated in
accordance with specified criteria (GAAP
or IFRS…)
 The auditor gathers evidence to determine
whether the statements contain material
errors or other misstatements


Audit of Historical Financial
Statements
Annual audit of Boeing’s financial
Example
statements

Information Boeing's financial statements

Established Generally accepted accounting
Criteria principles
Available Documents, records, and outside
Evidence sources of evidence

XBRL Electronic Data to Improve
Financial Reporting

Extensible Business Reporting Language

Enables sorting and comparing of financial data

Public companies required to provide interactive
financial statement data



Identify the primary types of
auditors.


Types of Auditors
 Independent certified public accounting firms

 Governmental general accounting office auditors

 Internal Revenue agents

 Internal auditors



Describe the requirements
for becoming a CPA.


Three Requirements for
Becoming a CPA
 Educational requirement

 Uniform CPA examination requirement

 Experience requirement


CPA Examination Sections

Financial
Auditing Accounting
and And
Attestation Reporting

Business
Environment
Regulation
and
Concepts

CBT-e: The CPA Exam Gets a
Makeover
New content and skill specification outline
revisions.

Exam structure changes and weighting of
individual exam components.

Coverage of international auditing and financial
reporting standards.


Three Requirements for Becoming
a CPA


End of Chapter 1


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