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Introduction to Introduction to Auditing and Auditing and

Assurance ServicesAssurance Services

"If you want to be successful, it's just this "If you want to be successful, it's just this simple:simple:

Know what you're doing. Love what you're Know what you're doing. Love what you're doing. And believe in what you're doing." doing. And believe in what you're doing." Will RogersWill Rogers

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Entry-level CPAs are expected to Entry-level CPAs are expected to practically walk on water. In addition practically walk on water. In addition to technical ability to do the job, they to technical ability to do the job, they

need communication and people need communication and people skills, computer savvy, a strong sense skills, computer savvy, a strong sense

of ethics---and even a nose that can of ethics---and even a nose that can detect fraud.detect fraud.

Journal of AccountancyJournal of Accountancy

June, 2005 p77 June, 2005 p77

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Study of AuditingStudy of Auditing

Technical, analytical and logical skills

Gather and assess the

evidence against assertions

More conceptual in nature

Improving the reliability of

information for decision makers

The study of auditing is different from other accounting courses that you have taken in college because …

LO# 1

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INFORMATION RISKINFORMATION RISK

RRisk (probability) that the information isk (probability) that the information (mainly financial) disseminated by a (mainly financial) disseminated by a company will be materially false or company will be materially false or misleadingmisleading

Users demand independent third Users demand independent third party assessment of the information party assessment of the information

..

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Reducing Information RiskReducing Information Risk

User verifies information.User verifies information.

User shares information risk with management.User shares information risk with management.

Audited financial statements are provided.Audited financial statements are provided.

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Assurance and Attestation Assurance and Attestation ServicesServices

Other Assurance ServicesOther Assurance Services

CertainCertainManagementManagementConsultingConsulting

Other Attestation ServicesOther Attestation Services(e.g., (e.g., WebTrust, SysTrustWebTrust, SysTrust))

ATTESTATION SERVICESATTESTATION SERVICES

AuditsAudits ReviewsReviews

Internal ControlInternal Controlover Financial Reportingover Financial Reporting

ASSURANCE SERVICESASSURANCE SERVICES

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The Attest FunctionThe Attest Function

Management

SubjectMatter

SuitableCriteria

The CPA

Gathers Evidence

SubjectMatter*

The AttestReport

IssuesReport

*May be management’s assertion about the subject matter.

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Attestation ServicesAttestation Services

1. Audit of historical financial statements

2. Attestation of internal control over financial reporting

3. Review of historical financial statements

4. Attestation services on information technology

5. Other attestation services

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Auditing vs AccountingAuditing vs Accounting

AccountingAccounting is the recording, classifying, is the recording, classifying,and summarizing of economic eventsand summarizing of economic eventsfor the purpose of providing financialfor the purpose of providing financialinformation used in decision making.information used in decision making.

AuditingAuditing is determining whetheris determining whetherrecorded information properlyrecorded information properlyreflects the economic events thatreflects the economic events thatoccurred during the accounting period.occurred during the accounting period.

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Definition of AuditingDefinition 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 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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Overview of Financial Statement Overview of Financial Statement AuditingAuditing

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Audit of a Tax Return Audit of a Tax Return

InternalInternalrevenuerevenue

agentagent

Competent,Competent,independentindependent

personperson

Examines cancelledExamines cancelledchecks and otherchecks and other

supporting recordssupporting records

Accumulates andAccumulates andevaluates evidenceevaluates evidence

DeterminesDeterminescorrespondencecorrespondence

Federal taxFederal taxreturns filedreturns filedby taxpayerby taxpayer

InformationInformation

Internal RevenueInternal RevenueCode and allCode and all

interpretationsinterpretations

Established criteriaEstablished criteria

Report on taxReport on taxdeficienciesdeficiencies

Report on resultsReport on results

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Relationships Among Auditors, Relationships Among Auditors, Client, and External UsersClient, and External Users

ClientClient

AuditorAuditorClient or auditClient or auditcommittee hirescommittee hiresauditorauditor

ExternalExternalUsersUsers

Auditor issuesAuditor issuesreport reliedreport reliedupon by usersupon by users

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Overview of the Financial Statement Overview of the Financial Statement Audit ProcessAudit Process

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Problems and Warning Problems and Warning SignsSigns

1990 2000

During the economic boom of the late 1990s and the early 2000s, accounting firms aggressively sought opportunities

to market a variety of high-margin nonaudit services to their audit clients.

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An Explosion of ScandalsAn Explosion of Scandals

Enron

WorldCom

Tyco

Xerox Adelphia

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Accounting Profession’s Decade of Accounting Profession’s Decade of Unprecedented Turmoil & ChangeUnprecedented Turmoil & Change

1. Failure of one of the largest public 1. Failure of one of the largest public accounting firms (Andersen)accounting firms (Andersen)

2. Four of the largest bankruptcies ever - each 2. Four of the largest bankruptcies ever - each in a company where financial statement in a company where financial statement misrepresentation had taken placemisrepresentation had taken place

3. Billions of investment and retirement dollars 3. Billions of investment and retirement dollars lostlost

4. Perception that auditors were not4. Perception that auditors were not

independent from their clientsindependent from their clients

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SEC Concerns About the Auditing SEC Concerns About the Auditing ProfessionProfession

Auditors unwilling to confront clients over Auditors unwilling to confront clients over questionable accounting practicesquestionable accounting practices

Consulting fees impairing auditor Consulting fees impairing auditor independenceindependence

Accountants using technical Accountants using technical interpretations of GAAP to push the interpretations of GAAP to push the limits of accountinglimits of accounting

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Government RegulationGovernment Regulation

In July 2002, Congress passed the Sarbanes-Oxley Public Company Accounting Reform and Investor

Protection Act.

The Sarbanes-Oxley Act effectively ended the profession’s era of “self-

regulation,” creating and transferring authority to set and enforce standards to the Public Company Accounting

Oversight Board (PCAOB).

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Sarbanes/Oxley ActSarbanes/Oxley Act

Established the Public Companies Accounting Established the Public Companies Accounting Oversight Board (PCAOB)Oversight Board (PCAOB)

Requires CEO and CFO to “certify” financial Requires CEO and CFO to “certify” financial statementsstatements

Requires Requires bothboth companies and auditors to provide a companies and auditors to provide a comprehensive report on internal controlscomprehensive report on internal controls

Gives Audit Committees expanded powers as the Gives Audit Committees expanded powers as the 'audit client' and for pre-approving any non-audit 'audit client' and for pre-approving any non-audit services by its external auditorsservices by its external auditors

Requires Audit Committees to report their activities to Requires Audit Committees to report their activities to the publicthe public

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Sarbanes/Oxley Act (Cont)Sarbanes/Oxley Act (Cont)

Audit Committees --- at least one person who is a Audit Committees --- at least one person who is a financial expert.financial expert.

Audit engagement partners rotation --- every five Audit engagement partners rotation --- every five yearsyears

A "cooling off" period of an audit partner or A "cooling off" period of an audit partner or manager before taking a high-level position with manager before taking a high-level position with an audit clientan audit client

Increased disclosure of material "off-balance Increased disclosure of material "off-balance sheet" transactions or agreementssheet" transactions or agreements

Requires the GAO to make a study a of Requires the GAO to make a study a of accounting issues of the effect of consolidation accounting issues of the effect of consolidation on competition within the accounting profession, on competition within the accounting profession, and an analysis of mandatory audit firm rotationand an analysis of mandatory audit firm rotation

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Prohibited Services to Audit ClientsProhibited Services to Audit Clients

Bookkeeping and related servicesBookkeeping and related servicesDesign or implementation of financial information Design or implementation of financial information

systemssystemsAppraisal or valuation servicesAppraisal or valuation servicesActuarial servicesActuarial servicesInternal audit outsourcing Internal audit outsourcing Management or human resources services Management or human resources services Investment or broker/dealer services Investment or broker/dealer services Legal and expert services (unrelated to the audit) Legal and expert services (unrelated to the audit)

Professional service firms may provide client tax Professional service firms may provide client tax services (with some restrictions) and other non-services (with some restrictions) and other non-prohibited services to audit clients if the prohibited services to audit clients if the company’s audit committee has approved them company’s audit committee has approved them in advance.in advance.

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Powers Granted to the Powers Granted to the PCAOBPCAOB

Set Auditing StandardsSet Auditing StandardsSet Financial Accounting StandardsSet Financial Accounting StandardsSet Internal Control and Risk Management Set Internal Control and Risk Management

Reporting StandardsReporting StandardsPerform Quality Reviews and Recommend Perform Quality Reviews and Recommend

PenaltiesPenaltiesEstablish Quality Control Standards for the Establish Quality Control Standards for the

Audits of Public CompaniesAudits of Public CompaniesRequire Registration of Public Accounting Require Registration of Public Accounting

Firms doing audits of public companies for Firms doing audits of public companies for license to perform such auditslicense to perform such audits

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Types of AuditsTypes of Audits

Operational

Compliance

Financial Statement

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Types of AuditorsTypes of Auditors

Financial (External Auditors/CPAs)Financial (External Auditors/CPAs)Ensure that financial statements are accurate.Ensure that financial statements are accurate.

Operational (Internal and Governmental Operational (Internal and Governmental Auditors/CIAs)Auditors/CIAs)Improve operational Improve operational economyeconomyImprove operational Improve operational efficiencyefficiency

Compliance (Internal and Governmental Compliance (Internal and Governmental Auditors)Auditors)Ensure compliance with company and/or governmental rules and Ensure compliance with company and/or governmental rules and

regulationsregulations

Forensic (Fraud Auditors/CFEs)Forensic (Fraud Auditors/CFEs) Most audits are a combination of financial, Most audits are a combination of financial,

operational, and compliance audits.operational, and compliance audits.

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PCAOB Management AssertionsPCAOB Management Assertions

Existence or OccurrenceExistence or Occurrence – Assets included in – Assets included in accounts exists and events that give rise to accounts exists and events that give rise to transactions have taken placetransactions have taken place

Rights and Obligations- Rights and Obligations- Entity has a legal claim Entity has a legal claim on all assets and revenues reported and has a on all assets and revenues reported and has a legal responsibility for all liabilities and expenseslegal responsibility for all liabilities and expenses

CompletenessCompleteness - All transactions have been - All transactions have been recordedrecorded

Valuation or AllocationValuation or Allocation – Transactions are – Transactions are recorded at the correct amount in the proper recorded at the correct amount in the proper periodperiod

Presentation and DisclosurePresentation and Disclosure – All accounts are – All accounts are presented in the appropriate place and all presented in the appropriate place and all information required has been disclosed in the information required has been disclosed in the statements and footnotesstatements and footnotes..

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Management AssertionsManagement Assertions ( (ABSABS))

Events and Transaction AssertionsEvents and Transaction Assertions OccurrenceOccurrence – Events giving rise to transactions – Events giving rise to transactions

have taken placehave taken place

Completeness and cutoffCompleteness and cutoff - - All transactions All transactions have been recorded and are recorded in the have been recorded and are recorded in the appropriate periodappropriate period

Accuracy Accuracy – – Transactions are recorded at the correct amount

ClassificationsClassifications – – Transactions have posted to Transactions have posted to the proper accountthe proper account

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Management AssertionsManagement Assertions ( (ABSABS))

Account Balance AssertionsAccount Balance Assertions Existence – Existence – Balances include only assets and Balances include only assets and

liabilities that existliabilities that exist

Rights and obligationsRights and obligations - - Entity has legal claim on all assets and revenues reportedEntity has a legal responsibility for all liabilities Entity has a legal responsibility for all liabilities

and expensesand expenses

CompletenessCompleteness – – Balances include all items Balances include all items which should be included according to GAAPwhich should be included according to GAAP

Accuracy and valuationAccuracy and valuation – –Balances included Balances included items recorded in the proper period at the proper items recorded in the proper period at the proper amount in accordance with GAAPamount in accordance with GAAP

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Management’s Financial Statement Management’s Financial Statement Assertions (ASB)Assertions (ASB)

Assertions about Presentation and DisclosuresAssertions about Presentation and DisclosuresOccurrence and rights and obligationsOccurrence and rights and obligations – items – items

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

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

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

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

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Exhibit 1.5Exhibit 1.5Example Assertions and their Relationships to Example Assertions and their Relationships to

the Financial Statementsthe Financial Statements

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Management AssertionsManagement Assertions

Financial statements issued by management contain explicit and implicit assertions.

Transactions

Management asserts that transactions

related to inventory actually occurred.

Account Balances

Management asserts that the entity owns

the inventory represented in the inventory account.

Presentation & Disclosure

Management asserts that the financial

statements properly classify and present

the inventory.

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Questions to AskQuestions to Ask

What do I need to know?What do I need to know?

How well do I know it?How well do I know it?

Does it make sense?Does it make sense?

What can go wrong?What can go wrong?

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Professional SkepticismProfessional Skepticism

Professional skepticism - auditor’s Professional skepticism - auditor’s questioning, evaluative, attitude toward questioning, evaluative, attitude toward evidenceevidenceManagement’s assertions without sufficient corroboration.Management’s assertions without sufficient corroboration.Financial trends need investigationFinancial trends need investigationDocuments are checked for authenticity or alterationDocuments are checked for authenticity or alterationAsk questions, get answers, then verify the answers.Ask questions, get answers, then verify the answers.

A potential conflict of interest always exists A potential conflict of interest always exists between the auditor and the client.between the auditor and the client.Management wants to portray the company and its operations in the Management wants to portray the company and its operations in the

best possible light.best possible light.Auditors want to portray the company and its operations fairly.Auditors want to portray the company and its operations fairly.

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CPAs Encouraged to ConductCPAs Encouraged to ConductThemselves at a High LevelThemselves at a High Level

LegalLegalLiabilityLiability

Division ofDivision ofCPA firmsCPA firms

ContinuingContinuingEducationEducation

RequirementsRequirements

GAAS andGAAS andInterpretationsInterpretations

Code ofCode ofProfessionalProfessional

ConductConduct

CPACPAExaminationExamination

QualityQualityControlControl

PeerPeerReviewReview

PCAOBPCAOBand SECand SEC

Conduct ofConduct ofCPA FirmCPA FirmPersonnelPersonnel

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Professional/Regulatory Professional/Regulatory OrganizationsOrganizations

SECSEC --- oversees the PCAOB and all companies --- oversees the PCAOB and all companies

publicly traded on the U.S. capital marketspublicly traded on the U.S. capital markets

AICPAAICPA --- primary governing organization of the --- primary governing organization of the

public accounting profession public accounting profession

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Professional/Regulatory Professional/Regulatory OrganizationsOrganizations

State Boards of AccountancyState Boards of Accountancy --- responsible --- responsible for certifying and licensing CPAs in their for certifying and licensing CPAs in their state. state.

Institute of Internal AuditorsInstitute of Internal Auditors --- issues internal --- issues internal auditing standards and administers the auditing standards and administers the Certified Internal Auditor programCertified Internal Auditor program

U. S. General Accounting OfficeU. S. General Accounting Office --- --- nonpartisan audit agency for Congress. The nonpartisan audit agency for Congress. The GAO develops auditing standards for GAO develops auditing standards for governmental audits.governmental audits.

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Other PartiesOther Parties

FASBFASBSets GAAP for entities other than federal, state and Sets GAAP for entities other than federal, state and

local governmentslocal governments

GASBGASBStandards of financial accounting for state and local Standards of financial accounting for state and local

government entitiesgovernment entities

FASABFASABAccounting standards for the US governmentAccounting standards for the US government

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Purpose: to assist in providing investors Purpose: to assist in providing investors with reliable information upon which to with reliable information upon which to make investment decisions.make investment decisions.

Securities and Exchange Securities and Exchange CommissionCommission

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Forms S-1 to S-16Forms S-1 to S-16

Securities and Exchange Securities and Exchange CommissionCommission

Form 8-KForm 8-K

Form 10-KForm 10-K

Form 10-QForm 10-Q

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AICPA’s Traditional RoleAICPA’s Traditional Role

Establish Standards --- Now only Establish Standards --- Now only private companiesprivate companies

Research and PublicationResearch and Publication

Continuing Professional EducationContinuing Professional Education

Self-RegulationSelf-Regulation

CPA ExaminationCPA Examination

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Establishes Standards--ExamplesEstablishes Standards--Examples

AICPA Auditing Standards BoardAICPA Auditing Standards BoardIssues official pronouncements on auditing matters for Issues official pronouncements on auditing matters for

nonpublic companies (“nonissuers”)nonpublic companies (“nonissuers”)

Statements on Auditing Standards (SASs)Statements on Auditing Standards (SASs)

Statements on Standards for Attestation Engagements Statements on Standards for Attestation Engagements (SSAEs)(SSAEs)

Accounting and Review Services Accounting and Review Services CommitteeCommitteeStatements on Standards for Accounting and Review Statements on Standards for Accounting and Review

Services (SSARS)Services (SSARS)

Standards for compilations or reviews not audits of Standards for compilations or reviews not audits of financial statementsfinancial statements

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Research and PublicationResearch and Publication

MagazinesMagazinesJournal of Accountancy (Monthly)Journal of Accountancy (Monthly)

The Tax AdvisorThe Tax Advisor

Audit PublicationsAudit PublicationsIndustry Audit and Accounting GuidesIndustry Audit and Accounting Guides

Audit Risk AlertsAudit Risk Alerts

Auditing Practice ReleasesAuditing Practice Releases

Other PublicationsOther PublicationsAccounting Research StudiesAccounting Research Studies

Statements of Position Statements of Position

Accounting Trends & TechniquesAccounting Trends & Techniques

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Professional RegulationProfessional Regulation

Development of CPE ProgramsDevelopment of CPE Programs

AICPAAICPA

State SocietiesState Societies

Other Professional OrganizationsOther Professional Organizations

Code of Professional ConductCode of Professional Conduct – Ethical Rules – Ethical Rules for CPAsfor CPAs

Membership requirements of the AICPAMembership requirements of the AICPA

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CPA ExamCPA Exam

National exam prepared and graded by the National exam prepared and graded by the AICPAAICPA

ComputerizedComputerizedFour Parts Four Parts

Auditing and Attestation—4. hrsAuditing and Attestation—4. hrsFinancial Accounting and Reporting—4 hrsFinancial Accounting and Reporting—4 hrsRegulation—3 hrs.Regulation—3 hrs.Business Environment—3 hrsBusiness Environment—3 hrs

Skill Sets—Research, Communication, Skill Sets—Research, Communication, Analysis, Analysis, Judgment,Judgment, Understanding Understanding

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Organization of the Organization of the ProfessionProfession

“Big Four” Accounting FirmsD&T, E&Y, KPMG, PWC

National Grant Thornton, BDO Seidman, Tilly Baker

Local/Regional Clifton Gunderson, C.P.A.

Wipfile, C.P.A.

Sole Proprietor

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Public Accounting Public Accounting Professional ServicesProfessional Services

Assurance ServicesAudit Engagements

Assurance Engagements

Attestation Engagements

Compilations

Reviews

Tax Consulting Services

Consulting Services

Litigation Support

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Professional Service Firm Professional Service Firm OrganizationOrganization

Executive CommitteeManaging Partner

Practice OfficesPartners-in-Charge

Consulting Services

Audit, Assurance and Business Advisory

Services

Tax ConsultingServices

Partner

ManagerManager Manager

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

Partner

ManagerManager Manager

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

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Firm Organizational StructureFirm Organizational Structure

ProprietorshipProprietorship

General PartnershipGeneral Partnership

General CorporationGeneral Corporation

Professional CorporationProfessional Corporation

Limited Liability CompanyLimited Liability Company

Limited Liability PartnershipLimited Liability Partnership

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Typical Structure of a National Typical Structure of a National CPA FirmCPA Firm

Partners

Managers

Seniors

Staff

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Hierarchy of a TypicalHierarchy of a TypicalCPA FirmCPA Firm

LevelLevel ExperienceExperience ResponsibilitiesResponsibilities

StaffStaffAssistantAssistant 0-2 years0-2 years Performs most of thePerforms most of the

detailed audit workdetailed audit work

Senior orSenior orIn-ChargeIn-ChargeAuditorAuditor

2-5 years2-5 yearsResponsible for the auditResponsible for the auditfield work, includingfield work, includingsupervising staff worksupervising staff work

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Hierarchy of a TypicalHierarchy of a TypicalCPA FirmCPA Firm

LevelLevel ExperienceExperience ResponsibilitiesResponsibilities

ManagerManager 5-10 years5-10 yearsHelps the plan, managesHelps the plan, managesthe audit, reviews work,the audit, reviews work,and works with the clientand works with the client

PartnerPartner 10+ years10+ yearsReviews audit work andReviews audit work andmakes significant auditmakes significant auditdecisionsdecisions

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Requirements to Become Requirements to Become Certified!Certified!

EducationEducation

ExaminationExamination

ExperienceExperience

State Certificate and License for CPA

Skills sets and your educationSkills sets and your education

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End of Chapter 1End of Chapter 1