arens14e ch01 ppt
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©2012 Prentice Hall Business Publishing, ©2012 Prentice Hall Business Publishing, Auditing 14/e,Auditing 14/e, Arens/Elder/Beasley Arens/Elder/Beasley 1 - 1 - 11
The Demand for Audit and The Demand for Audit and Other Assurance ServicesOther Assurance Services
Chapter 1Chapter 1
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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
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Adelphia
Enron
Tyco
WorldCom
Sarbanes-Oxley ActSarbanes-Oxley Act
The Act established the Public CompanyAccounting Oversight Board.
It also requires auditors to report on the effectiveness of internal control over financial reporting.
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Learning Objective 1Learning Objective 1
Describe auditing.Describe auditing.
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Nature of AuditingNature of Auditing
Auditing is the accumulation and evaluationof evidence about information to determineand report on the degree of correspondencebetween 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
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Information and Established Information and Established CriteriaCriteria
To do an audit, there must be information in averifiable form and some standards (criteria)by which the auditor can evaluate the information.
IASBFASBCriteria
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Auditors routinely perform audits of quantifiable information, including companies’ financial statementsand individuals’ federal income tax returns.
They also audit more subjective information, such as the effectiveness of computer systems and efficiencyof manufacturing operations
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Information and Established Information and Established CriteriaCriteria
The criteria for evaluating The criteria for evaluating information also vary depending on information also vary depending on the information being audited.the information being audited.
In the audit of historical financial In the audit of historical financial statements by CPA firms, the criteria statements by CPA firms, the criteria may be GAAP or IFRSmay be GAAP or IFRS
For more subjective information it is For more subjective information it is more diffucult to establish criteriamore diffucult to establish criteria
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Accumulating Evidence and Accumulating Evidence and Evaluating Evidence Evaluating Evidence
Evidence is any information used by the auditorto determine whether the information beingaudited is stated in accordance with theestablished criteria.
Client inquiry
Written andelectronic
Communications with outsiders
Observations
Transaction data
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Accumulating Evidence and Accumulating Evidence and Evaluating Evidence Evaluating Evidence
Evidence takes many different forms Evidence takes many different forms including;including;– electronic and documentary data about electronic and documentary data about
transactionstransactions– written communication with outsiderswritten communication with outsiders– observations by the auditorobservations by the auditor– oral testimony of the auditee (client)oral testimony of the auditee (client)
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Competent, Independent Competent, Independent PersonPerson
The auditor must be qualified to understand thecriteria used and must be competent to knowthe types and amount of evidence to accumulateto reach the proper conclusion after theevidence has been examined.
The competence of the individual performingthe audit is of little value if he or she is biasedin the accumulation and evaluation of evidence.
The auditor must also have an independent mentalattitude
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Competent, Independent Competent, Independent PersonPerson
Judgment and Experience
Evaluation of Evidence
Competence
Proper Conclusion
Independence
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Competent, Independent Competent, Independent PersonPerson
Auditors strive to maintain a high level Auditors strive to maintain a high level of independence to keep the confidence of independence to keep the confidence of users relying on their reportsof users relying on their reports
Auditors reporting on company financial Auditors reporting on company financial statements are often called statements are often called independent auditorsindependent auditors
Even though such auditors are paid fees Even though such auditors are paid fees by the company, they are normally by the company, they are normally sufficiently independent to conduct sufficiently independent to conduct auditsaudits
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Audit ReportAudit Report
The final stage in the auditing process ispreparing the Audit Report, which is thecommunication of the auditor’s findings to users.
Results differ in nature, but all must inform readersof the degree o correspondence between information and established criteria.
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To the Board of Directors and Stockholders ofABC Corporation and SubsidiariesAnywhere, USAWe 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 LLPAnywhere, USAFebruary 28, 2011
The final step communicates the findings to users.
Audit ReportAudit Report
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Audit of a Tax Return Audit of a Tax Return ExampleExample
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Learning Objective 2Learning Objective 2
Distinguish between auditingDistinguish between auditing
and accounting.and accounting.
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Distinguish BetweenDistinguish BetweenAuditing and AccountingAuditing and Accounting
Accounting is the recording, classifying,and summarizing of economic eventsfor the purpose of providing financialinformation used in decision making.
Auditing is determining whetherrecorded information properlyreflects the economic events thatoccurred during the accounting period.
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Learning Objective 3Learning Objective 3
Explain the importance of auditingExplain the importance of auditing
in reducing information risk.in reducing information risk.
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Economic DemandEconomic Demand for Auditingfor Auditing
Information risk reflects the possibility thatthe information upon which the businessrisk decision was made was inaccurate.
Auditing can have a significant effecton information risk.
To illustrate the need for auditing, considerthe decision of a bank officer in making aloan to a business…(Risk-free interest rate, business risk for the customer,İnformation risk…
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Learning Objective 4Learning Objective 4
List the causes of information risk, and List the causes of information risk, and explain how this risk may be explain how this risk may be
reduced.reduced.
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Causes of Information RiskCauses of Information Risk Remoteness of informationWhen information is obtained from others,likelihood of it being intentionally or unintentionally misstated increases Biases and motives of the providerIf information is provided by someone whose goals areİnconsistent with those of the decision maker, the İnformation may be biased in favor of the provider Voluminous dataAs organizations become larger, so does the volume of theirexchange transactions. This increases the likelihood that İmproperly recorded information is included in the records Complex exchange transactions
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Reducing Information RiskReducing Information Risk
User verifies information
User shares information risk with management
Audited financial statements are provided
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Reducing Information RiskReducing Information Risk User verifies informationThe user may go to the business premises to examine records and obtain information about the reliability of the statements
User shares information risk with managementIf users rely on inaccurate financial statements and as a result incur a financial loss, they may have basis for a lawsuit against managementBut users may not be able to collect on losses
Audited financial statements are providedThe most common way for users to obtain reliable informationİs to have an independent audit
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Relationships Among Relationships Among Auditors, Client, and Auditors, Client, and
External UsersExternal Users
Auditor
ClientExternalUsers
Client or auditcommittee hires
auditor
Auditor issuesreport relied
upon by users to reduce information risk
Provides capital
Client provides financial statements to users
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Learning Objective 5Learning Objective 5
Describe assurance services and Describe assurance services and distinguish audit services from other distinguish audit services from other assurance and non-assurance assurance and non-assurance services provided by CPAs.services provided by CPAs.
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Assurance ServicesAssurance ServicesAn independent professional service that improves thequality of information for decision makers.
Can be performed by CPAs or by a variety of other professionals
Individuals who are responsible for making businessdecisions seek assurance services to help improve the reliability and relevance of the information used
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Assurance ServicesAssurance Services
CPAs have provided many assurance CPAs have provided many assurance services for years, particularly services for years, particularly assurances about historical financial assurances about historical financial statementsstatements
They have also performed assurance They have also performed assurance services related to lotteries and contests services related to lotteries and contests to provide assurance that winners were to provide assurance that winners were determined in an unbiased fashion in determined in an unbiased fashion in accordance with contest rulesaccordance with contest rules
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Attestation ServicesAttestation Services
A type of assurance service
CPA reports on the reliability of an assertion
That is the responsibility of another party.
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Attestation ServicesAttestation Services
Historical Financial
Statements
1. Audit 3. Review3. Review
2. Internal Control over
Financial Reporting
4. Information 4. Information TechnologyTechnology
5. Other
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1. Audit of historical financial statements
The auditor issues a written report The auditor issues a written report expressing an opinion about whether expressing an opinion about whether the financial statements are fairly the financial statements are fairly stated in accordance with the stated in accordance with the applicable accounting standards.applicable accounting standards.
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2. Audit of Internal Control over Financial Reporting
Management asserts that internal controls Management asserts that internal controls have been developed and implemented have been developed and implemented following well established criteriafollowing well established criteria
Section 404 of the SOX act requires public Section 404 of the SOX act requires public companies to report management’s companies to report management’s assessment of the effectiveness of controlassessment of the effectiveness of control
The act also requires auditors to attest to The act also requires auditors to attest to the effectiveness of internal control over the effectiveness of internal control over financial reportingfinancial reporting
This evaluation increases user confidence This evaluation increases user confidence about future financial reportingabout future financial reporting
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3. Review of Historical Financial Statements
Management asserts that the Management asserts that the statements are fairly stated in statements are fairly stated in accordance with accounting standardaccordance with accounting standard
The CPA provides only a moderate The CPA provides only a moderate level of assurance for reviews of level of assurance for reviews of financial statements, compared to a financial statements, compared to a high level for audits, therefore less high level for audits, therefore less evidence is neededevidence is needed
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4. Attestation Services on Information Technology
WebTrust and SysTrust also meet the criteria of attestation service
Management makes various assertions about the reliability and security of electronic information
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5. Other Assurance Services
Most of the other assurance services that CPAsprovide do not meet the formal definitionof attestation services.
The CPA is not required to issue a written report.
The assurance does not have to be about thereliability of another party’s assertion aboutcompliance with specified criteria.
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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.
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Other Assurance Services Examples
Assess risks of accumulation, distribution,and storage of digital information…
assessing security risks and relatedcontrols over data and other informationstored electronically, including theadequacy of backup and off-site storage.
including
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Other Assurance Services Examples
Compliance with trading policies and procedures
Compliance with entertainment royalty agreements
ISO 900 certification
Environmental audit
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Nonassurance Services Nonassurance Services Provided by CPAsProvided by CPAs
1. Accounting and bookkeeping services
2. Tax services
3. Management consulting services
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Assurance, Attestation, and Nonassurance Services
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Learning Objective 6Learning Objective 6
Differentiate the three main types of Differentiate the three main types of audits.audits.
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Types of AuditsTypes of Audits
Operational
Compliance
Financial Statement
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Operational AuditOperational AuditEvaluates the efficiency and effectiveness Evaluates the efficiency and effectiveness
of any part of an organization’s operating of any part of an organization’s operating procedures and methodsprocedures and methods
At the end, management normally At the end, management normally expects recommendations for improving expects recommendations for improving operationsoperations
The reviews are not limited to accounting.The reviews are not limited to accounting.They can include the evaluation of They can include the evaluation of
organizational structure, computer organizational structure, computer operations, production methods…operations, production methods…
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Operational AuditOperational Audit
It is impossible to characterize the It is impossible to characterize the conduct of a typical operational auditconduct of a typical operational audit
It is more diffucult to objectively It is more diffucult to objectively evaluate whether the efficiency and evaluate whether the efficiency and effectiveness of operations meets effectiveness of operations meets established criteria than it is for established criteria than it is for compliance and financial statement compliance and financial statement auditsaudits
In this sense operational audit is more In this sense operational audit is more like management consultinglike management consulting
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Operational AuditOperational Audit
ExampleEvaluate computerized payroll systemfor efficiency and effectiveness
InformationNumber of records processed, costs ofthe department, and number of errors
EstablishedCriteria
Company standards for efficiency andeffectiveness in payroll department
AvailableEvidence
Error reports, payroll records, andpayroll processing costs
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Compliance AuditCompliance Audit
Conducted to determine whether the Conducted to determine whether the auditee is follow,ng specific procedures, auditee is follow,ng specific procedures, rules, or regulations set by some higher rules, or regulations set by some higher authorityauthority
Governmental units, such as school Governmental units, such as school districts are subject to considerable districts are subject to considerable compliance auditing because of extensive compliance auditing because of extensive government regulationgovernment regulation
Results of compliance audit is typically Results of compliance audit is typically reported to managementreported to management
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Compliance AuditCompliance Audit
ExampleDetermine whether bank requirementsfor loan continuation have been met
Information Company records
EstablishedCriteria
Loan agreement provisions
AvailableEvidence
Financial statements andcalculations by the auditor
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Financial Statement AuditFinancial Statement Audit
Conducted to determine whether the Conducted to determine whether the financial statements are stated in financial statements are stated in accordance with specified criteria accordance with specified criteria (GAAP or IFRS…)(GAAP or IFRS…)
The auditor gathers evidence to The auditor gathers evidence to determine whether the statements determine whether the statements contain material errors or other contain material errors or other misstatementsmisstatements
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Audit of Historical Financial Audit of Historical Financial StatementsStatements
ExampleAnnual audit of Boeing’s financialstatements
Information Boeing's financial statements
EstablishedCriteria
Generally accepted accountingprinciples
AvailableEvidence
Documents, records, and outsidesources of evidence
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XBRL Electronic Data to Improve Financial Reporting
Extensible Business Reporting Language
Enables sorting and comparing of financial data
Public companies required to provide interactivefinancial statement data
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Learning Objective 7Learning Objective 7
Identify the primary types of Identify the primary types of auditors.auditors.
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Types of AuditorsTypes of Auditors
Internal auditors
Independent certified public accounting firms
Internal Revenue agents
Governmental general accounting office auditors
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Learning Objective 8Learning Objective 8
Describe the requirementsDescribe the requirements
for becoming a CPA.for becoming a CPA.
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Three Requirements forThree Requirements forBecoming a CPABecoming a CPA
Educational requirement
Uniform CPA examination requirement
Experience requirement
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CPA Examination SectionsCPA Examination Sections
Auditing and
Attestation
Financial Accounting
And Reporting
Business Environment
and Concepts
Regulation
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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 financialreporting standards.
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Three Requirements for Becoming a CPA
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End of Chapter 1End of Chapter 1