Chapter 1 – Auditing and Assurance Services

Presentation Outline

I. The Demand for Reliable InformationII. Understanding Assurance Services

III. Management AssertionsIV. Sarbanes-Oxley Act of 2002

V. Becoming a CPA

I. The Demand for Reliable Information

A. Understanding a Client’s BusinessB. Environmental Conditions

C. Information Risk

A. Understanding a Client’s Business

Business risk is the risk that an entity will

fail to meet its objectives.

Failing to reach objectives can

eventually result in temptation to misstate financial statements to avoid business

failure.

B. Environmental Conditions• Complexity – Decisions makers

are not trained to collect, compile, and summarize the key operating

information themselves.• Remoteness – Investors are not

able to personally visit locations to check on investments.

• Time sensitivity – Decisions must often be made on a moment’s

notice.• Consequences – A drop in investment value can wipe out

one’s life savings.

I lost my savings in a

bad investment!

C. Information Risk Information risk is the

probability that the information circulated by a company will be false or

misleading. Client management has an

incentive to make the business appear better than

it actually may be. This can create a conflict of

interest between client management and investors.

Financial Statements

II. Understanding Assurance Services

A. Definition of Assurance Services B. Definition of Attestation Services

C. Definition of AuditingD. Overview of Financial Statement AuditingE. Graphical Representation of Assurance

Services

A. Assurance Service Elements

Assurance services are (1) independent (2) professional services that (3) improve the quality of information, or its context, (4) for decision makers. Assurance services include many areas of information, including

nonfinancial areas.(See examples on page 7 of text)

B. Definition of Attestation Services

Attestation involves an engagement resulting in the issuance of a report on subject matter or an

assertion about the subject matter that is the responsibility of another

party. Auditing is a specific type

of attestation.(See examples on p. 6 of

text)

C. Definition of Auditing(See Auditing Insight on p. 5 of text)

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).

D. Overview of Financial Statement Auditing

E. Graphical Representation of Assurance Services

The Relationships Among Auditing, Attestation, and Assurance Engagements

Assurance ServicesAny Information

Attestation ServicesPrimarily Financial Information

AuditingFinancial Statements

III. Management Assertions

A. Presentation and DisclosureB. Existence or OccurrenceC. Rights and Obligations

D. CompletenessE. Valuation or Allocation

A. Presentation and Disclosure

Footnote disclosure of important accounting policies must be relevant and

reliable.Transactions must be classified in the

correct accounts.Information must be transparent (i.e.,

understandable to a reasonably sophisticated person).

B. Existence or Occurrence

Assets, liabilities, and equities on the balance sheet actually exist.

Each of the revenue and expense transactions actually occurred.

C. Rights and Obligations

Amounts reported as assets of the company represent its property rights.

Amounts reported as liabilities represent its obligations.

D. CompletenessAll transactions, events, assets, liabilities, and equities

that should have been recorded have been recorded.All disclosures that should have been discussed in the

footnotes are there.

Cutoff refers to accounting for revenue, expense, and other transactions in the proper period (neither

postponing some recordings to the next period (i.e., completeness) nor accelerating next period’s

transactions into the current year accounts (i.e., existence or occurrence)). The cutoff date refers to

the client’s year-end balance sheet date.

E. Valuation or Allocation

Determine whether proper values have been assigned to assets, liabilities, and

equities.Examples include collectibility of

receivables, recalculating depreciation, obtaining lower of cost or market data, etc.

IV. Sarbanes-Oxley Act of 2002(SOX)

A. Major Provisions of Sarbanes-OxleyB. Management Responsibility Under SOX

C. Prohibited Services to Audit Clients

A. Major Provisions of Sarbanes-OxleyCongress passed the Sarbanes-Oxley Act in an attempt

to address a number of weaknesses found in corporate financial reporting in the wake of the recent

accounting scandals. The Act’s major provisions include:

Requirement of CEO/CFO certification of financial statements (Section 302)

Requirement of auditor examination of company internal controls

Creation of the Public Company Accounting Oversight Board (PCAOB) to serve as an auditing profession “watchdog.”

Prohibition of certain client services by firms conducting a client’s audit.

B. Management’s Responsibility Under SOX

One of its most important provisions (Section 302) states that the key company officials must certify the financial statements.

Certification means that 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).

C. Prohibited Services to Audit Clients SOX and the PCAOB prohibit professional service firms from

providing any of the following services to an audit client: bookkeeping and related services

design or implementation of financial information systems

appraisal or valuation services actuarial services

internal audit outsourcing management or human resources services

investment or broker/dealer services 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. SOX prohibits professional service firms from performing any

client services where auditors may find themselves making management decisions or auditing their own firm’s work.

V. Becoming a

A. EducationB. ExaminationC. Experience

Note that successful candidates actually receive a CPA certificatefrom their State Board of Accountancy. Reciprocal CPA certificates for other states are also possible.

A. Education Most states require 150

semester hours of college education to sit for the

exam. Continuing professional

education of 120 contact hours (not college semester or quarter hours) over three year reporting periods with

no less than 20 hours in any one year is a common

requirement in most states.

B. Examination The AICPA Board of Examiners administers the Uniform CPA Exam as a computer-based examination

in four parts 1. Auditing and attestation—4.5 hrs

2. Financial accounting and reporting—4 hrs3. Regulation—3 hrs.

4. Business environment—2.5 hrs Consists of multiple-choice testlets (24-30 questions

each) and simulation problems where students electronically research a solution to a problem.

Revealing exam material can result in certifications being revoked.

Testing is on demand with 75% considered a passing score.

C. Experience Although not a requirement

to sit for the CPA exam, accounting experience

supervised by a competent accountant is required to

become certified. Generally 2 years for persons with a bachelors

degree and 1 year for those with a masters.

Some states require the experience to be in public

accounting.

SummaryAudit process considers business risk,

information risk.Environmental factors result in need for audits.

Understanding assurance, attestation, and auditing

The effect of Sarbanes-Oxley on the audit process.

CPA requirements include education, examination, and experience.