The Demand for Audit The Demand for Audit and Other Assurance and Other Assurance ServicesServices

Chapter 1Chapter 1

Learning Objective 1Learning Objective 1

Describe auditing.Describe auditing.

Nature of AuditingNature of Auditing

AuditingAuditing is the accumulation and evaluation is the accumulation and evaluationof evidence about information to determineof evidence about information to determineand report on the degree of correspondenceand report on the degree of correspondencebetween the information and established criteria.between the information and established criteria.

Auditing should be done by a competent,Auditing should be done by a competent,independent person.independent person.

Information and Established Information and Established CriteriaCriteria

To do anTo do an audit, there must be information in aaudit, there must be information in averifiable formverifiable form and someand some standardsstandards (criteria)(criteria)by which the auditor can evaluate the information.by which the auditor can evaluate the information.

Accumulating Evidence and Accumulating Evidence and Evaluating EvidenceEvaluating Evidence

EvidenceEvidence is any information used by the auditor is any information used by the auditorto determine whether the information beingto determine whether the information beingaudited is stated in accordance with theaudited is stated in accordance with theestablished criteria.established criteria.

Competent, Independent PersonCompetent, Independent Person

The auditor must be qualified to understand theThe auditor must be qualified to understand thecriteria used and must be criteria used and must be competentcompetent to know to knowthe types and amount of evidence to accumulatethe types and amount of evidence to accumulateto reach the proper conclusion after theto reach the proper conclusion after theevidence has been examined.evidence has been examined.

The competence of the individual performingThe competence of the individual performingthe audit is of little value if he or she is biasedthe audit is of little value if he or she is biasedin the accumulation and evaluation of evidence.in the accumulation and evaluation of evidence.

ReportingReporting

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

Audit of a Tax Return ExampleAudit of a Tax Return Example

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

Learning Objective 2Learning Objective 2

Distinguish betweenDistinguish between

auditing and accounting.auditing and accounting.

Distinguish BetweenDistinguish BetweenAuditing and AccountingAuditing and 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.

Learning Objective 3Learning Objective 3

Explain the importanceExplain the importance

of auditing in reducingof auditing in reducing

information risk.information risk.

Economic DemandEconomic Demandfor Auditingfor Auditing

Information risk reflects the possibility thatInformation risk reflects the possibility thatthe information upon which the businessthe information upon which the businessrisk decision was made was inaccurate.risk decision was made was inaccurate.

Auditing can have a significant effectAuditing can have a significant effecton information risk.on information risk.

Learning Objective 4Learning Objective 4

List the causes of informationList the causes of information

risk, and explain how thisrisk, and explain how this

risk may be reduced.risk may be reduced.

Causes of Information RiskCauses of Information Risk

Remoteness of informationRemoteness of information

Biases and motives of the providerBiases and motives of the provider

Voluminous dataVoluminous data

Complex exchange transactionsComplex exchange transactions

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.

Capital Costs to Shrink: Elliott’s Capital Costs to Shrink: Elliott’s ExampleExample

Assuming a cost of capital of 13%, ElliottAssuming a cost of capital of 13%, Elliottestimates this rate is composed of the following:estimates this rate is composed of the following:

5.5% risk-free interest rate5.5% risk-free interest rate

3.5% economic risk premium (business risk)3.5% economic risk premium (business risk)

4.0% information cost (information risk)4.0% information cost (information risk)

Capital Costs to Shrink: Elliott’s Capital Costs to Shrink: Elliott’s ExampleExample

Elliott believes the following factors willElliott believes the following factors willdrastically reduce information risk:drastically reduce information risk:

Advanced technologyAdvanced technology

New accounting and auditing standardsNew accounting and auditing standards

Auditors finding more efficient ways to auditAuditors finding more efficient ways to audit

Learning Objective 5Learning Objective 5

Describe assurance servicesDescribe assurance services

and distinguish audit servicesand distinguish audit services

from other assurance andfrom other assurance and

nonassurance servicesnonassurance services

provided by CPAs.provided by CPAs.

Assurance ServicesAssurance Services

Assurance services are professionalAssurance services are professionalservices that improve the quality ofservices that improve the quality ofinformation for decision makers.information for decision makers.

Assurance services can beAssurance services can beperformed by CPAs or byperformed by CPAs or bya variety of other professionals.a variety of other professionals.

Attestation ServicesAttestation Services

An An attestation serviceattestation service is a type of assurance is a type of assuranceservice in which the CPA firm issues aservice in which the CPA firm issues areport about the reliability of an assertionreport about the reliability of an assertionthat is the responsibility of another party.that is the responsibility of another party.

Attestation ServicesAttestation Services

1. Audit of historical financial statements1. Audit of historical financial statements

2. Effectiveness of internal control over2. Effectiveness of internal control over financial reportingfinancial reporting

3. Review of historical financial statements3. Review of historical financial statements

4. Other attestation services4. Other attestation services

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

Other Assurance ServicesOther Assurance Services

Most of the other assurance services that CPAsMost of the other assurance services that CPAsprovide do not meet the formal definitionprovide do not meet the formal definitionof attestation services.of attestation services.

The CPA is not required to issue a written report.The CPA is not required to issue a written report.

The assurance does not have to be about theThe assurance does not have to be about thereliability of another party’s assertion aboutreliability of another party’s assertion aboutcompliance with specified criteria.compliance with specified criteria.

AICPA Assurance ServicesAICPA Assurance Services

The AICPA formed the Special CommitteeThe AICPA formed the Special Committeeon Assurance Services (SCAS).on Assurance Services (SCAS).

Assurance Services on Assurance Services on Information TechnologyInformation Technology

The growth of the Internet and new waysThe growth of the Internet and new waysof conducting business electronicallyof conducting business electronically((e-commercee-commerce) is driving the demand) is driving the demandfor other assurance services.for other assurance services.

Assurance Services on Assurance Services on Information TechnologyInformation Technology

WebTrustWebTrust is an attestation service, and theis an attestation service, and theWebTrustWebTrust seal is a symbolic representationseal is a symbolic representationof the CPA’s report on management’sof the CPA’s report on management’sassertions about its disclosure ofassertions about its disclosure ofelectronic commerce practices.electronic commerce practices.

Assurance Services on Assurance Services on Information TechnologyInformation Technology

SysTrustSysTrust is an attest-type engagement is an attest-type engagementto evaluate and test system reliability into evaluate and test system reliability inareas such as security and data integrity.areas such as security and data integrity.

Principles for Principles for WebTrustWebTrust and and SysTrustSysTrust Services Services

1. Online privacy1. Online privacy2. Security2. Security3. Processing integrity3. Processing integrity4. Availability4. Availability5. Confidentiality5. Confidentiality6. Certification authorities (6. Certification authorities (WebTrustWebTrust only) only)

Other AssuranceOther AssuranceServices ExamplesServices Examples

Controls over and risks related to investments,Controls over and risks related to investments,including policies related to derivatives…including policies related to derivatives…

assessing the processes in a company’sassessing the processes in a company’sinvestment practices to identify risks and toinvestment practices to identify risks and todetermine the effectiveness of those processes.determine the effectiveness of those processes.

Other AssuranceOther AssuranceServices ExamplesServices Examples

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

assessing security risks and relatedassessing security risks and relatedcontrols over data and other informationcontrols over data and other informationstored electronically, including thestored electronically, including theadequacy of backup and off-site storage.adequacy of backup and off-site storage.

Other AssuranceOther AssuranceServices ExamplesServices Examples

Fraud and illegal acts risk assessment…Fraud and illegal acts risk assessment…

developing fraud risk profiles and assessing thedeveloping fraud risk profiles and assessing theadequacy of company systems and policies inadequacy of company systems and policies inpreventing and detecting fraud and illegal acts.preventing and detecting fraud and illegal acts.

Other AssuranceOther AssuranceServices ExamplesServices Examples

Compliance with trading policies and proceduresCompliance with trading policies and procedures

Compliance with entertainment royalty agreementsCompliance with entertainment royalty agreements

ISO 900 certificationISO 900 certification

Environmental auditEnvironmental audit

Assurance, Attestation, and Assurance, Attestation, and Nonassurance ServicesNonassurance Services

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

Assurance, Attestation, and Assurance, Attestation, and Nonassurance ServicesNonassurance Services

CertainCertainManagementManagementConsultingConsulting

NONASSURANCE SERVICESNONASSURANCE SERVICES

Other ManagementOther ManagementConsultingConsulting

TaxTaxServicesServices

Accounting andAccounting andBookkeepingBookkeeping

Learning Objective 6Learning Objective 6

Differentiate the threeDifferentiate the three

main types of audits.main types of audits.

Types of AuditsTypes of Audits

Operational AuditOperational Audit

ExampleExample Evaluate computerized payroll systemEvaluate computerized payroll systemfor efficiency and effectivenessfor efficiency and effectiveness

InformationInformation Number of records processed, costs ofNumber of records processed, costs ofthe department, and number of errorsthe department, and number of errors

EstablishedEstablishedCriteriaCriteria

Company standards for efficiency andCompany standards for efficiency andeffectiveness in payroll departmenteffectiveness in payroll department

AvailableAvailableEvidenceEvidence

Error reports, payroll records, andError reports, payroll records, andpayroll processing costspayroll processing costs

Compliance AuditCompliance Audit

ExampleExample Determine whether bank requirementsDetermine whether bank requirementsfor loan continuation have been metfor loan continuation have been met

InformationInformation Company recordsCompany records

EstablishedEstablishedCriteriaCriteria Loan agreement provisionsLoan agreement provisions

AvailableAvailableEvidenceEvidence

Financial statements andFinancial statements andcalculations by the auditorcalculations by the auditor

Financial Statement AuditFinancial Statement Audit

ExampleExample Annual audit of Boeing’sAnnual audit of Boeing’sfinancial statementsfinancial statements

InformationInformation Boeing's financial statementsBoeing's financial statements

EstablishedEstablishedCriteriaCriteria

Generally accepted accountingGenerally accepted accountingprinciplesprinciples

AvailableAvailableEvidenceEvidence

Documents, records, and outsideDocuments, records, and outsidesources of evidencesources of evidence

Learning Objective 7Learning Objective 7

Identify the primaryIdentify the primary

types of auditors.types of auditors.

Types of AuditorsTypes of Auditors

Internal auditorsInternal auditors

Certified public accounting firmsCertified public accounting firms

Internal revenue agentsInternal revenue agents

General accounting office auditorsGeneral accounting office auditors

Learning Objective 8Learning Objective 8

Describe the requirementsDescribe the requirements

for becoming a CPA.for becoming a CPA.

Three Requirements forThree Requirements forBecoming a CPABecoming a CPA

Educational requirementEducational requirement

Uniform CPA examination requirementUniform CPA examination requirement

Experience requirementExperience requirement

CPA Examination SectionsCPA Examination Sections

Auditing and AttestationAuditing and Attestation

Financial Accounting and ReportingFinancial Accounting and Reporting

RegulationRegulation

Business Environments and ConceptsBusiness Environments and Concepts

End of Chapter 1End of Chapter 1