McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter 1 Auditing and Assurance Services

Objectives
1.
2.
3.

4.
5.
6.
7.

Define information risk and explain how auditing and assurance

services play a role in reducing this business risk.
Define and contrast auditing, attestation, and assurance services.
Describe and define the management assertions embodied in financial
statements and explain why auditors use them as a focal point of the
audit.
Explain some characteristics of professional skepticism.
Describe the organization of public accounting firms and identify the
various services they offer.
Describe the audits and auditors in governmental, internal, and
operational auditing.
List and explain the requirements for becoming a certified information
professional.

1-2

User Demand for Reliable Information

Todays information

More complex
Demanded by remote users
Demanded in a more timely manner
Has far reaching consequences

Information risk
the risk (probability) that the information (mainly financial)
disseminated by a company will be materially false or
misleading.
users demand an independent third party assessment of the
information

1-3

Definition of Auditing

Financial Statements
(including footnotes)

Persons who rely on

the financial reports
Creditors
Investors

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
GAAP
and communicating the results to
Auditor's Report/
interested users.
Other Reports

Source: American Accounting Association Committee on Basic Auditing

Concepts. 1973. A Statement of Basic Auditing Concepts, American
Accounting Association (Sarasota, FL).
1-4

Assurance Services
Assurance services are independent professional services
that improve the quality of information, or its context, for
decision makers.
Examples
Consumer reports
Underwriters laboratories
CPA WebTrust
Assistance with XBRL reporting

1-5

Attestation Engagements
An attestation engagement - a practitioner is assesses and
reports on subject matter or an assertion about the subject
matter that is the responsibility of another party.
Some financial attestation engagements (other than audits)
Supplementary financial statistics
Pro forma financial information
Financial forecasts and projections

Some non-financial attestation engagements

Compliance with contractual requirements
Effectiveness of internal control systems
Inventory quantities and locations

1-6

Sarbanes-Oxley Act of 2002

In response to several accounting related corporate
scandals Congress passed the Sarbanes-Oxley Act
The Acts major provisions include:
Requirement of CEO/CFO certification of financial statements
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 clients
audit.

1-7

Sarbanes-Oxley:
Managements Responsibility For Financial Reporting

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

Source: U.S. Congress, Sarbanes-Oxley Act of 2002, Pub. L. 107-204, 116 Stat/ 745
(2002).

1-8

PCAOB Management Assertions

Existence or occurrence Assets included in accounts exists
and events that give rise to transactions have taken place
Rights and obligations- Entity has a legal claim on all assets
and revenues reported and has a legal responsibility for all
liabilities and expenses
Completeness - All transactions have been recorded
Valuation or allocation Transactions are recorded at the
correct amount in the proper period
Presentation and disclosure All accounts are presented in
the appropriate place and all information required has been
disclosed in the statements and footnotes.

1-9

Management Assertions (SAS 106)

Transaction Assertions
Occurrence Events giving rise to transactions have
taken place

Completeness and cutoff - All transactions have

been recorded and are recorded in the appropriate period

Accuracy Transactions are recorded at the correct

amount

Classifications Transactions have posted to the

proper account
1-10

Management Assertions (SAS 106)

Balance Assertions
Existence Balances include only assets exist
Rights and obligations
Entity has legal claim on all assets and revenues reported
Entity has a legal responsibility for all liabilities and
expenses

Completeness Balances include all items

Accuracy and valuation Balances included items
recorded in the proper period at the proper amount

1-11

Management Assertions (SAS 106)

Presentation and Disclosure Assertions
Occurrence and rights and obligations items
presented include information regarding ownership

Completeness - All accounts are included

Classification and understandability
All accounts are appropriately grouped
Users can comprehend statements and disclosures

Accuracy and valuation Statements include proper

measurements
1-12

Professional Skepticism
Professional skepticism - auditors questioning, evaluative,
attitude toward evidence

Managements assertions without sufficient corroboration.

Financial trends need investigation
Documents are checked for authenticity or alteration
Ask questions, get answers, then verify the answers.

A potential conflict of interest always exists between the

auditor and the client.
Management wants to portray the company and its operations in the
best possible light.
Auditors want to portray the company and its operations fairly.
1-13

Professional Service Firm Organization

Executive Committee
Managing Partner
Practice Offices
Partners-in-Charge

Tax Consulting
Services

Audit, Assurance and

Business Advisory
Services

Partner
Manager

Manager

Consulting
Services
Partner

Manager

Senior (In-charge) Accountants

Staff Accountants (or Associates)

Manager

Manager

Manager

Senior (In-charge) Accountants

Staff Accountants (or Associates)

1-14

Prohibited Services to Audit Clients

Sarbanes-Oxley and the PCAOB prohibit professional service firms from

providing any of the following services to an audit client:
1) bookkeeping and related services
2) design or implementation of financial information systems
3) appraisal or valuation services
4) actuarial services
5) internal audit outsourcing
6) management or human resources services
7) investment or broker/dealer services
8) 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
companys audit committee has approved them in advance.
In summary, Sarbanes-Oxley prohibits professional service firms from
performing any client services in which the auditors may find themselves
making management decisions or auditing their own firms work.

1-15

Types of Audits and Auditors

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

Operational (Internal and Governmental Auditors/CIAs)

Improve operational economy
Improve operational efficiency

Compliance (Internal and Governmental Auditors)

Ensure compliance with company and/or governmental rules and
regulations

Forensic (Fraud Auditors/CFEs)

Most audits are a combination of financial, operational, and
compliance audits.

1-16