Chapter 1 - The Nature, Purpose, Scope of Audit and

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Chapter 1

The Nature, Purpose, Scope of Audit and


Assurance Services

Copyright © 2014 Pearson Education


Describe auditing.

Distinguish between auditing and


accounting.
Explain the importance of auditing in
reducing information risk.
List the causes of information risk, and
explain how this risk can be reduced.

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Describe assurance services and
distinguish audit services from other
assurance and nonassurance services
provided by CPAs.
Differentiate the three main types of
audits.
Identify the primary types of auditors.

Describe the requirements for becoming a


CPA.
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Describe auditing.

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Nature of Auditing
The Latin meaning of the word “auditor” was
a “hearer or listener”
Auditing is the accumulation and evaluation
of evidence about information to determine
and report on the degree of correspondence
between the information and established
criteria.
Auditing should be done by a competent,
independent person.
Skill
Competence = Qualification
Experience
Judgment
Auditor

Independence :
Competence No bias , No conflict of
interest &/or undue
influence

Evaluation of
Evidence

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Nature of Auditing…
Information in verifiable form
Evidence is any information used by the auditor to
determine whether the information being audited is
stated in accordance with the established criteria.
It may be oral testimony, observations, outsiders or
documents
Established criteria.
Qualified : competent in financial accounting
Independent mental attitude
the audit report : communicates the auditor’s findings
to users.
Accumulating Evidence and
Evaluating Evidence
Example
Observations Inventory Take
Cash Count

Written and Example


electronic A/R ---------Customers
Communications A/P------------Suppliers
with outsiders Cash --------------Bank

Example
Transaction A/R ---------Sales Invoice
data A/P------Purchase Order

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Accumulating Evidence and Evaluating Evidence
One assertion of management about
economic actions is that all the assets
reported on the balance sheet actually exist
at the balance sheet date. (This is the
existence assertion).
management asserts that the company owns
all these assets. They do not belong to
anyone else. (This is the rights and
obligations assertion).
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Distinguish between auditing
and accounting.

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Accounting is the recording, classifying, and
summarizing of economic events for the
purpose of providing financial information
used in decision making.

Auditing is determining whether recorded


information properly reflects the economic
events that occurred during the accounting
period.

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Explain the importance of
auditing
in reducing information risk.
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The Importance of Auditing
It can be said that the function of
auditing is to lend credibility to the
financial statements.
the auditor enhances the usefulness
and the value of the financial
statements, but he also increases the
credibility of other non-audited
information released by
management.
Demand Driver Information risk

Auditing can have a significant effect


on information risk.

What is meant by “Information risk”?

Information risk reflects the possibility that the


information upon which the business risk decision was
made was inaccurate. A likely cause of the information
risk is the possibility of inaccurate financial statements
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List the causes of information
risk, and explain how this
risk can be reduced.

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 Remoteness of information

 Biases and motives of the provider

 Voluminous data

 Complex exchange transactions

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 User verifies information

 User shares information risk with management

 Audited financial statements are provided

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Client or audit Auditor issues
committee hires report relied
auditor
Auditor upon by users to reduce
information risk

Provides capital
External
Client
Users
Client provides financial
statements to users
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Describe assurance services and
distinguish audit services from other
assurance and non-assurance services
provided by CPAs.

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Assurance Services
 An assurance service is an independent
professional service that improves the
quality of information for decision
makers.
 Assurance services can be done by
CPAs or by a variety of other
professionals. For example, Consumers
Union, a non-prof it organization, tests a
wide variety of products used by
consumers and reports their evaluations
of the quality of the products tested in
Consumer Reports.
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Attestation Services
 An attestation service is a type of assurance
service in which the CPA firm issues a report
about a subject matter or assertion that is made
by another party.
 Primary categories of attestation services
include:
1) Audit of historical financial statements
2) Audit of internal control over financial
reporting
3) Review of historical financial statements
4) Other attestation services that may be
applied to a broad range of subject matter
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Attestation Services cont'd…
1) Audit of historical financial
statements
 In an audit of historical financial
statements, management asserts that
the financial statements are fairly
stated in accordance with applicable,
 Audits are designed to provide
reasonable assurance that the
financial statements are free of
material misstatements.
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Attestation Services cont'd…
2) Audit of internal control over financial
reporting
 an audit of internal control over financial
reporting, management asserts that internal
controls have been developed and
implemented
3) Review of historical financial statements
 management asserts that the statements
are fairly stated in accordance with
accounting standards(IFRS), the same as
for audits.
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Attestation Services cont'd…
4) Other attestation services that may be applied to a
broad range of subject matter
 Typically, the CPA is engaged to provide written
assurance about the reliability of an assertion made
by management.
5) Other assurance Services
 These assurance services differ from attestation
services in that the CPA is not required to issue a
written report, and the assurance does not have to be
about the reliability of another party’s assertion
about compliance with specified criteria.
 These other assurance service engagements focus on
improving the quality of information for decision
makers,
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just like attestation services.
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Attestation Services cont'd…

Five
Categories
1. Audit 3. Review
Historical
Financial
Statements

2. Internal
Control over 4. Information
Financial 5. Other
Technology
Reporting

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Most of the other assurance services that CPAs
provide do not meet the formal definition
of attestation services.

The CPA is not required to issue a written report.

The assurance does not have to be about the


reliability of another party’s assertion about
compliance with specified criteria.

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Non-assurance Services provided by CPAs
CPA firms perform numerous other services that generally
fall outside the scope of assurance services. Three specific
examples are:
1) Accounting and bookkeeping services
2) Tax services
3) Management consulting services
Most accounting and bookkeeping services, tax services,
and management consulting services fall outside the
scope of assurance services, although there is similarity
between some consulting and assurance services. While
the primary purpose of an assurance service is to
improve the quality of information, the primary purpose
of a management consulting engagement is to generate a
recommendation to management
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Non-assurance Services provided by CPAs

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Differentiate the three main types
of audits.

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 Operational Audit

 Compliance Audit

 Financial Statement Audit

 Forensic Audit

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Checks efficiency, effectiveness and economy in day to day
activities .
Evaluate computerized payroll system
Example
for efficiency and effectiveness
Number of records processed, costs of
Information
the department, and number of errors
Established Company standards for efficiency and
Criteria effectiveness in payroll department
Available Error reports, payroll records, and
Evidence payroll processing costs
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Determine whether bank requirements
Example
for loan continuation have been met

Information Company records

Established
Loan agreement provisions
Criteria
Available Financial statements and
Evidence calculations by the auditor
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Checks if financial statements are prepared/stated in
accordance with specified criteria(International GAAP/IFRS)
Annual audit of Boeing’s financial
Example
statements

Information Boeing's financial statements

Established
International GAAP/IFRS
Criteria
Available Documents, records, and outside
Evidence sources of evidence
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A forensic audit is an examination and evaluation of a firm's or
individual's financial records to derive evidence that can be used in a court
of law or legal proceeding.

Example Tax evasion investigation

Information ABC International's financial statements

Established Tax regulations


Criteria International GAAP/IFRS
Available Documents, records, and outside
Evidence sources of evidence
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Identify the primary types of
auditors.

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 Certified public accounting firms:
Certified public accounting(CPA) firms are responsible for
auditing the historical financial statements of all publicly
traded companies, most other reasonably large companies,
and many smaller companies and noncommercial
organizations.
Government Accountability Office Auditor
Auditor working for the Government Accountability Office (GAO), a
nonpartisan agency in the legislative branch of the federal government.
Headed by the Comptroller/Audit General, the GAO reports to and is
responsible solely to Congress/House of Peoples Representative

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IRA is responsible for enforcing the federal tax laws as they have been
defined by Congress and interpreted is responsible for enforcing the federal
tax laws as they have been defined by Congress and interpreted by the
courts. A major responsibility of the IRS is to audit taxpayers’ returns to
determine whether they have complied with the tax laws. These audits are
solely compliance audits. The auditors who perform these examinations are
called internal revenue agents.

Internal auditors are employed by all types of organizations to audit for


management with oversight by the board of directors, much as the GAO does for
Congress. Internal auditors’ responsibilities vary considerably, depending on the
employer. To maintain independence from other business functions, the internal
audit group typically reports directly to the president, another high executive
officer, or the audit committee of the board of directors. However, internal auditors
cannot be entirely independent of the entity as long as an employer–employee
relationship
39 exists.
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Describe the requirements
for becoming a Certified
Accountant.

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 Educational requirement

 Uniform CPA examination requirement

 Experience requirement

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Educational Examination
Experience Requirement
Requirement Requirement

An undergraduate or
graduate degree with a
major in business
studies or any other 14 Papers
field Minimum of 3 years as
A person can sit four an audit manager.
Depending on a times a year .
person’s background
the association
provides exemptions
of 4 papers.

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Financial
Auditing Accounting
and And
Attestation Reporting

Business
Environment
Regulation
and
Concepts
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Concept Check
What is meant by determining the degree of correspondence between
information and established criteria? What is the criteria for an audit of a
company’s financial statements?

What are the major causes of information risk? How can information risk be
reduced?

Review Questions
What are the information and established criteria for the audit of Jones
Company’s tax return by an internal revenue agent? What are they for the audit of
Jones Company’s financial statements by a CPA firm?

In the conduct of audits of financial statements, it would be a serious breach of


responsibility if the auditor did not thoroughly understand accounting. However,
many competent accountants do not have an understanding of the auditing
process. What causes this difference?

Discuss changes in accounting and business operations over the last decade
that have
44 increased the need for independent audits.
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Distinguish among the following three factors impacting a loan interest rate:
risk-free interest rate, business risk, and information risk. Which one or ones
does the auditor reduce by performing an audit?

Identify the three main ways information risk can be reduced. What are the
advantages and disadvantages of each?

Explain how the increased use of fair value accounting might increase
information risk.

Explain audit services, attestation services, and assurance services, and give
examples of each.

Describe the nature of the evidence the internal revenue agent will use in the
audit of Jones Company’s tax return.

List five examples of specific operational audits that can be conducted by an


internal auditor in a manufacturing company.

What knowledge does the auditor need about the client’s business in an audit
of historical financial statements? Explain how this knowledge may be useful in
performing other assurance or consulting services for the client.
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