Auditors Have a Great Responsibility

• Internal auditor Gene Morse found an unsupported entry

for $500 million in computer acquisitions.

• Billions of dollars in fees paid to telephone companies were

recorded as capital assets turning a $662 million loss into a $2.4 billion profit in

2001.• Total amount of fraud discovered at WorldCom amounted to $11 billion.Page 3

Chapter 1The Demand for Audit and Other

Assurance Services

Company Owners

and Lenders

Company Managers

Presentation Outline

I. The Nature of Auditing

II. Auditing and Investor Risk

III. Assurance Services

IV. Requirements for CPA Certification

I. The Nature of Auditing

A. Auditing DefinedB. The Distinction Between Accounting and Auditing

C. Types of AuditsD. Types of Auditors

A. Auditing DefinedAuditor

accumulates and evaluates evidence

to ascertain correspondence between

the informationestablished

criteriaand

and communicates results

to interestedusers

B. The Distinction Between Accounting and Auditing

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.

C. Types of AuditsOperational Audit

Involves evaluation of any part of an organization’s operating efficiency and effectiveness. Not limited to accounting areas.

Compliance AuditDetermine whether the auditee has complied with specific

procedures, rules, or regulations set by some higher authority.

Financial Statement Audit Determine whether overall financial statements are stated in

accordance with specified criteria. Generally accepted accounting principles are normally the

criteria, although other basis of accounting are at times used.

D. Types of Auditors

External or Independent Auditors – CPAs are the only group permitted to provide financial statement audits. Such audits

are required of all publicly traded companies.General Accounting Office Auditor – works for the

Comptroller General who reports to and is solely responsible to Congress. They audit various governmental bodies.

Internal Revenue Agents – evaluate taxpayer compliance with tax laws.

Internal auditors – Auditors who are employees of the companies they audit.

II. Auditing and Investor Risk

A. The Cost of DebtB. Causes of Information Risk

C. Ways of Reducing Information Risk

A. The Cost of Debt

When a bank makes a loan, it will charge a rate of interest determined by primarily three factors:

Risk-free rate – return on U.S. Treasury notes for the term of the business loan.

Business risk for the customer – risk associated with a particular business that may result in it being unable to

repay a loan.Information risk – Improper business risk decisions

resulting from inaccurate information.

Auditing has no effect on either the risk-free rate or

business risk, but it can have a significant effect on information risk!

B. Causes of Information Risk Remoteness of information

– information provided by others must be relied upon.

Biases and motives of the provider – can result from

honest optimism of intentional misstatement.

Voluminous data – the amount of data grows with the organization. Important

details can be lost. Complex exchange transactions – business

transactions are becoming increasingly complex.

WarningThin Ice!

C. Ways of Reducing Information Risk

User verifies information – normally impractical for user to go to business and examine information.

User shares information risk with management – although users may bring suit against management for supplying inaccurate information, it is often difficult to collect on

losses. Provide audited financial statements – most feasible

approach is to have an independent party check for completeness, accuracy, and removal of bias.

III. Assurance Services

A. Assurance Services

B. Attestation Services

C. Other Assurance Services

D. Non-Assurance Services

A. Assurance ServicesDecision makers seek assurance

regarding the reliability information they use to make

decisions.Assurance services are valued

because the assurance provider is perceived as an independent

and unbiased evaluator of information.

Assurance services can be provided by CPAs and a variety

of other professionals.

B. Attestation ServicesMany other assurance services do not meet the criteria of attestation

services: a CPA who issues a report about the reliability of an assertion that is the responsibility of another party. There are

four categories of attestation services.

ASSURANCE SERVICES

ATTESTATION SERVICES

1. Audits of historical financial statements2. Effectiveness of internal control over financial reporting

3. Review of historical financial statements4. Other attestation services

B1. Audits of Historical Financial Statements An audit of historical financial statements is a

form of attestation in which the auditor issues a written

report expressing an opinion about whether the financial statements are in material conformity with generally

accepted accounting principles.

Publicly traded companies in the United States are required to have audits

under the federal securities acts.

Ben JohnsonCertified Public Accountant

B2. Attestation on Internal Control over Financial Reporting

Section 404 of the Sarbanes-Oxley Act requires public

companies to report management’s assessment

of the effectiveness of internal controls over financial reporting.

The Act further requires auditors to attest to the effectiveness of internal control over financial

reporting.

B3. Review of Historical Financial Statements

Many nonpublic companies want to

provide assurance on their financial statements

without incurring the cost of an audit.

In comparison to an audit, less evidence is necessary

to support the level of assurance provided by a

review.

B4. Other Attestation Services

Other attestation services are natural extensions of

financial statement engagements:

Debtor compliance with loan agreement

provisions.Forecasted financial

statements.WebTrust and SysTrust

for Internet sites (see p. 11)

C. Other Assurance Services

Other assurance services differ from those involving attestation in that:

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. (see examples in Table 1-2 on p. 12)

ASSURANCE SERVICES

ATTESTATION SERVICES

AuditsInternal Controls

ReviewsOther

OTHERASSURANCE

SERVICES

D. Non-Assurance Services

CPAs also provide non-assurance services

including:Accounting and

bookkeepingTaxes

Management consulting

IV. Requirements for CPA Certification

A. Educational Requirement

B. Uniform CPA Examination Requirement

C. Experience Requirement

A. Educational Requirement

Normally, an undergraduate degree

with a major in accounting.

Some states require 150 semester hours before the exam can

be taken. Others require the hours

before certification.

B. Uniform CPA Examination Requirement

A computer-based examination offered at various testing centers.

The examination consists of the following four sections:

Auditing and Attestation – 4.5 hoursFinancial Accounting and Reporting – 4 hours

Regulation – 3 hoursBusiness Environments and Concepts – 2.5 hours

C. Experience Requirement

Varies among states from no experience to

2 years experience.Some states include

experience for working for

governmental units or in internal auditing.

Summary

The Audit Process

Types of Audits and Auditors

Risk and the Need for Auditing

Assurance and Attestation

Becoming a CPA