Accounting Week 6 - Auditing

Principle Shareholders

• Absentee Owners

  • Not involved in day-to-day operations

Agent Management

• Involved in the day-to-day of the business

• Responsible for financial statements, not accountants/auditors/audit committee, etc…

Information Asymmetry Gap

• Time gap between Agent and Principal

  • due to principle not being involved in the day-to-day to see changes in bus ops

Auditor

• Goal is to fill the asymmetry gap so shareholders have more reliable information

• independent

• free from bias

Big Dilemma

• Who pays the auditors?

  • = The agent does

Why do we Audit?

• Fosters Trust in financial information

• Ensures Accuracy and Reliability for investors, lenders, & general public

• Essential for business to Secure Investors

• Vital for maintaining Operations

Definition of Auditing

To objectively obtain and evaluate evidence regarding assertions made by management

Main Goal of Auditing

Ensure a business is free from material misstatements

They are NOT responsible for —>

• Do NOT detect fraud

  • do consider that, but not their goal

• Do NOT test every transaction

• Do NOT certify statements, rather ensure reliability

Materiality Limit

Threshold above which any misstatement or omission in F/S is considered significant enough to potentially influence investors’ decisions

• Do not share the materiality threshold with management or the company, as knowing this limit could encourage them to intentionally commit fraud up to that threshold.

Auditing accuracy based in accordance to GAAP

• Systematic process (lots of planning)

  • GAAS (Generally Accepted Accounting Standards)

    • Risk-based approach to auditing by calculating the materiality limit

• Objectively collect and evaluate evidence to support testing

  • auditors must be independent (objectivity)

    • must act with integrity and objectivity

• Assertions made by management

  • Assertions: everything in the financial statement

    • ex) management asserted that the A/R balance is 500k

• Assertions should conform to specific rules (GAAP & IFRS)

  • ex) “Financial statements is fair in all material aspects and in accordance with GAAP.”

• Report results (auditing findings) to users - BOP, Debt & Equity & Equity Investors

  • Present and Audit Opinion: Report of independent registered accounts + found in 10k

Types of Assertions

Occurrence

Completeness

Accuracy

Cut-off

Classification

Existence

Valuation

Rights & Obligations

• note: all are fairly self explanetory and can be understood by what the word means

Occurrence

• Transactions actually happened/took place

  • Reporting a sale - auditor checks occurrence

Completeness

• Did all transactions get recorded

  • makes sure that all sales/expense transactions are on F/S

Accuracy

• Number & Details in F/S are correct

  • transactions are recorded in proper amounts

Cut-off

• Ensures transactions are recorded in the correct accounting period

  • December expenses are not recorded in January’s #s

Classification

• Transactions are recorded in the correct accounts

Existence

• Ensures that the transaction really exists on the F/S date

Valuation

• Assets/Liabilities on F/S at the correct value

  • inventory not recorded @ made up expense

Rights & Obligations

• Owns assets and is responsible for liabilities

  • does company have the title for the asset

Audit Risk

• Auditors do not audit every transaction. Therefore, audit risk can never be 0

• Auditors grant reasonable assurance that the financial statements are free from material misstatements

Types of Opinions

• Unmodified/Unqualified: “Clean” and free from material misstatements

• Modified: Minor misstatements, and parts do not present fairly

• Adverse: Do not present fairly (RUN!)

• Disclaimer: ^

  • may not be independent

  • the auditor could not obtain enough evidence

Management ←→ Auditor

Types of Fraud

• 1) Misappropriation of Assets (stealing)

  • more common, smaller losses

• 2) Fraudulent Financial Reporting

  • less common, larger losses

Fraud Traingle

• Opportunity

  • the only point of the Fraud Triangle that management can control by using internal controls: activities to safeguard assets and minimize errors/fraud in financial reporting

Management/Company cannot control →

• Rationalization

  • “I don’t get paid enough.”

  • “I was going to pay it back.”

• Pressure

  • Financial medical bills

  • Expensive taste