B4555 - Chapter 1-5

Study of Auditing

Focuses on the development of analytical and logical skills, different from other accounting courses that focus on rules and computations.

Demand for Auditing and Assurance

Arises from the need for accountability when business owners hire others to manage their businesses, ensuring that information reported to investors is real and fairly stated.

Principal/Agent Relationship

Refers to the relationship between shareholders (principals) and management (agents), where shareholders have a valid interest in the proper use of a company's resources.

Role of Auditing

Overcomes information asymmetry between shareholders and management by providing assurance that management is acting in the best interest of the firm.

Relationships among Auditing, Attest, and Assurance Services

Auditing is a form of attest function, which is a form of assurance, with auditing being the smallest and assurance being the broadest.

Audit Assertions/Objectives

Management assertions about classes of transactions and events, account balances, and related disclosures are tested during an audit.

Materiality

The magnitude of an omission or misstatement of accounting information that would influence the judgment of a reasonable person relying on the information.

Audit Risk

The risk that the auditor mistakenly expresses a clean audit opinion when the financial statements are materially misstated.

Audit Evidence

Consists of underlying accounting data and additional information that assists the auditor in evaluating management's financial statement assertions.

Sampling

Auditors use a sampling approach to examine a subset of transactions based on previous audits, internal control systems, or industry knowledge.

Major Phases of an Audit

Client acceptance/continuance, preliminary engagement activities, planning the audit, considering and auditing internal control, auditing business processes and related accounts, completing the audit, and evaluating results and issuing the audit report.

Types of Audit Reports

Unqualified (clean), qualified, adverse, and disclaimer, depending on the presence and impact of material misstatements in the financial statements.

Auditing Demands Logic, Reasoning, and Resourcefulness

Auditors need to use common sense, logical thinking, and reasoning skills to understand and apply auditing concepts effectively.

Types of Auditors

External auditors, internal auditors, government auditors, and forensic auditors, each with specific roles and responsibilities.

Types of Audit and Assurance Services

Internal control audits, compliance audits, operational audits, and other audit services that go beyond the traditional financial statement audit.

Performance Audit

A systematic evaluation of an organization's activities to assess effectiveness and efficiency.

Forensic Audit

An audit conducted to detect or deter fraudulent activities.

Assurance Services

Services provided by CPAs that provide assurance but do not qualify as auditing or attestation.

Non-Audit Services

Services that CPAs can offer that are not related to financial statement audits, such as tax preparation and management advisory services.

Compilation

The preparation of financial statements by a public accounting firm.

Public Accounting Firms

Organizations that provide professional accounting-related services, including auditing.

Audit Team Members

Individuals involved in the audit process, such as partners, managers, seniors, and associates/staff.

Expectations Gap

The difference between what the public expects auditors to do and what auditors are actually responsible for.

Corporate Governance

Mechanisms in place to oversee and supervise managers in business organizations.

Business Processes

Five broad categories of processes auditors organize their audits around, including revenue, financing, purchasing, HR management, and inventory management.

Auditing Standards

Standards that ensure F/S audits are conducted consistently and thoroughly.

Principles Underlying an Audit

Categories of principles that guide the purpose, responsibilities, performance, and reporting of an audit.

Purpose of an Audit

To enhance the confidence of users in the F/S by expressing an opinion on their fairness and compliance with financial reporting frameworks.

Responsibilities

The auditor's responsibilities include competence, ethical compliance, and exercising professional judgment.

Performance

The auditor obtains reasonable assurance by planning the work, assessing risks, and obtaining sufficient appropriate audit evidence.

Inherent limitations

The auditor cannot provide absolute assurance that financial statements are free from material misstatement due to limitations arising from the nature of financial reporting, audit procedures, and the need for a reasonable balance between benefit and cost.

Opinion

The auditor expresses an opinion, modification of opinion, or denial of opinion in a written report based on the evaluation of audit evidence obtained. The opinion states whether the financial statements are presented fairly, in all material respects, in accordance with the applicable financial reporting framework.

Auditing Standards

AASB (Auditing Standards Board) in Canada and IAASB (International Auditing and Assurance Standards Board) internationally establish auditing standards. CAS (Canadian Auditing Standards) and ISA (International Standards on Auditing) are the respective sets of standards.

Ethics

Ethics refers to a system or code of conduct based on moral duties and obligations that indicate how auditors should behave. It includes independence, which is the state of objectivity in fact and appearance, and the absence of significant conflicts of interest.

Rules of Professional Conduct

The CPA's (Certified Public Accountant) Rules of Professional Conduct provide guidance for acceptable behavior for auditors. It applies to all auditors, including those auditing public companies.

Client Acceptance and Continuance

Before accepting a new client, the accounting firm must determine if it has the capabilities to perform the engagement, complies with legal and ethical requirements, and has considered the integrity of the client.

Internal Audit Function

The internal audit function is an independent, objective assurance and consulting activity that adds value and improves an organization's operations. Factors for evaluating its reliability include objectivity, competence, and a systematic and disciplined approach.

Audit Committee

The audit committee is a subcommittee of the board of directors responsible for the financial reporting and disclosure process. Its members must be independent, oversee the work of the auditors, and have authority to engage independent counsel.

Engagement Letter

The engagement letter formalizes the arrangement between the auditor and the client, outlining the responsibilities of both parties and preventing misunderstandings. It is signed by the auditor and may include additional arrangements and services.

Audit Strategy and Plan

The auditor develops an overall audit strategy to determine the resources needed and an audit plan that details the nature, timing, and extent of audit procedures. Factors considered include business risks, materiality, multi-locations, specialists, violations of laws and regulations, related parties, and additional value-added services.

Excessive Commissions

Sale commissions or agent's fees that are unusually high compared to industry standards or the services received.

Unusual Payments

Payments made in cash, cashiers' cheques payable to bearer, or transfers to numbered bank accounts that are not typical or easily traceable.

Unauthorized Transactions

Transactions that are not properly authorized or recorded.

Non-compliance with Laws or Regulations

Failure to comply with laws or regulations that have been identified in regulatory agency reports available to the auditor.

Failure to File Tax Returns

Failure to submit tax returns or pay government duties or fees that are common in the entity's industry or nature of business.

Related Parties

Parties that have a relationship with the entity and may be involved in transactions with the entity.

Identification of Related Parties

The process of identifying and disclosing transactions with related parties.

Inquiring about Related Parties

Auditors should inquire about the names, nature of relationships, types of transactions, and reasons for transactions with related parties.

Sources of Information on Related Parties

Minutes of board meetings, conflict-of-interest statements, financial and reporting information provided to creditors, investors, and regulators, contracts or agreements.

Additional Value-Added Services

Services provided by auditors beyond the audit, such as tax planning, system design, internal reporting, risk assessment, business performance measurement, and electronic commerce.

Documenting Audit Strategy, Plan, and Programs

The process of documenting how the entity manages its risk, the effects of risks and controls on audit procedures, and the auditor's preliminary decisions concerning control risk and substantive tests.

Supervision of the Audit

The responsibilities of the engagement partner and other supervisory members of the audit team, including informing team members of their responsibilities, reviewing their work, and ensuring the objectives of procedures are achieved.

Types of Audit Tests

Risk assessment procedures, tests of control, substantive procedures, and analytical procedures.

Risk Assessment Procedures

Procedures used to understand the entity and its environment, including internal control, through inquiries, preliminary analytical procedures, observation, and inspection.

Tests of Control

Procedures to evaluate the effectiveness of the design and operation of internal controls, including inquiries, inspections, observations, reperformance, and walkthroughs.

Substantive Procedures

Procedures to detect material misstatements in transactions, account balances, and disclosures, including tests of transactions and tests of details of account balances and disclosures.

Internal Controls

Processes and procedures implemented by the entity to achieve its objectives, including separation of duties, credit approval, numerical sequence control, and agreement of invoices.

Vouching

The use of documentation to support recorded transactions or amounts, focusing on the occurrence/existence assertion.

Tracing

The use of documentation to determine if transactions or amounts are included in the accounting records, focusing on the completeness assertion.

Materiality

The concept of determining if a fact would significantly alter the total mix of information available to a reasonable investor, requiring professional judgment.

Steps in Applying Materiality

Determining overall materiality, determining tolerable misstatement, and evaluating auditing findings.

Determining Overall Materiality

Establishing a quantitative benchmark based on income, assets, revenues, net assets, equity, and adjusting for qualitative factors.

Determining Tolerable Misstatement

Allocating planning materiality to individual accounts or classes of transactions, considering that not all accounts will be misstated by their full allocation.

Evaluate Auditing Findings

Aggregating misstatements, considering misstatements not adjusted in the prior year, comparing aggregate misstatement to overall materiality, and making adjustments if necessary.

Audit Risk

The risk that an auditor expresses an inappropriate audit opinion when the financial statements are materially misstated.

Audit Risk Model

The model that considers audit risk at the assertion level, consisting of inherent risk, control risk, and detection risk.

Inherent Risk

The susceptibility of an assertion to a misstatement due to error or fraud before considering any related controls.

Control Risk

The risk that a misstatement in an assertion will not be prevented, detected, or corrected by the entity's internal control.

Detection Risk

The risk that audit procedures will not detect misstatements that exist and could be material.

Engagement Risk

The auditor's exposure to financial loss and damage to professional reputation due to litigation, adverse publicity, or other events related to the audited financial statements.

Use of the Audit Risk Model

Setting a planned level of audit risk, assessing the risk of material misstatement, and determining the appropriate level of detection risk.

Relationship of Business Risks to the Audit Risk Model

The entity's business risks contribute to the assessment of inherent risk and control risk, which together form the risk of material misstatement.

High Assessment of Detection Risk

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Audit Risk Model

A planning tool used by auditors to assess the risk of material misstatement in the financial statements and determine the appropriate level of evidence required.

Auditor's Risk Assessment Process

The process by which auditors identify and assess the risks of material misstatement in the financial statements.

Inquiries of Management, Other Entity Personnel, and Others Outside the Entity

The process of obtaining information about the entity and its environment through discussions with management, personnel responsible for financial reporting, and external parties.

Analytical Procedures

Evaluations of financial information made through the analysis of plausible relationships among financial and non-financial data.

Observation and Inspection

The act of observing and inspecting the entity and its environment to gather evidence for the audit.

Nature of the Entity

Information about the entity's business operations, revenue sources, products and services, alliances, joint ventures, and other relevant factors.

Industry, Regulatory, and External Factors

External factors that may impact the entity's operations, such as industry conditions, regulatory environment, and general economic conditions.

Objectives, Strategies, and Business Risks

The entity's objectives, strategies, and the associated business risks that may affect the financial statements.

Internal Control

The system of policies and procedures implemented by management to ensure the reliability of financial reporting and the effectiveness of operations.

Risk Assessment

The identification, analysis, and management of risks relevant to the preparation of financial statements that are fairly presented in conformity with GAAP.

Causes and Types of Misstatements

Errors and fraud are the two primary types of misstatements that can occur in the financial statements.

Fraud Risk Assessment Process

The process of identifying and assessing the risk of fraud in the financial statements, including discussions among the audit team, inquiries of management, identification of fraud risk factors, analytical procedures, and investigation of unexpected period-end adjustments.

Conditions Indicative of Fraud and Fraud Risk Factors

The conditions and risk factors that may indicate the presence of fraud, including incentives/pressures, opportunities, and attitudes/rationalizations.

Auditor's Response to the Risk Assessment Results

The actions taken by the auditor in response to the identified risks of material misstatement, such as assigning more experienced personnel, evaluating accounting policies, and incorporating additional elements of unpredictability in audit procedures.

Evaluation of Audit Tests Results

The process of assessing the results of audit tests to determine if the financial statements are materially misstated and taking appropriate actions, such as requesting management to make adjustments or issuing a qualified or adverse opinion.

Documentation of the Auditor's Risk Assessment

The requirement for auditors to document discussions, procedures performed, fraud risks, and the nature, timing, and extent of procedures performed in response to fraud risks.

Communications about Fraud

The auditor's responsibility to communicate evidence of fraud to appropriate levels of management and the audit committee, as well as the conditions under which disclosure to other parties may be necessary.

Management Assertions

The implicit or explicit assertions made by management regarding the recognition, measurement, and presentation of transactions, account balances, and disclosures in the financial statements.

Completeness

All transactions and events that should have been recorded have been recorded, and all related disclosures that should have been included in the F/S have been included.

Authorization

All transactions and events have been properly authorized.

Cut-off

Transactions and events have been recorded in the correct accounting period.

Presentation

Transactions and events are appropriately aggregated or disaggregated and clearly described, and related disclosures are relevant and understandable in the context of the requirements of the applicable financial reporting framework.

Classification

Transactions and events have been recorded in the proper accounts.

Accuracy

Amounts and other data relating to recorded transactions and events have been recorded appropriately, and related disclosures have been appropriately measured and described.

Rights and obligations

The entity holds or controls the rights to assets, and liabilities are the obligations of the entity.

Existence

Assets, liabilities, and equity interests exist.

Accuracy, valuation, and allocation

Assets, liabilities, and equity interests have been included in the F/S at appropriate amounts, and any resulting valuation or allocation adjustments have been appropriately recorded, and related disclosures have been appropriately measured and described.