Auditing Chapter 1
Chapter 1: An Introduction to Assurance and Financial Statement Auditing
Overview
Title: Auditing and Assurance Services: A Systematic Approach, Twelfth Edition
Publication Year: 2022, McGraw Hill Education
Use: Intended solely for classroom instruction, prohibits reproduction without consent.
The Study of Auditing
Distinct from Other Accounting Courses:
Other Courses: Focus on rules, techniques, and computations for preparing and analyzing financial data.
Auditing: Requires analytical and logical skills, centering more on conceptual understanding.
Importance: These skills are beneficial for all business professionals, not just auditors.
The Demand for Auditing and Assurance
Historical Context: The evolution of the corporate form and global economy has significantly increased the demand for auditor assurance in the last 200 years.
Principal-Agent Relationship
Definition:
A public company sells stocks/bonds, which gives the public legitimate interest in how the company utilizes resources.
Roles:
Agents: Managers who run the company.
Principals: Stockholders who have vested interests in company performance.
Management Assertions by Category
Types of Assertions:
Assertions about Transactions:
Occurrence: Ensuring recorded transactions/events actually took place.
Completeness: Verifying all appropriate transactions/events are recorded.
Authorization: Ensuring all transactions/events have proper authorization.
Accuracy: Confirming that transaction data is recorded accurately.
Cutoff: Transactions must be recorded in the right accounting period.
Classification: Transactions/events must be recorded in correct accounts.
Presentation: Ensures transactions/events are described transparently.
Assertions about Account Balances:
Existence: Assets and liabilities must exist.
Rights and Obligations: Entity controls the rights to reported assets; liabilities must be obligations.
Completeness: All necessary account balances must be recorded.
Valuation and Allocation: Accurate amounts should be recorded and any necessary adjustments noted.
Financial Statement Audit Process
Key Steps in the Process:
Flow of Management Activities:
Implements internal controls → Conducts transactions → Accumulates transactions into balances → Prepares financial statements → Issues statements to users.
Flow of Auditor Activities:
Obtains evidence → Tests management assertions → Evaluates overall fairness → Issues audit report.
Fundamental Concepts in Conducting Audits
Materiality:
Definition: The significance of an omission/misstatement in accounting that could influence the decision of a reasonable person.
Audit Risk:
Definition: The risk that an inappropriate audit opinion is expressed due to materially misstated financial statements.
Reasonable assurance in auditing implies an unavoidable risk of material misstatement.
Audit Evidence:
Auditors assess evidence to evaluate management assertions:
Relevance: Evidence must directly relate to the assertion being evaluated.
Reliability: Evidence must accurately reflect the state of the assertion.
Sampling and Inference
Purpose: Auditors may use sampling to examine a portion of transactions; comprehensive transaction reviews are often impractical. Data analytics can sometimes cover entire populations.
Major Phases of the Audit
Steps:
Client acceptance/continuance
Preliminary engagement activities
Planning the audit
Assessing and auditing internal control
Auditing business processes and accounts
Completing the audit
Evaluating results and issuing the audit report.
Types of Audit Reports
Different Opinions:
Unqualified: Financial statements are free of material misstatements.
Qualified: Material misstatement present; statements are fairly presented apart from specified issues.
Adverse: Material misstatements are so severe that financial statements are not reliable.
Disclaimer: Scope limitations prevent forming an opinion on fairness.
Conclusion: Skills Required for Auditors
Key Skills: Beyond accounting concepts, auditors need logical reasoning, analytical thinking, and creativity. Understanding audit concepts is vital for various business roles.