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:

  1. Client acceptance/continuance

  2. Preliminary engagement activities

  3. Planning the audit

  4. Assessing and auditing internal control

  5. Auditing business processes and accounts

  6. Completing the audit

  7. 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.