Auditing Fundamentals and the CPA Profession

The Demand for Audit and Other Assurance Services

  • Sarbanes-Oxley Act:
    • Established the Public Company Accounting Oversight Board (PCAOB).
    • Requires auditors to report on the effectiveness of internal control over financial reporting.

Describing Auditing

  • Nature of Auditing:
    • Auditing is the accumulation and evaluation of evidence about information to determine and report on the degree of correspondence between the information and established criteria.
    • Auditing should be performed by a competent, independent person.
  • Information and Established Criteria:
    • An audit requires information in a verifiable form and standards (criteria) to evaluate the information.
  • Accumulating and Evaluating Evidence:
    • Evidence is any information used by the auditor to determine whether the information being audited is stated in accordance with the established criteria.
  • Competent, Independent Person:
    • The auditor must be qualified to understand the criteria used.
    • The auditor must be competent to know the types and amount of evidence to accumulate to reach a proper conclusion.
    • The auditor must be unbiased during evidence accumulation and evaluation.
  • Audit Report:
    • The final stage is the Audit Report, communicating the auditor’s findings to users.
  • Audit of a Tax Return Example:
    • Internal Revenue agent examines cancelled checks and supporting records.
    • Accumulates and evaluates evidence to determine correspondence with the Internal Revenue Code.
    • Reports on tax deficiencies.
    • Information: Federal tax returns filed by taxpayer.
    • Established criteria: Internal Revenue Code and interpretations.

Auditing vs. Accounting

  • Distinction:
    • Accounting involves recording, classifying, and summarizing economic events for providing financial information used in decision making.
    • Auditing involves determining whether recorded information properly reflects the economic events that occurred during the accounting period.

Importance of Auditing in Reducing Information Risk

  • Economic Demand for Auditing:
    • Information risk reflects the possibility that the information upon which the business risk decision was made was inaccurate.
    • Auditing can significantly reduce information risk.
  • Causes of Information Risk:
    • Remoteness of information
    • Biases and motives of the provider
    • Voluminous data
    • Complex exchange transactions
  • Reducing Information Risk:
    • User verifies information
    • User shares information risk with management
    • Audited financial statements are provided

Assurance Services

  • Definition:
    • An assurance service is an independent professional service that improves the quality of information for decision makers.
    • Assurance services can be performed by CPAs or other professionals.
  • Attestation Services:
    • A type of assurance service in which the CPA firm issues a report about the reliability of an assertion that is the responsibility of another party.
    • Examples:
      1. Audit of historical financial statements
      2. Attestation of internal control over financial reporting
      3. Review of historical financial statements
      4. Attestation services on information technology
      5. Other attestation services
  • Relationships:
    • Auditor is hired by the Client or audit committee.
    • Auditor issues a report that is relied upon by the External Users, reducing information risk.
    • Client provides financial statements to users.
    • External Users provide capital.
  • Other Assurance Services:
    • CPAs provide other assurance services that may not meet the formal definition of attestation services.
    • A written report is not always required, and assurance does not always relate to the reliability of another party’s assertion.
  • Attestation Services on Information Technology:
    • WebTrust and SysTrust meet the criteria of attestation service.
  • Nonassurance Services Provided by CPAs:
    1. Accounting and bookkeeping services
    2. Tax services
    3. Management consulting services
  • Other Assurance Services Examples:
    • Assess risks of accumulation, distribution, and storage of digital information.
    • Assessing security risks and related controls over data stored electronically.
    • Compliance with trading policies and procedures.
    • Compliance with entertainment royalty agreements.
    • ISO 900 certification.
    • Environmental audit.
  • Hierarchy of Services:
    • Assurance Services encompass Attestation Services and Nonassurance Services.
    • Attestation Services include Audits, Reviews, and Internal Control over Financial Reporting.
    • Nonassurance Services include Tax Services, Accounting and Bookkeeping, and Consulting.

Types of Audits

  • Types:
    1. Operational
    2. Compliance
    3. Financial Statement
  • Operational Audit Example:
    • Evaluation of a computerized payroll system for efficiency and effectiveness.
    • Information: Number of records processed, costs, and number of errors.
    • Established Criteria: Company standards for efficiency and effectiveness.
    • Available Evidence: Error reports, payroll records, and processing costs.
  • Compliance Audit Example:
    • Determination of whether bank requirements for loan continuation have been met.
    • Information: Company records.
    • Established Criteria: Loan agreement provisions.
    • Available Evidence: Financial statements and auditor's calculations.
  • Audit of Historical Financial Statements Example:
    • Annual audit of Boeing’s financial statements.
    • Information: Boeing's financial statements.
    • Established Criteria: Generally accepted accounting principles.
    • Available Evidence: Documents, records, and outside sources.

Types of Auditors

  • Types:
    1. Internal auditors
    2. Independent certified public accounting firms
    3. Internal Revenue agents
    4. Governmental general accounting office auditors

Requirements for Becoming a CPA

  • Three Requirements:
    1. Educational requirement
    2. Uniform CPA examination requirement
    3. Experience requirement
  • CPA Examination Sections:
    1. Auditing and Attestation
    2. Financial Accounting and Reporting
    3. Regulation
    4. Business Environments and Concepts

The CPA Profession

Nature and Structure of CPA Firms

  • Certified Public Accounting Firms:
    • The legal right to perform audits is granted to CPA firms by state regulation.
    • CPA firms offer tax and consulting services, along with financial planning, business valuation, and information technology services.
  • Types of CPA Firms:
    1. Big Four international firms
    2. National firms
    3. Regional and large local firms
    4. Small local firms
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