Chapter 1

1

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

  • must be done by a competent, independent person
    • capable of having the knowledge to do so
    • competent to know the types and amount of evidence needed to reach proper conclusions
    • not affiliated with the company and no bias
    • audit adds little to no value if the individual is biased towards any of the information

independent auditors: CPAs or firms that perform audits of commercial and noncommercial entities

  • information must be in a verifiable form and some standards or criteria in order to evaluate information
    • audits of quantifiable information
    • financial statements
      • historical financial statements audited by CPAs, criteria needs to match GAAP
      • can also be audited over internal controls of financial reporting
    • federal income tax returns
      • criteria is found in the Internal revenue code (IRC)
    • audits of subjective information
    • efficiency of systems
      • criteria can be the level of input or output errors
    • efficiency of manufacturing operations
    • compliance
    • internal controls
      • criteria needs to match the COSOs framework

evidence: any information used by the auditor to determine whether the information being audited is stated in accordance with established criteria

  • data on transactions
  • communication with outsiders
  • observations
  • oral testimony of client

must obtain sufficient quality and quantity of evidence

determine the amount of evidence needed to evaluate information and its correspondence to establish criteria

audit report: communication of auditors findings to its users

  • final stage of the audit
  • informs readers of the degree of correspondence between the information audited and established criteria
  • can differ in forms
    • financial statement audits are highly technical
    • operational audits can be given orally

\
2

Auditing vs. Accounting

accounting: the recording, classifying, and summarizing of economic events in a logical manner for the purpose of providing financial information for decision making

  • accountants must develop a systems in order to make sure events are recorded timely and at a reasonable cost
  • auditors focus on determining whether recorded information properly reflects the economic events that occurred during the accounting period
  • auditors must have the expertise in accumulation and interpretation of audit evidence

\
3

Information Risk

rate of interest usually determined by 3 factors

  • risk free rate - the rate the bank could earn by investing in treasury notes for the same length of time as business loans
  • business risk for the customer - risk reflects the possibility that the business will not be able to repay its loan because of economic or business conditions (recession, management decisions, competition)
  • information risk - reflects the possibility that the information was inaccurate

information risk: the risk that information upon which a business decision was made is inaccurate

auditing has no effect on RFR or BR, but can have a significant effect on information risk

makes sure that the information given to outsiders is as accurate as possible

\
4

Causes of Information Risk

  • Remoteness
    • information gathered is often relied on others, when its obtained from others the likelihood of It being intentionally or unintentionally misstated increases
  • Bias and motives of providers
    • information by someone whose goals are inconsistent with those of the decision maker
    • can result in inadequate or incomplete disclosures of information
  • Voluminous Data
    • in larger organizations, the volume of exchange transactions is fairly large
    • increases the prob. that there is improperly recorded data in the record
  • Complex Exchange Transactions
    • exchange transactions between orgs have become more and more complex
    • acquisitions
    • combining and disclosing results of operations in different industries
    • properly valuing and disclosing derivative financial instruments

reducing information risk

  • smaller businesses tend to keep info risk higher in order to reduce the cost of trying to reduce it

  • larger businesses will pay the extra money in order to reduce their information risk

    \

  • 3 main ways to reduce it

  • user verifies information

    • user may go to the business and examine records and obtain information such as physical count
    • often impractical due to cost of it
    • IRS does this with tax returns
    • in acqusitions, company may hire an outside audit team to perform these tasks
  • user shares information risk with management

    • managemnet is responsible for providing reliable Information to users
    • legal issues may arise is decisions were made on false information
  • audited financial statements are provided

    • most common way to obtain reliable information is to have an independent audit
    • external users like stockholders and lenders rely on such information to be as accurate as possible
    • audit assurance is valued because the information is complete, accurate and unbiased

\
5

Assurance Services

assurance service: Is an independent professional service that improves the quality of information for decision makers

  • done by an independent person relaying unbiased information

SOX 404

  • provisions resulted in the act now requires CPAs to perform internal control audits
  • CPAs have also expanded their audits to include things such as:
    • information of interest to investors
    • reports on CSR and sustainability reports

attestation services: a type of assurance service in which the CPA firm issues a report about a subject matter or assertion that is made by another party

primary categories include

  • audit of historical financial statements
  • audit of internal controls over financial reporting
  • reviews of historical financial statements
  • other attestation services that may be applied to a broad range of subject matter

audit of historical financial statements: a form of attestation service in which the auditor issues a written report stating whether the financial statements are in material conformity with accounting standards

  • most common assurance service provided by CPA firms
  • designed to provide reasonable assurance that statements are free of material misstatements
  • publicly traded companies are required to have audits under the federal securities act and opinions can be found in their annual financial reports

internal control over financial reporting: an engagement in which the auditor reports in the effectiveness of internal control over financial reporting; such reports are required for accelerated filer public companies under SOX 404

  • must attest to the effectiveness of internal control over financial reporting

review of historical financial statements: management asserts that the statements are fairly stated in accordance wiht accounting standards, the same as an audit, but a lower level of assurance is needed

  • requires less evidence to perform
  • requires less money
  • but gives a lower assurance level

nonassurance services provided by CPAs

  • accounting and bookkeeping services
  • tax services
  • management consulting services

the quality of information is often an important criterion in management consulting, this gial is not the primary purpose

\
6

Types of Audits

operational audits: evaluates the efficiency and effectiveness of any part of an organization’s operating procedures and methods, gives recommendations for improving operations

  • operational audit
    • reviews are not limited to accounting
    • can evaluate organizational structure, computer operations, production methods, marketing, and any other area that auditor is qualified
    • effective and efficiency must also meet the established criteria for compliance and financial audits
    • more like management consulting than auditing

compliance audit: conducted to determine whether the auditee is following specific procedures, rules, or regulations set by some higher authority

  • compliance audit
    • determine whether personnel are following the procedures prescribed by controller
    • review wage rates for compliance with minimum wage laws
    • contractual agreements with bankers and lenders
    • mortages in compliance with governmental regulations
    • governmental units like school districts, subject to audits due to governmental regulations
    • results are typically reported to management rather than outsiders

financial statement audits: conducted to determine whether financial statements are stated in accordance with specific criteria

  • financial statement audit
    • using cash basis or other
    • stated in accordance to accounting standards and regulations
    • gathers evidence to look for material errors or misstatements
    • auditors must have extensive knowledge of the company due to different complexities within

\
7

Types of Auditors

Certified public accounting firms: responsible for auditing historical financial statements of all publicly traded companies, large, small and noncommercial organizations

Government accountability office auditors: an auditor working for the US government accountability office (GAO), a nonpartisan agency in the legislative branch of the federal government

  • reports and is responsible solely to Congress
  • audits information prepped by federal government agencies before its submitted to congress
  • evaluates the operational efficiency and effectiveness of federal programs

Internal revenue agents: auditors who work for the IRS and conduct examinations of taxpayers returns

  • responsible for enforcing federal tax laws
  • solely compliance audits

Internal auditors: auditors employed by a company to audit for the companies board of directors and management

  • can range from 1-100s, depending on the size of the company
  • involved in operational auditing or computer systems
  • reports directly to high executive office to remain independent from rest of business
  • outsiders don’t rely solely on internal audits because of the lack of independence

Certified Public Accountant: a person who has met state regulatory requirements, including passing the Uniform CPA exam, and thus has been certified; a CPA may have their primary responsibility the performance of the audit function on historical financial statements of commercial and noncommercial financial entities

\
\
\
\