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