CH 1 Adv. Audit

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ADVANCED

AUDITING
&
ASSURANC
E
AcFn 631
CHAPTER ONE: THE DEMAND FOR AUDIT
AND OTHER ASSURANCE SERVICES
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 done by a competent, independent person.
 To do an audit, there must be information in a verifiable form
and some standards (criteria) by which the auditor can evaluate
the information.
For example: Quantifiable information: companies’ financial statements
and individuals’ federal income tax returns.
 Subjective information: the effectiveness of computer
systems and the efficiency of manufacturing operations.
Cont…
 The criteria for evaluating information might be
 IFRS,
 Internal Control Integrated Framework issued by the Committee of
Sponsoring Organizations (COSO),
 Internal revenue code
 For subjective information, it is more difficult to establish criteria.
 Typically, auditors and the entities agree on the criteria well before

the audit starts.


 For example, in an audit of the effectiveness of specific aspects of
computer operations, the criteria might include the allowable level
of input or output errors
Cont…
 Evidence is any information used by the auditor to determine
whether the information being audited is stated in accordance
with the established criteria.
 Evidence takes many different forms, including:
 Electronic and documentary data about transactions
 Written and electronic communication with outsiders
 Observations by the auditor
 Oral testimony of the auditee (client)
Cont…
 The auditor must be :
 qualified to understand the criteria used and

 must be competent to know the types and amount of evidence

to accumulate in order to reach the proper conclusion after


examining the evidence.
 The auditor must also have an independent mental attitude.
 Even though auditors are paid fees by the company, they are
normally sufficiently independent to conduct audits that can be
relied on by users.
 Even internal auditors—those employed by the companies they
audit—usually report directly to top management and the board of
directors.
Cont…
 The final stage in the auditing process is preparing the audit
report, which communicates the auditor’s findings to users.
 Reports differ in nature, but all must inform readers of the
degree of correspondence between the information audited
and established criteria.
Example for auditing tax return
Distinction between auditing and accounting
Most auditing is usually concerned with accounting information,
and many auditors have considerable expertise in accounting
matters. EG. CPA
Accounting Auditing

 is the recording, • Auditors focus on determining whether


classifying, and recorded information properly reflects
summarizing of the economic events that occurred
economic events in a during the accounting period.
logical manner for the
purpose of providing
financial information for
decision making.
 accountants must • the auditor must possess expertise in the
develop a system to accumulation and interpretation of audit
Importance of auditing in reducing information risk

 Auditing has significant effect on information risk.


 Information risk reflects the possibility that the information upon
which the business risk decision was made was inaccurate.
 A likely cause of the information risk is the possibility of
inaccurate financial statements.
 As society becomes more complex, decision makers are more
likely to receive unreliable information.
Cont…
 There are several reasons for Unreliable information:
 remoteness of information,

 biases and motives of the provider,

 voluminous data, and

 the existence of complex exchange transactions.

Eg acquisition of an entity and fair value estimation


To reduce information risk:
 User Verifies Information: The user may go to the business
premises to examine records and obtain information about the
reliability of the statements.
 It is costly
 User Shares Information risk with Management: There is
considerable legal precedent indicating that management is
responsible for providing reliable information to users.
 If users rely on inaccurate financial statements and as a result incur a
financial loss, they may have a basis for a lawsuit against management
 Audited Financial Statements are provided: The most
common way for users to obtain reliable information is to have
an independent audit.
Assurance service
 An assurance service is an independent professional service that
improves the quality of information for decision makers.
 Such services are valued because the assurance provider is
independent and perceived as being unbiased with respect to
the information examined.
 Assurance services can be done by CPAs or by a variety of other
professionals (eg. Consumer union).
 CPAs have expanded the types of assurance services they
perform
 For example, businesses and consumers often seek assurances that
companies with which they conduct business produce products and
services in a socially responsible manner.
Cont…
 One category of assurance services provided by CPAs is
attestation services.
 An attestation service is 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 of attestation services include:
 Audit of historical financial statements
 Audit of internal control over financial reporting
 Review of historical financial statements
 Other attestation services that may be applied to a broad range of
subject matter
Audit of historical Financial
Statements
 Management asserts that the financial statements are fairly
stated in accordance with applicable international accounting
standards.
 An audit of these statements is a form of attestation service in
which the auditor issues a written report expressing an opinion
about
 whether the financial statements are fairly stated in accordance with
the applicable accounting standards.
 These audits are the most common assurance service provided
by CPA firms.
Audit of Internal Control over Financial reporting

 Management asserts that internal controls have been


developed and implemented following well established
criteria.
 This evaluation, which is integrated with the audit of the
financial statements, increases user confidence about future
financial reporting,
 because effective internal controls reduce the likelihood of future
misstatements in the financial statements.
Review of historical Financial
Statements
 Management asserts that the statements are fairly stated in
accordance with accounting standards, the same as for audits.
 The CPA provides a lower level of assurance for reviews of
financial statements compared to a high level for audits,
therefore less evidence is needed.
 A review is often adequate to meet financial statement users’
needs.
 It can be provided by the CPA firm at a much lower fee than an
audit because less evidence is needed.
 Many nonpublic companies use this attestation option to provide
limited assurance on their financial statements without incurring
the cost of an audit.
Other attestation Services
 CPAs provide numerous other attestation services.
 As users seek independent assurances about other types of
information.
 For example, when a bank loans money to a company, the loan
agreement may require the company to engage a CPA to provide
assurance about the company’s compliance with the financial
provisions of the loan.
Other assurance services
 CPAs also provide other assurance services that do not meet
the definition of attestation services.
 These assurance services differ from attestation services in
that
 the CPA is not required to issue a written report, and
 the assurance does not have to be about the reliability of another
party’s assertion about compliance with specified criteria.
 These other assurance service engagements focus on
improving the quality of information for decision makers, just
like attestation services.
 For example: Accounting and bookkeeping services, Tax services,
Management consulting services
Types of audits
 Three primary types of audits:
1. Operational audit
2. Compliance audit
3. Financial statement audit
Operational audit
 An operational audit evaluates the efficiency and
effectiveness of any part of an organization’s operating
procedures and methods.
 At the completion of an operational audit, management
normally expects recommendations for improving operations.
 For example, auditors might evaluate the efficiency and accuracy
of processing payroll transactions in a newly installed computer
system
 In operational auditing, the reviews are not limited to
accounting.
 They can include the evaluation of organizational structure,
computer operations, production methods, marketing, and any
other area in which the auditor is qualified.
Compliance audit
 It is conducted to determine whether the auditee is following
specific procedures, rules, or regulations set by some higher
authority.
 Following are examples of compliance audits for a private
business.
 Determine whether accounting personnel are following the
procedures prescribed by the company controller.
 Review wage rates for compliance with minimum wage laws.
 Examine contractual agreements with bankers and other lenders to
be sure the company is complying with legal requirements.
 Determine whether a mortgage bank is in compliance with newly-
enacted government regulations.
Financial statement audit
 It is conducted to determine whether the financial statements
(the information being verified) are stated in accordance with
specified criteria.
 Normally, the criteria are international accounting standards,
although auditors may conduct audits of financial statements
prepared using the cash basis or some other basis of
accounting appropriate for the organization.
 The auditor gathers evidence to determine whether the
statements contain material errors or other misstatements.
Cont…
Types of auditors
 The most common are:
 certified public accounting firms,
 government accountability office auditors,
 internal revenue agents, and
 internal auditors.
Certified public accounting Firms
 Often called external auditors or independent auditors to
distinguish them from internal auditors.
 Responsible for auditing the historical financial statements of
 all publicly traded companies,
 most other reasonably large companies, and
 many smaller companies and
 noncommercial organizations.
Government accountability office
auditor
 It is an auditor working for the U.S. Government Accountability
Office (GAO), a nonpartisan agency in the legislative branch of
the federal government.
 Headed by the Comptroller General, the GAO reports to and is
responsible solely to Congress.
 The GAO audits much of the financial information prepared by
various federal government agencies before it is submitted to
Congress.
 Because the authority for expenditures and receipts of
governmental agencies is defined by law, there is considerable
emphasis on compliance in these audits.
 In Ethiopia it is called office of the federal auditor general
Internal revenue agent
 It is responsible for enforcing the federal tax laws
 A major responsibility of the IRS is to audit taxpayers’ returns
to determine whether they have complied with the tax laws.
 These audits are solely compliance audits.
 The auditors who perform these examinations are called
internal revenue agents.
Internal auditors
 They are employed by all types of organizations to audit for
management with oversight by the board of directors
 To maintain independence from other business functions, the
internal audit group typically reports directly to the president,
another high executive officer, or the audit committee of the
board of directors.
 However, internal auditors cannot be entirely independent of
the entity as long as an employer–employee relationship
exists.
 Users from outside the entity are unlikely to want to rely on
information verified solely by internal auditors because of
their lack of independence.
Requirements for becoming a CPA
End of the
chapter!

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