Ch. 1 Rittenberg

8/3/2019 Ch. 1 Rittenberg

1/32

Chapter 1

Auditing:

Integral to the

Economy

Copyright 2010 South-Western/Cengage Learning

Rittenberg

Johnstone

Gramling

Auditing

A Business Risk

Approach

7e


2/32

Audit Opinion Formulation Process


3/32

The Audit Function

Perform tests on an organizations records todetermine that they are accurate.

Interpret FASB, IASB, GASB, and other

authoritative pronouncements to ensure that financialstatements are fairly presented.

Make judgments about the fairness of complexaccounting processes and then test, the organizations

system of internal control over financial reporting. Do all this in a totally objective, unbiased, and

professionally skeptical manner.


4/32

LO 1: Auditing

A systematic process of objectively

obtaining and evaluating evidence

regarding assertions about economicactions and events to ascertain the degree

of correspondence between those

assertions and established criteria andcommunicating the results to interested

users.


5/32

What is Attestation?

Attestation involves gathering evidence aboutassertions, evaluating the evidence againstobjective criteria, and communicating theconclusion reached.

Auditing is specific attestation service where theauditor gathers evidence to determine whetherthe financial statements are fairly presented in

accordance with Generally Accepted AccountingPrinciples and issues an opinion to be used bythird-party users, management, and the Board ofDirectors.


6/32

Auditing Process

Gathering evidence to attest to assertions.

Evaluating those assertions against

objective criteria. Communicating the audit conclusion to

interested parties.


7/32

LO 2: Auditing: A Special Function

Auditing is both more and less than public

accounting.

More because it includes internal and operational

auditing, governmental auditing, and other services

that evaluate and report on managerial

performance.

Less because public accounting firms provide avariety of other assurance and non-audit services.


8/32

Challenges of the Profession

Detect material fraud and assure that users of

financial statements are free from fraud.

Complex accounting transactions and

organizational structures.

Computer systems are complex.

Many companies are global. Time pressure to get audit done.

Need to generate sufficient audit fees.


9/32

Users of Audited Financial Statements


10/32

The Need for Assurance Services

Potential bias in providing information, that is, theproviding party may want to convey a betterimpression than real circumstances merit.

Remoteness between a user and the organization or

trading partner. Complexity of the transactions, information, or

processing systems such that it is difficult todetermine their proper presentation without a review

by an independent expert. Riskiness of Investments: Investors need to managetheir risk and thereby minimize financial surprises.


11/32

LO 3: The Accounting Professions Decade

of Unprecedented Turmoil and Change

The failure of one of the largest publicaccounting firms (Andersen).

Four of the largest bankruptcies ever - each in

companies where financial statementmisrepresentation had taken place.

Billions of investment and retirement dollars

lost. Perception that auditors were not independent

from their clients.


12/32

Changes in the Profession: Increased

Demand for Accountability

The Sarbanes-Oxley Act of 2002 provided criticalimprovements related to auditing and the financialstatements.

The Act focused on: Improved corporate governance. Required reporting on internal controls.

Audit standard setting moved to a new quasi-publicorganization.

Improved independence of the external audit function.

Acknowledgment of greater public expectations ofauditors.


13/32

Improved Corporate Governance

The lack of corporate governance was a major factor

in business failures; most notably, a failure of Boards

of Directors to oversee management, and effectively

utilize the audit function. Sarbanes requires Boards of Directors be independent

of the organization and exercise oversight over

management and the audit function.

Further, the Board of Directors, through its auditcommittee, is the "client" of the public accounting

firm.


14/32

LO 4: Required Reporting on

Internal Controls

In most cases of major fraud, companies had poor internal

controls over financial reporting.

Effective internal control system that produces reliableinformation should be established.

Report deficiencies in public reports so that its impact can beassessed.

Treadway Commissions report on Fraudulent FinancialReporting in 1987 advanced the need for public reporting oninternal control.

Sarbanes requires the CEO and CFO of SEC registered

companies to assess and publicly report on the quality of its

internal controls over financial reporting.


15/32

Audit Standard Setting and Auditor

Independence

The audit function must be independent and objectiveif assurances are to be trusted by third parties.

Auditor independence has been strengthened byrequiring:

1. The audit committee has the authority to hire and fire theexternal auditors.

2. Mandatory rotation of the audit engagement partner every fiveyears.

3. Consulting work cannot be performed for audit clients.

4. Increased oversight of potential independence conflicts by theaudit committee.

Non-public companies and smaller audit firms are notrequired to follow all these guidelines.


16/32

Audit Standard Setting Moved

The public lost confidence in the ability of theprofession to serve the public interest.

Sarbanes created the Public Company AccountingOversight Board (PCAOB).

The PCAOB has authority to develop audit standards foraudits of publicly traded companies.

The PCAOB is also charged with performing peer reviewof all public accounting firms that perform audits of publiccompanies.

The PCAOB is comprised of five public membersappointed by the SEC.

No more than two members can be CPAs.


17/32

LO 5: The AICPAs Definition of

Assurance Services

The AICPA's Special Committee on Assurance

Services defines assurance as: Independent

professional services that improve the quality of

information, or its context, for decision makers."

Assurance services involve three components:

Information or a process on which the assurance is provided.

A user or group of users who derive value from the assuranceprovided.

An assurance service provider.


18/32

What are the Attributes Needed to

Perform Assurance Services?

1. Subject matter knowledge

2. Independence from parties requesting

assurance3. Agreed upon criteria to evaluate quality of

presentation

4. Expertise in the process of gathering and

evaluating evidence


19/32

What are the Levels of Assurance

Provided?

1. Positive assurance (such as an audit

opinion)

2. Limited or negative assurance (such as areview of financial statements)

3. No assurance (such as a compilation of

financial statements)


20/32

The AICPA's Special Committee on Assurance

Services has identified six areas of potential service:

1. Risk Assessment: Quality of processes implemented by anorganization to identify, assess, and manage risks.

2. Business Performance Measurement: Processes to identify,measure, and communicate alternative measures of

performance.

3. Information System Reliability: Quality of controls to ensuresystem security, reliability, timeliness, and accuracy.

4. Healthcare Performance Measurement: Provide informationabout the quality of services provided by healthcare providers.

5. Electronic Commerce: Provide assurance that systems andtools are designed and functioning with integrity and security.

6. Elder Care Plus: Provide assurance whether the needs of theelderly are being met by various caregivers.


21/32

What are Attest Services?

Attest services are a subset of assurance

services.

Attest services always involve evaluation of anassertion made by one party to a third party.

Attest services always involve a report sent to

a third party.


22/32

LO 6: Requirements to Enter the

Public Accounting Profession

Accounting and Auditing Expertise: In addition to technicalknowledge, auditor must have sound conceptual understandingof financial reporting and auditing.

Internal Auditing Expertise: Auditor must be able to analyze

the organizations internal controls to determine if there areweaknesses.

Knowledge of Business and its Risks: Auditor mustunderstand the basic structure of a business in order to identifysignificant risks affecting the client.

Understanding Accounting System Complexity: Auditor mustunderstand the challenges posed in a system in whichtraditional source documents do not exist.


23/32

Who Are the Providers of Assurance

Services?

The Public Accounting Profession

The Internal Audit Profession

The Governmental Audit Profession


24/32

The Public Accounting Profession

More than 45,000 CPA firms in the United States,ranging sole-practitioners to large multinationals such asthe Big 4.

These firms provide a variety of services in the areas of

assurance and financial statement services, tax planningand compliance, and consulting.

The SEC has prohibited accounting firms from providingmost consulting services to public companies that theyaudit.

Such restriction on services has not been specified by theAICPA or regulatory authorities for public accountingfirms that do not audit SEC registered clients.


25/32

Organization of CPA Firms

The organizational hierarchy of CPA firms has beendescribed as a pyramidal structure. Partners (or owners) are at the top and are responsible for

the overall conduct of each audit.

Next, managers review the detailed audit work performedby staff auditors.

Seniors are responsible for overseeing much of the day-to-day activities on a specific audit.

Staff auditors perform the basic, detailed audit work.

Partners and managers may be involved in a number ofaudit engagements being conducted simultaneously; seniorsand staff are usually assigned to only one audit at a time.


26/32

The Internal Audit Profession

Internal auditing is defined as:

An independent, objective assurance and

consulting activity designed to add value and

improve an organization's operations. It helps an

organization accomplish its objectives by bringing

a systematic, disciplined approach to evaluate and

improve the effectiveness of risk management,control, and governance processes."


27/32

Internal Auditors Add Value to an

Organization

Internal auditors evaluate processes to identify andmanagement risk, develop and implement effective internalcontrols.

Internal auditors assure management and the Board of

Directors on the company's compliance with policies orregulatory requirements, or the effectiveness of processes andoperations.

Internal auditors provide consulting services such as analyzing

problems and identifying potential solutions. Internal auditors perform operational audits designed to

evaluate the effectiveness, economy, and efficiency withwhich resources are employed.


28/32

Governmental Auditing Profession

Employed by various Federal, state, and local

agencies.

Governmental auditors perform all the types of

audits that internal auditors perform including

compliance, operational, and performance

audits.


29/32

LO 8: Professional and Regulatory

Organizations The PCAOB established as part of the Sarbanes-Oxley Act of

2002 has authority to set auditing standards for audits of publiccompanies and to perform quality reviews of all registeredCPA firms.

The SEC oversees the PCAOB and all companies publicly

traded on the U.S. capital markets. It has the authority toestablish GAAP for publicly traded companies, and to

prosecute companies who violate SEC laws.

The AICPA has long served as the primary governingorganization of the public accounting profession. It provides a

variety of continuing education programs and administers theUniform CPA Examination. Membership in the AICPA isvoluntary.


30/32

The Securities and Exchange

Commission (SEC)

Established by Congress in 1934 to regulate

the capital market system.

Over site of PCAOB and all public companies

required to register with it to gain access to the

U.S. capital market.

Has the authority to establish GAAP for

publicly traded companies.

Has prosecutorial authority.


31/32

The American Institute of Certified

Public Accountants (AICPA)

Primary governing body of the public

accounting profession

Continues to develop standards for audits of

non-public companies

Administers the Uniform CPA Examination


32/32

Professional and Regulatory

Organizations

The State Boards of Accountancy are responsible forcertifying and licensing CPAs in their state. While allstate boards require passage of the Uniform CPAExamination, education and experience requirements

vary by state.

The Institute of Internal Auditors issued internalauditing standards and administers the CertifiedInternal Auditor program.

The U. S. General Accounting Office is thenonpartisan audit agency for Congress. The GAOdevelops auditing standards for governmental audits.

Documents

Ch. 1 Rittenberg