Chapter 1 Auditing and Assurance Services "If you want to be successful, it's just this simple: Know what you're doing. Love what you're doing. And believe in what you're doing." -- Will Rogers McGraw-Hill/Irwin ©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

©2007 by the McGraw-Hill Companies, Inc. All rights reserved. Chapter 1 Objectives 1. Define information risk and explain how auditing and assurance services play a role in reducing this business risk. 2. Define and contrast auditing, attestation, and assurance services. 3. Describe and define the management assertions embodied in financial statements, and explain why auditors use them as a focal point of the audit. 4. Explain some characteristics of professional skepticism. 5. Describe the organization of public accounting firms and identify the various services they offer. 6. Describe the audits and auditors in governmental, internal, and operational auditing. 7. List and explain the requirements for becoming a certified information professional. McGraw-Hill/Irwin ©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

User Demand for Reliable Information User demand for reliable, relevant information is a consequence of Complexity Remoteness Time sensitivity Consequences Information risk is the risk (probability) that the information (mainly financial) disseminated by a company will be materially false or misleading. Demand for auditing and assurance services McGraw-Hill/Irwin ©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

Exhibit 1.1 Overview of Financial Statement Auditing McGraw-Hill/Irwin ©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

Definition of Auditing Auditing is a systematic process of objectively obtaining and evaluating evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between the assertions and established criteria and communicating the results to interested users. Financial Statements (including footnotes) GAAP Auditor's Report/ Other Reports Persons who rely on the financial reports Creditors Investors Source: American Accounting Association Committee on Basic Auditing Concepts. 1973. A Statement of Basic Auditing Concepts, American Accounting Association (Sarasota, FL). McGraw-Hill/Irwin ©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

©2007 by the McGraw-Hill Companies, Inc. All rights reserved. Exhibit 1.2 The Relationships Among Auditing, Attestation, and Assurance Engagements Assurance Services Any Information Attestation Services Primarily Financial Information Auditing Financial Statements McGraw-Hill/Irwin ©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

©2007 by the McGraw-Hill Companies, Inc. All rights reserved. Assurance Services Assurance services are independent professional services that improve the quality of information, or its context, for decision makers. Examples CPA WebTrust (http://www.cpawebtrust.org) Systrust Performance View PrimePlus Services (formerly known as ElderCare) Can you think of others? McGraw-Hill/Irwin ©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

Attestation Engagements An attestation engagement is one “in which a practitioner is engaged to issue or does issue a report on subject matter or an assertion about the subject matter that is the responsibility of another party.” Some financial attestation engagements (other than audits) Supplementary financial statistics Pro forma financial information Financial forecasts and projections Some non-financial attestation engagements Compliance with contractual requirements Effectiveness of internal control systems Inventory quantities and locations McGraw-Hill/Irwin ©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

©2007 by the McGraw-Hill Companies, Inc. All rights reserved. Sarbanes-Oxley Act of 2002 Congress passed the Sarbanes-Oxley Act in an attempt to address a number of weaknesses found in corporate financial reporting in the wake of the recent accounting scandals. The Act’s major provisions include: Requirement of CEO/CFO certification of financial statements Requirement of auditor examination of company internal controls Creation of the Public Company Accounting Oversight Board (PCAOB) to serve as an auditing profession “watchdog.” Prohibition of certain client services by firms conducting a client’s audit. McGraw-Hill/Irwin ©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

Sarbanes-Oxley: Management’s Responsibility for Financial Reporting One of its most important provisions (Section 302) states that the key company officials must certify the financial statements. Certification means that the company CEO and CFO must sign a statement indicating: They have read the financial statements. They are not aware of any false or misleading statements (or any key omitted disclosures). They believe that the financial statements present an accurate picture of the company’s financial condition. Source: U.S. Congress, Sarbanes-Oxley Act of 2002, Pub. L. 107-204, 116 Stat/ 745 (2002). McGraw-Hill/Irwin ©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

Management Assertions (SAS 31) Existence (assets) or occurrence (transactions) Rights and obligations – ownership/owership Valuation or allocation Completeness - all accounts included Presentation and disclosure McGraw-Hill/Irwin ©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

©2007 by the McGraw-Hill Companies, Inc. All rights reserved. Exhibit 1.4 Example Assertions and their Relationships to the Financial Statements McGraw-Hill/Irwin ©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

The New, Improved (?) Management Assertions (SAS 106)* *(Recommended, but not required) Assertions About transactions About account balances Presentation and disclosure Occurrence  Existence Completeness Cutoff Rights and obligations Accuracy Valuation or allocation Classification Understandability McGraw-Hill/Irwin ©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

Professional Skepticism Professional skepticism is an auditor’s tendency not to believe management’s assertions without sufficient corroboration. A potential conflict of interest always exists between the auditor and the client. Management wants to portray the company and its operations in the best possible light. Auditors want to portray the company and its operations fairly. Ask questions, get answers, then verify the answers. McGraw-Hill/Irwin ©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

Exhibit 1.5 Professional Service Firm Organization Executive Committee Managing Partner Practice Offices Partners-in-Charge Tax Consulting Services Audit, Assurance and Business Advisory Services Consulting Services Partner Partner Manager Manager Manager Manager Manager Manager Senior (In-charge) Accountants Staff Accountants (or Associates) Senior (In-charge) Accountants Staff Accountants (or Associates) McGraw-Hill/Irwin ©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

The Public Accounting Profession Assurance services Audit engagements Assurance engagements Attestation engagements Compilations Reviews Tax consulting services Consulting services McGraw-Hill/Irwin ©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

Prohibited Services to Audit Clients Sarbanes-Oxley and the PCAOB prohibit professional service firms from providing any of the following services to an audit client: bookkeeping and related services design or implementation of financial information systems appraisal or valuation services actuarial services internal audit outsourcing management or human resources services investment or broker/dealer services legal and expert services (unrelated to the audit) Professional service firms may provide client tax services (with some restrictions) and other non-prohibited services to audit clients if the company’s audit committee has approved them in advance. In summary, Sarbanes-Oxley prohibits professional service firms from performing any client services in which the auditors may find themselves making management decisions or auditing their own firm’s work. McGraw-Hill/Irwin ©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

Types of Audits and Auditors Financial (External Auditors/CPAs) Ensure that financial statements are fairly presented in accordance with GAAP. Operational (Internal Auditors/CIAs) Improve operational economy Improve operational efficiency Compliance (Governmental Auditors) Ensure compliance with company and/or governmental rules and regulations Forensic (Fraud Auditors/CFEs) Most audits are a combination of financial, operational, and compliance audits. McGraw-Hill/Irwin ©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

Organization of the Profession “Big Four” Accounting Firms D&T, E&Y, KPMG, PwC National e.g., Grant Thornton, BDO Seidman Local/Regional e.g., Melton & Melton (Texas), Postlethwaite & Netterville (Louisiana), Goodman & Company (Virginia) Sole Proprietor McGraw-Hill/Irwin ©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

©2007 by the McGraw-Hill Companies, Inc. All rights reserved. Become Certified! Education Examination Experience State Certificate and License for CPA Skills sets and your education McGraw-Hill/Irwin ©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

©2007 by the McGraw-Hill Companies, Inc. All rights reserved. The New CPA Exam Computerized Four parts Auditing and attestation—4.5 hrs Financial accounting and reporting—4 hrs Regulation—3 hrs. Business environment—2.5 hrs Skill sets—research, communication, analysis, judgment and understanding McGraw-Hill/Irwin ©2007 by the McGraw-Hill Companies, Inc. All rights reserved.

©2007 by the McGraw-Hill Companies, Inc. All rights reserved. Engagement Overview OBTAIN (OR RETAIN) CLIENT ENGAGEMENT PLANNING INTERNAL CONTROL EVALUATION EVIDENCE GATHERING REPORTING McGraw-Hill/Irwin ©2007 by the McGraw-Hill Companies, Inc. All rights reserved.