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Management Income Statement Balance Sheet Stmt of CF Management Prepares 1 Users Basic Mistrust 2 Auditors Independent Auditor 3 Lends Credibility 4 Auditors serve as intermediaries between Preparers and Users of financial information.

Auditing is a systematic process of... obtaining and evaluating evidence regarding management assertions to ascertain the degree of correspondence between those assertions and established criteria and communicating the results. Auditing Defined

4 Management Assertions Existence or Occurrence Completeness Valuation or Allocation Rights and Obligations Presentation and Disclosure

5 Existence or Occurrence exist Whether assets or liabilities of the entity exist at a given date and occurred Whether recorded transactions have occurred during a given period.

6 Completeness Whether all transactions and accounts that should be presented in the financial statements are so included.

7 Valuation or Allocation Whether asset, liability, revenue, and expense components have been included in the financial statements at appropriate amounts.

8 Rights and Obligations Whether  assets are the rights of the entity and  liabilities are the obligations of the entity at a given date.

9 Presentation and Disclosure Whether particular components of the financial statements are properly  classified,  described, and  disclosed.

10 Management Assertions: An Example

11 Inventory Example Consider a bicycle shop that has just prepared its financial statements and shows an inventory of $50,000. In order for the inventory to be a correct representation on the financial statements, the inventory must...

12 The inventory must... Be Complete All of the transactions regarding the inventory have been recorded prior to year-end; That is, the company must have recorded all receipts of inventory before year-end.

13 The inventory must... Be owned by the company (Rights) The company had title to all the inventory and has control over the bicycles and other products.

14 The inventory must... Be properly valued At the lower of cost or market at some acceptable valuation method (FIFO, LIFO). All old or obsolete inventory should be written down to its scrap or wholesale price.

15 The inventory must... Be properly disclosed The inventory methods used (e.g., LIFO, FIFO) must be disclosed; As well as the nature of the inventory (e.g., bicycles, parts, accessories, and so on.)

16 Audit Program... The audit program should gather convincing evidence that... The inventory exists That it is owned Completely recorded, Properly valued and Properly disclosed.

17 Audit Program... The amount, timing, and nature of the specific audit tests to be performed will be influenced by: The integrity of management The client’s internal control system The amount of misstatement that could make a difference to a user (materiality).

18 Overview of Financial Statement Auditing

Independent Auditor Obtains & Evaluates Evidence Audit Report Other Reports FASB APB ARB GASB AICPA AcSEC EITF SEC Assertions About Economic Events A s c e r t a i n D e g r e e o f C o r r e s p o n d e n c e Fin Stmts

20 How’d They do that?

21 Evidence... Consists of... The underlying accounting data and all corroborating information available to the auditor.

22 Evidence... Must be objectively gathered. Most audits are performed on a test basis.

Population infer Pull sample and then infer from the sample to the population Objectively Gathered Evidence Sample

24 Generally Accepted Auditing Standards (GAAS) Guidelines for Auditors

25 Generally Accepted Auditing Standards (GAAS) are general guidelines to aid auditors in fulfilling their professional responsibilities in the audit of financial statements.

26 Auditing Standards... General Standards  Three standards relating to the characteristics of the auditor. Standards of Field Work  Three standards relating to the conduct of the examination. Reporting Standards  Four standards relating to communication of results.

27 Generally Accepted Auditing Standards (GAAS) The General Standards

28 General Standards... 1.The examination is to be performed by a person or persons having adequate technical training and proficiency as an auditor.

29 General Standards... 2.In all matters relating to the assignment, an independence in mental attitude is to be maintained by the auditor or auditors.

30 General Standards... 3.Due professional care is to be exercised in the performance of the examination and the preparation of the report.

31 Generally Accepted Auditing Standards (GAAS) The Standards of Field Work

32 Standards of Field Work 1.The work is to be adequately planned and assistants, if any, are to be properly supervised.

33 Standards of Field Work 2.A sufficient understanding of the internal control structure is to be obtained to plan the audit and to determine the nature, timing, and extent of tests to be performed.

34 Standards of Field Work inspectionobservationinquiries confirmation 3.Sufficient competent evidential matter is to be obtained through inspection, observation, inquiries, and confirmation to afford a reasonable basis for an opinion regarding the financial statements under examination.

35 Generally Accepted Auditing Standards (GAAS) The Standards of Reporting

36 Standards of Reporting 1.The report shall state whether the financial statements are presented in accordance with generally accepted accounting principles.

37 2.The report shall identify those circumstances in which such principles have not been consistently observed in the current period in relation to the preceding period. Standards of Reporting

38 3.Informative disclosures in the financial statements are to be regarded as reasonably adequate unless otherwise stated in the report. Standards of Reporting

39 4.The report shall either contain An opinion regarding the financial statements, taken as a whole, or An assertion to the effect that an opinion cannot be expressed. When an overall opinion cannot be expressed, the reasons therefor should be stated. Standards of Reporting

40 In all cases where an auditor’s name is associated with financial statements, the report should contain a clear-cut indication of the character of the auditor’s examination, if any, and the degree of responsibility taken. Standards of Reporting

41 Overview The Audit Risk Model

42 The Audit Risk Model  Generally Accepted Auditing Standards establish a “model” for carrying out audits.

43 The Audit Risk Model  Requires auditors to use their judgment...  In assessing risks, and  Then in deciding what procedures to carry out.

44 Based on...  The auditor’s assessment of various risks and  any tests of controls, the auditor makes judgments about kinds of evidence needed to achieve “reasonable assurance.”

45 Some Terms The Audit Risk Model

46 The risk that the auditor may unknowingly fail to appropriately modify his/her opinion on financial statements that are materially misstated. Audit Risk (AR)

47 The risk that an assertion is susceptible to a material misstatement, assuming there are no related controls. Inherent Risk (IR)

48 The risk that a material misstatement that could occur in an assertion will not be prevented or detected on a timely basis by the entity’s internal control. Control Risk (CR)

49 The risk that the auditor will not detect a material misstatement that exists in an assertion. Detection Risk (DR)

50 AR = IR x CR x DR Highly judgmental The objective in an audit is to limit audit risk (AR) to a low level, as judged by an auditor. Mathematially

51 Auditors assess IR and CR along a spectrum Maximum risk Moderate risk Low risk Audit Risk

52 A maximum risk assessment (i.e., 100%) means that the auditor believes controls are unlikely to be effective; or The evaluation of their effectiveness would be inefficient. Audit Risk

FAFAICPAPOBISB Securities and Exchange Commission FASACFASB AcSECASBEthics SECPS Exec Comm. PRCQCIC PITF SEC Reg