An Introduction to Assurance and Financial Statement Auditing Chapter 1 An Introduction to Assurance and Financial Statement Auditing McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

LO# 1 The Study of Auditing The study of auditing is different from other accounting courses that you have taken in college because … Technical, analytical and logical skills Gather and assess the evidence against assertions More conceptual in nature Improving the reliability of information for decision makers

The Study of Auditing Vocab and Language is unique Relies on Analytical and Logical Skills

The Demand for Auditing and Assurance LO# 2 The Demand for Auditing and Assurance The development of the corporate form of business and the expanding world economy over the last 200 years have given rise to an explosion in the demand for assurance provided by auditors.

Why Audit ? Legal and Contractual Requirements Restrictive Covenants in Debt Agreements Modern Corporation Setup – Absentee Stockholders and profesional Managers Principal –Agent Relationships Lack on information symmetry Conflicts of Interest Cost Effective Monitoring Device

LO# 2 The Role of Auditing

The Role of Auditing OBJECTIVITY INDEPENDANCE

Auditing, Attest, and Assurance Services Defined LO# 4 Auditing, Attest, and Assurance Services Defined Attest Assurance Services Auditing A systematic process of objectively obtaining and evaluating evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between those assertions and established criteria and communicating the results to interested users.

Auditing, Attest, and Assurance Services Defined LO# 4 Auditing, Attest, and Assurance Services Defined Attest Assurance Services Auditing Attest services occur when a practitioner is engaged to issue or does issue a report on subject matter, or an assertion about subject matter, that is the responsibility of another party.

Auditing, Attest, and Assurance Services Defined LO# 4 Auditing, Attest, and Assurance Services Defined Attest Assurance Services Auditing Independent professional services that improve the quality of information, or its context, for decision makers.

Relationships among Auditing, Attest, and Assurance Services LO# 4 Relationships among Auditing, Attest, and Assurance Services

Relationships among Auditing, Attest, and Assurance Services LO# 4 Relationships among Auditing, Attest, and Assurance Services

Overview of the Financial Statement Audit Process LO# 5 Overview of the Financial Statement Audit Process

LO# 5 Audit Risk Audit risk is the risk that the auditor may unknowingly fail to appropriately modify his or her opinion on financial statements that are materially misstated. The auditor’s standard report states that the audit provides only reasonable assurance that the financial statements do not contain material misstatements. Reasonable assurance implies some risk that a material misstatement could be present in the financial statements and the auditor will fail to detect it.

LO# 5 Materiality Materiality is the magnitude of an omission or misstatement of accounting information that, in light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement.

Materiality So What is Material ?

Evidence Regarding Management Assertions LO# 5 Evidence Regarding Management Assertions Evidence that assists the auditor in evaluating management’s financial statement assertions consists of the underlying accounting data and any corroborating information available to the auditor. Relevance Reliability

Sampling: Inferences Based on Limited Observations LO# 6 Sampling: Inferences Based on Limited Observations Auditors use (1) their knowledge about the transactions and/or (2) a sampling approach to examine the transactions. It would be too costly for the auditor to examine every transaction.

Major Phases of the Audit LO# 7 Major Phases of the Audit The “404” Audit

So What is the End Product of A Financial Statement Audit?

LO# 8 Issue the Audit Report The auditor’s report (audit opinion) is the main product or output of the audit. The standard unqualified (clean) audit report is the most common type of report issued.

LO# 8 Issue the Audit Report The title line of the audit report includes the word “Independent,” and usually, the report is addressed to the stockholders of the company. The audit report includes an introductory paragraph, a scope paragraph, an opinion paragraph, an explanatory paragraph referring to the audit of internal control, the name of the auditor or audit firm, and the date of the audit report.

The auditor may issue a qualified opinion. LO# 8 Issue the Audit Report The auditor may issue a qualified opinion. Suppose a client’s financial statements contain a misstatement that the auditor considers material and the client refuses to correct the misstatement. The auditor will likely qualify the report, explaining that the financial statements are fairly stated except for the misstatement identified by the auditor.

The auditor may issue an adverse opinion. LO# 8 Issue the Audit Report The auditor may issue an adverse opinion. Suppose a client’s financial statements contain a misstatement that the auditor considers so material that it pervasively affects the interpretation of the financial statements. Given such a situation, the auditor will issue an adverse opinion, indicating that the financial statements are not fairly stated and should not be relied upon.

The Unqualified Audit Report Most Common Audit Must be Conducted IAW Applicable Standards Auditor must be Independent No Significant Limitations imposed on the Auditor’s Procedures Client’s F/S must be Free of Material Departures from GAAP

Auditing demands Logic, Reasoning, and Resourcefulness An auditor needs to understand both accounting and the concepts and techniques of gathering and evaluating evidence to assess management’s assertions. Auditing is a fundamentally logical process of thinking and reasoning – so use your common sense and reasoning skills! As you learn new auditing concepts, take some time to understand the underlying logic and how the concepts interrelate with other concepts. Being a good auditor sometimes requires imagination and innovation.

End of Chapter 1