MODERN AUDITING 7th Edition William C. Boynton California Polytechnic State University at San Luis Obispo Raymond N. Johnson Portland State University Walter G. Kell University of Michigan Developed by: Dr. Raymond N. Johnson, CPA Gregory K. Lowry, MBA, CPA John Wiley & Sons, Inc.

CHAPTER 2 FINANCIAL STATEMENT AUDITS AND AUDITORS’ RESPONSIBILITIES Fundamentals Underlying Financial Statement Audits Independent Auditor Relationships Auditing Standards Assurance Provided by an Audit The Auditor’s Report Trends Affecting Auditor Responsibilities

Relationship Between Accounting and Auditing Figure 2-1

Need for Financial Statement Audits Conflict of Interest Management and Board of Directors Shareholders and Creditors 2. Consequence 3. Complexity 4. Remoteness

Economic Benefits of an Audit 1. Access to Capital Markets 2. Lower Cost of Capital 3. Deterrent to Inefficiency and Fraud 4. Control and Operational Improvements

Limitations of a Financial Statement Audit Following are 2 important economic limits: 1. Reasonable Cost 2. Reasonable Length of Time

Limitations of a Financial Statement Audit Following are 2 important limitations associated with the established accounting framework: 1. Alternative Accounting Principles 2. Accounting Estimates

Independent Auditor Relationships Management Assumption of management honesty Need for professional skepticism 2. Board of Directors and Audit Committee 3. Internal Auditors Not a substitute for independent auditor’s work 4. Stockholders (and other users)

Generally Accepted Auditing Standards Figure 2-2 General Standards 1. The audit is to be performed by a person or persons having adequate technical training and proficiency as an auditor. 2. In all matters relating to the assignment, an independence in mental attitude is to be maintained by the auditor or auditors. 3. Due professional care is to be exercised in the performance of the audit and the preparation of the report.

Generally Accepted Auditing Standards Figure 2-2 Standards of Field Work 1. The work is to be adequately planned, and assistants, if any, are to be properly supervised. 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. 3. Sufficient competent evidential matter is to be obtained through inspection, observation, inquiries, and confirmations to afford a reasonable basis for an opinion regarding the financial statements under audit.

Generally Accepted Auditing Standards Figure 2-2 Standards of Reporting 1. The report shall state whether the financial statements are presented in accordance with generally accepted accounting principles. 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. 3. Informative disclosures in the financial statements are to be regarded as reasonably adequate unless otherwise stated in the report.

Generally Accepted Auditing Standards Figure 2-2 Standards of Reporting 4. The report shall either contain an expression of 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 therefore should be stated. 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 work, if any, and the degree of responsibility the auditor is taking.

Assurance Provided by an Audit 1. Auditor Independence 2. Reasonable Assurance 3. Definition of Fraud Fraudulent financial reporting Misappropriation of assets 4. Responsibility to Detect Fraud Assess risk of fraud Design plan to provide reasonable assurance that fraud does not exist that is material to the financial statements based on risk assessment. Use due professional care in implementing audit plan

Assurance Provided by an Audit 5. Responsibility to Report Fraud Employee fraud Management fraud Confidential client information 6. Illegal Client Acts Direct and material Indirect 7. Assurance About a Going Concern

Auditor’s Standard Report Basic Elements of Auditor’s Standard Report Title Addressee Introductory Paragraph Scope Paragraph Opinion Paragraph Firm’s Signature Date

Introductory Paragraph We have audited the accompanying consolidated balance sheets of Intel Corporation as of December 25, 1999 and December 26, 1998, and the related consolidated statements of income, stockholders’ equity and cash flows for each of the three years in the period ended December 25, 1999. These financial statements are the responsibility of management. Our responsibility is to express an opinion on these financial statements based on our audits.

Scope Paragraph We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosure in the financial statements. An audit also includes assessing the accounting principles used and significant accounting estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

Opinion Paragraph In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Intel Corporation at December 25, 1999 and December 26, 1998, and the consolidated results of operations and its cash flows for each of the three years in the period ended December 25, 1999, in conformity with accounting principles generally accepted in the United States.

Types of Auditors’ Reports and Circumstances Figure 2-4

Types of Auditors’ Reports and Circumstances Figure 2-4

Standard Report with Explanatory Language Reason for Opinion The financial statements present fairly in all material respects Used with Changes in accounting principles Material uncertainties Going concern matters Emphasis of a matter Form of Opinion 4th paragraph to explain issue and refer to note in the financial statements

Qualified Opinion Reason for Opinion Form of Opinion Material departure from GAAP Material scope limitation Except for the qualification, the financial statements present fairly. Form of Opinion 3rd paragraph before the opinion to explain the exception its impact on the financial statements 4th paragraph is opinion paragraph. “In our opinion, except for ….

Adverse Opinion Reason for Opinion Form of Opinion Departures from GAAP are so material and so pervasive to the financial statement that the auditor concludes that the financial statement do not present fairly … Form of Opinion 3rd paragraph before the opinion to explain the exception its impact on the financial statements 4th paragraph is opinion paragraph. “In our opinion,… the financial statements referred to above do not present fairly….

Disclaimer of Opinion Reason for Opinion Form of Opinion The auditor is unable to obtain sufficient evidence to form an opinion on the financial statements Common with client imposed scope restrictions Form of Opinion Omit 2nd scope paragraph 3rd paragraph before the opinion to explain the reason for the disclaimer of opinion 4th paragraph is opinion paragraph. “… the scope of our work was not sufficient to enable us to express, and we do not express, an opinion on the financial statements.

Management Responsibility Report Figure 2-5

Trends Affecting Auditor Responsibilities 1. Information Technologies 2. Assurance Services

CHAPTER 2 FINANCIAL STATEMENT AUDITS AND AUDITORS’ RESPONSIBILITIES

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