1 - 1 Introduction to 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 Will Rogers

1 - 2 Entry-level CPAs are expected to practically walk on water. In addition to technical ability to do the job, they need communication and people skills, computer savvy, a strong sense of ethics---and even a nose that can detect fraud. Journal of Accountancy June, 2005 p77

1 - 3 Study of Auditing 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 is different from other accounting courses that you have taken in college because … LO# 1

1 - 4 INFORMATION RISK INFORMATION RISK Risk (probability) that the information (mainly financial) disseminated by a company will be materially false or misleading Risk (probability) that the information (mainly financial) disseminated by a company will be materially false or misleading Users demand independent third party assessment of the information Users demand independent third party assessment of the information.

1 - 5 Reducing Information Risk User verifies information. User shares information risk with management. Audited financial statements are provided.

1 - 6 Assurance and Attestation Services Other Assurance Services CertainManagementConsulting Other Attestation Services (e.g., WebTrust, SysTrust) ATTESTATION SERVICES Audits Reviews Internal Control over Financial Reporting ASSURANCE SERVICES

1 - 7 The Attest Function Management Subject Matter Suitable Criteria The CPA Gathers Evidence Subject Matter* The Attest Report Issues Report *May be management’s assertion about the subject matter.

1 - 8 Attestation Services 1. Audit of historical financial statements 2. Attestation of internal control over financial reporting 3. Review of historical financial statements 4. Attestation services on information technology 5. Other attestation services

1 - 9 Auditing vs Accounting Accounting is the recording, classifying, and summarizing of economic events for the purpose of providing financial information used in decision making. Auditing is determining whether recorded information properly reflects the economic events that occurred during the accounting period.

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 A Statement of Basic Auditing Concepts, American Accounting Association (Sarasota, FL). 1-10

Overview of Financial Statement Auditing

Audit of a Tax Return Audit of a Tax Return InternalrevenueagentCompetent,independentperson Examines cancelled checks and other supporting records Accumulates and evaluates evidence Determinescorrespondence Federal tax returns filed by taxpayer Information Internal Revenue Code and all interpretations Established criteria Report on tax deficiencies Report on results

Relationships Among Auditors, Client, and External Users Client Auditor Client or audit committee hires auditor ExternalUsers Auditor issues report relied upon by users

Overview of the Financial Statement Audit Process LO# 5

Problems and Warning Signs During the economic boom of the late 1990s and the early 2000s, accounting firms aggressively sought opportunities to market a variety of high-margin nonaudit services to their audit clients. LO# 1

An Explosion of Scandals Enron WorldCom Tyco Xerox Adelphia LO# 1

Accounting Profession’s Decade of Unprecedented Turmoil & Change Accounting Profession’s Decade of Unprecedented Turmoil & Change 1. Failure of one of the largest public accounting firms (Andersen) 2. Four of the largest bankruptcies ever - each in a company where financial statement misrepresentation had taken place 3. Billions of investment and retirement dollars lost 4. Perception that auditors were not independent from their clients independent from their clients

SEC Concerns About the Auditing Profession SEC Concerns About the Auditing Profession Auditors unwilling to confront clients over questionable accounting practices Consulting fees impairing auditor independence Accountants using technical interpretations of GAAP to push the limits of accounting

Government Regulation In July 2002, Congress passed the Sarbanes-Oxley Public Company Accounting Reform and Investor Protection Act. The Sarbanes-Oxley Act effectively ended the profession’s era of “self- regulation,” creating and transferring authority to set and enforce standards to the Public Company Accounting Oversight Board (PCAOB). LO# 1

Sarbanes/Oxley Act Sarbanes/Oxley Act Established the Public Companies Accounting Oversight Board (PCAOB) Established the Public Companies Accounting Oversight Board (PCAOB) Requires CEO and CFO to “certify” financial statements Requires CEO and CFO to “certify” financial statements Requires both companies and auditors to provide a comprehensive report on internal controls Requires both companies and auditors to provide a comprehensive report on internal controls Gives Audit Committees expanded powers as the 'audit client' and for pre-approving any non-audit services by its external auditors Gives Audit Committees expanded powers as the 'audit client' and for pre-approving any non-audit services by its external auditors Requires Audit Committees to report their activities to the public Requires Audit Committees to report their activities to the public

Sarbanes/Oxley Act (Cont) Sarbanes/Oxley Act (Cont) Audit Committees --- at least one person who is a financial expert. Audit engagement partners rotation --- every five years A "cooling off" period of an audit partner or manager before taking a high-level position with an audit client Increased disclosure of material "off-balance sheet" transactions or agreements Requires the GAO to make a study a of accounting issues of the effect of consolidation on competition within the accounting profession, and an analysis of mandatory audit firm rotation

Prohibited Services to Audit Clients 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.

Powers Granted to the PCAOB Set Auditing Standards Set Financial Accounting Standards Set Internal Control and Risk Management Reporting Standards Perform Quality Reviews and Recommend Penalties Establish Quality Control Standards for the Audits of Public Companies Require Registration of Public Accounting Firms doing audits of public companies for license to perform such audits

Types of Audits   Operational   Compliance   Financial Statement

Types of Auditors Financial (External Auditors/CPAs) Ensure that financial statements are accurate. Operational (Internal and Governmental Auditors/CIAs) Improve operational economy Improve operational efficiency Compliance (Internal and 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. Most audits are a combination of financial, operational, and compliance audits.

PCAOB Management Assertions Existence or Occurrence – Assets included in accounts exists and events that give rise to transactions have taken place Rights and Obligations- Entity has a legal claim on all assets and revenues reported and has a legal responsibility for all liabilities and expenses Completeness - All transactions have been recorded Valuation or Allocation – Transactions are recorded at the correct amount in the proper period Presentation and Disclosure – All accounts are presented in the appropriate place and all information required has been disclosed in the statements and footnotes.

Management Assertions (ABS) Events and Transaction Assertions Occurrence – Events giving rise to transactions have taken place Occurrence – Events giving rise to transactions have taken place Completeness and cutoff - All transactions have been recorded and are recorded in the appropriate period Completeness and cutoff - All transactions have been recorded and are recorded in the appropriate period Accuracy – Accuracy – Transactions are recorded at the correct amount Classifications – Transactions have posted to the proper account Classifications – Transactions have posted to the proper account

Management Assertions (ABS) Account Balance Assertions Existence – Balances include only assets and liabilities that exist Existence – Balances include only assets and liabilities that exist Rights and obligations - Rights and obligations - Entity has legal claim on all assets and revenues reported Entity has a legal responsibility for all liabilities and expenses Completeness – Balances include all items which should be included according to GAAP Completeness – Balances include all items which should be included according to GAAP Accuracy and valuation – Balances included items recorded in the proper period at the proper amount in accordance with GAAP Accuracy and valuation – Balances included items recorded in the proper period at the proper amount in accordance with GAAP

Management’s Financial Statement Assertions (ASB) Assertions about Presentation and Disclosures Occurrence and rights and obligations – items presented have occurred and are either owned by or represent the responsibility of the entity Completeness – the proper disclosures have all been made by the entity Classification and understandability – accounts in the disclosures have been appropriately grouped and users can comprehend the disclosures Accuracy and valuation – the amounts in the disclosures have been properly measured and are valued in accordance with GAAP 1-29

Exhibit 1.5 Example Assertions and their Relationships to the Financial Statements

Management Assertions Financial statements issued by management contain explicit and implicit assertions. Transaction s Management asserts that transactions related to inventory actually occurred. Account Balances Management asserts that the entity owns the inventory represented in the inventory account. Presentation & Disclosure Management asserts that the financial statements properly classify and present the inventory. LO# 5

Questions to Ask What do I need to know? How well do I know it? Does it make sense? What can go wrong?

Professional Skepticism Professional skepticism - auditor’s questioning, evaluative, attitude toward evidence Management’s assertions without sufficient corroboration. Financial trends need investigation Documents are checked for authenticity or alteration Ask questions, get answers, then verify the answers. 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.

CPAs Encouraged to Conduct Themselves at a High Level LegalLiability Division of CPA firms ContinuingEducationRequirements GAAS and Interpretations Code of ProfessionalConduct CPAExamination QualityControl PeerReview PCAOB and SEC Conduct of CPA Firm Personnel

Professional/Regulatory Organizations SEC --- oversees the PCAOB and all companies publicly traded on the U.S. capital markets AICPA --- primary governing organization of the public accounting profession AICPA --- primary governing organization of the public accounting profession

Professional/Regulatory Organizations State Boards of Accountancy --- responsible for certifying and licensing CPAs in their state. State Boards of Accountancy --- responsible for certifying and licensing CPAs in their state. Institute of Internal Auditors --- issues internal auditing standards and administers the Certified Internal Auditor program Institute of Internal Auditors --- issues internal auditing standards and administers the Certified Internal Auditor program U. S. General Accounting Office --- nonpartisan audit agency for Congress. The GAO develops auditing standards for governmental audits. U. S. General Accounting Office --- nonpartisan audit agency for Congress. The GAO develops auditing standards for governmental audits.

Other Parties FASB Sets GAAP for entities other than federal, state and local governments GASB Standards of financial accounting for state and local government entities FASAB Accounting standards for the US government

Purpose: to assist in providing investors with reliable information upon which to make investment decisions. Securities and Exchange Commission

Forms S-1 to S-16 Securities and Exchange Commission Form 8-K Form 10-K Form 10-Q

AICPA’s Traditional Role Establish Standards --- Now only private companies Research and Publication Continuing Professional Education Self-Regulation CPA Examination

Establishes Standards--Examples AICPA Auditing Standards Board Issues official pronouncements on auditing matters for nonpublic companies (“nonissuers”) Statements on Auditing Standards (SASs) Statements on Standards for Attestation Engagements (SSAEs) Accounting and Review Services Committee Statements on Standards for Accounting and Review Services (SSARS) Standards for compilations or reviews not audits of financial statements

Research and Publication Magazines Journal of Accountancy (Monthly) The Tax Advisor Audit Publications Industry Audit and Accounting Guides Audit Risk Alerts Auditing Practice Releases Other Publications Accounting Research Studies Statements of Position Accounting Trends & Techniques

Professional Regulation Professional Regulation Development of CPE Programs Development of CPE Programs AICPA AICPA State Societies State Societies Other Professional Organizations Other Professional Organizations Code of Professional Conduct – Ethical Rules for CPAs Membership requirements of the AICPA

CPA Exam National exam prepared and graded by the AICPA Computerized Four Parts Auditing and Attestation—4. hrs Financial Accounting and Reporting—4 hrs Regulation—3 hrs. Business Environment—3 hrs Skill Sets—Research, Communication, Analysis, Judgment, Understanding

Organization of the Profession “Big Four” Accounting Firms D&T, E&Y, KPMG, PWC National Grant Thornton, BDO Seidman, Tilly Baker Local/Regional Clifton Gunderson, C.P.A. Wipfile, C.P.A. Sole Proprietor

Public Accounting Professional Services Public Accounting Professional Services Assurance Services Audit Engagements Assurance Engagements Attestation Engagements Compilations Reviews Tax Consulting Services Consulting Services Litigation Support

Professional Service Firm Organization Executive Committee Managing Partner Practice Offices Partners-in-Charge Consulting Services Audit, Assurance and Business Advisory Services Tax Consulting Services Partner Manager Senior (In-charge) Accountants Staff Accountants (or Associates) Partner Manager Senior (In-charge) Accountants Staff Accountants (or Associates)

Firm Organizational Structure Proprietorship General Partnership General Corporation Professional Corporation Limited Liability Company Limited Liability Partnership

Typical Structure of a National CPA Firm Partners Managers Seniors Staff

Hierarchy of a Typical CPA Firm Level LevelExperience Responsibilities Responsibilities StaffAssistant 0-2 years Performs most of the detailed audit work Senior or In-ChargeAuditor 2-5 years Responsible for the audit field work, including supervising staff work

Hierarchy of a Typical CPA Firm Level LevelExperience Responsibilities Responsibilities Manager 5-10 years Helps the plan, manages the audit, reviews work, and works with the client Partner 10+ years Reviews audit work and makes significant audit decisions

Requirements to Become Certified! EducationExaminationExperience State Certificate and License for CPA Skills sets and your education

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