Copyright © 2007 Pearson Education Canada 1 Chapter 1: The Demand for Auditing and Assurance Services

Copyright © 2007 Pearson Education Canada 1-2 Chapter 1 objectives  Learn about the different types of accountants and what they do  Explain the difference between accounting, auditing, assurance and non-assurance services  Describe how public accounting firms are organized  List the market forces that help ensure high quality audit and assurance engagements  Explain how standards are developed and quality assurance monitored

Copyright © 2007 Pearson Education Canada Professional accountants and their work  Professional accounting/auditing organizations represented in Canada (p. 3): – Canadian Institute of Chartered Accountants – Certified General Accountants Association of Canada – Society of Management Accountants of Canada – Institute of Internal Auditors – Information Systems Audit and Control Association

Copyright © 2007 Pearson Education Canada 1-4 What is an audit? (text, p. 4)  Auditing is the accumulation and evaluation of evidence about information to determine and report on the degree of correspondence between the information and established criteria.  Auditing is done by a competent, independent person.

Copyright © 2007 Pearson Education Canada 1-5 Five key components of auditing 1.Quantifiable information (related to entity) 2.Criteria: normally generally accepted accounting principles (GAAP) 3.Evidence gathering and evaluation 4. Competent, independent person 5.Report

Copyright © 2007 Pearson Education Canada 1-6 Figure 1-1 Audit of a tax return illustrates these principles

Copyright © 2007 Pearson Education Canada 1-7 Practice question 1-19 (p. 29)  Review the components of an audit  A PA (public accountant) can even audit trucks – let’s discuss how this is done!

Copyright © 2007 Pearson Education Canada 1-8 Factors that affect demand for audits  Remoteness of information  Bias and motives of provider  Voluminous data  Complex exchange transactions  Perceived cost/benefit

Copyright © 2007 Pearson Education Canada 1-9 Economic demand for auditing: illustrates why auditing is necessary  Auditing can reduce information risk associated with financial statements (the risk that the financial statements are inaccurate)  The independent audit provides assurance to users with respect to the reliability of the financial statements

Copyright © 2007 Pearson Education Canada 1-10 Practice question 1-22 (p. 30)  Compare an unusual service to the work done by PAs  Discuss the nature of information risk  Compare the risks of using financial statements to the risks of buying a vehicle

Copyright © 2007 Pearson Education Canada 1-11 Distinction between accounting and auditing  What is accounting?  What is auditing?  Who is responsible for accounting or auditing?  Can an auditor do both for the same company?

Copyright © 2007 Pearson Education Canada 1-12 Types of audits  Financial statement audit: Conducted to determine whether the overall financial statements are stated in accordance with specified criteria.  Compliance audit: To determine whether the auditee is following specific procedures or rules set down by a higher authority.  Operational audit: A review of any part of an organization’s operating procedures and methods for the purpose of evaluating economy, efficiency and effectiveness.

Copyright © 2007 Pearson Education Canada 1-13 Assurance services, attestation services, and nonassurance services

Copyright © 2007 Pearson Education Canada 1-14 Types of auditors  What type of auditor would you like to be? – Public accountant – Government auditor – Canada Revenue Agency auditor – Internal auditor

Copyright © 2007 Pearson Education Canada 1-15 Practice problem 1-20 (p. 29)  Let’s familiarize ourselves with the different activities completed by auditors  This question provides a list of activities for us to examine  Which type of auditor does what kind of work?

Copyright © 2007 Pearson Education Canada 1-16 What type of public accounting firms are present in your city or town?  Go through the local business pages of your telephone directory and see how many of the following types of firms you can identify: – International firms – National firms – Large local and regional firms – Small local firms or sole proprietorships

Copyright © 2007 Pearson Education Canada 1-17 Encouraging professional conduct among PAs

Copyright © 2007 Pearson Education Canada 1-18 Generally Accepted Auditing Standards (GAAS) (p. 18)  These are broad guidelines that help auditors in fulfilling their professional responsibilities.  General: qualifications and conduct  Examination: performance of the audit  Reporting: describing the results

Copyright © 2007 Pearson Education Canada 1-19 Structure of GAAS

Copyright © 2007 Pearson Education Canada 1-20 General: qualifications and conduct  Adequate technical training and proficiency in auditing  Due care  Objective state of mind

Copyright © 2007 Pearson Education Canada 1-21 Examination: performance of the audit  Adequate planning  Proper execution  Proper supervision  Sufficient understanding of environment and internal control  Sufficient appropriate audit evidence

Copyright © 2007 Pearson Education Canada 1-22 Reporting: results  Prepare a standardized report  Identify the financial statements  State responsibilities of management and the auditor  Explain the scope of the engagement  Provide the appropriate type of opinion (or state why you could not do so)

Copyright © 2007 Pearson Education Canada 1-23 Practice problem 1-26 (p. 31)  This practice problem shows you what can go wrong when GAAS is not followed.  Take a look at this problem and identify what Holmes did wrong (or simply did not do!) in the context of GAAS.

Copyright © 2007 Pearson Education Canada 1-24 Sources of auditing standards  Canadian CICA Assurance Handbook: Recommendations and Guidelines  U.S. have both the AICPA (American Institute of Certified Public Accountants) and the PCAOB (Public Company Accounting Oversight Board)  IFAC (International Federation of Accountants)

Copyright © 2007 Pearson Education Canada 1-25 Quality control  Why is it important for the public accounting firm to have quality control procedures?  What could go wrong without them?

Copyright © 2007 Pearson Education Canada 1-26 Quality control  Consists of the methods used to make sure that the firm meets its professional responsibilities  Includes the organizational structure of the PA firm and its procedures  Helps to ensure that GAAS is follows on every audit

Copyright © 2007 Pearson Education Canada 1-27 Elements of quality control  1. Leadership and responsibilities within the firm. E.g. An organizational culture that promotes audit quality; quality control procedures that are developed, documented, implemented, and communicated.  2. General ethical requirements. E.g. Address at the policy level general ethical principles of integrity, objectivity, professional competence and due, confidentiality

Copyright © 2007 Pearson Education Canada 1-28 Elements of quality control (cont’d)  3. Independence. E.g. develop, communicate and monitor policies and procedures to ensure that the firm complies with the independence guidelines.  4. Client acceptance or continuance. E.g. Document annual risk assessment processes, including evaluation of a client’s management integrity and auditor competence and independence.

Copyright © 2007 Pearson Education Canada 1-29 Elements of quality control (cont’d)  5. General human resource policies. E.g. Have adequate hiring policies that ensure competence and integrity of personnel.  6. Extent of professional development. E.g. Employees adequately trained in the skills needed to conduct audits.  7. Engagement performance. E.g. Have adequate processes and procedures to ensure that the audit is conducted in accordance with GAAS.

Copyright © 2007 Pearson Education Canada 1-30 Elements of quality control (cont’d)  8. Engagement quality control review. E.g. Ensure that quality control review takes place during the engagement and that monitoring occurs after the engagement is completed.  9. Documentation. E.g. Have policies that address the extent of documentation (hard copy or electronic) including retention, storage, security and back-up.

Copyright © 2007 Pearson Education Canada 1-31 Enforcement of quality control  Quality control is enforced by means of practice inspection  A practice inspection can occur by any one of: – One owns’ firm quality control staff – By the provincial institute or ordre – By the CPAB (Canadian Public Accountability Board)

Copyright © 2007 Pearson Education Canada 1-32 Practice question 1-25 (p. 31)  Let’s look at the differences between conducting an audit for a private company and for a public company  How are the audit standards involved?  How are quality control procedures and quality control enforcement different for the audit of a public company?