An Introduction to Assurance and Financial Statement Auditing Chapter 1 An Introduction to Assurance and Financial Statement Auditing Chapter 1 is an introduction to FS Auditing. What we are going to discuss is WHAT exactly audit and assurance services are, the need for audits and assurance services, and also give you a brief introduction to some auditing terms and concepts that might be new to you.

Auditing Demands Logic, Reasoning, and Resourcefulness The study of auditing is different from other accounting courses because… an auditor needs to understand more than just the accounting concepts and techniques. Auditing is a fundamentally logical process of thinking and reasoning – you must learn to use your common sense and reasoning skills! Take time to understand the underlying logic and how the concepts interrelate with other concepts. Being a good auditor requires imagination and innovation. 1-2

Principals and Agents Stockholders Managers Principals Agents A public company is a company that sells its stocks or bonds to the public, giving the public a valid interest in the proper use of the company’s resources. Stockholders Managers Principals Agents

The Principal-Agent Relationship and Information Risk

The Role of Auditing Summary of Management Assertions by Category 1-5

Relationships among Auditing, Attest, and Assurance Services LO# 3 Relationships among Auditing, Attest, and Assurance Services Right-click on the hyperlinks below: The Big Bang Theory and CPAs E&Y and the Emmys! 1-6

Auditing, Attest, and Assurance Services Defined Attestation Assurance Services 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 in a written report to interested users. Right-click on Mickey

Auditing, Attest, and Assurance Services Defined Attestation Assurance Services Attest services occur when a practitioner is engaged to issue a written report on a subject matter, or an assertion about subject matter, that is the responsibility of another party. For example, forecasts, projections, compliance with debt covenants, statutory rules, or tax laws.

Auditing, Attest, and Assurance Services Defined Attestation Assurance Services Auditing Independent professional services that improve the quality of information, or its context, for decision makers. Note - no written report is required! The accounting firm of Deloitte tabulates the Heisman ballots. Deloitte is responsible for mailing ballots and voting instructions. PwC is well-known as the “accountants” to the Academy since 1935, safeguarding the ballots and tabulating the voting.. 1-9

Overview of the Financial Statement Audit Process 1-10 10

Concepts in Conducting a Financial Statement Audit Risk Materiality Evidence

Are you telling the truth, the whole truth…? Materiality Information is material if misstating it or omitting it could influence decisions that users make on the basis of the financial information of a specific reporting entity. Determining materiality is a matter of professional judgment. Are you telling the truth, the whole truth…?

Audit Risk Audit risk is the risk that the auditor expresses an inappropriate audit opinion. The opinion states that the F/S are fairly stated when, in fact, they’re materially misstated. The auditor’s standard report states that the audit provides only reasonable assurance that the F/S do not contain material misstatements. Reasonable assurance implies some risk that a material misstatement could be present in the F/S and the auditor will fail to detect it (detection risk).

Audit Evidence Regarding Management Assertions Evidence that assists the auditor in evaluating management’s F/S assertions consists of the underlying accounting data and any additional information available to the auditor, whether originating from the client or externally. Relevance – Is the information related to the specific F/S assertion being tested? Reliability – Can the information be relied upon to support the specific F/S assertion being tested?

Sampling: Inferences Based on Limited Observations LO# 6 Sampling: Inferences Based on Limited Observations Auditors use a sampling approach to examine a subset of transactions. Why? It’s too costly and time consuming to examine every transaction. Sampling is closely tied to materiality. If I told you to examine every invoice over $500 vs. $5,000, in which case would you look at more invoices? Sample size and which accounts get sampled will be based on: risk, previous audits, an understanding of the company’s internal control system, and/or knowledge of the industry.

Major Phases of the Audit Client acceptance/continuance Preliminary engagement activities Plan the audit Consider and audit internal control Audit business processes and related accounts (e.g. how is revenue generated and what accounts are affected) Complete the audit Evaluate results and issue audit report

Issuing the Audit Report The title line of the audit report includes the word “Independent” (or “Registered Independent” for a client that’s publically held). The report is usually addressed to the stockholders of the company or BODs. The audit report includes an introductory paragraph, a scope paragraph, an opinion paragraph, (and for publically held entities 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. Unqualified Qualified Adverse

Issuing the Audit Report The auditor may issue an unqualified opinion. 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. In this context, unqualified (a.k.a. unmodified) means that because the F/S are free of material misstatements, the auditor does not find it necessary to qualify his or her opinion about the fairness of the F/S. Any material problems associated with the audit has been resolved!

Issuing the Audit Report The auditor may issue a qualified opinion. Suppose an auditee’s F/S contain a misstatement that the auditor considers material, but not pervasive, and management refuses to correct the misstatement. The auditor will likely qualify the report, explaining that the F/S are fairly stated “except for” the misstatement(s) identified by the auditor. This is serious enough to warn the F/S users but not serious enough to issue an adverse opinion (see next slide).

Issuing the Audit Report The auditor may issue an adverse opinion. If an auditee’s F/S contain a misstatement that the auditor considers so material and pervasive that it affects the interpretation of the F/S, the auditor will issue an adverse opinion, indicating that the F/S are not fairly stated and should not be relied upon. We discuss scope limitations and disclaimers later on in the semester