1. 9.401 Auditing Chapter 1 Introduction

2. Definition of Auditing The accumulation and evaluation The accumulation and evaluation Of evidence about information Of evidence about information To determine and report on To determine and report on The degree of correspondence between The degree of correspondence between The information and established criteria. The information and established criteria. Auditing should be done by Auditing should be done by A competent and independent person A competent and independent person

3. Types of Audits 1. Financial Statement Audits  Evaluates correspondence between financial statements and GAAP 2. Operational Audits  Evaluates correspondence between org’s procedures and methods and criteria of efficiency and effectiveness 3. Compliance Audits  Evaluates correspondence between org’s operations and specific procedures or rules 4. Comprehensive Audits

4. Accounting vs. Auditing 1. Accounting  Recording, classifying and summarizing of economic events for the purpose of providing financial information for decision making  Requires understanding of GAAP 2. Auditing  Determining whether recorded information properly reflects the economic events of the period  Requires understanding of GAAP AND of accumulation and interpretation of audit evidence

5. Financial Statement Audit Objectives The objective of the audit of financial statements is to express an opinion whether the financial statements present fairly, in all material respects, the financial position, results of operations and changes in financial position in accordance with generally accepted accounting principles. The objective of the audit of financial statements is to express an opinion whether the financial statements present fairly, in all material respects, the financial position, results of operations and changes in financial position in accordance with generally accepted accounting principles. Opinion Fairly Materiality GAAP

6. FUNDAMENTAL CONCEPTS Materiality Materiality  Something is material if, in auditor’s judgment, its omission or misstatement would probably affect a user’s decision. Audit risk Audit risk  The risk that the auditor may unknowingly provide a “clean” opinion on financial statements that are materiality misstated. “Presents fairly” means that this risk is at an appropriately low level.

7. So, an audit opinion… is NOT an assurance as to the future viability of an entity is NOT an assurance as to the future viability of an entity is NOT an opinion as to the efficiency or effectiveness with which its operations, including internal control, have been conducted is NOT an opinion as to the efficiency or effectiveness with which its operations, including internal control, have been conducted Is NOT a guarantee that the financial statements are free of error Is NOT a guarantee that the financial statements are free of error

8. Benefits of Being Audited 1. Operational Audits  Improves efficiency and effectiveness 2. Compliance Audits  Reduces cost of non-compliance  Reassures external parties 3. Financial Statement Audits  May be mandatory  Reduces cost of capital. Why?…….

9. Business Risk vs. Information Risk 1. Business Risk  Risk that organization will fail to achieve its objectives 2. Information Risk  Risk that the information upon which a business decision was made is inaccurate The financial stakeholders of a firm face both types of risk. A financial statement audit reduces information risk, but not business risk

10. Sources of Information Risk Remoteness of Information Remoteness of Information Voluminous Data Voluminous Data Complex Exchange Transactions Complex Exchange Transactions Bias and Motives of Information Provider Bias and Motives of Information Provider

11. Who Performs Audits? 1. Public Accounting Firms Independent as external to audit client Independent as external to audit client Primarily f/s audits, but can be hired to perform other types of audits Primarily f/s audits, but can be hired to perform other types of audits 2. Internal Auditors Employees of org. Less independent:depends on org structure Employees of org. Less independent:depends on org structure Primarily operational and compliance audits Primarily operational and compliance audits

12. Who Performs Audits? 3. Government Auditors Often perform comprehensive audits, but depends on mandate Often perform comprehensive audits, but depends on mandate 4. Revenue Canada Auditors Compliance audits Compliance audits

13. What makes external auditors credible? Legal Liability Legal Liability Quality Control Adopted by Firm Quality Control Adopted by Firm Provincial Securities Commissions Provincial Securities Commissions Members of a Profession (usually CICA, but in some provinces CGA’S and CMA’s also have power to perform external financial statement audits) Members of a Profession (usually CICA, but in some provinces CGA’S and CMA’s also have power to perform external financial statement audits)

14. Authority of Professional Bodies 1. CICA Sets accounting and auditing standards Sets accounting and auditing standards 2. CICA, SMAC, CGA Publish materials for members Publish materials for members Set entrance standards and administer exams Set entrance standards and administer exams Continuing professional education Continuing professional education Codes of Professional Conduct Codes of Professional Conduct Inspection and Discipline Inspection and Discipline

15. Financial Statement Audits In an audit of financial statements, the auditor complies with generally accepted auditing standards (GAAS)…… In an audit of financial statements, the auditor complies with generally accepted auditing standards (GAAS)…… GAAS are developed by CICA GAAS are developed by CICA

16. Generally Accepted Auditing Standards ( Generally Accepted Auditing Standards ( GAAS) - General Standard The General Standard The General Standard  "The examination should be performed and the report prepared by a person or persons having adequate technical training and proficiency in auditing, with due care and with an objective state of mind" [Sept 1975 ] General Standard therefore emphasizes: General Standard therefore emphasizes:  Competence  Objectivity  Due Professional Care

17. Generally Accepted Auditing Standards (GAAS) Generally Accepted Auditing Standards (GAAS) Examination Standards Adequate Planning and Supervision Adequate Planning and Supervision  (i) The work should be adequately planned and properly executed. If assistants are employed they should be properly supervised. [Sept. 1975]

18. Generally Accepted Auditing Standards (GAAS) Sufficient Understanding of Internal control Sufficient Understanding of Internal control  (ii) A sufficient understanding of internal control should be obtained to plan the audit. When control risk is assessed below maximum, sufficient appropriate audit evidence should be obtained through tests of controls to support the assessment. [Oct. 1992]

19. Quick discussion of Internal Control u Control comprises those elements of an organization (including it resources, systems, processes, culture, structure and tasks) that, taken together, support people in the achievement of the organization’s objectives. u Objectives relate to: u effectiveness and efficiency of operations, including safeguarding of assets u reliability of internal and external reporting u compliance with applicable laws, regulations, and internal policies

20. Generally Accepted Auditing Standards (GAAS) Sufficient and Appropriate Audit Evidence Sufficient and Appropriate Audit Evidence  (iii) Sufficient appropriate audit evidence should be obtained by such means as inspection, observation, enquiry, confirmation, computation and analysis, to afford a reasonable basis to support the content of the report. [Sept. 1975]

21. GAAS Reporting Standards (i)The report should identify the financial statements and distinguish between the responsibilities of management and the responsibilities of the auditor. (i)The report should identify the financial statements and distinguish between the responsibilities of management and the responsibilities of the auditor. (ii)The report should describe the scope of the auditor's examination. (ii)The report should describe the scope of the auditor's examination. (iii) The report should contain either an expression of opinion on the financial statements or an assertion that an opinion cannot be expressed. In the latter case, the reasons therefor should be stated. (iii) The report should contain either an expression of opinion on the financial statements or an assertion that an opinion cannot be expressed. In the latter case, the reasons therefor should be stated.

22. Reporting Standards (iv) Where an opinion is expressed, it should indicate whether the financial statements present fairly, in all material respects, the financial position, results of operations and changes in financial position in accordance with an appropriate disclosed basis of accounting, which except in special circumstances should be generally accepted accounting principles. The report should provide adequate explanations with respect to any reservation contained in such opinion." (iv) Where an opinion is expressed, it should indicate whether the financial statements present fairly, in all material respects, the financial position, results of operations and changes in financial position in accordance with an appropriate disclosed basis of accounting, which except in special circumstances should be generally accepted accounting principles. The report should provide adequate explanations with respect to any reservation contained in such opinion."