Chapter 1

1. Chapter 1 Auditing and Assurance Services Chapter 1

2. 1. Introduction - What is Auditing? • Misunderstandings • Overview of auditing • Ultimate purpose of audit • To issue an opinion on the fairness of financial statements (and in some cases, on the client’s internal control structure) Chapter 1

3. 1. Introduction – Purpose of Audit • Ultimate purpose of audit (formal def) • To obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, thereby enabling the auditor to express an opinion on whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting frameworkand to report on the financial statements and communicate the findings as required by GAAS. Chapter 1

4. 1. Introduction – Who is Client? • Who is the client? • Stanford University professor Maureen McNichols questioned how independent an auditing firm can be when its job depends on the client. • “When a firm hires its auditor, it is hard for the auditor to be truly independent … Audit firms speak of the companies they audit as their clients. When you look at the Web sites of public accounting firms, you see language that describes how their purpose is to provide value to their clients and to build relationships, to help clients solve complex business problems and enhance their ability to build value. I believe public accounting firms were created to serve a different client, the investing public” Chapter 1

5. 1. Introduction – Who is Client? • In the United States, Deloitte LLP and its subsidiaries have 57,000 professionals with a single focus: serving our clients and helping them solve their toughest problems. We work in four key business areas — audit, financial advisory, tax and consulting — but our real strength comes from combining the talents of those groups to address clients’ needs. • Ernst & Young is a global leader in assurance, tax, transaction and advisory services. Worldwide, our 135,000 people are united by our shared values and an unwavering commitment to quality. We make a difference by helping our people, our clients and our wider communities achieve their potential. • KPMG delivers a globally consistent set of multidisciplinary services based on deep industry knowledge. Our industry focus helps KPMG professionals develop a rich understanding of clients' businesses and the insight, skills, and resources required to address industry-specific issues and opportunities. • Imagine the power of 180,000 people with a common purpose — building relationships that create value for you and your business. This is PwC. Every day, our people work with you to build the value you are looking for. Chapter 1

6. 1. Introduction – Who is Client? • US Chief Justice Warren Burger in 1984 Supreme Court decision in US v. Arthur Young: • By certifying the public reports that collectively depict a corporation’s financial status, the independent auditor assumes a public responsibility transcending any employment relationship with the client. The independent public accountant performing this special function owes ultimate allegiance to the corporation’s creditors and stockholders, as well as to the investing public. This “public watchdog” function demands … complete fidelity to the public trust. Chapter 1

7. 1. Introduction – Confidence/Ethics Chapter 1

8. 1. What is Auditing? - Ethics Chapter 1

9. 1. What is Auditing? - Ethics Chapter 1

10. 2. Why Study Auditing? • Required • To obtain employment • On CPA, CMA, CFE, CIA, etc., exams • Other reasons Chapter 1

11. 3. Definitions of Auditing • AAA definition • AICPA definition • Information risk Chapter 1

12. 3. Definition of Auditing • AAA definition: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 to interested users. Chapter 1

13. 3. Definitions of Auditing • AICPA definition:The objective of the ordinary examination of financial statements by the independent auditor is the expression of an opinion on the fairness with which they present, in all material respects, financial position, results of operations, and cash flows in conformity with GAAP. Chapter 1

14. 3. Definitions of Auditing • Information risk • Information risk is the risk that the financial statements will not be reliable (i.e., they will be false or misleading) • Consequence of unreliable financial statements: users make wrong decisions • Wrong decisions lead to inefficient capital markets • ∴ auditing is the process that improves the reliability of financial information Chapter 1

15. 4. Does Auditing Add Value to Financial Data? • Conditions creating a demand for auditing • complexity • remoteness • time-sensitivity • consequences • *conflict of interest Chapter 1

16. 4. Does Auditing Add Value to Financial Data? • Other evidence • market forces • agency theory • information theory • insurance hypothesis • by products Chapter 1

17. 5. Significant Events inHistory of Auditing • Ancient to 1850 • 1850 to 1900 • 1900 to 1940 • 1940 to 1975 • 1975 to 1985 • 1985 to 1995 • 1995 to 2002 • 2002 Chapter 1

18. 6. Types of Audits • Financial statement audits • Compliance audits • Operational audits • (Governmental audits) • Information systems audits • Fraud audits • Quality audits • Environmental audits Chapter 1

19. 7. Types of Auditors • External auditors • Internal auditors • Governmental auditors Chapter 1

20. 8. Professional Services Assurance Services Any Information Attestation Services Primarily Financial Information Audit Services Financial Statements Chapter 1

21. 8. Professional Services • Attestation Services • examinations, reviews, or agreed upon procedures • Examples • financial forecasts and projections • pro forma financial information • compliance with contractual requirements • effectiveness of internal control systems • examination of MD&A • reporting on controls at a service organization Chapter 1

22. 8. Professional Services • Assurance Services Examples • Risk assessment • Business performance measurement • Information systems reliability • Electronic commerce • Third party reimbursement maximization • XBRL reporting • Customer satisfaction surveys Chapter 1

23. 9. Professional Skepticism • Standards require you to exercise professional skepticism • Potential conflict of interest always exists between • auditor • management of the entity being audited • Neither assume management is • dishonest • nor assume unquestioned honesty • hold no preconceived conclusions on any side of issue • Have an attitude that includes a questioning mind and a critical assessment of evidence Chapter 1

24. 10. Financial Statement Assertions • AU-C 315 • Management makes assertions regarding financial statements • Auditors use assertions to guide evidence gathering Chapter 1

25. 10. Financial Statement Assertions (Con’t) * PCAOB Assertions Chapter 1

26. 11. SOX and PCAOB • Sarbanes-Oxley Act of 2002 • Passed by Congress in response to accounting related corporate scandals • Applies to audits of issuers • Some major provisions • Creation of PCAOB • Requirement for audit of internal controls • CEO/CFO certification of f/s • Prohibition of certain client services Chapter 1

27. 11. SOX and PCAOB • Prohibited services to audit clients • bookkeeping and related services • design or implementation of financial IT sys • 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) • Some tax services and other non-prohibited services okay if preapproved by Audit Comm Chapter 1

28. 12. Public Accounting Firms • Big 4 • National • Regional • Local Chapter 1

29. 13. Certification • CPA • CMA • CFE • CIA • CISA Chapter 1

30. 13. Certification • Components • education, examination, experience, CPE • 150 hour rule for CPA Exam • CPA Exam • Auditing and attestation—4 hrs • Financial accounting and reporting—4 hrs • Regulation—3 hrs. • Business environment concepts—3 hrs Chapter 1

31. 14. Organizations of the Accounting Profession • PCAOB • AICPA • State Boards of Public Accountancy • State Societies of CPAs Chapter 1

32. 15. CPA Mobility • To practice in another state • Driver’s license model • Legislation adopted in 51 jurisdictions so far • To obtain permit to practice in another state Chapter 1

33. 16. Updates Firm mobility and updated definition of attest included in updated UAA Journal of Accountancy MAY 20, 2014 • The definition of attest in the newly amended UAA requires that only CPAs operating within a CPA firm can perform: • Audits in accordance with Statements on Auditing Standards (SAS); • Reviews under Statements on Standards for Accounting and Review Services (SSARS); and • Examinations, reviews, and agreed-upon procedures under Statements on Standards for Attestations Engagements (SSAE). • Any engagement performed under PCAOB standards. • An exception would be public officials and public employees, who are not prohibited by the UAA from performing any of their duties. So, for example, state audit organizations would continue to be able to perform engagements under the SAS, SSARS, and SSAE. Chapter 1

34. 16. Updates • The UAA also has been updated to provide for CPA firm mobility across state lines under a no-notice, no-fee, no-escape regime. • This would allow firms registered in one state to provide attest services to clients in another state without registering the firm or paying fees in the second state. Under the UAA provisions, CPA firms would be subject to the laws and regulations of both their home state and the second state, and they would have to meet the peer review and CPA ownership requirements of any mobility state in which they are seeking to perform those attest services. CPAs and CPA firms can already provide nonattest services out-of-state without registering.  Chapter 1

35. Review Questions for Discussion • Chapter 1 1.3 1.5 1.6 1.9 1.14 • 1.15 • 1.17 • 1.19 • 1.20 • 1.21 Chapter 1