1-1 Chapter 1 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 McGraw-Hill/Irwin ©2005 by the McGraw-Hill Companies, Inc. All rights reserved. 1-2 Chapter 1 Objectives • • • • • • • Define auditing and explain its link to information risk Understand the difference between accounting, auditing, attestation, and assurance Describe five management assertions Explain professional skepticism Describe public accounting firms List requirements for becoming a CPA Describe different types of audits McGraw-Hill/Irwin ©2005 by the McGraw-Hill Companies, Inc. All rights reserved. 1-3 User Demand for Reliable Information Demand for Auditing and Assurance Services Complexity • Remoteness • Time sensitivity • Consequences • Information risk is the risk (probability) that the information (mainly financial) disseminated by a company will be materially false or misleading. McGraw-Hill/Irwin ©2005 by the McGraw-Hill Companies, Inc. All rights reserved. 1-4 Exhibit 1-1 Overview of Financial Statement Auditing McGraw-Hill/Irwin ©2005 by the McGraw-Hill Companies, Inc. All rights reserved. 1-5 Definition of Auditing Financial Statements (including footnotes) Persons who rely on the financial reports •Creditors •Investors 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 GAAP and communicating the results to Auditor's Report/ interested users. Other Reports Source: American Accounting Association Committee on Basic Auditing Concepts. 1973. A Statement of Basic Auditing Concepts, American Accounting Association (Sarasota, FL). McGraw-Hill/Irwin ©2005 by the McGraw-Hill Companies, Inc. All rights reserved. 1-6 Exhibit 1-2 The Relationships Among Auditing, Attestation, and Assurance Services Assurance Services Any Information Attestation Services Primarily Financial Information Auditing Financial Statements McGraw-Hill/Irwin ©2005 by the McGraw-Hill Companies, Inc. All rights reserved. 1-7 Assurance Services • Assurance services are independent professional services that improve the quality of information, or its context, for decision makers. • Examples • CPA WebTrust (http://www.cpawebtrust.org) • Systrust • Performance View • PrimePlus Services (formerly known as ElderCare) • Can you think of others? McGraw-Hill/Irwin ©2005 by the McGraw-Hill Companies, Inc. All rights reserved. 1-8 Attestation Engagements • An attestation engagement is one “in which a practitioner is engaged to issue or does issue a report on subject matter or an assertion about the subject matter that is the responsibility of another party.” • Some financial attestation engagements (other than audits) • Supplementary financial statistics • Pro forma financial information • Financial forecasts and projections • Some non-financial attestation engagements • Compliance with contractual requirements • Effectiveness of internal control systems • Inventory quantities and locations McGraw-Hill/Irwin ©2005 by the McGraw-Hill Companies, Inc. All rights reserved. 1-9 Sarbanes-Oxley Act of 2002 • The Act’s major provisions include: – Requirement of CEO/CFO certification of financial statements and internal controls. – Requirement of auditor examination of company internal controls – Creation of the Public Company Accounting Oversight Board (PCAOB) to serve as an auditing profession “watchdog.” – Prohibition of certain client services by firms conducting a client’s audit. McGraw-Hill/Irwin ©2005 by the McGraw-Hill Companies, Inc. All rights reserved. Sarbanes-Oxley: Management’s Responsibility For Financial Reporting 1-10 One of its most important provisions (Section 302) states that the key company officials must certify the financial statements. Certification means that the company CEO and CFO must sign a statement indicating: 1. They have read the financial statements. 2. They are not aware of any false or misleading statements (or any key omitted disclosures). 3. They believe that the financial statements present an accurate picture of the company’s financial condition. Source: U.S. Congress, Sarbanes-Oxley Act of 2002, Pub. L. 107-204, 116 Stat/ 745 (2002). McGraw-Hill/Irwin ©2005 by the McGraw-Hill Companies, Inc. All rights reserved. 1-11 Management Assertions (SAS 31) • Presentation and disclosure – Footnotes – Classification • Existence (assets) or occurrence (transactions) • Rights and obligations – ownership • Completeness - all accounts/transactions included – Cutoff • Valuation or allocation – Accuracy McGraw-Hill/Irwin ©2005 by the McGraw-Hill Companies, Inc. All rights reserved. Exhibit 1-4 Example Assertions and their Relationships to the Financial Statements McGraw-Hill/Irwin ©2005 by the McGraw-Hill Companies, Inc. All rights reserved. 1-12 1-13 Professional Skepticism • Professional skepticism is an auditor’s tendency not to believe management’s assertions without sufficient corroboration. • Agency theory • Ask questions, get answers, then verify the answers. McGraw-Hill/Irwin ©2005 by the McGraw-Hill Companies, Inc. All rights reserved. 1-14 Exhibit 1-5 Professional Service Firm Organization Executive Committee Managing Partner Practice Offices Partners-in-Charge Tax Consulting Services Audit, Assurance and Business Advisory Services Partner Manager Manager Partner Manager Senior (In-charge) Accountants Staff Accountants (or Associates) McGraw-Hill/Irwin Consulting Services Manager Manager Manager Senior (In-charge) Accountants Staff Accountants (or Associates) ©2005 by the McGraw-Hill Companies, Inc. All rights reserved. 1-15 The Public Accounting Profession • Assurance services • • • • • Audit engagements Assurance engagements Attestation engagements Compilations Reviews • Tax consulting services • Consulting services • Litigation support McGraw-Hill/Irwin ©2005 by the McGraw-Hill Companies, Inc. All rights reserved. 1-16 Prohibited Services Under Sarbanes-Oxley • In summary, Sarbanes-Oxley prohibits professional service firms from performing any client services in which the auditors may find themselves auditing their own firm’s work. • Professional service firms may provide client tax services or other non-prohibited services to audit clients if the company’s audit committee has approved them in advance. McGraw-Hill/Irwin ©2005 by the McGraw-Hill Companies, Inc. All rights reserved. 1-17 Sarbanes-Oxley Prohibited Services Sarbanes-Oxley prohibits firms from providing the following services to an audit client: 1) bookkeeping and related services 2) design or implementation of financial information systems 3) appraisal or valuation services; 4) actuarial services; 5) internal audit outsourcing; 6) management or human resources services; 7) investment or broker/dealer services; and 8) legal and expert services (unrelated to the audit). McGraw-Hill/Irwin ©2005 by the McGraw-Hill Companies, Inc. All rights reserved. 1-18 Types of Audits and Auditors • Financial (External Auditors/CPAs) • Ensure that financial statements are accurate. • Operational (Internal Auditors/CIAs) • Improve economy • Improve efficiency • Compliance (Governmental Auditors) • Ensure compliance with company and/or governmental rules and regulations • Forensic (Fraud Auditors/CFEs) – Usually used when fraud is suspected McGraw-Hill/Irwin ©2005 by the McGraw-Hill Companies, Inc. All rights reserved. 1-19 Organization of the Profession • “Big Four” Accounting Firms – D&T, E&Y, KPMG, PwC • National – Grant Thornton, BDO Seidman • Local/Regional – Melton & Melton (Houston) – Postlethwaite & Netterville (Louisiana) • Sole Proprietor McGraw-Hill/Irwin ©2005 by the McGraw-Hill Companies, Inc. All rights reserved. 1-20 McGraw-Hill/Irwin ©2005 by the McGraw-Hill Companies, Inc. All rights reserved. 1-21 Become Certified! • • • • • Education Examination Experience State Certificate and License for CPA Skills sets and your education McGraw-Hill/Irwin ©2005 by the McGraw-Hill Companies, Inc. All rights reserved. 1-22 The New CPA Exam • Computerized • Four parts (beginning April 2004) – – – – Auditing and attestation—4.5 hrs Financial accounting and reporting—4 hrs Regulation—3 hrs. Business environment—2.5 hrs • Skill sets—research, communication, analysis, judgment and understanding McGraw-Hill/Irwin ©2005 by the McGraw-Hill Companies, Inc. All rights reserved. 1-23 Engagement Overview OBTAIN (OR RETAIN) CLIENT ENGAGEMENT PLANNING McGraw-Hill/Irwin INTERNAL CONTROL EVALUATION SUBSTANTIVE PROCEDURES ISSUE REPORT ©2005 by the McGraw-Hill Companies, Inc. All rights reserved.