Auditors Have a Great

Responsibility

Page 3

Internal auditor Gene Morse

found an unsupported entry
for $500 million in computer
acquisitions.
Billions of dollars in fees paid
to telephone companies were
recorded as capital assets
turning a $662 million loss
into a $2.4 billion profit in
2001.
Total amount of fraud
discovered at WorldCom
amounted to $11 billion.

Chapter 1
The Demand for Audit and Other
Assurance Services
Company
Owners
and
Lenders

Company
Managers

Presentation Outline
I. The Nature of Auditing
II. Auditing and Investor Risk
III. Assurance Services
IV. Requirements for CPA Certification

I. The Nature of Auditing

A. Auditing Defined
B. The Distinction Between Accounting and Auditing
C. Types of Audits
D. Types of Auditors

A. Auditing Defined
Auditor

accumulates and
evaluates evidence
to ascertain correspondence between
the information

and

established
criteria

and communicates results

to interested
users

B. The Distinction Between Accounting and

Auditing

Accounting is the recording, classifying, and

summarizing of economic events for the
purpose of providing financial information
used in decision making.
Auditing is determining whether recorded
information properly reflects the economic
events that occurred during the accounting
period.

C. Types of Audits
Operational Audit
Involves evaluation of any part of an organizations
operating efficiency and effectiveness.
Not limited to accounting areas.
Compliance Audit
Determine whether the auditee has complied with specific
procedures, rules, or regulations set by some higher
authority.
Financial Statement Audit
Determine whether overall financial statements are stated in
accordance with specified criteria.
Generally accepted accounting principles are normally the
criteria, although other basis of accounting are at times
used.

D. Types of Auditors

External or Independent Auditors CPAs are the only group

permitted to provide financial statement audits. Such audits
are required of all publicly traded companies.
General Accounting Office Auditor works for the
Comptroller General who reports to and is solely responsible
to Congress. They audit various governmental bodies.
Internal Revenue Agents evaluate taxpayer compliance
with tax laws.
Internal auditors Auditors who are employees of the
companies they audit.

II. Auditing and Investor Risk

A. The Cost of Debt

B. Causes of Information Risk
C. Ways of Reducing Information Risk

A. The Cost of Debt

Auditing has no effect on
either the risk-free rate or
business risk, but it can have a
significant effect on
information risk!

When a bank makes a loan, it will charge a rate of interest

determined by primarily three factors:
Risk-free rate return on U.S. Treasury notes for the term
of the business loan.
Business risk for the customer risk associated with a
particular business that may result in it being unable to
repay a loan.
Information risk Improper business risk decisions
resulting from inaccurate information.

B. Causes of Information Risk

Remoteness of information
information provided by
others must be relied upon.
Biases and motives of the
provider can result from
honest optimism of
intentional misstatement.
Warning Voluminous data the
Thin Ice! amount of data grows with
the organization. Important
details can be lost.
Complex exchange
transactions business
transactions are becoming
increasingly complex.

C. Ways of Reducing Information Risk

User verifies information normally impractical for user to

go to business and examine information.
User shares information risk with management although
users may bring suit against management for supplying
inaccurate information, it is often difficult to collect on
losses.
Provide audited financial statements most feasible
approach is to have an independent party check for
completeness, accuracy, and removal of bias.

III. Assurance Services

A. Assurance Services
B. Attestation Services
C. Other Assurance
Services
D. Non-Assurance Services

A. Assurance Services
Decision makers seek assurance
regarding the reliability
information they use to make
decisions.
Assurance services are valued
because the assurance provider
is perceived as an independent
and unbiased evaluator of
information.
Assurance services can be
provided by CPAs and a variety
of other professionals.

B. Attestation Services
Many other assurance services do not meet the criteria of attestation
services: a CPA who issues a report about the reliability of an
assertion that is the responsibility of another party. There are
four categories of attestation services.

ASSURANCE SERVICES
ATTESTATION
SERVICES
1. Audits of historical financial statements
2. Effectiveness of internal control over financial reporting
3. Review of historical financial statements
4. Other attestation services

B1. Audits of Historical Financial Statements

An audit of historical
financial statements is a
Ben Johnson
form of attestation in which Certified Public Accountant
the auditor issues a written
report expressing an opinion
about whether the financial
statements are in material
conformity with generally
accepted accounting
principles.
Publicly traded companies in
the United States are
required to have audits under
the federal securities acts.

B2. Attestation on Internal

Control over Financial Reporting
Section 404 of the SarbanesOxley Act requires public
companies to report
managements assessment of
the effectiveness of internal
controls over financial
reporting.
The Act further requires
auditors to attest to the
effectiveness of internal
control over financial
reporting.

B3. Review of Historical

Financial Statements

Many nonpublic
companies want to
provide assurance on their
financial statements
without incurring the cost
of an audit.
In comparison to an audit,
less evidence is necessary
to support the level of
assurance provided by a
review.

B4. Other Attestation Services

Other attestation services
are natural extensions of
financial statement
engagements:
Debtor compliance with
loan agreement
provisions.
Forecasted financial
statements.
WebTrust and SysTrust
for Internet sites (see p.
11)

C. Other Assurance Services

ASSURANCE SERVICES
ATTESTATION
SERVICES
Audits
Internal Controls
Reviews
Other

OTHER
ASSURANCE
SERVICES

Other assurance services differ from those involving

attestation in that:
The CPA is not required to issue a written report.
The assurance does not have to be about the reliability
of another partys assertion about compliance with
specified criteria. (see examples in Table 1-2 on p. 12)

D. Non-Assurance Services
CPAs also provide nonassurance services
including:
Accounting and
bookkeeping
Taxes
Management consulting

IV. Requirements for CPA

Certification

A. Educational Requirement
B. Uniform CPA Examination Requirement
C. Experience Requirement

A. Educational Requirement
Normally, an
undergraduate degree
with a major in
accounting.
Some states require
150 semester hours
before the exam can
be taken. Others
require the hours
before certification.

B. Uniform CPA Examination Requirement

A computer-based examination offered at various

testing centers.
The examination consists of the following four
sections:
Auditing and Attestation 4.5 hours
Financial Accounting and Reporting 4 hours
Regulation 3 hours
Business Environments and Concepts 2.5 hours

C. Experience Requirement
Varies among states
from no experience to
2 years experience.
Some states include
experience for
working for
governmental units or
in internal auditing.

Summary
The Audit Process
Types of Audits and Auditors
Risk and the Need for Auditing
Assurance and Attestation
Becoming a CPA