Chapter 1 The Demand for Audit and Other Assurance Services

 Word association: what do you think of when you hear the word, “auditing?”

 Understand the nature of auditing  Understand the distinction between auditing and accounting  Understand the economic factors that create a demand for auditing and the role it plays in the economy  To be familiar with types of audits and how they relate to the definition of auditing.  To be familiar with other types of assurance services

 Auditing is the accumulation and evaluation of evidence about information to determine and report on the degree of correspondence between the information and established criteria. Auditing should be done by a competent and independent person.

 What are some ways that auditors might accumulate evidence  What is the key to effectively evaluating evidence?

 What is the purpose of accounting?  What is the purpose of auditing?  What is the purpose of this class?

 Why does auditing exist? Agency theory  Principal = Owner  Agent = Management  Does the agent have the same goals as the principal?  Do the two parties have the same information?  Information asymmetry  Information risk  Agency costs Agency theory does not tell the whole story of auditing, however. More to come on this later.

 Remoteness of information  Voluminous data  Complex exchange transactions  Biases and motives of the provider  P1-17, 18

 Financial Statement  Operational  Compliance the accumulation and evaluation of evidence to determine and report on the degree of correspondence between the assertions and established criteria. Auditing should be done by a competent and independent person.  Let’s look at that definition of auditing again (slightly modified): the accumulation and evaluation of evidence to determine and report on the degree of correspondence between the assertions and established criteria. Auditing should be done by a competent and independent person.

 Example: Annual audit of WorldCom Inc. financial statements  Assertions  Established Criteria  Evidence  Report  Competence  Independence

 Example: Annual audit of WorldCom Inc. financial statements  Assertions—Financial Statements  Established Criteria--GAAP  Evidence—Inquiry, observation, reperformance, recalculation, inspection of records and documents, confirmation, inspection of tangible assets (Chapter 7)  Report—Chapter 3  Competence—Know GAAP, know how to audit.  Independence—mental attitude and appearance

 Example: Efficiency and effectiveness of computerized payroll system  Assertions  Established Criteria  Evidence  Report  Competence  Independence

 Example: Efficiency and effectiveness of computerized payroll system  Assertions—e.g., “The payroll system provides timely and accurate payment of wages to employees of record for time worked.”  Established Criteria—management’s policies and procedures, contracts  Evidence--same  Report—internal. Goes to executives, payroll dept management, and audit committee  Competence—Know company policies. Know how to audit  Independence—mental attitude.

 Example: IRS audits of tax returns  Assertions  Established Criteria--  Evidence—  Report—  Competence—  Independence—  P1-8, 15  Additional examples: debt covenant audit for loan continuation, compliance with EEO laws or minimum wage laws, grant audits, Audit of a school district.

 Example: IRS audits of tax returns  Assertions—Tax return  Established Criteria--IRC  Evidence—receipts, records  Report—report of findings  Competence—Know the code, know how to audit.  Independence—mental attitude  P1-8, 15  Additional examples: debt covenant audit for loan continuation, compliance with EEO laws or minimum wage laws, grant audits, Audit of a school district.

Other Assurance Services CertainManagementConsulting Other Attestation Services (e.g., WebTrust, SysTrust) ATTESTATION SERVICES Audits Reviews Internal Control over Financial Reporting ASSURANCE SERVICES

 Career paths involving auditing  Large public clients—highly specialized  Small private clients—generalist and other services.  Industry—internal auditor  Governmental—LLA, GAO, etc.  P1-20