1. The Financial Statement Auditing Environment
Chapter 2
The Financial Statement
Auditing Environment

2. Problems and Warning Signs
LO# 1
Problems and Warning Signs
1990
2000
During the economic boom of the late 1990s and the early 2000s, accounting firms aggressively sought opportunities to market a variety of high-margin nonaudit services to their audit clients.

3. Problems and Warning Signs
LO# 1
Problems and Warning Signs

4. An Explosion of Scandals
WorldCom
Enron
Tyco
Adelphia
Xerox

5. Government Regulation
LO# 1
Government Regulation
In July 2002, Congress passed the Sarbanes-Oxley Public Company Accounting Reform and Investor Protection Act.
The Sarbanes-Oxley Act effectively ended the profession’s era of “self-regulation,” creating and transferring authority to set and enforce standards to the Public Company Accounting Oversight Board (PCAOB).

6. Context of Financial Statement Auditing
LO# 2
Context of Financial Statement Auditing
The primary context with which an auditor is concerned is the industry or business of his or her audit client. For example, if you are auditing a computer hardware manufacturer, one of your concerns will be whether your client has inventories that are not selling quickly and are becoming obsolete due to industry innovation. Such inventory might not be properly valued on the client’s financial records. If you are auditing a jeweler you will probably not be as worried about obsolescence, but you will be interested in whether the diamonds and other gems in inventory are valued properly. You may need to hire a qualified gemologist to help you assess the valuation assertion, and you would want to keep up on the dynamics of the international diamond and gem markets. In other words, the context provided by the client’s business impacts the auditor and the audit, and is thus a primary component of the environment in which financial statement auditing is conducted.

7. LO# 3
A Model of Business
Business organizations exist to create value for their stakeholders. Due to the way resources are invested and managed in the modern business world, a system of corporate governance is necessary, through which managers are overseen and supervised.
Board of Directors
Audit Committee

8. A Model of Business Processes: Five Components
Financing Process
Purchasing Process
Human Resource Management Process
Inventory Management Process
Revenue Process

9. An Overview of Business
LO# 4
An Overview of Business

10. Management Assertions
LO# 5
Management Assertions
Financial statements issued by management contain explicit and implicit assertions.
Transactions
Management asserts that transactions related to inventory actually occurred.
Account Balances
Management asserts that the entity owns the inventory represented in the inventory account.
Presentation & Disclosure
Management asserts that the financial statements properly classify and present the inventory.

11. Management Assertions
LO# 5
Management Assertions

12. Auditing Standards Board
LO# 6, 7
Auditing Standards
Auditing standards serve as guidelines for and measures of the quality of the auditor’s performance.
Public Companies
PCAOB
Nonpublic Companies
Auditing Standards Board

13. The 10 Generally Accepted Auditing Standards (GAAS)
LO# 6, 7
The 10 Generally Accepted Auditing Standards (GAAS)
GAAS
General
Field Work
Reporting

14. Adequate Technical Training & Proficiency
LO# 6, 7
General Standards
Adequate Technical Training & Proficiency
Independence
Due Professional Care

15. Standards of Field Work
LO# 6, 7
Standards of Field Work
Adequate Planning & Supervised Assistants
Obtain Sufficient Understanding of Internal Controls
Obtain Sufficient Appropriate Evidential Matter

16. Standards of Reporting
LO# 6, 7
Standards of Reporting
GAAP
Consistency
Disclosures
Opinion

17. LO# 6, 7
GAAS

18. Statements on Auditing Standards (SAS)—Interpretations of GAAS
LO# 8, 9
Statements on Auditing Standards (SAS)—Interpretations of GAAS
GAAS and SAS are considered to be minimum standards of performance for auditors.
PCAOB adopted, on an interim basis, GAAS and SAS. Standards issued by PCAOB are called Auditing Standards (AS).

19. Statements on Auditing Standards (SAS)—Interpretations of GAAS
LO# 8, 9
Statements on Auditing Standards (SAS)—Interpretations of GAAS
SAS are classified by two numbering categories: SAS and AU numbers. The SAS number applies to the order in which the standards are issued and are thus chronological. The AU number applies to the topical content in the statement.

20. Statements on Auditing Standards (SAS)—Interpretations of GAAS
LO# 8, 9
Statements on Auditing Standards (SAS)—Interpretations of GAAS
For example, SAS No. 39, “Audit Sampling,” is found under AU 350 because the AU 300s relate to the standards of field work or evidence collection and evaluation.

21. Ethics, Independence, and the Code of Professional Conduct
LO# 10
Ethics, Independence, and the Code of Professional Conduct
Ethics refers to a system or code of conduct based on moral duties and obligations that indicates how we should behave.
Professionalism refers to the conduct, aims, or qualities that characterize or mark a profession or professional person. All professions operate under some type of code of ethics or code of conduct.

22. Ethics, Independence, and the Code of Professional Conduct
LO# 10
Ethics, Independence, and the Code of Professional Conduct
Code of Professional Conduct
Principles
Rules of Conduct
Interpretations of the Rules

23. The Auditor’s Responsibility for Errors, Fraud, and Illegal Acts
LO# 11
The Auditor’s Responsibility for Errors, Fraud, and Illegal Acts
The auditor has a responsibility to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud.
The auditor has no responsibility to plan and perform the audit to obtain reasonable assurance that misstatements, whether caused by errors or fraud, that are not material to the financial statements will be detected.
Because of the nature of audit evidence and the characteristics of fraud, the auditor is able to obtain reasonable, but not absolute, assurance that material misstatements are detected.

24. Public Accounting Firms
LO# 12
Public Accounting Firms
Public accounting firms range in size from a single proprietor to thousands of owners (or “partners”) and thousands of professional and administrative staff employees.
Deloitte
Ernst & Young
KPMG
Pricewaterhouse Coopers
Big 4 Public Accounting Firms

25. LO# 12
Audit Teams

26. Types of Audit, Attest, and Assurance Services
LO# 13
Types of Audit, Attest, and Assurance Services
Internal Control Audits
Compliance Audits
Operational Audits
Forensic Audits
Audit Services

27. Types of Audit, Attest, and Assurance Services
LO# 13
Types of Audit, Attest, and Assurance Services
Reporting on Internal Control
Financial Forecasts and Projections
Attest Services

28. Types of Audit, Attest, and Assurance Services
LO# 13
Types of Audit, Attest, and Assurance Services
Risk Assessment
Performance Measurement
Assurance Services
Information System Reliability & E-Commerce

29. Types of Audit, Attest, and Assurance Services
LO# 13
Types of Audit, Attest, and Assurance Services
Tax Services
Management Advisory Services
Other Nonaudit Services
Accounting and Review Services

30. Types of Auditors External Auditors Internal Auditors
LO# 14
Types of Auditors
External Auditors
Internal Auditors
Government Auditors
Forensic Auditors

31. Organizations That Affect the Public Accounting Profession
LO# 15
Organizations That Affect the Public Accounting Profession
American Institute of Certified Public Accountants (AICPA)
Securities and Exchange Commission (SEC)
Public Company Accounting Oversight Board (PCAOB)
Financial Accounting Standards Board (FASB)

32. End of Chapter 2