1. MODERN AUDITING 7th Edition Developed by: Gregory K. Lowry, MBA, CPA Saint Paul’s College John Wiley & Sons, Inc. William C. Boynton California Polytechnic State University at San Luis Obispo Raymond N. Johnson Portland State University Walter G. Kell University of Michigan

2. CHAPTER 2 FINANCIAL STATEMENT AUDITS AND AUDITORS’ RESPONSIBILITIES u Fundamentals Underlying Financial Statement Audits u Independent Auditor Relationships u Auditing Standards u Assurance Provided by an Audit u The Auditor’s Report u Trends Affecting Auditor Responsibilities

3. Relationship Between Accounting and Auditing Figure 2-1

4. Need for Financial Statement Audits 1. Conflict of Interest 2. Consequence 3. Complexity 4. Remoteness

5. Economic Benefits of an Audit 1. Access to Capital Markets 2. Lower Cost of Capital 3. Deterrent to Inefficiency and Fraud 4. Control and Operational Improvements

6. Limitations of a Financial Statement Audit Following are 2 important economic limits: 1. Reasonable Cost 2. Reasonable Length of Time Following are 2 important limitations associated with the established accounting framework: 1. Alternative Accounting Principles 2. Accounting Estimates

7. Independent Auditor Relationships 1. Management 2. Board of Directors and Audit Committee 3. Internal Auditors 4. Stockholders

8. Generally Accepted Auditing Standards Figure 2-2 General Standards 1. The audit is to be performed by a person or persons having adequate technical training and proficiency as an auditor. 2. In all matters relating to the assignment, an independence in mental attitude is to be maintained by the auditor or auditors. 3. Due professional care is to be exercised in the performance of the audit and the preparation of the report.

9. Standards of Field Work 1. The work is to be adequately planned, and assistants, if any, are to be properly supervised. 2. A sufficient understanding of the internal control structure is to be obtained to plan the audit and to determine the nature, timing, and extent of tests to be performed. 3. Sufficient competent evidential matter is to be obtained through inspection, observation, inquiries, and confirmations to afford a reasonable basis for an opinion regarding the financial statements under audit. Generally Accepted Auditing Standards Figure 2-2

10. Standards of Reporting 1. The report shall state whether the financial statements are presented in accordance with generally accepted accounting principles. 2. The report shall identify those circumstances in which such principles have not been consistently observed in the current period in relation to the preceding period. 3. Informative disclosures in the financial statements are to be regarded as reasonably adequate unless otherwise stated in the report. Generally Accepted Auditing Standards Figure 2-2

11. Standards of Reporting 4. The report shall either contain an expression of opinion regarding the financial statements, taken as a whole, or an assertion to the effect that an opinion cannot be expressed. When an overall opinion cannot be expressed, the reasons therefore should be stated. In all cases where an auditor’s name is associated with financial statements, the report should contain a clear-cut indication of the character of the auditor’s work, if any, and the degree of responsibility the auditor is taking. Generally Accepted Auditing Standards Figure 2-2

12. Assurance Provided by an Audit 1. Auditor Independence 2. Reasonable Assurance 3. Detection of Fraud 4. Responsibility to Detect Fraud 5. Responsibility to Report Fraud 6. Illegal Client Acts 7. Assurance About a Going Concern

13. Auditor’s Standard Report Basic Elements of Auditor’s Standard Report Title Addressee Introductory Paragraph Scope Paragraph Opinion Paragraph Firm’s Signature Date

14. Types of Auditors’ Reports and Circumstances Figure 2-4

16. Management Responsibility Report Figure 2-5

17. Trends Affecting Auditor Responsibilities 1. Information Technologies 2. Assurance Services

18. CHAPTER 2 FINANCIAL STATEMENT AUDITS AND AUDITORS’ RESPONSIBILITIES

19. CopyrightCopyright Copyright 2001 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make backup copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.