SOLUTION: Auditing & Assurance Services Discussion

Chapter 01
“Tax or Audit?
Auditing & Assurance
Services 7e
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Chapter 01
Auditing and Assurance Services
“Our system of capital formation relies upon the confidence of
millions of savers to invest in companies.
The auditor’s opinion is critical to that trust.”
— James R. Doty, Chairman
Public Company Accounting Oversight Board (PCAOB)
©McGraw-Hill Education
Chapter 1 Learning Objectives
1. Define information risk and explain how the financial statement auditing process helps to
reduce this risk, thereby reducing the cost of capital for a company.
2. Define and contrast financial statement auditing, attestation, and assurance services.
3. Describe and define the assertions that management makes about the recognition,
measurement, presentation, and disclosure of the financial statements and explain why
auditors use them as the focal point of the audit.
4. Define professional skepticism and explain its key characteristics.
5. Describe the organization of public accounting firms and identify the various services that they
6. Describe the audits and auditors in governmental, internal, and operational auditing.
7. List and explain the requirements for becoming a certified public accountant (CPA) and other
certifications available to an accounting professional.
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User Demand for Reliable Information

LO 1-1
Today’s information
– More complex
– Demanded by remote users
– Demanded in a more timely manner
– Has far reaching consequences

Business risk
– The risk that an entity will fail to meet its stated business objectives

Information risk
– The risk that the information disseminated by a company will be materially
false or misleading.
– Users demand an independent third-party assessment of the information
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Definition of Financial Statement Auditing
Financial Statements
(including footnotes)
Persons who rely on
the financial reports
LO 1-2
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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
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).
What is an Audit
Audit is a type of assurance that provides credibility to the financial statements.
The finished product of an audit is an auditor’s opinion on the financial statements
provided by client’s management.
©McGraw-Hill Education.
Why Audit?
An audit is a type of assurance that gives credibility to the financial statements.
Companies provide financial statements.
2. Creditors and investors look at these financial statements and will wonder if the
numbers represented there are reliable, accurate, true, etc.
3. Creditors and investors need to know if FS are wrong either as a result of a mistake or
fraud (intent to mislead)
It would help to have an objective, independent, third party to perform some tests to
determine if the info in FS is legitimate, does it follow GAAP and if it is free from Material
misstatements (materiality determined by looking as a percentage of totals).
©McGraw-Hill Education.
Why Audit?
Auditor needs to obtain reasonable assurance-not an absolute one.
Auditor comes in and after doing his/her work, issues an opinion whether the FS is in
conformity with GAAP and if they are free from material misstatements.
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The Simplified Audit Process in 3 steps
Risk Assessment – What could go wrong?
Perform risk assessment procedures to identify and assess the risks of material
misstatement in the financial statements.
Risk Response – Did it go wrong?
Perform procedures to respond to the assessed risks and determine of material
misstatements have occurred.
Reporting – Auditor’s Opinion
What is the appropriate wording of the audit opinion based on the audit work
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Audit Process
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Key Processes in an Audit of Financial Statements

Pre-audit activities (1 of 3):
This is the first processes that normally perform by auditors. At this stage, audit
engagement is prepared and agreed between auditors and clients. Key things that should
be included in the engagement are audit scope, objective, reporting time-frame, audit fee,
and as well as responsibilities.
Auditors should perform Know Your Client procedures to see if client key management and
client’s business involved with money laundering or terrorist. If that is the case, the auditor
should not accept the engagement.
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Pre-audit activities (2 of 3):
Understanding client nature of the business to see if the audit team have enough
competence and expertise to perform audit works that related to client industry. The
auditor might reject the engagement on the ground that they don’t have enough resources
or competency to do the works.
Responsibility should also need to be clarified before performing audit works. These
include auditor’s responsibility to the financial statements and the entity’s responsibility to
financial statements.
©McGraw-Hill Education.
Pre-audit activities (3 of 3):
Obviously, the auditor is responsible for auditing an entity’s financial statements and
express the opinion of the financial statements preparation and present based on the
applicable standard and guideline.
The entity is responsible for setting proper internal control over financial reporting to make
sure that financial statements are preparing in accordance with the standards, risks of
errors and fraud are minimized, and the statements are prepared and delivered on time.
Audit fee and logistic timeline is also the importance and should be clarified before
performing audit works. Audit fee should be based on audit work and timeline should be
enough for auditor deliver quality auditors results.
©McGraw-Hill Education.
Audit plan (1 of 4):
Audit planning is one of the most important audit processes. Right audit plan leading to
deliver right audit report. That mean auditor has enough resources and time to execute
audit strategy and audit procedures.
There are numbers of things auditors perform during the audit planning process:
©McGraw-Hill Education.
Audit plan (2 of 4):
•Resources allocation: Once auditor agrees to perform an audit on client financial
statements, the audit planning process will consider starting based on available timeline
and resources. Auditor allocates the right audit team to conduct audit tasks. That means
they should have enough team member should perform auditor works so that they could
have enough time to execute audit procedures, review audit workings papers and prepare
the reports. A team member should have enough competency to handle audit works. For
example, if the engagement is with Construction Company then audit team should contain
the member that have experiences in auditing the construction company. Deadline and
sections allocation should confirm with all team members.
©McGraw-Hill Education.
Audit plan (3 of 4):
•Understanding key internal control: Auditor may assess the client’s internal control over
financial reporting to see if the control could detect or prevent risks errors or fraud that
could materially affect the financial statements. To assess this, auditors need to obtain an
understanding of the client control environment and control activities. Result of assessing
could affect the way or method of audit samplings.
•Risks assessment: Auditors need to perform risks assessment on financial statements to
see if there any fraud or error could possibly happen. The auditor will need to look detail in
the high risks areas and might be less focus on the low risks areas.
©McGraw-Hill Education.
Audit plan (4 of 4):
•Materiality assessment: Planning materiality and performance materiality are normally set
in the planning process.
•Conflict of interest between the audit firm and client, and between the audit team and
client management team should be confirmed in this stage. If there is a conflict of interest,
then there should be the proper guideline to reduce the risks. If the conflict could not
minimize, then the auditor should not accept the engagement.
©McGraw-Hill Education.
Review internal control over financial reporting (1 of 4):
In this process, auditors review the client’s internal control over financial reporting. The
review normally uses COSO (Committee of Sponsoring Organizations) frameworks for
assessment. For example, auditors use five components of COSO frameworks such as
Control environment, Risk Assessment, Control Activities, Information and Communication,
and monitoring to documents and assess the entity’s internal control.
©McGraw-Hill Education.
Review internal control over financial reporting (2 of 4):
There are many documents that auditors might need in these processes. For example, the
company’s org chart, policies and procedures, chart of accounts, financial statements,
management accounts, and other related documents for their documentations.
©McGraw-Hill Education.
Review internal control over financial reporting (3 of 4):
Auditors might also interview and inquire about the client’s personnel to obtain
information for their documentation and assessment.
The strength and weakness of control over financial reporting are significantly affecting
substantive audit procedures. Normally, if the auditor concludes that the control over
financial reporting sounds strong then auditors might put some rely on the controls. In
other words, they might perform their works less in substantive procedures.
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Review internal control over financial reporting (4 of 4):
Auditors might perform a large volume of sampling to the financial data if they conclude
that internal control over financial reporting could not be relying on.
AI Discussion…
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Substantive review on financial data (1 of 3):
It does not matter how strong internal control over financial reporting is, the auditor could
not rely a hundred percent on it, and not perform substantive testing.
Detail review of financial data still needs to be done.
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Substantive review on financial data (2 of 3):
Common audit procedure that auditor uses in this audit processes are Analytical review,
inquiry, observation, inspection, recalculation, confirmation and so on. Audit sampling is
also important to help auditors perform their works effectively and efficiently.
©McGraw-Hill Education.
Substantive review on financial data (3 of 3):
Common documents that auditors normally need are financial statements, management
accounts, and supporting documents. Original supporting documents are normally
including contracts, invoices, receipts, bank statements, and other related documents.
©McGraw-Hill Education.
Reporting the result (1 of 5):
Once auditors complete their testing, auditors will issue the audit reports based on the
result of their testing. This is the importance of audit processes. The Audit Report includes
the importance of information such as audit scope, auditors’ right and responsibilities,
management’s responsibilities, key accounting policies, audited financial statements, and
audit opinion.
©McGraw-Hill Education.
Reporting the result (2 of 5):
Auditors normally express one of the four audit opinions. Such as unqualified opinion,
qualified opinion, disclaimer opinion, and an adverse opinion.
©McGraw-Hill Education.
Reporting the result (3 of 5):
An unqualified opinion is an independent auditor’s judgment that a company’s financial
statements are fairly and appropriately presented, without any identified exceptions, and in
compliance with generally accepted accounting principles (GAAP). An unqualified
opinion is the most common type of auditor’s report.
©McGraw-Hill Education.
Reporting the result (4 of 5):
When would we issue a qualified opinion?
It is an auditor’s opinion that suggests the financial information provided by a company was
limited in scope or there was a material issue with regard to the application of generally
accepted accounting principles (GAAP)—but one that is not pervasive.
Qualified opinions may also be issued if a company has inadequate disclosures in
the footnotes to the financial statements.
©McGraw-Hill Education.
Reporting the result (5 of 5):
An adverse opinion is a professional opinion made by an auditor indicating that a
company’s financial statements are misrepresented, misstated, and do not accurately
reflect its financial performance and health.
A disclaimer of opinion is a statement made by an auditor that no opinion is being given
regarding the financial statements of a client. For example, the auditor may not have been
allowed or been able to complete all planned audit procedures.
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Overview of Financial Statement Auditing
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Audit Assertions
Audit Assertions are the implicit or explicit claims and representations made by the
management responsible for the preparation of financial statements regarding the
appropriateness of the various elements of financial statements and disclosures.
©McGraw-Hill Education.
Multiple Choice
The risk to investors that a company’s financial statements may be materially
misleading is called:
A. Client acceptance risk.
B. Information risk.
C. Moral hazard.
D. Business risk.
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Multiple Choice
The risk to investors that a company’s financial statements may be
materially misleading is called:
A. Client acceptance risk.
B. Information risk.
C. Moral hazard.
D. Business risk.
By definition, information risk is the probability that the information
circulated by a company will be false or misleading.
©McGraw-Hill Education.
Why is auditing important?
Why is auditing important?
Public companies’ management has an incentive to make their company’s FS look good by
manipulating data.
Auditors run tests to determine if FS are in compliance with GAAP and are free of material
It is critical to the success of financial markets. More investment and credit activity in the
market takes place when FS are audited.
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Is an audit required?

Auditing is assumed to be required.

This may sound to be true as all of the public companies are required to file
audited financial statements with the SEC.

Non public companies, although not required to have audited FS, may still go
through an audit voluntarily to have their FS look more trustworthy in the eyes
of potential creditors and investors.

Think of yourself as a potential investor or creditor. Would you not be more
comfortable looking at audited set of FS?
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The Relationships Among Auditing,
Attestation, and Assurance Engagements
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Audit – Attestation – Assurance

Audit is a subset of an Attestation Service
Attestation is a subset of an Assurance Service
Audit is the highest level of Assurance service
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Attestation Engagements

An attestation engagement – a practitioner assesses and reports on “subject matter, or
an assertion about subject matter that is the responsibility of another party.”

Some financial attestation engagements (other than audits)
• Financial forecasts and projections
• Examination of Management’s Discussion & Analysis
• Pro forma financial information (what if FS)
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Attestation Engagements

An attestation engagement – a practitioner assesses and reports on “subject matter, or
an assertion about subject matter that is the responsibility of another party.”

Some non-financial attestation engagements
• Effectiveness of internal control systems
• Compliance with environmental regulations
• Sustainability reporting engagements (​A sustainability report is a report published
by a company or organization about the economic, environmental and
social impacts caused by its everyday activities.)
©McGraw-Hill Education.
A Non-Financial Attestation Engagement:
Sustainability Reporting

One example of a non-financial attestation engagement completed by CPAs is a
sustainability reporting engagement. In today’s global business environment,
activist shareholders are increasingly pressuring board of director members and
upper management teams regarding issues of social responsibility, the
environment, and other matters related to sustainability. As a direct result, more
companies than ever are directly integrating their sustainability initiatives into
their overall business strategy and then seeking to quantify their sustainability and
social responsibility efforts with measurable outputs. These measurements might
help to quantify the company’s performance in areas such as the environment,
labor, and human rights.
©McGraw-Hill Education.
Assurance Services

Assurance services are independent professional services that improve the quality
of information, or its context, for decision makers. Examples include:
• Information risk assessment
• Customer satisfaction surveys
• Internal audit outsourcing
• Fraud and illegal acts prevention and deterrence
• Cyber risk assessment and assurance
• XBRL Reporting (eXtensible Business Reporting Language (XBRL) is a freely
available global framework of accounting standards used for exchanging
business information. XBRL is based on XML coding and is a standardized way
of transmitting financial records around the world.)
©McGraw-Hill Education.
Audit – Attestation – Assurance
Audit-provides credibility to company’s FS by rendering of an audit opinion.
Attestation can apply to any assertion made by the Company Mgmt., such as Proforma
reports, Future Projections, etc.
Assurance can be any type of info financial or non-financial that you are rendering an
opinion on.
Examples would include state lottery or film awards, where CPA will ensure that the
lottery is run correctly and there is no fraud, the winning ticket holder gets the money or
right film award goes to the right people.
©McGraw-Hill Education.
Audit – Attestation – Assurance
The Oscar for best picture was being presented at the 89th Academy Awards on Sunday night, Tim
Ryan, the United States chairman of PwC, was sitting in a plush seat in the Dolby Theater, watching with
PwC, an accounting firm based in London, has tabulated the votes for the Academy Awards for 83 years.
And the Oscars, while not its most lucrative client, is perhaps its most important.
The firm leans on its long history as Hollywood’s chief vote-counter to enhance its appeal in efforts like
business development and recruiting.
So when “La La Land” was named the best-picture winner and the producers began delivering their
acceptance speeches, it appeared Mr. Ryan’s work for the night was done.
Then chaos erupted on the stage. A PwC partner had handed Warren Beatty, a …
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