AUDITING: A RISK ANALYSIS APPROACH

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AUDITING A RISK ANALYSIS APPROACH
5th edition
Larry F. Konrath
Electronic Presentation
by Harold O. Wilson
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CHAPTER 1
ATTESTATION AND ASSURANCE
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KEY CONCEPTS OVERVIEW

• Audits add creditability to published financial
  statements.
• Opinions by independent CPAs, as to fairness of
  financial statements are generally required by
  securities laws.
• Auditors evaluate evidence supporting financial
  statements and assess fairness of
  presentations.

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GENERAL TOPICS

• Perspectives of Auditing.
• Attestations and Assurances.
• Auditing defined in contrast to accounting.
• Independent Auditor and Internal Auditor
  Training and Competencies.
• Evidence Collection and Evaluation.

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LEARNING OBJECTIVES

• Differentiate attestation and assurance.
• Identify various services by auditors.
• Define auditing and its assertions.
• Distinguish independent and internal audits.
• Understand audit evidence and its merits.
• Describe audit reports and their variations.
• Understand steps in the auditing process.

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ASSURANCE SERVICES, ATTESTATION AUDITING

• ASSURANCE SERVICES Independent professional
  services designed to improve the quality of
  information for decision making. A very broad
  definition!

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ASSURANCE SERVICES, ATTESTATION AUDITING

• ATTESTATION An experts communication of a
  conclusion about the reliability of
  someone elses assertions. A broad
  definition.
• ASSERTATIONS in our context The
  representations of management as to the fairness
  of financial statements content.

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ASSURANCE SERVICES, ATTESTATION AUDITING

• AUDITING A systematic process of objectively
  obtaining and evaluating evidence regarding
  selected assertions about economic actions and
  events to ascertain the degree of correspondence
  between those assertions and
  established criteria, and communicating the
  results to interested
  parties.

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ASSURANCE
ATTESTATION
AUDITING
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FINANCIAL STATEMENT ASSERTIONS by Management

• Existence or Occurrence
• Completeness
• Rights Obligations
• Valuations or Allocation
• Presentation Disclosure

Assertions are to be truthful, fair, and
just--not misleading!
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AUDITOR OBJECTIVES
Independent Auditors are to determine whether
management assertions are fair, and not
misleading, in light of established criteria

• GAAS
• FASB pronouncementsincluding GAAP
• Other respected authorities (e.g., SEC, GAO,
  IRS, FCC)

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GENERALLY ACCEPTED AUDITING STANDARDS
The AICPAs Auditing Standards Board established
GAAS as the principles of independent auditing,
relative to competence, evidence and reporting.

• Internal Controls evaluated.
• Evidence (sample data) gathered.
• Presentations compared to GAAP.
• Audit Reports prepared.

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Process of Auditing

• Includes
• Evaluating Internal Controls
• Testing the Substance of Transactions Balances

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What are Internal Controls why are they so
important?

• Internal controls are policies procedures put
  in place by management to ensure the integrity of
  the accounting system.
• Internal controls are tested because the more
  effective the accounting system is, then the more
  reliable the outputthe financial statements!

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EVIDENCE UNDER GAAS A very broad concept!
The stronger (more extensive) the clients
internal control system, the higher the
confidence in its output! Evidence must support
such conclusions by auditor.

• Evidence (e.g., samples) must be sufficient
• Evidence must be competent (valid relevant).
• Evidence must be unbiased, and objectively
  gathered in light of practicality.

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AUDIT REPORTSCOMMUNICATION OF RESULTS!

• Scope of the audit work
• Financial statements identified
• Conclusions of the auditor
• Unqualified Opinion (typical)
• Qualified Opinion (unusual circumstances)
• Adverse Opinion (rare in practice)
• Disclaimer of Opinion (various causes)

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RISK-BASED AUDITS

• Risk-based audit An audit in which the auditor
  carefully analyzes the entity and its existing
  internal controls, identifies areas that pose a
  higher risk probability of financial statement
  errors, and therefore allocates a greater
  proportion of audit resources to those areas.

Errors, irregularities, and/or fraud are
specific considerations as controls and test
results are analyzed objectively and subjectively.
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BASIC MOTIVES FOR FRAUDS

• Management of earnings data (to
  mislead or defraud outsiders)
• Internal embezzlement schemes

Auditors must think in terms of probabilities and
the internal controls designed to prevent and/or
detect potential misrepresentations. Evidence
should support reality or the detection of
defalcations!
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NECESSITY OF INDEPENDENT AUDITS

• Wide-spread recognition of the value provided by
  audits of public companies
• Conflict of interest between management
  stockholders
• Complex accounting issues require evaluation by
  an expert

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INDEPENDENT AUDITORS VS. INTERNAL AUDITORS

• Independent Auditors
• Independent of management
• Serve third parties
• Concerned with financial auditing

• Internal Auditors
• Primary concerns are operational compliance
  auditing
• Not necessarily independent
• Work is broader in scope
• Report to audit committee

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Governmental Auditing Agencies

• General Accounting Office
• Reports to Congress
• Performs all types of audits of governmental
  agencies, projects, functions
• Defense Contract Audit Agency
• Performs compliance audits of entities with
  government contracts
• IRS
• Performs compliance audits with federal tax laws

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Primary Concerns of AUDITING vs. ACCOUNTING

• Auditing
• Verifying financial statement information and its
  fairness, emphasizing evidence (and odds)
• Accounting
• Collecting, sorting, summarizing, and reporting
  financial measurements, plus interpreting
  financial information.

The Link Generally Accepted Accounting
Principles
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AUDITOR COMPETENCE KNOWLEDGE

• Understanding of clients industry current
  authoritative literature/pronouncements
• GAAP Accounting systems, accounting theory,
  financial reporting
• Knowledgeable in the area of evidence gathering
  and evaluation
• Solid grasp of internal control concepts

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What is Internal Control?

• Policies procedures designed by management to
  enhance the reliability of evidence provided by
  the entity
• Enhances the reliability of financial data
• Safeguards the entitys assets

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Sufficient Competent EVIDENCE

• Sufficient evidence provides reasonable not
  absolute assurance of freedom from material
  misstatement.
• Competence concerns the degree of reliability
• Externally generated evidence is more convincing
  than client generated evidence.
• Generation under extensive controls is more
  convincing than under weak control systems.
• Competent evidence must also be valid relevant.

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AUDITORS REPORT

• Introductory paragraph
• Audit Work Managements role
• Scope paragraph
• Auditors followed GAAS
• Opinion paragraph (The findings!)
• Clean opinion, Qualifications, Adverse

Of course, a report may be a Disclaimer of an
Opinion.
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AUDIT REPORTS OPINIONS

• Clean Opinion. No exceptions to GAAP
  conformity and no audit scope restrictions
• Qualified Opinion. Fair, except for
  Specific qualification(s) where auditor had
  specific scope restrictions or not-too- severe
  reservations (e.g., as to contingencies or
  alternatives)
• Adverse Opinion. Unfair or misleading
  presentations severe qualifications

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AUDIT REPORTS DISCLAIMER OF OPINION
If there is a lack of independence, or there
were severe scope restrictions, OR a clients
financial statements have material uncertainties
(or strange-but-true inconsistencies to GAAP),
the reasons for precluding the formation of an
opinion must be clearly stated by the auditor.
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CAUTION!
A Disclaimer is NOT to be issued in lieu of an
Adverse Opinion in cases where the latter is
appropriate!
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AUDIT PLANNING 1PRELIMINARIES

• Client acceptance decision
• Are we independent?
• Gain a working knowledge of the entity
• Identify high-risk areas
• Client questionnaire

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AUDIT PLANNING 2ENGAGEMENT LETTER

• Provides written evidence of the audit
  agreement
• Clarifies the type of engagement
• Prevents possible misunderstandings
• Should be used for all types of assurance services

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AUDIT PLANNING 3RISK ANALYSIS
Audit Risk (AR) Probability of rendering an
unqualified opinion on financial statements that
are materially misstated. MM, in dollars MM,
in percentages
As a generalization, Audit Risk may be or should
be quantified as a Probability, P AR
P(MM) lt 5
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AUDIT PLANNING 4FIELD WORK PLANNING

• 1. Preliminary audit programs
• Collections of audit procedures to be applied to
  meet audit objectives (opinion)
• Based on the preliminaries, analysis of business
  industry, assessment of internal controls
• Refined during the audit, based on
• Interim tests of transactions, and
• Substantive testing
• 2. Time budgets

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INTERIM AUDIT WORK

• Testing the clients internal accounting controls
• Performing substantive tests of transactions

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A Note on Terminology
Tests of Transactions Examining (sampling) data
processing cycles, such as the creation of
shipping tickets, approvals of prices, sales
invoices, journalizing, postings of such to
general and subsidiary ledgers, and the like.
Substantive Testing Examining (sampling) the
components of an account balance, such as the
physical observation of inventories, confirmation
of accounts payable at fiscal year end,
calculations of prepaids, etc.
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A Note on Technology
Information processing systems have encouraged
continuous auditing throughout a clients
fiscal year. Computer systems and personnel (and
changes) tend to obscure (or destroy) audit
trails traditionally traced by auditors.
Auditor ingenuity
is continuously challenged!
Audit Trails refer to the documentary evidence
and related approvals occurring in the accounting
cycle (business transactions, documents,
journalizing, posting or sorting, and
summarizing).
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FINAL AUDIT WORK

• Substantive tests of transactions
• Substantive tests of balances
• End-of-year inventory observation

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FINAL PROCEDURES

• Concluding an Audit
• Discussion with client obtaining a Clients
  Representation Letter
• Considerations of Subsequent Events
• The Audit Report (an opinion or a disclaimer)
• Management Letters (post-audit advice as to
  improving internal control)

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CPA FIRMS NON-AUDIT
SERVICES

• Tax planning and compliance services
• Management Consulting
• Accounting/Computer Systems advice
• Forensic Accounting Expert Witnessing
• Other assurance servicescompilations reviews
• Accounting payroll services

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End of Chapter 1