Chapter 1: Introduction to Auditing PDF

Chapter 1 Learning Objectives Understand… …What is “risk”? …What is “assurance”? …What are “assurance services” and why do we need them? …What is an “assertion”? … AND… WHAT IS AUDITING!? What is “risk”? Definition (Merriam-Webster) Risk: possibility of loss or peril Uncert...

Chapter 1 Learning Objectives Understand… …What is “risk”? …What is “assurance”? …What are “assurance services” and why do we need them? …What is an “assertion”? … AND… WHAT IS AUDITING!? What is “risk”? Definition (Merriam-Webster) Risk: possibility of loss or peril Uncertainty: lack of sureness Types of Risk Pure Risk: No possibility of gain, only the possibility of loss from an event e.g. loss from a flood Speculative Risk: The possibility of profit or loss from an event e.g., investments Business Risk: Risk that an entity will fail to meet its stated business objectives A subset of Speculative Risk What is “risk”? Some Types of Business Information Risk Risk/Uncertainty 1) Environmental The risk that the 2) Political information disseminated 3) Credit by a company will be 4) Competition materially false or 5) Foreign exchange misleading. 6) Price Today’s information 7) Interest rate – More complex 8) Operational – Demanded by remote users 9) Information Risk – Needs to be more timely – Has far reaching consequences  How do you determine the price/value of company? Capital Asset Pricing Model Discounted Cash Flows (CAPM) where: where: DPV is the discounted present value of the future E(Ri) is the expected return on the capital asset cash flow (FV), or FV adjusted for the delay in receipt; Rf is the risk-free rate of interest such as interest arising from government bonds FV is the nominal value of a cash flow amount in a future period; βi (“beta”) is the sensitivity of the expected excess asset returns to r is the interest rate or discount rate, which reflects the expected excess market returns the cost of tying up capital and may also allow for E(Rm) is the expected return of the market the risk that the payment may not be received in full; E(Rm) - Rf is sometimes known as the market premium n is the time in years before the future cash flow E(Ri) - Rf is the expected return of the market occurs. Sourc https://en.wikipedia.org/wiki/Discounted_cash_flo https://en.wikipedia.org/wiki/Capital_asset_pricing_mod What are “assurance services”? What is “assurance ”? What is “auditing”? Why do we Figure 1-1 Overview of the Principal-Agent Relationship Leading to the Demand for Auditing need “audit services”? So… What is “AUDITING”??? Assurance Independent professional services that improve the quality of information, or its context, for decision makers Attestation Occurs when a practitioner is engaged to issue or does issue an examination, a review, or an agreed-upon procedures report on subject matter, or an assertion about subject matter, that is the responsibility of another party (AT Section 101) Auditing Systematic process of objectively obtaining and evaluating evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between those assertions and established criteria and communicating the results to interested users (AAA 1973).  Book Definition (page 9) “…auditing refers specifically to expressing an opinion on financial statements and attestation refers more generally to expressing an opinion on any type of information or subject matter that is the responsibility of another party (such as sustainability measures), assurance services includes an even broader set of information, including nonfinancial information.”  What is (Information) “auditing”? Internal/External Users Structured/Unstructured Procedures Report/No Report F/S External Users Financial/Non-financial Events More Structured Procedures Audit Report Financial Events External Users Some Structured Procedures Report Financial/Non-Financial Events Relationships among Auditing, Attest, and Assurance Services  What is “auditing”? Official Definition UNOFFICIAL Definition Auditing is a systematic process of Auditing is a systematic process objectively obtaining and [where an independent] and evaluating evidence regarding objective [third party (i.e., assertions about economic actions auditor)] obtain[s] and evaluat[es]evidence to [verify and events to ascertain the degree that] [managements’] assertions of correspondence between the (about economic actions and assertions and established criteria events) [agree with] established and communicating the results to criteria and communicating the interested users. results to interested users. Source: American Accounting Association Committee on Basic Auditing Concepts. 1973. A Statement of Basic Auditing Concepts, American Accounting Association (Sarasota, FL).  Overview of Financial Statement What is “auditing”? Auditing Auditing is a systematic process [where an independent] and objective [third party (i.e., auditor)] obtain[s] and evaluat[es]evidence to [verify that ] [verify that] [managements’] assertions about (economic actions and events) [agree with] and established criteria and communicating the results to interested users. Persons who rely on the financial reports Creditors Investors 1-12 What are “management’s assertions”? What is an “assertion” ?  What are “management’s assertions”? Existence or occurrence – Assets and liabilities included in the accounts exist and recorded transactions are valid and have actually occurred. Rights and obligations- Entity has a legal claim on all assets and revenues reported and has a legal responsibility for all liabilities and expenses Completeness - All balances and transactions have been recorded in the financial statements Valuation or allocation – Assets, liabilities and recorded transactions have been valued in accordance with GAAP Presentation and disclosure – All accounts are presented in the appropriate place and all information required has been disclosed in the statements and footnotes. ©McGraw-Hill Education.  What are “manageme nt’s assertions”? What do managers do? …They “assert that…” ©McGraw-Hill Education.  What are “manageme nt’s assertions”? What do auditors do? …They “verify that…” ©McGraw-Hill Education. Overview of the Financial Statement Audit Process 17  What is your product? The Audit Report – Expresses an opinion on financial statements – Provides reasonable assurance (“high level”) OK… – Conducted in accordance with auditing standards (e.g., PCAOB, AICPA, or IAASB) – Asserts that the financial statements are presented fairly, in all material respects, in conformity with an applicable framework (e.g., GAAP, IFRS). Beginning in 2004, the auditor must also express BUT what are you “selling”??? an opinion on the Company’s internal controls over financial reporting for large companies (much more on this later in the course). Expanded Audit Report ( https://pcaobus.org/News/Releases/Pages/auditor s-report-standard-adoption-6-1-17.aspx ) 18  Audit Firms Any questions? Big 4, regional, local firms Audit, Tax, Advisory / Consulting Partner, Sr. Mgr., Mgr., Sr. Assoc., Assoc 19  Next Class… HOW do we audit? Official Definition What is “systematic”? Auditing is a systematic process of What is “objective”? objectively obtaining and evaluating evidence regarding assertions about What is “independent”? economic actions and events to ascertain the degree of correspondence between the What is “professional assertions and established criteria and communicating the results to skepticism”? interested users. Source: American Accounting Association Committee on Basic Auditing Concepts. 1973. A Statement of Basic Auditing Concepts, American Accounting Association (Sarasota, FL). 20