Auditing: The Art and Science of Assurance Engagements

Chapter 1: The Demand for an Auditing and Assurance Profession

Americans like to make money; Canadians like to audit it. I know no other country where accountants have a higher social and moral status.
Northrop Frye, Canadian literary critic and Professor of English, University of Toronto

Chapter 1 Learning Objectives

1. Identify the components of an audit and explain why there is a demand for audits. Differentiate accounting from auditing. 2. Describe assurance services. Distinguish audit engagements from other assurance and nonassurance services.

Nature and Relevance of Auditing

 Auditing is the accumulation and evaluation of evidence about information to determine and report on the degree of correspondence between the information and established criteria.  Auditing is done by a competent, independent person.

Five Key Components of Auditing

1. Quantifiable information (related to entity) 2. Criteria: normally generally accepted accounting principles (GAAP). Multiple criteria may be used in accordance with CAS 210. 3. Evidence gathering and evaluation 4. Competent, independent person 5. Reporting
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Distinction between Auditing and Accounting

 What is accounting?  What is auditing?  Who is responsible for accounting or auditing?  Can an auditor do both for the same company?

Distinction between Auditing and Accounting

 Accounting is the recording, classifying and summarizing of economic events for decision making.  Auditing involves examining accounting information and auditors must have expertise in accounting.

Distinction between Auditing and Accounting

 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 those assertions and established criteria and communicating the results to interested users. WHY ARE THE UNDERLINED WORDS IMPORTANT?

Distinction between Auditing and Accounting

 When auditing accounting data, the auditor must determine whether the recorded information reflects the underlying economic events of the company.  Individuals of any accounting designation who perform external audits are called public accountants.

Factors that affect the demand for audits

 Remoteness of information  Bias and motives of provider  Voluminous data  Complex exchange transactions  Perceived cost/benefit

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Economic Demand for Auditing

 Auditing can reduce information risk associated with financial statements (the risk that the financial statements are inaccurate).  Financial information is prepared by an entity s management this leads to a natural conflict of interest between company managers and other parties.

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Economic Demand for Auditing

 Managers (agents) have superior information to the users of the information (principals):
  

Gives rise to the principal-agent problem; Existence of information asymmetry; Credibility of financial reports prepared by managers may be in doubt.

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Economic Demand for Auditing

 The independent audit provides assurance to users with respect to the reliability of the financial statements.

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Assurance and Non-Assurance Services

 Assurance services are independent professional services in which the auditor issues a report about the reliability of an assertion prepared by another party.  Attestation services is a significant category of assurance services provided by accounting firms.

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Assurance and Non-Assurance Services

 Examples of attestation services include:
  

audits reviews reports on the effectiveness of internal control over financial reporting attestation services on information technology

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Assurance and Non-Assurance Services

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Relationship Among Users

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Audit of Historical Financial Statements

 The auditor s report expresses an opinion on whether the financial statements conform with what is known as a fair presentation framework typically, Canadian GAAP.

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Audit of Historical Financial Statements

 The auditor s report describes the financial statements being audited, the responsibility of the auditor and management, how the audit was conducted and the auditor s opinion.  Canadian publicly traded companies are required to have audits.

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Review of Historical Financial Statements

 A review provides a lower level of assurance than an audit.  For a review management also asserts that the financial statements are prepared in accordance with GAAP.  Reviews are discussed in more detail in Chapter 23.

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Attestation on Internal Control Over Financial Reporting

 The auditor reports on the management assertion that internal controls have been developed and implemented following appropriate criteria.

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Attestation on Internal Control Over Financial Reporting

 The Sarbanes-Oxley Act in the U.S. requires public companies listed on the SEC to include in their annual report, management s assessment of the effectiveness of internal control and, for auditor s to attest to the effectiveness of internal control over financial reporting.

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Attestation Services on Information Technology

 The growth of the internet and electronic commerce and the related concerns of privacy and security have lead to the growth of two assurance services:


WebTrust: an electronic seal on a web site which ensures users that established criteria have been met. SysTrust: provides assurance on information system reliability in areas such as security and data integrity.
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Other Attestation Services

 An auditor might provide an opinion on financial information other than financial statements or on compliance with an agreement or regulations.  There are almost no limits to the types of assurance services that auditors can provide.

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Non-Assurance Services
 Some of the most common non-assurance services are compilations, tax services and management advisory services.  A compilation involves the preparation of the financial statements from a client s records by a public accountant.

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Non-Assurance Services
 A compilation provides no assurance and involves less work/cost than a review engagement.  Compilations are discussed in more detail in Chapter 23.

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Types of audits
 Financial statement audit: Conducted to determine whether the overall financial statements are stated in accordance with specified criteria.  Compliance audit: To determine whether the auditee is following specific procedures or rules set down by a higher authority.

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Types of audits
 Operational audit: A review of any part of an organization s operating procedures and methods for the purpose of evaluating efficiency and effectiveness.  Value-for-Money audits: Like a operational audit; usually done in the public sector where it considers economy were the overall objectives achieved in the MOST cost-effective manner?
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Public Accountants
 Public accounting firms normally perform external audits of publicly traded and other large companies.  Canadian provinces restrict the audit attest function to those accountants licensed in that province.  This normally includes one or more of chartered accountants, certified general accountants or certified management accountants, or others approved by an appropriate body (such as in BC).
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Government Auditors
 The Government of Canada and the provincial and territorial governments have Auditor Generals who are responsible for auditing the ministries, departments, and agencies who report to that government.  They report to their respective legislatures and are responsible to the body appointing them.

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Canada Revenue Agency (CRA) Auditors

 CRA is responsible for the enforcement of the Canadian federal tax laws.  A major responsibility of a CRA auditor is to audit the returns of taxpayers to ensure compliance with the tax laws.  CRA auditors have expertise in the various aspects of personal and corporation taxation.
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Internal Auditors
 Internal auditors are employed by companies to perform internal audits of aspects of the company.  The internal audit department is normally independent of management and reports to the Audit Committee of the Board of Directors.

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