,CHAPTER01 c
AuditingandAssuranceServices
c
LEARNINGOBJECTIVES
Review Multiple Exercises,Problems,
Checkpoints
n Choice
n andSimulations
n
1. Define information risk and explain how the
n n n n n n n 1,2,3 29,31,38
c 65*
financial statement auditing process helps to
n n n n n n
reduce this risk, thereby reducing the cost of
n n n n n n n n
capitalforacompany.
n
2. Defineandcontrastassurance,attestation, c 4,5,6,7,8
c c 23,25,28,44,
c c 60,65*
andfinancialstatementauditingservices.
c 50
3. Describeanddefinetheassertionsthat 9,10,11 36,39,40,41,45,
c c 62,63,67,68,69
c c
managementmakesabouttherecognition,
n 46,47,48,49,52,
c c
measurement,presentation,anddisclosureof
n c c c
53,54,55,57,58,
c c
thefinancialstatementsand explainwhy
n c 59
auditorsusethemasafocalpointoftheaudit.
n c
4. Defineprofessionalskepticismandexplainits c 12 24,37
c 61
keycharacteristics.
n
5. Describetheorganization ofpublicaccounting c 13,14 30,42,56
c 72
firmsandidentifythevariousservicesthat
n
theyoffer.
n
6. Describetheaudits andauditors in c c n 15,16,17,18
c 26,27,32,34,35
c c 64,66
governmental,internal,andoperational
n
auditing.
n
7. Listandexplain therequirementsfor c 19,20,21,22
c 33,43,51
c 70,71
becoming acertifiedpublic accountant(CPA)
n h c h
andothercertificationsavailabletoan
n
accountingprofessional.
n c
(*)Item relatestomultiplelearningobjectives
h c
,SOLUTIONSFORREVIEWCHECKPOINTS
1.1 Businessriskistheriskthatanentitywillfailtomeetitsbusinessobjectives.Whenassessingbusiness
c n
n risk,aprofessional mustconsiderallpossiblethreatstoanentity‗sgoalsandobjectives.Some
c c c c c c
illustrativeexamplesincludetheriskthat:1)itsexistingcustomerswillstartbuyingproductsorservicesfromits
n c c c c
primarycompetitors;2)itsproductlines willbecomeobsolete;3)itstaxes willincrease;4)key
n c c n c c c c
ngovernmentcontractswillbelost;5)keyemployeeswillleavetheentity;andmanyotherexamplesexist.
c c c c
1.2 Tohelpminimizebusinessriskandtakeadvantageofotheropportunitiespresentedintoday‗scompetitive c c c c c c
businessenvironment,decision makerssuchaschiefexecutiveofficers(CEOs)demandtimely,relevant,
n c c n
nandreliableinformation.Thereareatleastfourenvironmentalconditionsthatincreasedemand forreliable
c c c c
information.First,complexitywhichimpliesthateventsand transactions intoday‗sglobalbusiness
n c c n
nenvironmentcanbecomplicated.Mostinvestorsdonothavethelevelofexpertiseneededtoproperlyaccount c c n
n forcomplextransactions.Secondisremotenesswhichimpliesthatdecisionmakersareoften c
separatedfrom currentandpotentialbusinessrelationshipsduetodistanceandtime.Forexample,investors may
c n c c c c c n
n notbeabletovisitdistantlocationstocheckupontheirinvestments.Third istime-sensitivitywhichimpliesthat c c n
nintoday‗s economicenvironment,investors andotherusersoffinancialstatements need tomakedecisions
c c c n c n
morerapidlythaneverbefore.Asaresult,theabilitytopromptlyobtainhigh-qualityinformation isessential.
n c c n
n Fourth isaconsequencewhichimpliesthatdecisionsmayverywellinvolvesignificantinvestments. As a
c n n c
result,theconsequencescanbesevereifinformationcannotbeobtained
n c
1.3 Ofallthedifferentrisksdiscussedinthechapteruptothispoint,informationriskistheonethatismostlikelyto c n
n createthedemandforindependentandobjectiveassuranceservicesisinformationriskortheprobabilitythat n
n theinformationcirculatedbyanentitywillbefalseormisleading.Becausetheprimarysourceofinformation c n
n forinvestors and creditorsis thecompanyitself,anincentiveexistsforthatcompany‗s
c c c
n managementtomaketheirbusinessorserviceappeartobebetterthanitactuallymaybe,toputtheirbestfoot
c c c c
nforward.Asaresult,preparersand issuersoffinancialinformation(directors,managers, c c
n accountants,andotherpeopleemployedinabusiness)mightbenefitbygivingfalse,misleading,oroverly
c c c c c c
optimisticinformation.Thispotentialconflictofinterestbetweeninformationprovidersand users which
n c c c c n
n providestheunderlyingbasisforthedemand forreliableinformation. c
1.4 Thefourmajor n n elementsofthebroaddefinition ofassuranceservicesare c c c
Independence. CPAswanttopreservetheirreputationandcompetitiveadvantagebyalwayspreserving
n c c c
nintegrityandobjectivitywhenperformingassuranceservices. c
Professionalservices.VirtuallyallworkperformedbyCPAsisdefinedas―professionalservices‖aslongasit c c c c c c c c
involvessomeelementofjudgmentbasedoneducationand experience.
n c c
Improvingthequalityofinformationoritscontext.Theemphasisison―information,‖CPAs‗traditionalareaof c c c c
n expertise.CPAscanenhancequalitybyassuringusersaboutthereliabilityandrelevanceofinformation,and
c c n
n thesetwofeaturesarecloselyrelated tothefamiliarcredibility-lendingproductsof c
attestation andauditservices.―Context‖isrelevanceina differentlight.Forassuranceservices,improving
n c c n c
nthecontextofinformationreferstoimprovingitsusefulnesswhentargetedtoparticulardecision makersin the c c c c c
nsurroundingsofparticulardecisionproblems. c
Fordecision makers. As the ―consumers‖ ofassurance services, decision makersarethebeneficiariesofthe
n n n n n n n n
assuranceservices.Decisionmakersmayor maynotbethe ―client‖thatpaysthe feeand mayormaynotbe one
n n n n n n
oftheparties to anassertionorother information, buttheypersonifytheconsumer focusof newand different
n n n n n n n n
professionalwork.
n
1.5 Anassuranceservicesengagementisanyassignmentthatimprovesthequalityofinformation,orits n
context,fordecisionmakers.Becauseinformation(e.g.,financialstatements)arepreparedbymanagersofan
n c c c c c
entitywhohaveauthorityandresponsibilityforfinancialsuccessorfailure,anoutsidermaybeskepticalthatthe
n c c c c c
ninformationtrulyisobjective,freefrombias,fullyinformative,and freefrommaterialerror,intentionalor c n
ninadvertent. Theservicesofanindependentauditorhelpsresolvethosedoubtsbecausethe
n c c c c
, auditor‗ssuccessdependsuponhisorherindependent,objective,andcompetentassessmentofthe n
n information(e.g.,theconformityofthefinancialstatementswiththeappropriatereportingframework). c c c c c
nTheindependentauditor‗sroleistolendcredibilitytotheinformation;hence,theoutsiderwilllikelyseekhisorher c c c c c
nindependentopinionaboutthefinancialstatements. c
1.6 Anattestationengagementis―anengagementin whichapractitionerisengaged toissueordoesissuea
c written c c c n
communication that expresses a conclusion about the reliability of a written assertion that is the
n n n n n n n n n n n n n n n
responsibilityof another party‖ (SSAE 10, AT 101.01). To attest means to lend credibility or to vouch for
n n n n n n n n n n n n n n n n n
thetruthoraccuracyofthestatementsthatonepartymakestoanother.Theattestfunctionisatermoften
n c applied c c n
totheactivities ofindependentCPAswhen acting as auditors offinancialstatements.
n c n c c c c
1.7 Anassuranceserviceengagementisonethatimprovesthequalityofinformation,oritscontext,fordecision makers. c c c c c n
Thus,an attestationserviceengagementisonetypeofan assuranceservice. Another wayofthinkingabout
n c c n c
theissueistorememberthatthefinancialstatementauditengagementisonetypeofanattestationservice.Please
n c c n
nseeexhibit1.3in thetextwhich depictstherelationshipamongassurance,attestation,and auditingengagements.
c c c
1.8 AccordingtotheAmericanAccountingAssociation,―Auditingisasystematicprocessofobjectively c c
nobtainingandevaluatingevidenceregardingassertionsabouteconomicactionsandeventstoascertainthe
c c c c c
degreeofcorrespondencebetweentheassertionsandestablishedcriteriaandcommunicatingtheresultsto
n c c c c c c
interestedusers.‖Ineffect,auditorsaddreliabilitytotheinformationthatisprovidedtointerestedusers.Of
n c c c n
ncourse,thisdefinitionisfocused onanexternalreportingcontext.Studentsmayalsodiscuss how
c c c c c c n
ngovernmentalandinternalauditorsoperateas well. c
In responseto―Whatdoauditorsdo?‖studentscanrespondb ystatingthatauditors(1)obtainandevaluate
h c n c c c c
nevidenceaboutassertions madebymanagementabouteconomicactionsandevents,(2)ascertainthe c n c
n degreeofcorrespondencebetweentheassertionsandtheappropriatereportingframework,and(3)issuean audit
c c c c c c c
nreport(opinion).Studentscanalsorespondmoregenerallybystatingthatauditorsessentiallylend credibilityto
c c c c c n
n thefinancialstatementspresentedbymanagement.
1.9 Financialaccountingreferstotheprocessofrecording,classifying,summarizing, andreportingabouta c n
ncompany‗sassets,liabilities,capital,revenues,andexpensesinthefinancialstatementsinaccordancewiththe
c c c c c
applicablefinancialreportingframework(e.g.,GAAP).Insodoing,themanagementteamismaking
n c c c c c
severalassertionsaboutthefinancialstatements.Thefinancialaccountingprocessistheresponsibilityofthe
n c c c c c
managementteam.
n
Financial statement auditing refers to the process whereby professional auditors gather evidence related to
n n n n n n n n n n n n n
ntheassertions that management makesinthe financial statements, evaluates theevidence and concludeson the
n n n n n n n n n n
nfairnessofthefinancial statementsinareport. c c c
Theydifferbecauseaccountants producethefinancialstatementsin accordancewiththeapplicable c c n
financialreportingframework.Afterthisiscomplete,financialstatementauditorsthenperformprocedures
n c c c c c
toascertain whetherthefinancialstatementshavebeenpreparedinaccordancewiththeapplicablefinancial
n c c c c c c c c
reporting framework.
n c
1.10 ThetwomajorclassificationsofASBassertionswithseveralassertionsineachclassificationare: c c c c c
n AssertionsAboutClassesofTransactionsand Events,andRelated Disclosures c c c
Occurrenceassertion:Theobjectiveistoestablishwithevidencethattransactionsgivingrisetoassets, c n
nliabilities,sales,andexpensesoccurred. Keyquestionsinclude―Didtherecordedsalestransactionsreally
c c n c c c
occur?‖
n
Completenessassertion:Theobjectiveistoestablish withevidencethatalltransactionsoftheperiod thatshould n n n c
nbe are included in the financial statements (including footnotes). Completeness also refers to proper
n n n n n n n n n n n n n
inclusioninfinancialstatementsofallrevenue,expense,andrelateddisclosures.Keyquestionsrelatedto
n c c c c c c c
AuditingandAssuranceServices
c
LEARNINGOBJECTIVES
Review Multiple Exercises,Problems,
Checkpoints
n Choice
n andSimulations
n
1. Define information risk and explain how the
n n n n n n n 1,2,3 29,31,38
c 65*
financial statement auditing process helps to
n n n n n n
reduce this risk, thereby reducing the cost of
n n n n n n n n
capitalforacompany.
n
2. Defineandcontrastassurance,attestation, c 4,5,6,7,8
c c 23,25,28,44,
c c 60,65*
andfinancialstatementauditingservices.
c 50
3. Describeanddefinetheassertionsthat 9,10,11 36,39,40,41,45,
c c 62,63,67,68,69
c c
managementmakesabouttherecognition,
n 46,47,48,49,52,
c c
measurement,presentation,anddisclosureof
n c c c
53,54,55,57,58,
c c
thefinancialstatementsand explainwhy
n c 59
auditorsusethemasafocalpointoftheaudit.
n c
4. Defineprofessionalskepticismandexplainits c 12 24,37
c 61
keycharacteristics.
n
5. Describetheorganization ofpublicaccounting c 13,14 30,42,56
c 72
firmsandidentifythevariousservicesthat
n
theyoffer.
n
6. Describetheaudits andauditors in c c n 15,16,17,18
c 26,27,32,34,35
c c 64,66
governmental,internal,andoperational
n
auditing.
n
7. Listandexplain therequirementsfor c 19,20,21,22
c 33,43,51
c 70,71
becoming acertifiedpublic accountant(CPA)
n h c h
andothercertificationsavailabletoan
n
accountingprofessional.
n c
(*)Item relatestomultiplelearningobjectives
h c
,SOLUTIONSFORREVIEWCHECKPOINTS
1.1 Businessriskistheriskthatanentitywillfailtomeetitsbusinessobjectives.Whenassessingbusiness
c n
n risk,aprofessional mustconsiderallpossiblethreatstoanentity‗sgoalsandobjectives.Some
c c c c c c
illustrativeexamplesincludetheriskthat:1)itsexistingcustomerswillstartbuyingproductsorservicesfromits
n c c c c
primarycompetitors;2)itsproductlines willbecomeobsolete;3)itstaxes willincrease;4)key
n c c n c c c c
ngovernmentcontractswillbelost;5)keyemployeeswillleavetheentity;andmanyotherexamplesexist.
c c c c
1.2 Tohelpminimizebusinessriskandtakeadvantageofotheropportunitiespresentedintoday‗scompetitive c c c c c c
businessenvironment,decision makerssuchaschiefexecutiveofficers(CEOs)demandtimely,relevant,
n c c n
nandreliableinformation.Thereareatleastfourenvironmentalconditionsthatincreasedemand forreliable
c c c c
information.First,complexitywhichimpliesthateventsand transactions intoday‗sglobalbusiness
n c c n
nenvironmentcanbecomplicated.Mostinvestorsdonothavethelevelofexpertiseneededtoproperlyaccount c c n
n forcomplextransactions.Secondisremotenesswhichimpliesthatdecisionmakersareoften c
separatedfrom currentandpotentialbusinessrelationshipsduetodistanceandtime.Forexample,investors may
c n c c c c c n
n notbeabletovisitdistantlocationstocheckupontheirinvestments.Third istime-sensitivitywhichimpliesthat c c n
nintoday‗s economicenvironment,investors andotherusersoffinancialstatements need tomakedecisions
c c c n c n
morerapidlythaneverbefore.Asaresult,theabilitytopromptlyobtainhigh-qualityinformation isessential.
n c c n
n Fourth isaconsequencewhichimpliesthatdecisionsmayverywellinvolvesignificantinvestments. As a
c n n c
result,theconsequencescanbesevereifinformationcannotbeobtained
n c
1.3 Ofallthedifferentrisksdiscussedinthechapteruptothispoint,informationriskistheonethatismostlikelyto c n
n createthedemandforindependentandobjectiveassuranceservicesisinformationriskortheprobabilitythat n
n theinformationcirculatedbyanentitywillbefalseormisleading.Becausetheprimarysourceofinformation c n
n forinvestors and creditorsis thecompanyitself,anincentiveexistsforthatcompany‗s
c c c
n managementtomaketheirbusinessorserviceappeartobebetterthanitactuallymaybe,toputtheirbestfoot
c c c c
nforward.Asaresult,preparersand issuersoffinancialinformation(directors,managers, c c
n accountants,andotherpeopleemployedinabusiness)mightbenefitbygivingfalse,misleading,oroverly
c c c c c c
optimisticinformation.Thispotentialconflictofinterestbetweeninformationprovidersand users which
n c c c c n
n providestheunderlyingbasisforthedemand forreliableinformation. c
1.4 Thefourmajor n n elementsofthebroaddefinition ofassuranceservicesare c c c
Independence. CPAswanttopreservetheirreputationandcompetitiveadvantagebyalwayspreserving
n c c c
nintegrityandobjectivitywhenperformingassuranceservices. c
Professionalservices.VirtuallyallworkperformedbyCPAsisdefinedas―professionalservices‖aslongasit c c c c c c c c
involvessomeelementofjudgmentbasedoneducationand experience.
n c c
Improvingthequalityofinformationoritscontext.Theemphasisison―information,‖CPAs‗traditionalareaof c c c c
n expertise.CPAscanenhancequalitybyassuringusersaboutthereliabilityandrelevanceofinformation,and
c c n
n thesetwofeaturesarecloselyrelated tothefamiliarcredibility-lendingproductsof c
attestation andauditservices.―Context‖isrelevanceina differentlight.Forassuranceservices,improving
n c c n c
nthecontextofinformationreferstoimprovingitsusefulnesswhentargetedtoparticulardecision makersin the c c c c c
nsurroundingsofparticulardecisionproblems. c
Fordecision makers. As the ―consumers‖ ofassurance services, decision makersarethebeneficiariesofthe
n n n n n n n n
assuranceservices.Decisionmakersmayor maynotbethe ―client‖thatpaysthe feeand mayormaynotbe one
n n n n n n
oftheparties to anassertionorother information, buttheypersonifytheconsumer focusof newand different
n n n n n n n n
professionalwork.
n
1.5 Anassuranceservicesengagementisanyassignmentthatimprovesthequalityofinformation,orits n
context,fordecisionmakers.Becauseinformation(e.g.,financialstatements)arepreparedbymanagersofan
n c c c c c
entitywhohaveauthorityandresponsibilityforfinancialsuccessorfailure,anoutsidermaybeskepticalthatthe
n c c c c c
ninformationtrulyisobjective,freefrombias,fullyinformative,and freefrommaterialerror,intentionalor c n
ninadvertent. Theservicesofanindependentauditorhelpsresolvethosedoubtsbecausethe
n c c c c
, auditor‗ssuccessdependsuponhisorherindependent,objective,andcompetentassessmentofthe n
n information(e.g.,theconformityofthefinancialstatementswiththeappropriatereportingframework). c c c c c
nTheindependentauditor‗sroleistolendcredibilitytotheinformation;hence,theoutsiderwilllikelyseekhisorher c c c c c
nindependentopinionaboutthefinancialstatements. c
1.6 Anattestationengagementis―anengagementin whichapractitionerisengaged toissueordoesissuea
c written c c c n
communication that expresses a conclusion about the reliability of a written assertion that is the
n n n n n n n n n n n n n n n
responsibilityof another party‖ (SSAE 10, AT 101.01). To attest means to lend credibility or to vouch for
n n n n n n n n n n n n n n n n n
thetruthoraccuracyofthestatementsthatonepartymakestoanother.Theattestfunctionisatermoften
n c applied c c n
totheactivities ofindependentCPAswhen acting as auditors offinancialstatements.
n c n c c c c
1.7 Anassuranceserviceengagementisonethatimprovesthequalityofinformation,oritscontext,fordecision makers. c c c c c n
Thus,an attestationserviceengagementisonetypeofan assuranceservice. Another wayofthinkingabout
n c c n c
theissueistorememberthatthefinancialstatementauditengagementisonetypeofanattestationservice.Please
n c c n
nseeexhibit1.3in thetextwhich depictstherelationshipamongassurance,attestation,and auditingengagements.
c c c
1.8 AccordingtotheAmericanAccountingAssociation,―Auditingisasystematicprocessofobjectively c c
nobtainingandevaluatingevidenceregardingassertionsabouteconomicactionsandeventstoascertainthe
c c c c c
degreeofcorrespondencebetweentheassertionsandestablishedcriteriaandcommunicatingtheresultsto
n c c c c c c
interestedusers.‖Ineffect,auditorsaddreliabilitytotheinformationthatisprovidedtointerestedusers.Of
n c c c n
ncourse,thisdefinitionisfocused onanexternalreportingcontext.Studentsmayalsodiscuss how
c c c c c c n
ngovernmentalandinternalauditorsoperateas well. c
In responseto―Whatdoauditorsdo?‖studentscanrespondb ystatingthatauditors(1)obtainandevaluate
h c n c c c c
nevidenceaboutassertions madebymanagementabouteconomicactionsandevents,(2)ascertainthe c n c
n degreeofcorrespondencebetweentheassertionsandtheappropriatereportingframework,and(3)issuean audit
c c c c c c c
nreport(opinion).Studentscanalsorespondmoregenerallybystatingthatauditorsessentiallylend credibilityto
c c c c c n
n thefinancialstatementspresentedbymanagement.
1.9 Financialaccountingreferstotheprocessofrecording,classifying,summarizing, andreportingabouta c n
ncompany‗sassets,liabilities,capital,revenues,andexpensesinthefinancialstatementsinaccordancewiththe
c c c c c
applicablefinancialreportingframework(e.g.,GAAP).Insodoing,themanagementteamismaking
n c c c c c
severalassertionsaboutthefinancialstatements.Thefinancialaccountingprocessistheresponsibilityofthe
n c c c c c
managementteam.
n
Financial statement auditing refers to the process whereby professional auditors gather evidence related to
n n n n n n n n n n n n n
ntheassertions that management makesinthe financial statements, evaluates theevidence and concludeson the
n n n n n n n n n n
nfairnessofthefinancial statementsinareport. c c c
Theydifferbecauseaccountants producethefinancialstatementsin accordancewiththeapplicable c c n
financialreportingframework.Afterthisiscomplete,financialstatementauditorsthenperformprocedures
n c c c c c
toascertain whetherthefinancialstatementshavebeenpreparedinaccordancewiththeapplicablefinancial
n c c c c c c c c
reporting framework.
n c
1.10 ThetwomajorclassificationsofASBassertionswithseveralassertionsineachclassificationare: c c c c c
n AssertionsAboutClassesofTransactionsand Events,andRelated Disclosures c c c
Occurrenceassertion:Theobjectiveistoestablishwithevidencethattransactionsgivingrisetoassets, c n
nliabilities,sales,andexpensesoccurred. Keyquestionsinclude―Didtherecordedsalestransactionsreally
c c n c c c
occur?‖
n
Completenessassertion:Theobjectiveistoestablish withevidencethatalltransactionsoftheperiod thatshould n n n c
nbe are included in the financial statements (including footnotes). Completeness also refers to proper
n n n n n n n n n n n n n
inclusioninfinancialstatementsofallrevenue,expense,andrelateddisclosures.Keyquestionsrelatedto
n c c c c c c c
