C HAPTER 1

AUDITING AND THE PUBLIC

ACCOUNTING PROFESSION – INTEGRITY OF
FINANCIAL REPORTING

Learning Objectives

The learning objectives for Chapter 1 have been stated in terms of Auditor Knowledge that the
student should understand. They are:
1. Know the common attributes of activities defined as auditing.
2. Know the differences between the different types of audits and auditors.
3. Know the common attributes of assurance services.
4. Know the variety of services and levels of assurance in the universe of assurance services.
5. Know the value of the audit and other assurance services.
6. Know a historical perspective of the demand for auditing.
7. Know the factors that influence the need for financial statement audits.
8. Know the economic benefits and inherent limitations associated with a financial statement
audit.
9. Know the public sector and private sector organizations associated with auditing and
assurance services.
10. Know the four components of the auditing profession’s multilevel regulatory framework.
11. Know the elements of a system of quality control for a CPA firm’s attest practice.

Chapter Outline

1. Chapter-opening Vignette: Internal Auditors Uncover Financial Fraud at WorldCom, 3

2. Preview of Chapter 1, 4
3. Focus on Auditor Knowledge, 4
4. Auditing and Assurance Services Defined, 5
4.1. Auditing Defined, 5 ………………………..(Figure 1-1: Overview of the Audit Process)
4.2. Types of Audits, 8 (Figure 1-2: Comparative Summary of Types of Audits)
4.2.1. Financial Statement Audit, 8
4.2.2. Compliance Audit, 8
4.2.3. Operational Audit, 9
4.3. Types of Auditors, 10
4.3.1. Independent Auditors, 10
4.3.2. Internal Auditors, 10

Instructor’s Manual to Modern Auditing: Copyright © 2005, John Wiley and Sons, Inc. 1-1
 4.3.3. Government Auditors, 10
4.4. Assurance Services Defined, 11
4.4.1. Example Assurance Services, 12 ….(Figure 1-3: Universe of Assurance Services)
4.4.1.1.Audit Engagements, 12
4.4.1.2.Attest Services, 13
4.4.1.3.Accounting and Compilations Services, 14
4.4.1.4.Levels of Assurance, 15
4.5. Value of Audit and Assurance Services, 15…….. (Figure 1-4: The Accountant’s Value
Chain)
5. The Demand for Auditing, 18
5.1. The Roots of Auditing, 18
5.2. Need for Financial Statement Audits, 20
5.3. Economic Benefits of an Audit, 21
5.4. Limitations of an Audit, 22
6. Organizations Associated with the Public Accounting Profession, 23 (Figure 1-5:
Organizations Associated with the Public Accounting Profession)
6.1. Public Sector Organizations, 23
6.1.1. Securities and Exchange Commission, 23
6.1.2. State Boards of Accountancy, 24
6.1.3. U.S. General Accounting Office, 24
6.1.4. Internal Revenue Service, 24
6.1.5. Federal and State Courts, 24
6.1.6. U.S. Congress, 25
6.2. Private Sector Organization, 25
6.2.1. Public Companies Accounting Oversight Board, 25
6.2.2. American Institute of Certified Public Accountants, 25
6.2.3. State Societies of Certified Public Accountants, 26
6.2.4. Practice Units (CPA Firms), 26 (Figure 1-6: Select
Accounting Firm Data)
6.2.5. Accounting Standard Setting Bodies, 27
7. Regulatory Framework for Ensuring High-Quality Services, 29
7.1. Standard Setting, 29 Figure 1-7: Standards Setting Organizations in the
United States)
7.1.1. Quality Control Standards, 30 (Figure 1-8: Quality Control Elements)
7.1.1.1.Independence, Integrity, and Objectivity, 30
7.1.1.2.Personnel Management, 32
7.1.1.3.Acceptance and Continuance of Clients and Engagements, 32
7.1.1.4.Engagement Performance, 30
7.1.1.5.Monitoring, 30

Instructor’s Manual to Modern Auditing: Copyright © 2005, John Wiley and Sons, Inc. 1-2
 7.2. Firm Regulation, 33
7.3. Inspection and Peer Review, 33
7.3.1. PCOAB Inspection Program, 33
7.3.2. AICPA Practice Monitoring (Peer Review) Program, 34
7.4. Government Regulation, 34
8. Focus on Auditor Knowledge ………….. (Figure 1-9: Summary of Auditor Knowledge
Discussed in Chapter 1)
9. Objective Questions, online at www.wiley.com/college/boynton
10. Comprehensive Questions, 38
11. Professional Simulation, 41

New to the 8th Edition

The 8th edition has several new features:

1. Chapter-opening vignette that discusses the success of internal auditors at WorldCom. This
exemplifies the best of the auditing profession and provides a basis for discussion regarding
the need for audits.
2. Focus on audit knowledge at the beginning of the chapter, in the margin throughout the
chapter and an end of chapter summary that focus on important auditor knowledge in the
chapter.
3. The discussion of the economic benefits of an audit, and inherent limitations of an audit, has
been moved from the 2nd chapter to the opening chapter.
4. A CPA exam style professional simulation has been added at the end of the chapter.

Key Questions for Students

Following is a list of common questions for students that instructors might want to weave into
class discussion of Chapter 1 topics.
o What are the common attributes of all audits?
o How do these attributes apply to a financial statement audit?
o How do these attributes apply to an audit of internal controls over financial reporting?
o What are the basic types of audits and types of auditors?
o How do assurance services differ from audits?
o What are the four basic levels of assurance that can be provided by CPAs?
o How does an audit support other decisions?
o How would investors have benefited if the WorldCom audit had been more effective?
o What factors influence the need for a financial statement audit?
o What are the economic benefits of an audit?
o What are the inherent limitations of an audit?

Instructor’s Manual to Modern Auditing: Copyright © 2005, John Wiley and Sons, Inc. 1-3
o What are the key public sector organizations that influence the auditing profession and what
is the role of each?
o What are the key private sector organizations that influence the auditing profession and what
is the role of each?
o What professional standards are relevant to the practice of audit and assurance services, what
is their purpose, and who sets each set of relevant standards?
o What is the purpose of quality control standards?
o What are the five basic groups of quality control standards?
o What is the purpose of each group?
o Who is responsible for monitoring the quality of audit practice?

Teaching Notes

This is an introductory chapter that addresses four basic topics.

1. Understanding the definitions of auditing services and assurance services.
2. Understanding the demand for audits.
3. Understanding the organizations associated with the public accounting profession.
4. Understanding the regulatory framework for ensuring high quality audit and assurance
services.

This is a straight forward chapter that lays the foundations for further discussions of financial
statement audits. The first half of the chapter is particularly important for future chapters. It will
help students to know the different types of auditors, types of audits, and levels of assurance that
auditors can provide. Students should also be familiar with the benefits and limitations of a
financial statement audit. Discussion of the following figures may also be helpful.
o Figure 1-1 provides a graphic description of the elements of the definition of auditing.
o Figure 1-2 lays out key elements of different types of audits.
o Figure 1-3 provides a graphic interpretation of the different types of audit and assurance
services.
o Figure 1-4 may be useful for discussing the importance of the audit for it is difficult to
transform complex information into knowledge, and support decision-making if the
underlying data is unreliable.

Instructors may make their own choices about the depth of coverage of the discussion of
organizations associated with the public accounting profession or the regulatory framework for
ensuring high quality audit and attest services. Discussion of the following figures may also be
helpful.
o Figure 1-5 may be useful for discussing the various public and private sector organizations.
o Figure 1-6 helps students understand the nature of work provided by CPA firms.
o Figure 1-7 helps students understand the organizations who are involved in standard setting
for private and public companies.
o Figure 1-8 is helpful for those who want to discuss quality control standards and their
relevance to audit quality.

Instructor’s Manual to Modern Auditing: Copyright © 2005, John Wiley and Sons, Inc. 1-4
Finally, Figure 1-9 provides an end of chapter summary that is tied to the chapter learning
objectives.

Instructor’s Manual to Modern Auditing: Copyright © 2005, John Wiley and Sons, Inc. 1-5