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Chapter One
An Introduction to Assurance
and Financial Statement Auditing

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Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

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The Demand for Auditing and


Assurance
The development of the corporate form of
business and the expanding world economy
over the last 200 years have given rise to
an explosion in the demand for assurance
provided by auditors.

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Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

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Principals and Agents


A public company is a company that sells its stocks or
bonds to the public, giving the public a valid interest in
the proper use, or stewardship, over the companys
resources.

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Managers

Stockholders

Agents

Principals
Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

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The Role of Auditing

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Auditing, Attest, and Assurance


Services Defined
Auditing

Attest

Assurance
Services

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.
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Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

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Auditing, Attest, and Assurance


Services Defined
Auditing

Attest

Assurance
Services

Services occur when a practitioner is


engaged to issue or does issue a
report on subject matter, or an
assertion about subject matter, that is
the responsibility of another party.
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Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

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Auditing, Attest, and Assurance


Services Defined
Auditing

Attest

Assurance
Services

Are independent professional services


that improve the quality of information,
or its context, for decision makers.

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McGrawHill/Irwin

Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

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Fundamental Concepts in Conducting a


Financial Statement Audit

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Audit Risk
Audit risk is the risk that the auditor may
unknowingly fail to appropriately modify his or her
opinion on financial statements that are materially
misstated.
The auditors standard
report states that the audit
provides only reasonable
assurance that the
financial statements do not
contain material
misstatements.
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Reasonable assurance
implies some risk that a
material misstatement
could be present in the
financial statements and
the auditor will fail to
detect it.
Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

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Materiality
Materiality is the magnitude of an
omission or misstatement of
accounting information that, in
light of surrounding
circumstances, makes it probable
that the judgment of a reasonable
person relying on the information
would have been changed or
influenced by the omission or
misstatement.
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Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

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Evidence Regarding Management


Assertions
Evidence that assists the auditor in evaluating
managements financial statement assertions
consists of the underlying accounting data and any
corroborating information available to the auditor.

Relevance

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Reliability

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Sampling: Inferences Based on


Limited Observations
Auditors use (1) their knowledge about the
transactions and/or (2) a sampling approach to
examine the transactions.

It would be too
costly for the auditor
to examine every
transaction.
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Major Phases of the Audit

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Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

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End of Chapter 1

McGrawHill/Irwin

Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.