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Chapter 1 – Auditing and

Assurance Services
Presentation Outline

I. The Demand for Reliable Information

II. Understanding Assurance Services
III. Management Assertions
I. The Demand for Reliable

A. Understanding a Client’s Business

B. Environmental Conditions
C. Information Risk
A. Understanding a Client’s
Business risk is the
risk that an entity will
fail to meet its
Failing to reach
objectives can
eventually result in
temptation to misstate
financial statements
to avoid business
B. Environmental Conditions
• Complexity – Decisions makers are not
I lost my trained to collect, compile, and
savings in a summarize the key operating
information themselves.
• Remoteness – Investors are not able to
personally visit locations to check on
• Time sensitivity – Decisions must often
be made on a moment’s notice.
• Consequences – A drop in investment
value can wipe out one’s life savings.
• Potential bias – Management has
incentives to bias financial information in
order to convey a better impression of
the financial data rather than real
circumstances might merit
C. Information Risk
 Information risk is the
probability that the
information circulated by a
company will be false or
 Client management has an
incentive to make the
business appear better than
it actually may be. Financial
 This can create a conflict of Statements

interest between client

management and investors.
II. Understanding Assurance

A. Definition of Assurance Services

B. Definition of Attestation Services
C. Definition of Auditing
D. Overview of Financial Statement Auditing
E. Graphical Representation of Assurance
A. Assurance Service Elements

Assurance services are (1) independent (2)

professional services that (3) improve the
quality of information, or its context, (4)
for decision makers. Assurance services
include many areas of information, including
nonfinancial areas.
• Definition
– Auditor’s satisfaction as to the reliability of an
assertion being made by one party for use by
another party
Assurance engagement
• An engagement in which a practitioner
expresses a conclusion designed to
enhance the degree of confidence of the
intended users other than the responsible
party about the outcome of the evaluation
or measurement of a subject matter
against a criteria
Elements of an assurance
1. Three-party relationship
2. Subject matter
3. Suitable criteria
4. Sufficient appropriate evidence
5. Assurance report
Three-party relationship
• Practitioner
• Responsible party
– Person or persons who;
• Responsible for the subject matter
• Responsible for the subject matter information
(the assertion), and may be responsible for the
subject matter
• Intended users
– person, persons or class or persons for whom the
practitioner prepares the assurance report. The
responsible party can be one of the intended users,
but not the only one.
Subject matter
• Forms
– Financial performance or conditions for which the
subject matter information may be the recognition,
measurement, presentation and disclosure
represented in financial statements
– Non-financial performance or conditions for which the
subject matter information may be the key indicators
on efficiency and effectiveness
– Physical characteristics
– Systems and processes
– Behavior (corporate governance, compliance with
Subject matter
• An appropriate subject matter is:
– Identifiable and capable of consistent
evaluation or measurement against the
identified criteria
– Such that the information about it can be
subjected to procedures for gathering
sufficient appropriate evidence to support a
reasonable assurance or limited assurance
conclusion, as appropriate
• Benchmarks used to evaluate or measure the
subject matter
• Suitable criteria – context sensitive
• Characteristics:
– Relevance
– Completeness
– Reliability (allow consistent evaluation/measurement)
– Neutrality (free from bias)
– Understandability (clear, comprehensive, and not
subject to different interpretations)
• The practitioner plans and performs an
assurance engagement with an attitude of
professional skepticism to obtain sufficient
appropriate evidence about whether the
subject matter information is free of
material misstatement.
• Most of the evidence available to the
auditor is persuasive rather than
conclusive, in nature.
• Professional skepticism
– Circumstances may exist that cause the
subject matter information may be materially
– Critical assessment, with a questioning mind,
of the validity of evidence obtained and is
alert to evidence that contradicts or brings into
question the reliability of documents or
representations by the responsible party
• Sufficiency
– Measure of quantity of evidence
• Appropriateness
– Measure of quality of evidence (relevance and
• Reliability
– Influenced by its source and nature, and is
dependent on the individual circumstances
under which it is obtained.
• Generalizations on the reliability of evidence
– Evidence is more reliable when it is obtained from
independent sources outside the entity
– Evidence that is generated internally is more reliable
when the related controls are effective
– Evidence obtained directly by the practitioner is more
reliable than evidence obtained indirectly or by
– Evidence is more reliable when it exists in
documentary form (paper, electronic, other media)
– Evidence provided by original documents is more
reliable than evidence provided by photocopies.
• Quantitative and qualitative factors
• Relevant when the practitioner determines
the nature, timing, and extent of evidence-
gathering procedures, and when
assessing whether the subject matter is
free of misstatement.
Assurance engagement risk
• The risk that the practitioner expresses an
inappropriate conclusion when the subject
matter information is materially misstated.
• Components:
– The risk that the subject matter is materially
misstated, which in turn consists of:
• Inherent risk: the susceptibility of the subject matter
information to a material misstatement assuming there are no
related controls
• Control risk: the risk that a material misstatement that could
occur will not be prevented, or detected and corrected, on a
timely basis by related internal controls
– Detection risk: the risk that the practitioner will not
detect a material misstatement that exists
Reasonable assurance
- A concept relating to accumulating
evidence necessary for the practitioner to
conclude in relation to the subject matter
information taken as a whole.
- High level of assurance
- Obtained when the auditor has obtained
sufficient appropriate audit evidence to
reduce audit risk to an acceptably low
Assurance report
• A written report containing a conclusion
that conveys the assurance obtained
about the subject matter information.
Types of assurance
• Audit
• Related services
– Review
– Agreed-upon procedures
– Compilation
to enable the auditor to express an
opinion whether the financial statements are
prepared, in all material respects, in
accordance with an identified financial
reporting framework.
“present fairly, in all material respects”
Level of assurance
High, but not absolute
to enable the auditor to state whether, on the
basis of procedures which do not provide all the
evidence that would be required in an audit,
anything has come to the auditor’s attention that
causes the auditor to believe that the financial
statements are not prepared, in all material
respects, in accordance with an identified financial
reporting framework.
Level of assurance:
Moderate level of assurance
• Comprises inquiry and analytical procedures
which are designed to review the reliability of an
assertion that is the responsibility of one party
for use by another party
• Does not ordinarily involve an assessment of
accounting and internal control systems, tests of
records and of response to inquiries by obtaining
corroborative evidence through inspection,
observation, confirmation, and computation,
which are procedures ordinarily performed in an
Agreed-upon Procedures
To carry out those procedures of an
audit nature to which the auditor and the
entity and any appropriate third parties have
agreed and to report factual finding.

Level of Assurance
No assurance
to use accounting expertise as
opposed to auditing expertise to collect,
classify, and summarize financial

Level of assurance: No assurance

B. Definition of Attestation Services
 Attestation involves an
engagement resulting in
the issuance of a report
on subject matter or an
assertion about the
subject matter that is the
responsibility of another
 Auditing is a specific type
of attestation.
C. Auditing

Auditing is a systematic process of

objectively obtaining and
evaluating evidence regarding
Financial Statements assertions about economic actions
(including footnotes)
and events to ascertain the degree
of correspondence between the
assertions and established criteria GAAP
and communicating the results to
interested users. Auditor's Report/
Persons who rely on Other Reports
the financial reports
•Creditors Source: American Accounting Association Committee on
•Investors Basic Auditing Concepts. 1973. A Statement of Basic
Auditing Concepts, American Accounting Association
(Sarasota, FL).
Types of audit
According to nature of assertion/data
1. Financial statements audit
2. Operational audit
3. Compliance audit

According to types of auditor

1. External audit
2. Internal audit
3. Government audit
According to nature of assertion/data

1. Financial statements audit

to enhance the degree of confidence of
intended users in the financial statements
According to nature of assertion/data

1. Financial Statements Audit

to obtain reasonable assurance about whether the
financial statements as a whole are free from material
misstatement, whether due to fraud or error, thereby
enabling the auditor to express an opinion whether the
financial statements are prepared, in all material respects,
in accordance with an applicable financial reporting
to report on the financial statements, and
communicate as required by the PSAs, in accordance with
the auditor’s findings
D. Overview of Financial Statement
E. Graphical Representation of Assurance Services

The Relationships Among Auditing, Attestation,

and Assurance Engagements

Assurance Services
Any Information

Attestation Services
Primarily Financial Information

Financial Statements
III. Management Assertions

A. Presentation and Disclosure

B. Existence or Occurrence
C. Rights and Obligations
D. Completeness
E. Valuation or Allocation
A. Presentation and Disclosure
Footnote disclosure of important
accounting policies must be relevant and
Transactions must be classified in the
correct accounts.
Information must be transparent (i.e.,
understandable to a reasonably
sophisticated person).
B. Existence or Occurrence

Assets, liabilities, and equities on the

balance sheet actually exist.
Each of the revenue and expense
transactions actually occurred.
C. Rights and Obligations

Amounts reported as assets of the

company represent its property rights.
Amounts reported as liabilities represent
its obligations.
D. Completeness
All transactions, events, assets, liabilities, and equities
that should have been recorded have been recorded.
All disclosures that should have been discussed in the
footnotes are there.

Cutoff refers to accounting for revenue, expense, and

other transactions in the proper period (neither
postponing some recordings to the next period (i.e.,
completeness) nor accelerating next period’s
transactions into the current year accounts (i.e.,
existence or occurrence)). The cutoff date refers to
the client’s year-end balance sheet date.
E. Valuation or Allocation

Determine whether proper values have

been assigned to assets, liabilities, and
Examples include collectibility of
receivables, recalculating depreciation,
obtaining lower of cost or market data, etc.
Audit process considers business risk,
information risk.
Environmental factors result in need for audits.
Understanding assurance, attestation, and