The Demand for Audit

and Other Assurance

Services
Chapter 1

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 1-1
 Why are we here?

1. SP = PV of all future dividends (plus animal spirits).

Current earnings → Future earnings (?) → Future
dividends (?). Why did Kodak go from $20→$1? Same
applies for loan from bank (private company), ability to pay
back loan and “r” are = Current earnings → Future
earnings (?). The Number (Berenson)
2. SEC Act of 1933 – F/S, SOX Section 404 – I/C (2002)
(Integrated audit)
3. Common source for 2 Acts?
4. Assurance, audit – what comes to mind?
©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 1-2
 Housekeeping
In the Cases and S-E for exams, you will be asked to “think” and I will
grade you on your ability to provide original, interesting thoughts.
Critical Thinking is the purposeful and reflective judgment about what to
believe or what to do in response to observations, experience, verbal
or written expressions, or arguments.
Analytical Thinking is the ability to scrutinize and break down facts and
thoughts into their strengths and weaknesses. Developing the
capacity to think in a thoughtful, discerning way, to solve problems,
analyze data, and recall and use information.
PRACTICAL THINKING (apply) and CREATIVE THINKING (solve)
NOT MEMORIZING AND REGURGITATING A LIST OF ITEMS
Some questions may request direct responses – but where possible –
THINK!
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 Housekeeping

Examples:
(1) SOX→Independence→Partner Rotation→Unintended
Consequences? Now Firm Rotation under consideration (tenure
good?)
(2) Brainstorming: where help and not help (WHY?),what are best
practices? What best practices are perhaps not cost beneficial
(why?)? What are the hurdles?

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 1-4
 Housekeeping

(3) Being Skeptical – always good? What about costs? What if you
find a reasonable explanation – no misstatement (HS Bias)?
How will you be evaluated? Does “Check with me” alleviate?
(4) Tell me something/ask a question I don’t know – outside,
relevant research to further your understanding. A/Ps and
current industry averages/ratios.
2. Please obtain feedback, but consistent with the real world – no dry
runs / reviews of initial drafts.
3. No cell phones / texting, etc. Only tech=laptop(notes
only)/calculator.

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 1-5
 Learning Objective 1

Describe auditing

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 1-6
 Nature of Auditing
Auditing is the accumulation and
evaluation of evidence (per GAAS) about
information (F/S) to determine and
report on the degree of
correspondence between the
information (F/S) and established criteria (GAAP).

Auditing should be done by a

competent (?), independent (?)
person (really a team).
©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 1-7
 Accumulating and
Evaluating Evidence
Evidence is any information used by the auditor
to determine whether the information being
audited (sales transaction) is stated in accordance
with the established criteria (GAAP).

F/S quantify/reflect economic activity

Think of economic events / accounts and examples of
evidence? Examples???

The last six years of my Research life: Are changes in

Revenues and Assets supported by changes in NFMs??

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 1-8
 Competent, Independent
Person
The auditor must be qualified to understand the
criteria (GAAP, COSO) used and must be competent to
know the types and amount of evidence to accumulate
to reach the proper conclusion after the
evidence has been examined (GAAS). How?

The competence of the individual performing the audit is of little

value if he or she is biased in the accumulation and evaluation of
evidence.
Audit Quality = Detect and Report Misstatement
Enron, Andersen, and SPEs (?)

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 1-9
 Reporting

The final stage in the auditing process is preparing the

Audit Report, which is the communication of the
auditor’s findings to users. See page 8 of annual report
in your book. MAY BE CHANGING - HW
See page 9 for mgt responsibilities for
preparing F/S and reporting on I/Cs

Examples of users? Research Results: Use of F/Ss and audit

report = 5.13, where 1 = “very unimportant” and 7 = “very
important.” SP info = 5.46, Advice from professionals = 5.07.
Retail / NP Investors

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 1 - 10
 Learning Objective 2

Distinguish between
auditing and accounting.

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 Distinction Between
Auditing and Accounting
Accounting is the recording, classifying,
and summarizing of economic
events (verbs = debits and credits) for the purpose of
providing financial information used in decision making.
Language of business

Auditing is determining whether recorded information

properly reflects the economic events (NFMs?) that
occurred during the accounting period.
Spell check on steroids!
Challenge = A lot of accounting in a little bit of time
Examples: sampling, analytical procedures, I/C reliance
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 Learning Objectives 4

List the causes of information

risk, and explain how this
risk can be reduced.

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 Causes of Information Risk

1. Remoteness of information (?): Mgt/Owner

2. Biases and motives of the provider (?)

3. Voluminous data→F/S (?)

4. Complex transactions→F/S (?)

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 Reducing Information Risk

1. User verifies information (IRS, Purchase)

2. User shares information risk with management

3. Audited financial statements are provided

Research: IPO → Owner/Mgt Dilemma↑ and # Users↑
Move to Larger Accounting Firm (deep pockets)

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 Relationships Among Auditors,
Client, and External Users

Client or audit Auditor issues

committee (?) hires report relied
auditor Auditor upon by users to reduce
information risk

Provides capital
External
Client
Users
Client provides financial
statements to users

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 1 - 16
 Learning Objective 5

Describe assurance services

and distinguish audit services
from other assurance and
nonassurance services
provided by CPAs.
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 Assurance Services
Assurance services are professional
services that improve the quality of
information for decision makers.
My Buddy and John Heisman

Assurance services can be

performed by CPAs or by
a variety of other professionals.
Not INSURANCE – why?
Could be: Mgt/BOD insures F/S, Insurer hires auditor
Better than current model where company pays fee?

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 Attestation Services

An attestation service is a type of assurance

service in which the CPA firm issues a
REPORT about the reliability of an assertion
that is the responsibility of another party.

REPORT = more liability = more expensive

Consumer Reports (articles) lawsuits < PwC
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 Attestation Services
Audits of historical financial statements
and internal controls over financial reporting (?)

Review of historical financial statements

Attestation on information technology:

WebTrust (like VeriSign) and SysTrust
Other attestation services – debt covenant
compliance, agreed upon procedures
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 Assurance, Attestation, and
Nonassurance Services
NONASSURANCE SERVICES

Management Accounting and

Consulting Bookkeeping

Tax
Services

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 Learning Objective 6

Differentiate the three

main types of audits.

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 Types of Audits

Financial Statement Audit

Operational Audit

Efficiency Effectiveness

Compliance Audit - Ex. IRS,

State grant and OBX, debt covenant, academic stds
©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 1 - 23
 Financial Statement Audit

Annual audit of Boeing’s

Example
financial statements
Boeing's financial
Information
statements and internal controls
Established Generally Accepted Accounting
Criteria Principles and COSO framework
Available Documents, records, and outside
Evidence sources of evidence
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 Operational Audit
Evaluate computerized payroll system
Example
for efficiency and effectiveness
Number of records processed, costs of
Information
the department, and number of errors
Established Company standards for efficiency and
Criteria effectiveness in payroll department
Available Error reports, payroll records, and
Evidence payroll processing costs

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 Compliance Audit
Determine whether bank requirements
Example
for loan continuation have been met

Information Company records

Established
Loan agreement provisions
Criteria
Available Financial statements and
Evidence calculations by the auditor

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 1 - 26
 Learning Objective 7

Identify the primary

types of auditors.

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 1 - 27
 Types of Auditors

Certified Public Accounting Firms

Govt. Accountability Office Auditors / State Auditors

Internal Revenue Agents

Internal Auditors

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 1 - 28
 Learning Objective 8

Describe the requirements

for becoming a CPA.

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 Three Requirements for
Becoming a CPA (3 Es)

Educational Requirement

Uniform CPA Examination Requirement

Experience Requirement

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 1 - 30
 CPA Examination Sections

Auditing and Attestation

Financial Accounting and Reporting

Regulations

Business Environment and Concepts

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 End of Chapter 1

©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 1 - 32