Introduction to Auditing
Introduction
• The role of audits is critical in the business
environment of the early twenty-first century.
• Important decisions are made on the basis of accounting
information.
• Audits reduce the risk that these decisions will be based
on inaccurate information.
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An Example
Assume that you are going to purchase a business.
• Businesses are frequently valued using a multiple of
earnings. Assume that your business should be valued at
five times annual profit.
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How Should Profit be Calculated?
The buyer and seller should agree on the method of
calculation of profit.
• GAAP provides a useful guideline.
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How Can We Trust the Financial
Information
The seller of the business prepares the financial
statements.
– The seller has a natural bias toward increasing income,
which will increase the selling price.
– The purchaser may not have the ability to check the
accuracy themselves.
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Three-Party Accountability
Users
Conclusion
Accountability
Subject
Matter
Auditor
Accountable Party
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Consider financial statements of an Entity
1. Accountable Party
2. Users
3. Auditor
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The Public Interest
Under three-party accountability the auditor is
expected to act in the interest of the user of the
information.
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Agency Theory and Accountability
When a task is delegated by one party to another
(Agent) it can create a problem when three
conditions are present:
The Auditor monitors the Agent (management)
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Demand for Reliable Information
Accounting attempts to record and summarize a
company’s transactions into financial statements for
the benefit of users.
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Auditing
Preparation of financial information by management
creates a conflict of interest between users of
financial information and management.
• The auditor serves as an independent intermediary who
lends credibility to the financial information.
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External Auditor
An external auditor is independent of management
and of the production of the financial information.
• This creates three-party accountability.
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Professional Judgement
A professional reaching a complex decision by
incorporating standards and ethics in a coherent
manner.
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Definition of Auditing
Auditing is a systematic process of:
1. Objectively obtaining and evaluating evidence
regarding assertions about economic actions and events
2. In order to ascertain the degree of correspondence
between the assertions and established criteria
3. And communicating the results to interested parties.
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Audit Objectives (CAS200)
The purpose of an audit is to enhance the degree of
confidence of intended users in the financial
statements.
This is achieved by the expression of an opinion by
the auditor on whether the financial statements are
prepared, in all material respects, in accordance with
an applicable financial reporting framework.
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Auditing and Risk Reduction
The auditor wants to reduce risk in the audit
What can happen with increased risk?
Business risk:
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Information risk:
Financial statements will fail to appropriately reflect
economic substance of business activities, including
business risks and uncertainties.
Auditing:
A process of reducing information risk to users of financial
statements.
• From the auditor’s perspective there are two major
categories of information risk.
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Audit Risk
The risk of insufficient evidence being gathered on
the facts concerning the entity’s economic
circumstances.
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Accounting Risk
Risk that errors associated with forecasts used in
GAAP accounting estimates are not properly
disclosed.
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Internal Auditing
Internal auditing is an independent, objective
assurance and consulting activity designed to add
value and improve an organization’s operations.
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Internal auditors need to be independent of line
managers in an organization.
Internal auditors have a larger scope of activities than
the external auditor.
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Operational Auditing
Operational auditing refers to the study of business
operations for the purpose of making
recommendations about:
The goal is to help managers meet their responsibilities and
improve profitability.
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Public Sector
(Governmental) Auditing
Governments at all levels make use of public sector
auditors.
Public sector audits
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Financial statement audits and the Public Sector
Compliance audits
Value-for-money audits
Comprehensive governmental audits include:
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Regulatory Auditors
Canada Customs and Revenue Agency (CCRA)
auditors:
Federal and provincial bank examiners:
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Fraud Auditing and
Forensic Accounting
Detection of fraud is not the primary responsibility of
the external auditor.
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The Accounting Profession
CPA Canada
Included the following:
Also have:
• Certified Internal Auditors
• Certified Fraud Examiners
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Public Accounting Firms
Perception of public firms is dominated by the “Big
Four” firms:
Accounting firms are organized as partnerships, or as
limited liability partnerships (LLPs).
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Organization of Public Accounting
Firm
Executive
Committee
Managing Partner
Practice Offices
Partners-in-Charge
Taxation
Department
Accounting and
Assurance
Department
Business Advisory
Department
Partner
Manager
Manager
Senior (in-charge)
Accountants
Staff Accountants
Partner
Manager
Manager
Manager
Manager
Senior (in-charge)
Accountants
Staff Accountants
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Public Accounting Services
Assurance services:
• Audit:
• Non-audit:
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Public Accounting Services
Taxation services:
• Taxation services include:
• A large proportion of practice in small accounting firms
is tax practice.
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Public Accounting Services
Consulting services:
– All accounting firms handle a great deal of consulting
– PAs compete against non-accountants for these services
– SOX restricts consulting services to audit clients
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International Auditing
The International Federation of Accountants (IFAC)
was created in 1977.
• This body mirrors the activities of domestic institutions
• Recommends international standards on auditing
• International convergence of standards
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