Understanding Auditing and Accounting

This assignment delves into the distinct concepts of accounting and auditing, highlighting their purposes, methods, and characteristics. It explains that accounting involves recording, classifying, and summarizing economic events for decision-making, whereas auditing determines whether recorded information accurately reflects these events. The text also explores types of audits, including operational, compliance, and financial statement audits, as well as the roles of different auditors, such as Certified Public Accounting Firms, Government Accountability Office Auditors, Internal Revenue Agents, and internal auditors. By understanding these differences, readers can appreciate the importance of auditing in verifying financial information and ensuring accountability.

B-402
Chapter 01: The Demand for Audit and
Assurance Service
Contents
Review of historical financial statement............................................................................................................2
Other Assurance Services..................................................................................................................................2
Non-Assurance Services....................................................................................................................................2
Economic Demand for Auditing........................................................................................................................3
a. Remoteness of Information.........................................................................................................................4
b. Biases and Motives of the Provider............................................................................................................4
c. Voluminous Data........................................................................................................................................4
d. Complex Exchange Transactions................................................................................................................4
Reducing Information Risk................................................................................................................................4
Verify Information.............................................................................................................................................4
Shares Information Risk with Management.......................................................................................................4
Nature of Audit..................................................................................................................................................4
Accounting vs. Auditing....................................................................................................................................5
Types of audit.....................................................................................................................................................5
Types of auditor.................................................................................................................................................5
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Review of historical financial statement
Review of Historical Financial Statements For a review of historical financial statements, management
asserts that the statements are fairly stated in accordance with accounting standards, the same as for audits.
Other Assurance Services
Other Assurance Services Service Activities
Controls over and risks related to
investments
Assess the processes in a company’s investment practices to identify risks and
to determine the effectiveness of those processes
Mystery shopping Perform anonymous shopping to assess sales personnel dealings with
customers and procedures they follow
Assess risks of accumulation,
distribution & storage of digital
information
Assess security risks and related controls over electronic data, including the
adequacy of backup and off-site storage
Fraud and illegal acts risk
assessment
Develop fraud risk profiles, and assess the adequacy of company systems and
policies in preventing and detecting fraud and illegal acts
Compliance with trading policies
and procedures
Examine transactions between trading partners to ensure that transactions
comply with agreements; identify risks in the agreements
Compliance with entertainment
royalty agreements
Assess whether royalties paid to artists, authors, and others comply with
royalty agreements
ISO 9000 certifications Certify a company’s compliance with ISO 9000 quality control standards,
which help ensure company products are of high quality
Corporate responsibility and
sustainability
Report on whether the information in a company’s corporate responsibility
report is consistent with company information and established reporting criteria
Non-Assurance Services
CPA firms perform numerous other services that generally fall outside the scope of assurance services.
Three specific examples are:
1. Accounting and bookkeeping services
2. Tax services
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AssuranceserviceAnassuranceserviceisanindependentprofessionalservicethatimprovesthequalityofinformationfordecisionmakers.Individualsseekassuranceservicestohelpimprovethereliabilityandrelevanceoftheinformationusedasthebasisfortheirdecisions.AttestationserviceAnattestationserviceisatypeofassuranceserviceinwhichtheCPAfirmissuesareportaboutthereliabilityofanassertionthatismadebyanotherparty.AuditifhistoricalfinancialstatementAuditofHistoricalFinancialStatementsInanauditofhistoricalfinancialstatements,managementassertsthatthestatementsarefairlystatedinaccordancewithapplicableU.S.orinternationalaccountingstandards.

3. Management consulting services
While the primary purpose of an Assurance Service is to improve the quality of information, the primary
purpose of a Management Consulting Service is to generate a recommendation to management.
CPA may be engaged to design and install a new information technology system for a client as a
consulting engagement.
The purpose of that engagement is to install the new system, with the goal of improved information
being a by-product of that engagement.
Economic Demand for Auditing
Rate of interest determined primarily by three factors:
1. Risk-free interest rate: This is approximately the rate the bank could earn by
investing in U.S. treasury notes for the same length of time as the business loan.
2. Business risk for the customer: This risk reflects the possibility that the business
will not be able to repay its loan because of economic or business conditions, such
as a recession, poor management decisions, or unexpected competition in the
industry.
3. Information risk: Information risk reflects the possibility that the information upon
which the business risk decision was made was inaccurate. A likely cause of the
information risk is the possibility of inaccurate financial statements.
Auditing has no effect on either the risk-free interest rate or business risk, but it can have a
significant effect on information risk.
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a. Remoteness of
Information
It is nearly impossible to have much firsthand knowledge about the organizations.
Information provided by others must be relied upon. When information is
obtained from others, the likelihood of it being intentionally or unintentionally
misstated increases.
b. Biases and
Motives of the
Provider
If information provider’s goals are inconsistent with those of the decision maker,
the information may be biased in favor of the provider. The reason can be honest
optimism about future events or an intentional emphasis to influence users. In
either case, the result is a misstatement of information.
c. Voluminous Data As organizations become larger, so does the volume of their exchange
transactions. This increases the likelihood that improperly recorded information is
included in the records, perhaps buried in a large amount of other information.
d. Complex
Exchange
Transactions
In the past few decades, exchange transactions between organizations have
become increasingly complex and therefore more difficult to record properly.
A small company may find it less expensive to pay higher interest costs than to increase the costs of
reducing information risk.
For larger businesses, it is usually practical to incur costs to reduce information risk.
Reducing Information Risk
Verify Information
The user may go to the business
premises to examine records and
obtain information about the
reliability of the statements. This
is impractical because of cost and
economically inefficient for all
users to verify the information
individually
Shares Information Risk with
Management
Management is responsible
for provide reliable
information to users. If users
rely on inaccurate financial
statements and as a result
incur a financial loss, they
may have a basis for a
lawsuit against management.
Audited Financial Statements
The most common way for
users to obtain reliable
information is to have an
independent audit.
Management of a private
company or the audit
committee engages the auditor
to provide assurances to users
that the financial statements
are reliable.
Nature of Audit
Auditing
Auditing is the accumulation and evaluation of evidence about information to determine and report on the
degree of correspondence between the information and established criteria. Auditing should be done by a
competent, independent person.
Information and
Established
Criteria
There must be information in a verifiable form and some standards (criteria) by which
the auditor can evaluate the information.
The criteria for evaluating information also vary depending on the information being
audited. In the audit of historical financial statements by CPA firms, the criteria may be
Generally Accepted Accounting Principles (GAAP)
Accumulating
and Evaluating
Evidence
Evidence is any information used by the auditor to determine whether the information
being audited is stated in accordance with the established criteria. Evidence takes many
different forms, including:
• Electronic & documentary data
• Written & electronic communication with outsiders
• Observations by the auditor
• Oral testimony of the auditee (client)
Competent and
Independent
Person
The auditor must be qualified to understand the criteria used and must be competent to
know the types and amount of evidence to reach the proper conclusion after examining the
evidence. The auditor must also have an independent mental attitude.
 Auditors reporting on company financial statements are called independent auditors
though the auditors are paid fees by the company, they are normally sufficiently
independent to conduct audits that can be relied on by users.
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Reporting Final stage of auditing process is preparing the audit report, which communicates the
auditor’s findings to users. Reports differ in nature, but all must inform readers about the
degree of correspondence between the information audited and established criteria.
Accounting vs. Auditing
Accounting Auditing
Accounting is the recording, classifying, and
summarizing of economic events in a logical manner
for the purpose of providing financial information
for decision making.
Auditing is determining whether recorded
information properly reflects the economic events
that occurred during the accounting period.
Continues process carried out throughout the year One time activity after the closure of accounting year
No qualification is required to be an accountant Must be an authorized Chartered accountant
Accountant is employee of the company Auditor is an independent professional
Gets regular salary for work Gets remuneration for work
Accounting is concerned with recording of business
transaction systematically
Concerned with verification of accounts prepared by
the accountant
Types of audit
CPAs perform three primary types of audits-
Operational audit
An operational audit evaluates the efficiency and effectiveness of any part of an
organization’s operating procedures and methods. At the completion of an operational audit,
management normally expects recommendations for improving operations.
Compliance audit
 A compliance audit is conducted to determine whether the auditee is following
specific procedures, rules, or regulations set by some higher authority.
 Results of compliance audits are typically reported to management, rather than
outside users, because management is the primary group concerned with the
extent of compliance with prescribed procedures and regulations.
Financial statement audit
 A financial statement audit is conducted to determine whether the financial
statements are stated in accordance with specified criteria.
 In determining whether financial statements are fairly stated in accordance with
accounting standards, the auditor checks material errors or other misstatements in
the statements.
Types of auditor
a. Certified Public Accounting Firms
Certified public accounting firms are responsible for auditing the published historical financial
statements of all publicly traded companies, most other reasonably large companies, and many smaller
companies and noncommercial organizations.
b. Government Accountability Office Auditors
A government accountability office auditor is an auditor working for the Government Accountability
Office.
c. Internal Revenue Agents
A major responsibility of the IRS is to audit taxpayers’ returns to determine whether they have complied
with the tax laws. These audits are solely compliance audits. The auditors who perform these
examinations are called internal revenue agents.
d. Internal Auditors
Internal auditors are employed by all types of organizations to audit for management. Internal audit
staffs may have more than 100 employees who have diverse responsibilities, including many outside the
accounting area.
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To maintain independence from other business functions, the internal audit group typically reports
directly to the president, executive officer, or the audit committee.
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