Chapter 1 The Demand for Audit and Assurance Services Key Objectives (from text): 2. 3. 4. 1. Describe auditing.

Distinguish between auditing and accounting. Explain the importance of auditing in reducing information risk. List the causes of information risk, and explain how this risk can be reduced. 5. Describe assurance services and distinguish audits from assurance and nonassurance services.

1.

Demand for Accounting Fueled by Sarbanes Oxley The SarbanesOxley Act has dramatically changed reporting requirements for public companies.

Public accounting is a regulated profession Public companies must report on internal control

The result is that the demand for audit services, and the demand for entry level accountants, has never been higher. 2. What is a financial statement audit? An audit provides reasonable assurance that the financial statements are free of material misstatements. Why does auditing exist? (Discussion)

Key point: We are the good guys Audits benefit society and the client by facilitating access to capital.

3.

Nature of 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. (Definition, p. 4) Note: You are not responsible for memorizing this definition, but it will help frame our discussion in following chapters.

Competency is addressed through the quality control standards discussed in Ch. 2 Reporting standards are covered in Ch. 3 Independence is the most importance of the ethical standards discussed in Ch. 4

4.

Distinction between auditing and accounting A good auditor must be a good accountant (GAAP is the criteria for a financial audit), but a good accountant may not be a good auditor.

5.

Economics of auditing audits and other assurance services provide value by reducing information risk. A. Sources of information risk 1. 2. 3. 4. Remoteness of information Biases of provider Volume of transactions Complex transactions

Auditors are valuable because: They are specialists transactions. in evaluating

Auditors are independent of the company and provide an unbiased evaluation. 3

B.

Importance of auditor reputation and independence -Third parties rely on the audit report, but the auditor is compensated by the company (note that as required by the SarbanesOxley Act, the audit committee of the board of directors for a public company is responsible for approving the selection and compensation of the audit firm). Further, outsiders are unable to observe the audit process. As a result, it is important that auditors and audit firms have outstanding reputations.

6.

Assurance, Attestation, and Audit Services The services provided by auditors have expanded to provide assurances on many other types of information. Figure 1-3 in the text provides a graphical representation of assurance, attestation and audit services, as well as other services provided by CPA firms. As a result of the SarbanesOxley Act and restrictions on non-audit services, the importance of consulting has significantly decreased, and auditing has greatly increased in importance.

Figure 1-3 Audit Services

Relationships among Assurance, Attestation, and

ASSURANCE SERVICES ATTESTATION SERVICES Audits Reviews

NON-ASSURANCE SERVICES Other Management Consulting Certain Managem ent Consulting Tax Servic Accounting and Bookkeeping

Internal Control over Financial Reporting Attestation on IT (i.e. WebTrust)

Other Assurance Services

A.

Attestation Services CPA issues a report about an assertion. In addition to audits and reviews of historical financial statements, CPA may attest to many other types of information. Examples include: Examinations of forecasts Reports on internal control Assurances on Web Sites (WebTrust) These services and the attestation standards are described in Chapter 25 (not covered).

B.

Attestation services statements 1. 2.

on

historical

financial

Audit high level of assurance expressed as positive assurance (financial statements are fairly stated) Review moderate assurance expressed as negative assurance.

Multiple Choice 1-14 (c) Which of the following services is an attestation engagement? 1. 2. 3. 4. A consulting engagement to provide computer processing advice. An engagement to report on statutory requirements. An income tax engagement to prepare state and federal tax returns. A compilation of financial statements from a client's financial records.

Assurance Services Services to improve the quality of information for decision making. The AICPA formed the Special Committee on Assurance Services (SCAS) to identify new assurance opportunities.
C.

The number of financial statement audits is not increasing substantially. However, SarbanesOxley requires reports on internal control, and audit demand and fees have increased significantly. In addition, a tremendous market for other, new types of assurance services is anticipated. What are some examples of other assurance services provided by CPAs ? What are some examples of assurances provided by government and other assurance providers? (Discussion)

Why is there an increased demand for other attestation and assurance services? (Discussion)

Multiple Choice 1-14 (a) Which of the following best explains why independent auditors are asked to express an opinion on financial statements? 1. 2. 3. It is difficult to prepare financial statements without the expertise of an auditor. It is management's responsibility to seek independent aid in the appraisal of financial statement information. The opinion of a third party is needed because a company may not be objective with respect to its financial statements.

4.

It is a customary courtesy that all stockholders receive an independent report on management's stewardship of the business.

7.

Three primary types of audits A. B. Financial statement audit - primary focus of course. Operational audit - audit of efficiency or effectiveness. Similar to management consulting, and increasing in importance. Discussed in Ch. 26, which we do not cover. Often performed by internal auditors. Compliance audit - Tests of compliance with laws and regulations, which is also discussed in Chapter 26. A rudimentary understanding of governmental compliance auditing under the Single Audit Act of 1984 and 1996 amendments is important for the CPA exam. Compliance audits are often performed by government or internal auditors, but are also performed by external auditors.

C.

8.

Certified Public Accountants CPAs are licensed and regulated by the state. The AICPA administers the CPA exam, but the state grants the license to practice. The AICPA is further discussed in Chapter 2. A. State of New York Information on the CPA exam and licensure is available at www.op.nysed.gov/cpa.htm. Exam CPA exam application can be obtained from CPA Examination Services at 1800-CPA-EXAM (www.nasba.org). B. C. Other States - Information is located on the NASBA web site. 150-hour rule - 150 hours of education is required to become a CPA in most states. New York requires 150 hours of education for CPA licensure effective August 1, 2009.

Candidates will still be allowed to sit for the CPA exam with 120 hours of education. For further information about careers in accounting, visit the AICPA's web site at www.aicpa.org. (Click Becoming a CPA link at left, and then CPA Candidates and Students). 9. Computerized CPA Exam The CPA exam became computerized and largely available on demand beginning in April 2004. The computerized exam also includes changes in exam format and content. Further information is available at www.cpa-exam.org.

Chapter 1 Homework Problems 1-17 Sample Multiple Choice (text) 1-14 (a), (c) 1-17 a. The interest rate for the loan that requires a review report is lower than the loan that did not require a review because of lower information risk. A review report provides moderate assurance to financial statement users, which lowers information risk. An audit report provides further assurance and lower information risk. As a result of reduced information risk, the interest rate is lowest for the loan with the audit report. Given these circumstances, Vial-tek should select the loan from City First Bank that requires an annual audit. In this situation, the additional cost of the audit is less than the reduction in interest due to lower information risk. The following is the calculation of total costs for each loan:

b.

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LENDER Existing loan First National Bank City First Bank

CPA SERVICE None Review Audit

COST OF CPA SERVICES 0 $ 20,000 $ 45,000

ANNUAL INTERE ST $ 332,500 $ 297,500 $ 262,500

ANNUAL LOAN COST $ 332,500 $ 317,500 $ 307,500

c.

With the lower interest rate on the loan from First National Bank and the higher cost of the audit, Vial-tek should select the loan from First National Bank that requires a review. In this case, the additional cost of the audit is more than the reduction in interest due to lower information risk. The following is the calculation of total costs for each loan: CPA SERVICE None Review Audit COST OF CPA SERVICES 0 $ 20,000 $ 50,000 ANNUAL INTERE ST $ 332,500 $ 280,000 $ 262,500 ANNUAL LOAN COST $ 332,500 $ 300,000 $ 312,500

LENDER Existing loan First National Bank City First Bank

d.

e.

Vial-tek may desire to have an audit because of the many other positive benefits that an audit provides. The audit will provide Vial-teks management with assurance about annual financial information used for decision-making purposes. The audit may detect errors or fraud, and provide management with information about the effectiveness of controls. In addition, the audit may result in recommendations to management that will improve efficiency or effectiveness. . The auditors knowledge of the clients business may improve the quality of the audit and reduce information risk further, resulting in a lower interest cost. The auditor may also be able to provide recommendations to the client, and provide consulting services if Vial-tek is a private company.

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