Chapter 1
The Demand for Audit and Other Assurance Services
Concept Checks
P. 8
To do an audit, there must be information in a verifiable form and some standards (criteria) by which the auditor can evaluate the information. Determining the degree of correspondence between information and established criteria is determining whether a given set of information is in accordance with the established criteria. For an audit of a company’s financial statements the criteria are U.S. generally accepted accounting principles or International Financial Reporting Standards.
The four primary causes of information risk are remoteness of information, biases and motives of the provider, voluminous data, and the existence of complex exchange transactions.
The three main ways to reduce information risk are:
User verifies the information.
User shares the information risk with management.
Audited financial statements are provided.
P. 16
The three main types of audits are operational audits, compliance audits, and financial statement audits. The table below summarizes the purposes and nature of each type of audit.
OPERATIONAL
AUDITS
COMPLIANCE
AUDITS
AUDITS OF
FINANCIAL
STATEMENTS
PURPOSE
To evaluate whether operating procedures are efficient and effective
To determine whether the client is following specific procedures set by a higher authority
To determine whether the overall financial statements are presented in accordance with specified criteria (usually GAAP)
Concept Checks (continued)
OPERATIONAL
AUDITS
COMPLIANCE
AUDITS
AUDITS OF
FINANCIAL
STATEMENTS
USERS OF AUDIT REPORT
Management of organization
Authority that established rules, regulations, and procedures, either internal or external to auditee
Different groups for different purposes — many outside entities
NATURE
Highly nonstandard; often subjective
Not standardized, but specific and usually objective
Highly standardized
PERFORMED BY:
CPAs
Frequently
Occasionally
Almost universally
GAO
AUDITORS
Frequently
Frequently
Occasionally
IRS
AUDITORS
Never
Universally
Never
INTERNAL
AUDITORS
Frequently
Frequently
Frequently*
* Internal auditors may assist CPAs in the audit of financial statements. Internal auditors may also audit internal financial statements for use by management.
The major differences in the scope of audit responsibilities for CPAs, GAO auditors, IRS agents, and internal auditors are:
CPAs perform audits of financial statements prepared using U.S. GAAP or IFRS in accordance with auditing standards.
GAO auditors perform compliance or operational audits in order to assure the Congress of the expenditure of public funds in accordance with its directives and the law.
IRS agents perform compliance audits to enforce the federal tax laws as defined by Congress, interpreted by the courts, and regulated by the IRS.
Internal auditors perform compliance or operational audits in order to assure management or the board of directors that controls and policies are properly and consistently developed, applied, and evaluated.
Review Questions
1-1 To do an audit, there must be information in a verifiable form and some standards (criteria) by which the auditor can evaluate the information. The information for Jones Company's tax return is the federal tax returns filed by the company. The established criteria are found in the Internal Revenue Code and all interpretations. For the audit of Jones Company's financial statements the information is the financial statements being audited and the established criteria are U.S. GAAP or IFRS.
1-2 This apparent paradox arises from the distinction between the function of auditing and the function of accounting. The accounting function is the recording, classifying, and summarizing of economic events to provide relevant information to decision makers. The rules of accounting are the criteria used by the auditor for evaluating the presentation of economic events for financial statements and he or she must therefore have an understanding of accounting standards, as well as auditing standards. The accountant need not, and frequently does not, understand what auditors do, unless he or she is involved in doing audits, or has been trained as an auditor.
1-3 An independent audit is a means of satisfying the need for reliable information on the part of decision makers. Recent changes in accounting and business operations include:
The Demand for Audit and Other Assurance Services
Concept Checks
P. 8
To do an audit, there must be information in a verifiable form and some standards (criteria) by which the auditor can evaluate the information. Determining the degree of correspondence between information and established criteria is determining whether a given set of information is in accordance with the established criteria. For an audit of a company’s financial statements the criteria are U.S. generally accepted accounting principles or International Financial Reporting Standards.
The four primary causes of information risk are remoteness of information, biases and motives of the provider, voluminous data, and the existence of complex exchange transactions.
The three main ways to reduce information risk are:
User verifies the information.
User shares the information risk with management.
Audited financial statements are provided.
P. 16
The three main types of audits are operational audits, compliance audits, and financial statement audits. The table below summarizes the purposes and nature of each type of audit.
OPERATIONAL
AUDITS
COMPLIANCE
AUDITS
AUDITS OF
FINANCIAL
STATEMENTS
PURPOSE
To evaluate whether operating procedures are efficient and effective
To determine whether the client is following specific procedures set by a higher authority
To determine whether the overall financial statements are presented in accordance with specified criteria (usually GAAP)
Concept Checks (continued)
OPERATIONAL
AUDITS
COMPLIANCE
AUDITS
AUDITS OF
FINANCIAL
STATEMENTS
USERS OF AUDIT REPORT
Management of organization
Authority that established rules, regulations, and procedures, either internal or external to auditee
Different groups for different purposes — many outside entities
NATURE
Highly nonstandard; often subjective
Not standardized, but specific and usually objective
Highly standardized
PERFORMED BY:
CPAs
Frequently
Occasionally
Almost universally
GAO
AUDITORS
Frequently
Frequently
Occasionally
IRS
AUDITORS
Never
Universally
Never
INTERNAL
AUDITORS
Frequently
Frequently
Frequently*
* Internal auditors may assist CPAs in the audit of financial statements. Internal auditors may also audit internal financial statements for use by management.
The major differences in the scope of audit responsibilities for CPAs, GAO auditors, IRS agents, and internal auditors are:
CPAs perform audits of financial statements prepared using U.S. GAAP or IFRS in accordance with auditing standards.
GAO auditors perform compliance or operational audits in order to assure the Congress of the expenditure of public funds in accordance with its directives and the law.
IRS agents perform compliance audits to enforce the federal tax laws as defined by Congress, interpreted by the courts, and regulated by the IRS.
Internal auditors perform compliance or operational audits in order to assure management or the board of directors that controls and policies are properly and consistently developed, applied, and evaluated.
Review Questions
1-1 To do an audit, there must be information in a verifiable form and some standards (criteria) by which the auditor can evaluate the information. The information for Jones Company's tax return is the federal tax returns filed by the company. The established criteria are found in the Internal Revenue Code and all interpretations. For the audit of Jones Company's financial statements the information is the financial statements being audited and the established criteria are U.S. GAAP or IFRS.
1-2 This apparent paradox arises from the distinction between the function of auditing and the function of accounting. The accounting function is the recording, classifying, and summarizing of economic events to provide relevant information to decision makers. The rules of accounting are the criteria used by the auditor for evaluating the presentation of economic events for financial statements and he or she must therefore have an understanding of accounting standards, as well as auditing standards. The accountant need not, and frequently does not, understand what auditors do, unless he or she is involved in doing audits, or has been trained as an auditor.
1-3 An independent audit is a means of satisfying the need for reliable information on the part of decision makers. Recent changes in accounting and business operations include: