Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
Summary of the Audit Process
PHASE I
Plan and design
an audit approach
PHASE II
Perform tests of
controls and
substantive tests
of transactions
PHASE III
Perform analytical
procedures and
tests of details
of balances
PHASE IV
Complete the
audit and
issue an audit
report
Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
ASSURANCE SERVICES
Assurance services are
professional services that improve
the quality of information for
decision makers.
Assurance services can be
performed by CPAs or by
a variety of other professionals.
CPAs have provided many
assurance services for years,
particularly assurances about
historical financial statement
information.
OBJECTIVE
Describe assurance services and
distinguish audit services from
other assurance and nonassurance
services provided by CPAs.
Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
Audit,Attestation and Assurance
Audit,Written report on whether F/S are in
accordance with GAAP ( Auditing Standards)
Attestation,Written report on reliability of an
assertion (e.g.,sales) (Attestation Standards)
Assurance,Service to improve the quality of information
Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
Attestation Services
An a tt es ta ti o n s er v ic e i s a ty pe o f a ss ur a nc e
se r v i c e i n w hi c h t he C P A fi r m i ss ue s a w r i tte n
c o m m uni c a ti o n t ha t e x pr e ss e s a c o nc l us i o n
a bo ut the r e l i a bi l i ty o f a w r i tte n a ss e r ti o n
o f a no the r pa r ty,
An attestation service is a type of assurance
service in which the CPA firm issues a written
communication that expresses a conclusion
about the reliability of a written assertion
of another party.
Example,Emmy Awards,Miss America Pageant,Lottery
Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
Audit of Historical Financial Statements
Is a form of attestation service in which the auditor
issues a written report expressing an opinion about whether
the financial statements are in material conformity with
generally accepted accounting principles.
Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
A review of historical financial statements is
another type of attestation service
performed by CPAs.
This type of review is often adequate to
meet
users’ needs and can be provided by the
CPA firm at a much lower fee than an
audit.
Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
The Elliott Committee was charged with researching
and developing new assurance services opportunities
for CPAs to provide to business and individual clients
who need relevant and reliable information for critical
decision making.
Assurance Services on Information Technology
There is even greater demand for assurance about computer controls
surrounding information transacted electronically and the security of the
information related to the transactions.
CPAs can help provide assurance about these functions.
Two examples,1,Assurances over Web site controls
2,Assurances about information system reliability
Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
CPA
WebTrust
CPA firms that are licensed by the AICPA to perform this
service provide assurance to users of Web sites through the
CPA’s electronic WebTrust seal affixed to the Web site.
This seal assures the user that the Web site owner has met
established criteria related to business practices,transaction
integrity,and information processes.
WebTrust is an attestation service,and the WebTrust seal is a symbolic
representation of the CPA’s report on management’s assertions about
its disclosure of electronic commerce practices.
Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
TABLE 1-1 Other Assurance Services Examples
Other Assurance Services
Controls over and risks related to investments,
including policies related to derivatives; these services involve
Assessing the processes surrounding a company’s investment activities
to identify risks and to determine the effectiveness of those processes
in meeting the company’s investment objectives
Mystery shopping Performing anonymous shopping to assess sales personnel interaction
with customers and procedures performed by sales personnel
Assessment of risks of accumulation,
distribution,and storage of digital
information Assessing physical and on-line security risks and related controls
surrounding data and other information stored electronically,
including the adequacy of back-up and off-site storage
Fraud and illegal
acts risk assessment Developing fraud risk profiles and assessing the adequacy of company
systems and policies in preventing and detecting fraud and illegal acts
Source,AICPA Special Committee on Assurance Services.
Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
TABLE 1-1
Continues
Annual
environmental audit Assessing whether company policies effectively ensure the company’s
compliance with environmental standards and laws
Compliance with trading policies and procedures
Examining transactions between trading partners to ensure that the
handling of the transactions complies with the terms of the trading
agreement or contract,including the identification of risk surrounding
the trade arrangement
Compliance with entertainment royalty agreements
Assessing whether royalties paid to artists,authors,and others are
in accordance with royalty agreement provisions.
ISO 9000 certifications
Certifying a company’s compliance with ISO 9000 quality control
standards,which help ensure company products are of high quality.
Source,AICPA Special Committee on Assurance Services.
Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
FIGURE 1 -1
ASSURANCE SERVICES NONASSURANCE SERVICES
ATTESTATION SERVICES
Audits Reviews
Other Attestation Services
(e.g.,CPA WebTrust)
Other Assurance Services
(e.g.,ElderCare Plus)
Certain
Management
Consulting
Other Management
Consulting
Accounting and
Bookkeeping
Tax
Services
Relationship among Assurance Services,
Attestation Services,and Nonassurance Services
Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
ECONOMIC DEMAND
FOR AUDITING
Information Risk
reflects the
possibility that the
information which
the business risk
decision was made
was inaccurate.
Auditing can have a significant
effect on information risk,If
the bank manager is satisfied
that there is minimal
information risk because a
borrower’s financial statements
are audited,the risk is
substantially reduced and the
overall interest rate to
the borrower can
be reduced.
Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
Causes of Information Risk
1,Remoteness of Information
2,Biases and Motives of the Provider
3,Voluminous Data
Reducing Information Risk
For larger businesses,it is usually practical to
incur costs to reduce information risk,There
are three main ways to do this.
1,User Verifies Information (IMPRACTICAL)
2,User Shares Information Risk with Management
- sue management if they lie - LAWSUIT
3,Audited Financial Statements are Provided
Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
CAPITAL COSTS TO SHRINK
5.5 PERCENT RISK-FREE INTEREST RATE
3.5 PERCENT ECONOMIC RISK PREMIUM (business risk)
4 PERCENT INFORMATION COST (information risk)
Elliott uses a hypothetical example:
Information risk comprises approximately 30 percent of the cost of capital.
Elliott believes the following factors will drastically reduce information
risk in the next 5 to 10 years:
Assuming a cost of capital of 13 percent,
he estimates this rate is composed of the following:
Advanced technology
New accounting and auditing standards
Auditors finding more efficient ways to audit
Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
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,
Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
Information and Established Criteria
To do an audit,there must be information in a
verifiable form and some standards (criteria) by which
the auditor can evaluate the information.
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,
Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
Competent,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 accumulate to reach the proper
conclusion after the evidence has been examined.
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.
Reporting
The final stage in the auditing process is preparing the
AUDIT REPORT which is the communication of the
auditor’s findings to users.
Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
,Strategic Systems” approach to auditing
The auditor must have a thorough understanding of the entity
and its environment:
Client’s industry
Regulations
Operations
Relationships
Business Strategies
Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
FIGURE 1 -2
Audit of a Tax Return
Internal
revenue
agent
Examines cancelled
checks and other
supporting records
Federal
tax returns
filed by
taxpayer
Internal Revenue
Code and
all interpretations
Report on tax
deficiencies
Competent,
independent
person
Accumulates and
evaluates evidence
Established criteria
Report on results
Information
Determines
correspondence
Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
DISTINCTION BETWEEN AUDITING & ACCOUNTING
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 auditing accounting data,determining whether recorded
information properly reflects the economic events that occurred during the
accounting period.
The auditor must possess expertise in the accumulation and interpretation
of audit evidence,It is this expertise that distinguishes auditors from accountants.
Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
TYPES of AUDITS
1,Financial Statement Audit - is conducted to determine
whether the overall financial statements (the information being
verified) are stated in accordance with specified criteria.
2,Operational Audit - is a review of any part of
an organization’s operating procedures and methods for
the purpose of evaluating efficiency and effectiveness.
3,Compliance Audit - is to determine whether the auditee
is following specific procedures,rules,or regulations set by
some higher authority.
Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
TABLE 1 - 2,Examples of the Three Types of Audits
Types of Audit Example Information Established Criteria Available Evidence
Financial Statement Annual Audit of General General Motors’ Financial Generally accepted Documents,records,and
Audit Motors’ financial statement Statement Accounting principles outside sources of evidence
Operational Audit Evaluate whether the Number of payroll records Company standards for Error reports,payroll records
computerized payroll processed in a month,efficiency and and payroll processing
processing for subsidiary H costs of the department,and effectiveness in payroll costs
is operating efficiently and number of errors made department
effectively
Compliance Audit Determine whether bank Company records Loan agreement provisions Financial statements and
requirements for loan calculations by the
continuation have been met auditor
Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
TYPES OF AUDITORS
C e r t i f i e d P u b l i c A c c o u n t i n g F i r m sCertified Public Accounting Firms
G e n e r a l A c c o u n t i n g O f f i c e A u d i t o r s
General Accounting Office Auditors
I n t e r n a l R e v e n u e A g e n t s
Internal Revenue Agents
I n t e r n a l A u d i t o r sInternal Auditors
Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
Three Requirements for Becoming a CPA
CERTIFIED PUBLIC ACCOUNTANT
FIGURE 1 - 3
Educational
Requirement
Uniform CPA
Examination Requirement
Experience
Requirement
Normally,an undergraduate
degree with a major in
accounting including a
minimum number of
accounting credits,Some
states require 150 semester
credits (225 quarter credits)
before taking the
examination; others
mandate fewer credits
before taking the
examination but require
150 semester credits before
receiving the certificate.
Two-day examination offered in May and November,
Examination sections are as follows:
Auditing - 4 1/2 hours
Accounting and Reporting - 3 1/2 hours
Financial Accounting and Reporting - 4 1/2 # hours
Business Law and Professional Responsibilities – 3hours
Now,auditing and attestation”
“accounting and reporting”
“regulations”
“business environments and concepts”
All parts except accounting and reporting include at least 20
percent essay and problems,Some states also require a
separate ethics examination.
Varies widely from
no experience to 2
years,including
auditing,Some
states include
experience working
for governmental
units or in internal
auditing.
2000 by Prentice Hall,Inc.
Summary of the Audit Process
PHASE I
Plan and design
an audit approach
PHASE II
Perform tests of
controls and
substantive tests
of transactions
PHASE III
Perform analytical
procedures and
tests of details
of balances
PHASE IV
Complete the
audit and
issue an audit
report
Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
ASSURANCE SERVICES
Assurance services are
professional services that improve
the quality of information for
decision makers.
Assurance services can be
performed by CPAs or by
a variety of other professionals.
CPAs have provided many
assurance services for years,
particularly assurances about
historical financial statement
information.
OBJECTIVE
Describe assurance services and
distinguish audit services from
other assurance and nonassurance
services provided by CPAs.
Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
Audit,Attestation and Assurance
Audit,Written report on whether F/S are in
accordance with GAAP ( Auditing Standards)
Attestation,Written report on reliability of an
assertion (e.g.,sales) (Attestation Standards)
Assurance,Service to improve the quality of information
Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
Attestation Services
An a tt es ta ti o n s er v ic e i s a ty pe o f a ss ur a nc e
se r v i c e i n w hi c h t he C P A fi r m i ss ue s a w r i tte n
c o m m uni c a ti o n t ha t e x pr e ss e s a c o nc l us i o n
a bo ut the r e l i a bi l i ty o f a w r i tte n a ss e r ti o n
o f a no the r pa r ty,
An attestation service is a type of assurance
service in which the CPA firm issues a written
communication that expresses a conclusion
about the reliability of a written assertion
of another party.
Example,Emmy Awards,Miss America Pageant,Lottery
Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
Audit of Historical Financial Statements
Is a form of attestation service in which the auditor
issues a written report expressing an opinion about whether
the financial statements are in material conformity with
generally accepted accounting principles.
Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
A review of historical financial statements is
another type of attestation service
performed by CPAs.
This type of review is often adequate to
meet
users’ needs and can be provided by the
CPA firm at a much lower fee than an
audit.
Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
The Elliott Committee was charged with researching
and developing new assurance services opportunities
for CPAs to provide to business and individual clients
who need relevant and reliable information for critical
decision making.
Assurance Services on Information Technology
There is even greater demand for assurance about computer controls
surrounding information transacted electronically and the security of the
information related to the transactions.
CPAs can help provide assurance about these functions.
Two examples,1,Assurances over Web site controls
2,Assurances about information system reliability
Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
CPA
WebTrust
CPA firms that are licensed by the AICPA to perform this
service provide assurance to users of Web sites through the
CPA’s electronic WebTrust seal affixed to the Web site.
This seal assures the user that the Web site owner has met
established criteria related to business practices,transaction
integrity,and information processes.
WebTrust is an attestation service,and the WebTrust seal is a symbolic
representation of the CPA’s report on management’s assertions about
its disclosure of electronic commerce practices.
Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
TABLE 1-1 Other Assurance Services Examples
Other Assurance Services
Controls over and risks related to investments,
including policies related to derivatives; these services involve
Assessing the processes surrounding a company’s investment activities
to identify risks and to determine the effectiveness of those processes
in meeting the company’s investment objectives
Mystery shopping Performing anonymous shopping to assess sales personnel interaction
with customers and procedures performed by sales personnel
Assessment of risks of accumulation,
distribution,and storage of digital
information Assessing physical and on-line security risks and related controls
surrounding data and other information stored electronically,
including the adequacy of back-up and off-site storage
Fraud and illegal
acts risk assessment Developing fraud risk profiles and assessing the adequacy of company
systems and policies in preventing and detecting fraud and illegal acts
Source,AICPA Special Committee on Assurance Services.
Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
TABLE 1-1
Continues
Annual
environmental audit Assessing whether company policies effectively ensure the company’s
compliance with environmental standards and laws
Compliance with trading policies and procedures
Examining transactions between trading partners to ensure that the
handling of the transactions complies with the terms of the trading
agreement or contract,including the identification of risk surrounding
the trade arrangement
Compliance with entertainment royalty agreements
Assessing whether royalties paid to artists,authors,and others are
in accordance with royalty agreement provisions.
ISO 9000 certifications
Certifying a company’s compliance with ISO 9000 quality control
standards,which help ensure company products are of high quality.
Source,AICPA Special Committee on Assurance Services.
Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
FIGURE 1 -1
ASSURANCE SERVICES NONASSURANCE SERVICES
ATTESTATION SERVICES
Audits Reviews
Other Attestation Services
(e.g.,CPA WebTrust)
Other Assurance Services
(e.g.,ElderCare Plus)
Certain
Management
Consulting
Other Management
Consulting
Accounting and
Bookkeeping
Tax
Services
Relationship among Assurance Services,
Attestation Services,and Nonassurance Services
Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
ECONOMIC DEMAND
FOR AUDITING
Information Risk
reflects the
possibility that the
information which
the business risk
decision was made
was inaccurate.
Auditing can have a significant
effect on information risk,If
the bank manager is satisfied
that there is minimal
information risk because a
borrower’s financial statements
are audited,the risk is
substantially reduced and the
overall interest rate to
the borrower can
be reduced.
Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
Causes of Information Risk
1,Remoteness of Information
2,Biases and Motives of the Provider
3,Voluminous Data
Reducing Information Risk
For larger businesses,it is usually practical to
incur costs to reduce information risk,There
are three main ways to do this.
1,User Verifies Information (IMPRACTICAL)
2,User Shares Information Risk with Management
- sue management if they lie - LAWSUIT
3,Audited Financial Statements are Provided
Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
CAPITAL COSTS TO SHRINK
5.5 PERCENT RISK-FREE INTEREST RATE
3.5 PERCENT ECONOMIC RISK PREMIUM (business risk)
4 PERCENT INFORMATION COST (information risk)
Elliott uses a hypothetical example:
Information risk comprises approximately 30 percent of the cost of capital.
Elliott believes the following factors will drastically reduce information
risk in the next 5 to 10 years:
Assuming a cost of capital of 13 percent,
he estimates this rate is composed of the following:
Advanced technology
New accounting and auditing standards
Auditors finding more efficient ways to audit
Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
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,
Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
Information and Established Criteria
To do an audit,there must be information in a
verifiable form and some standards (criteria) by which
the auditor can evaluate the information.
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,
Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
Competent,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 accumulate to reach the proper
conclusion after the evidence has been examined.
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.
Reporting
The final stage in the auditing process is preparing the
AUDIT REPORT which is the communication of the
auditor’s findings to users.
Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
,Strategic Systems” approach to auditing
The auditor must have a thorough understanding of the entity
and its environment:
Client’s industry
Regulations
Operations
Relationships
Business Strategies
Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
FIGURE 1 -2
Audit of a Tax Return
Internal
revenue
agent
Examines cancelled
checks and other
supporting records
Federal
tax returns
filed by
taxpayer
Internal Revenue
Code and
all interpretations
Report on tax
deficiencies
Competent,
independent
person
Accumulates and
evaluates evidence
Established criteria
Report on results
Information
Determines
correspondence
Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
DISTINCTION BETWEEN AUDITING & ACCOUNTING
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 auditing accounting data,determining whether recorded
information properly reflects the economic events that occurred during the
accounting period.
The auditor must possess expertise in the accumulation and interpretation
of audit evidence,It is this expertise that distinguishes auditors from accountants.
Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
TYPES of AUDITS
1,Financial Statement Audit - is conducted to determine
whether the overall financial statements (the information being
verified) are stated in accordance with specified criteria.
2,Operational Audit - is a review of any part of
an organization’s operating procedures and methods for
the purpose of evaluating efficiency and effectiveness.
3,Compliance Audit - is to determine whether the auditee
is following specific procedures,rules,or regulations set by
some higher authority.
Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
TABLE 1 - 2,Examples of the Three Types of Audits
Types of Audit Example Information Established Criteria Available Evidence
Financial Statement Annual Audit of General General Motors’ Financial Generally accepted Documents,records,and
Audit Motors’ financial statement Statement Accounting principles outside sources of evidence
Operational Audit Evaluate whether the Number of payroll records Company standards for Error reports,payroll records
computerized payroll processed in a month,efficiency and and payroll processing
processing for subsidiary H costs of the department,and effectiveness in payroll costs
is operating efficiently and number of errors made department
effectively
Compliance Audit Determine whether bank Company records Loan agreement provisions Financial statements and
requirements for loan calculations by the
continuation have been met auditor
Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
TYPES OF AUDITORS
C e r t i f i e d P u b l i c A c c o u n t i n g F i r m sCertified Public Accounting Firms
G e n e r a l A c c o u n t i n g O f f i c e A u d i t o r s
General Accounting Office Auditors
I n t e r n a l R e v e n u e A g e n t s
Internal Revenue Agents
I n t e r n a l A u d i t o r sInternal Auditors
Arens,Loebbecke; Auditing,8/E
2000 by Prentice Hall,Inc.
Three Requirements for Becoming a CPA
CERTIFIED PUBLIC ACCOUNTANT
FIGURE 1 - 3
Educational
Requirement
Uniform CPA
Examination Requirement
Experience
Requirement
Normally,an undergraduate
degree with a major in
accounting including a
minimum number of
accounting credits,Some
states require 150 semester
credits (225 quarter credits)
before taking the
examination; others
mandate fewer credits
before taking the
examination but require
150 semester credits before
receiving the certificate.
Two-day examination offered in May and November,
Examination sections are as follows:
Auditing - 4 1/2 hours
Accounting and Reporting - 3 1/2 hours
Financial Accounting and Reporting - 4 1/2 # hours
Business Law and Professional Responsibilities – 3hours
Now,auditing and attestation”
“accounting and reporting”
“regulations”
“business environments and concepts”
All parts except accounting and reporting include at least 20
percent essay and problems,Some states also require a
separate ethics examination.
Varies widely from
no experience to 2
years,including
auditing,Some
states include
experience working
for governmental
units or in internal
auditing.
