CHAPTER 1: AN INTRODUCTION TO ASSURANCE AND FINANCIAL STATEMENT AUDITING

1. The Demand for Auditing and Assurance

a. Principals and Agents

- The managers serve as agents for the owners (principals), and fulfill a stewardship function by managing the
corporation’s assets.

- Accouting and auditing play important roles in principal-agent relationship:

o Information assymetry: manager has more information about true financial position and results of operations of
the entity

o Conflict of interest between the manager and the absentee owener.

b. The Role of Auditing

- To determine whether the reports prepared my managers conform to the contract’s prpvisions  add creditbility to the
report and reduces information risk.

2. An Assurance Analogy: The Case of the House Inspector

a. Relating the House Inspection Analogy to Financial Statements Auditing

- Difference: buyer of house hires inspector BUT the companies selling bonds/stock hire and pay the aditors.

- Reputable independent auditor’s opinion can provide assurance to thousands of investors  the company can sell securities
at more favourable prices  reduce cost of capital

b. Management Assertions and Financial Statements

- Financial statements assertions are management’s expressed or implied claims about information reflected in financial
statements.

- Main task of auditor: Collect sufficent appropriate evidence that management’s assertions are correct.

3. Auditing, Attest, and Assurance Services Defined

a. Auditing

- Auditing is a systematic process of objectively obtaining and evaluating evidence regarding assertions about economic
actions and events to ascertain the degree of correspondence between those assertions and established criteria and
communicating the results to interested users.
 b. Attestation

- Attest services occur when a practitioner is engaged to issue . . . a report on subject matter, or an assertion about subject
matter, that is the responsibility of another party.

- Not limited to economic events or actions.

c. Assurance

- Assurance services are independent professional services that improve the quality of information, or its context, for
decision makers.

- Report not only on the reliability and creditbility of information but also on the relevance and timeliness of that
information.

4. Fundamentals Concepts in Conducting a Financial Statements

- Assessment of audit risk and materiality influence the nature, timing, and extent of audit evidence

a. Materiality

- Materiality is the amount by which a set of financial statemetns could be misstated without affecting the judgement of
reasonable person

- Important:

o not practical or cost beneficial for auditors to ensure that financial statemetns are completely free of any small
misstatements.

o Help the auditor determine the nature, timing, and extent of audit procedures used to collect audit evidence

- When testing is complete, the auditor will evaluate the audit results and ask the company to adjust its financial records for
identified misstatements. The auditor will issue a clean audit opiion if the auditor’s estimate of remaining, unadjusted
misstatements in all accounts less than overall materiality.

b. Audit Risk

- Audit risk is the risk that the auditor mistakenly expresses a clean audit opinion when the financial statements are
materially misstated.

- Reasonable Assurance: even when the auditor does a good job, there is some risk that a material misstatement could be
present in the financial statements and the auditor will fail to detect it.

- The more effective and extensive the audit work ( thus the type and amount of audit evidence collected), the lower the risk
of undetected misstatements and auditor issue an inappropriate report.

c. Audit Evidence Regarding Management Assertions

- Consist of underlying accounting data and any additional information available

- Descriptors of audit evidence:

o Sufficiency: quantity of evidence

o Appropriateness: relevant and reliable

o Relevance: relates to specific management assertions

o Reliability: diagnosticity of the evidence

5. Sampling: Inferences Based on Limited Observations

- Cost + infeasibility to test all account balances and transactions  trade-off between the exactness or precision of the audit
and its cost

- Auditor select a subset of accounts and transactions to test based on understanding of client’s internal control system and
knowledge of client’s industry

- Auditor has no special knowledge about transactions or items may be misstated, use random sampling to get a samples
that is representative of the population  use laws of probability to make inferences about potential misstatements.
 6. The Audit Process

a. Overview of the Financial Statement Auditing Process

- Auditor can collect evidence in each of three different statges in client’s accouting systems:

o Internal control: ensure proper handling of transactions (indirect information)

o Transactions: affect each account balance

o Account Balances: direct information, highest quality, costliest

 use combination of evidence from all three stages.

b. Major Phases of the Audit

- Client acceptance/Continuance: C3

- Preliminary Engagement Activities: C3

- Plan the Audit: C3, 4, 5

- Consider and Audit Internal Control: C6, 7

- Audit Business Processes and Related Accounts: C10-16

- Complete the Audit: C17

- Evaluate Results and Issue Audit Report: C1 and C18

c. The Unqualified/Unmodified Audit Report

- Unqualified: FS are free from material misstatements, the auditor does not find it necessary ti qualify his/her “clean” audit
opinion.

d. Other Types of Audit Reports

- Qualified: FS contain a misstatement that the auditor considers material and the client refuses to correct the
misstatements. (“fairly stated except for the misstatments identified by the auditor”).

- Adverse opinion: misstatements are so material that it pervasively affects the interpretation of FS.

- Auditor unable to obtain all the necessary information to conclude the account is fairly stated  the auditor will qualify the
report (“fairly stated except for the fact that the auditor was unable to get sufficient evidence).

- Disclaimer of opinion: Scope limitation is so pervasive that it limits the ability of the auditor to conclude the FS as a whole
 not possible to express an opinion on fairness of FS.