Auditing &

Assurance
Services,
6e

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Chapter 01
Auditing and Assurance Services
Our system of capital formation relies upon the confidence of
millions of savers to invest in companies.
The auditors opinion is critical to that trust."
-- James R. Doty, Chairman
Public Company Accounting Oversight Board (PCAOB)

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Learning Objectives

Define information risk and explain how the financial statement auditing process
helps to reduce this risk, thereby reducing the cost of capital for a company.
Define and contrast financial statement auditing, attestation, and assurance
services.
Describe and define the assertions that management makes about the recognition,
measurement, presentation, and disclosure of the financial statements and explain
why auditors use them as the focal point of the audit.
Define professional skepticism and explain its key characteristics.
Describe the organization of public accounting firms and identify the various
services that they offer.
Describe the audits and auditors in governmental, internal, and operational
auditing.
List and explain the requirements for becoming a certified public accountant
(CPA) and other certifications available to an accounting professional.

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User Demand for Reliable Information

Todays information

More complex
Demanded by remote users
Demanded in a more timely manner
Has far reaching consequences

Information risk
The risk that the information disseminated by a
company will be materially false or misleading.
Users demand an independent third party assessment of
the information

Business risk
The risk that an entity will fail to meet its stated
business objectives
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Definition of Auditing

Financial Statements
(including footnotes)

Persons who rely on

the financial reports
Creditors
Investors

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 the
assertions and established criteria
GAAP
and communicating the results to
Auditor's Report/
interested users.
Other Reports

Source: American Accounting Association Committee on Basic Auditing

Concepts. 1973. A Statement of Basic Auditing Concepts, American
Accounting Association (Sarasota, FL).
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Exhibit 1.1: Overview of Financial

Statement Auditing

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Independent Auditors Report (AS 5)

Report
Title

Report of Independent Registered Public Accounting Firm

Addressee

The Board of Directors and Shareholders of McDonalds Corporation

Introducto
ry
Paragraph

We have audited the accompanying consolidated balance sheets of McDonalds Corporation as of

December31, 2012 and 2011, and the related consolidated statements of income, shareholders
equity, and cash flows for each of the three years in the period ended December31, 2012. These
financial statements are the responsibility of the Companys management. Our responsibility is to
express an opinion on these financial statements based on our audits.

Scope
Paragraph

We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis for our opinion.

Opinion
Paragraph

In our opinion, the financial statements referred to above present fairly, in all material respects,
the consolidated financial position of McDonalds Corporation at December 31, 2012 and 2011, and
the consolidated results of its operations and its cash flows for each of the three years in the period
ended December 31, 2012, in conformity with U.S. generally accepted accounting principles.

Internal
Control
Paragraph

We also have audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), McDonalds Corporations internal control over financial reporting as of
December 31, 2012, based on criteria established in Internal ControlIntegrated Framework issued by
the Committee of Sponsoring Organizations of the Treadway Commission and our report dated
February 25, 2013 expressed an unqualified opinion thereon.
Ernst & Young LLP (signed)
Chicago, Illinois
February 25, 2013

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3-8

Attestation Engagements
An attestation engagement - a practitioner is to assess and
report on subject matter or an assertion about the subject
matter that is the responsibility of another party.
Some financial attestation engagements (other than audits)
Financial forecasts and projections
Examination of Managements Discussion & Analysis
Pro forma financial information

Some non-financial attestation engagements

Effectiveness of internal control systems
Compliance with environmental regulations
Sustainability reporting engagements

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Exhibit 1.2: Sustainability Report for UPS

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Assurance Services
Assurance services are independent professional services
that improve the quality of information, or its context, for
decision makers.
Examples
XBRL Reporting
Information risk assessment
Customer satisfaction surveys.
Internal audit outsourcing

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Exhibit 1.4: The Relationships Among

Auditing, Attestation, and Assurance
Engagements
Assurance Services

Attestation Services

Auditing

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Sarbanes-Oxley Act of 2002

Managements Responsibility For Financial Reporting

One of its most important provisions clearly indicates that the management
team is responsible for the financial reporting process and the financial
statements.
In fact, Section 302 of the Act states that the key company officials must certify
the financial statements. That is, the company CEO and CFO must sign a
statement indicating:
1.
2.
3.

They have read the financial statements.

They are not aware of any false or misleading statements (or any key omitted
disclosures).
They believe that the financial statements present an accurate picture of the
companys financial condition.

Source: U.S. Congress, Sarbanes-Oxley Act of 2002, Pub. L. 107-204, 116 Stat/ 745 (2002).

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Managements Financial
Statement Assertions (PCAOB)
Existence or occurrence Assets and liabilities included in
the accounts exist and recorded transactions are valid and have
actually occurred.
Rights and obligations- Entity has a legal claim on all assets
and revenues reported and has a legal responsibility for all
liabilities and expenses
Completeness - All balances and transactions have been
recorded in the financial statements
Valuation or allocation Assets, liabilities and recorded
transactions have been valued in accordance with GAAP
Presentation and disclosure All accounts are presented in
the appropriate place and all information required has been
disclosed in the statements and footnotes.
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Managements Financial
Statement Assertions (ASB)
Assertions about Events and Transactions
Occurrence Events giving rise to transactions are
valid and have taken place

Completeness and Cutoff - All transactions have

been recorded and are recorded in the appropriate period

Accuracy Transactions are recorded at the correct

amount

Classification Transactions have been posted to the

proper account
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Managements Financial
Statement Assertions (ASB)

Assertions about Account Balances

Existence Balances include only assets and liabilities that
exist

Rights and obligations Entity has legal claim on all

assets and revenues reported and has a legal responsibility for
all liabilities and expenses

Completeness Balances include all items that should be

included in accordance with GAAP

Accuracy and valuation Balances are reported at the

proper amount in accordance with GAAP

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Managements Financial
Statement Assertions (ASB)
Assertions about Presentation and Disclosures
Occurrence and rights and obligations items presented
have occurred and are either owned by or represent the responsibility
of the entity

Completeness the proper disclosures have all been made by the

entity

Classification and understandability accounts in the

disclosures have been appropriately grouped and users can
comprehend the disclosures

Accuracy and valuation the amounts in the disclosures have

been properly measured and are valued in accordance with GAAP

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Exhibit 1.6: Assertions and their

Relationships to the Financial Statements

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Professional Skepticism
Refers to an auditors questioning mindset towards
representations made by management and evidential matter
gathered
Inquiry alone is never enough. The auditor must obtain sufficient
corroborative evidence.
Unusual financial trends need investigation
Documents are always checked for authenticity or possible alteration
Ask questions, get answers, then verify the answers.

Must be skeptical because a potential conflict of interest always

exists between the auditor and the client.
Management wants to portray the company and its operations in the best
possible light.
Auditors want to make sure that this portrayal is fair and accurate.

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A Professional Judgment Process

Clarify the issues and objectives

Consider the possible alternatives
Gather and evaluate the relevant evidence
Reach an audit conclusion
Carefully document rationale for the
professional judgment reached

Source: Elevating Professional Judgment in Accounting and Auditing: The

KPMG Professional Judgment Framework (Montvale, NJ: KMPG, 2011).

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The Public Accounting Profession

Assurance services

Financial Statement Audit engagements

Assurance engagements
Attestation engagements
Compilations
Reviews

Tax services
Consulting and Advisory services

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Exhibit 1.7: Public Accounting Firm

Organization

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Organization of the Profession

Big Four Accounting Firms
Deloitte, EY, KPMG, PwC

National
Grant Thornton, BDO, McGladrey

Local/Regional
Melton & Melton (Houston)
Plante Moran (Michigan/Illinois/Wisconsin)
Goodman & Company (Virginia)

Sole Proprietor

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Exhibit 1.8: Revenues for the Big Four

CPA Firms

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Prohibited Professional Services

In summary, Sarbanes-Oxley prohibits professional service firms from

performing any client services for audit clients in which the auditors may
find themselves making management decisions or auditing their own
firms work.
Specifically, Sarbanes-Oxley prohibits professional service firms from
providing any of the following services to an audit client:
1) bookkeeping and related services
2) design or implementation of financial information systems
3) appraisal or valuation services
4) actuarial services
5) internal audit outsourcing
6) management or human resources services
7) investment or broker/dealer services
8) legal and expert services (unrelated to the audit)
Professional service firms may provide client tax services (with some
restrictions) and other non-prohibited services to audit clients if the
companys audit committee has approved them in advance.

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Types of Audits and Auditors

Financial (External Auditors/CPAs)
Ensure that financial statements are reliable

Operational (Internal and Governmental Auditors/CIAs)

Improve operational economy
Improve operational efficiency

Compliance (Internal and Governmental Auditors)

Ensure compliance with company and/or governmental rules
and regulations

Forensic (Fraud Auditors/CFEs)

Designed to investigate a crime and will often involve
gathering evidence designed to convict a fraudster

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Become Certified!

Education
Examination
Experience
State Certificate and License
Skills sets and your education

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The CPA Exam

Significantly Revised in 2011
Computerized
14 Hours - Four parts

Auditing and Attestation (AUD)

Financial Accounting and Reporting (FAR)
Regulation (REG)
Business Environment and Concepts (BEC)

Multiple Choice Questions and Task-Based

Simulations
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