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1. Tips for Learning Auditing

a. Auditing focuses on learning the analytical and logical skills necessary
to evaluate the relevance and reliability of financial information as well
as of the systems and processes responsible for recording and
summarizing that information.
2. The Demand for Auditing and Assurance
a. Auditing has uses outside of being compliant with the law.
b. Principals and Agents
i. The demand for auditing can be understood as the need for
accountability when business owners hire others to manage
their business, as is typical in modern corporations.
ii. The birth of modern accounting and auditing occurred during the
industrial revolution, when companies became larger and
needed to raise capital to finance expansion.
iii. A public company is a company that sells its stocks or bonds to
the public, giving the public a valid interest in the proper use of
the companys resources.
1. Thus, the growth of the modern corporation led to diverse
groups of owners who are not directly involved in running
the business (stockholders) and the use of professional
managers hired by owners to run the corporation on a
day-to-day basis.
2. In this setting, managers serve as agents for the owners
(who are sometimes principals) and fulfill a stewardship
function by managing the corporations assets.
iv. Information asymmetry- the manager generally has more
information about the true financial position and results of
operations of the entity than does the absentee owner.
1. Because their goals may not coincide, there is a natural
conflict of interest between the manager and absentee
owner. If both parties seek to maximize their self-interest,
the manager may not always act in the best interests of
the owner.
2. The owner can attempt to protect him or herself against
the possibility of improper use of resources by reducing
the managers compensation by the amount of company
resources that the owner expects the manager to
consume.
3. One primary role of accounting information is to hold the
manager accountable to the owner.
c. The Role of Auditing
i. The auditors role is to determine whether the reports prepared
by the manager conform to the contracts provisions.
ii. The auditors verification of the financial information adds
credibility to the report and reduces information risk, or the risk
 that information circulated by a companys management will be
false or misleading.
iii. Reducing information risk potentially benefits both the owner
and the manager.

iv. In summary, auditing is demanded because it plays a valuable

role in monitoring the contractual relationships between the
entity and its stockholders, managers, employees, and debt
holders.
v. CPAs have been charged with providing audit services because
of their traditional reputation of competence independence,
objectivity, and concern for public interest.
1. As a result, they are able to add credibility to information
produced and reported by management to outside
parties.
3. An Assurance Analogy: The Case of the House Inspector
a. The buyer and seller of a home have a natural conflict of interest and a
certain amount of information asymmetry (seller knows more about
the home than the buyer). This presents an information risk to the
buyer.
b. Relating the House Inspection Analogy to Financial Statement Auditing
i. Information asymmetry and conflicts of interest also exist
between the managers of companies and potential investors.
ii. The companies selling stocks or bonds to the public typically
hire and pay the auditor.
 1. A reputable independent auditors opinion can provide
assurance to thousands of potential investors.
2. By purchasing the assurance provided by an audit, a
company can sell its stocks and bonds to prospective
owners and creditors at more favorable prices,
significantly reducing the cost of capital.
iii. Reputation to an auditing firm is everything. Investors and
creditors want a name they can recognize. This is why 95% of
the auditing market is taken by the big four accounting firms.
c. Management Assertions and Financial Statements
i. Financial statement assertions are managements expressed or
implied claims about information reflected in financial
statements.
ii. Assertions are central to auditing because they are the focus of
the auditors evidence collection efforts. Much of what auditors
do revolves around collecting and evaluating evidence about
managements financial statement assertions.
iii. One of the main tasks of the auditor is to collect sufficient
appropriate evidence that managements assertions regarding
the financial statements are correct.
iv. First an auditor carefully considers the most import assertions
the company is making about an account, and then they decide
what evidence is needed to substantiate the truthfulness of each
important assertion.
1. EX: For cash, to ensure the amount exists, the auditor
may examine bank statements or send a letter to the
bank requesting confirmation of the balance. Then, to
insure the cash hasnt been pledged or restricted, you
might review the minutes of key management meetings
to look for discussions or agreements on this issue.
v. Management assertions can be divided into three aspects of
information reflected in financial statements: transactions,
account balances, and presentation and disclosure.
4. Auditing, Attest, and Assurance Services Defined
a. Accounting professionals can provide assurance about the reliability
and relevance of information given by one party to another.
i. The broadest category of such services is simply called
assurance services.
ii. Assurance- the evaluation of evidence to determine whether
information has been recorded and presented in accordance
with a predetermined set of criteria, together with the issuance
of a report that indicates the degree of correspondence.
b. Auditing- 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.
i. Systematic process means that there should be a well-planned
and thorough approach for conducting an audit.
ii. The approach involves objectively obtaining and evaluating
evidence.
iii. While different types of criteria might be available in different
settings, GAAP usually serve as the basis for evaluating
managements assertions in the context of a financial statement
audit.
c. Attestation
i. Auditors have a reputation of independence and objectivity.
 1. As a result, it has always been common for various parties
to request that auditors attest to information beyond
historical financial information.
ii. 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.

iii.
iv. The definition is broader than the one previously discussed for
auditing because it is not limited to economic events or actions.
v. The subject matter of attest services can take many forms,
including prospective information, analyses, systems and
processes, and even the specific actions of specified parties.
d. Assurance
i. Assurance services- independent professional services that
improve the quality of information, or its context, for decision
makers.
1. The definition focuses on decision making.
2. The definition relates to improving the quality of
information or its context. An assurance service
engagement can improve quality through increasing
confidence in the informations reliability and relevance.
3. The definition includes independence, which relates to the
objectivity of the service provider.
ii. To summarize, assurance services can include almost any
service provided by accounting professionals that involves
capturing information, improving its quality, or enhancing its
usefulness for decision makers.
5. Fundamental Concepts in Conducting a Financial Statement Audit
a. Intro:
i. The conceptual and procedural details of financial statement
audit build on three fundamental concepts: materiality, audit
risk, and evidence relating to managements financial statement
assertions.
ii. The auditors assessments of audit risk and materiality influence
the nature, timing, and extent of the audit evidence to be
gathered.
b. Materiality
i. Materiality- refers to the amount by which a set of financial
statements could be misstated without affecting the judgment of
reasonable people.
ii. One of the auditors first tasks in planning an audit is to make a
judgment about just how big a misstatement would have to be
before it would significantly affect users judgements.
iii. It isnt practical or cost beneficial for auditors to ensure that
financial statements are completely free of any small
misstatements.
iv. While other factors must be considered in determining
materiality, a common rule of thumb is that total (aggregated)
misstatements of more than 3 to 5 percent of income before tax
would cause the financial statements to be materially misstated.
c. Audit Risk
i. Audit risk- the risk that the auditor mistakenly expresses a clean
audit opinion when the financial statements are materially
misstated.
ii. The auditors standard report states that the audit provides
reasonable assurance that the financial statements do not
contain material misstatements.
1. Implies that there is always some risk that material
misstatement could be present in the financial statements
and the auditor will fail to detect it.
iii. Due to cost constraints and the sheer impossibility of
investigating every item reflected in an entitys financial
statements, the risk that an auditor will mistakenly issue a clean
opinion on materially misstated financial statements should be
low, but it cannot be driven to zero.
d. Audit Evidence Regarding Management Assertions
 i. The third major concept involved in auditing is evidence
regarding managements assertions or, more simply, audit
evidence.
ii.