The Demand for Auditing

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Chapter 1

• The Demand for Auditing Assurance Services

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Why do we need auditors?

• Provide assurance
• Examine controls
• Provide business advisory and tax services
• Technical knowledge
• Independent from management

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Professional accountants and their work

• Professional accounting/auditing organizations
  represented in Canada
• Canadian Institute of Chartered Accountants (CAs)
• Certified General Accountants Association of
  Canada (CGAs)
• Society of Management Accountants of Canada (CMAs)

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What is an audit?

• The accumulation and evaluation of evidence
  (tests)
• Determine and report on the degree of
  correspondence between the information and
  established criteria (GAAP)
• Auditing is done by a competent, independent
  person.

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Five key components of auditing

• 1. Quantifiable information (related to entity)
• 2. Criteria normally generally accepted
  accounting principles (GAAP)
• 3. Evidence gathering and evaluation
• 4. Competent, independent person
• 5. Report

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The Nature of Auditing

• Information and Established Criteria
• Info is in a verifiable form and some standards
  by which auditor can evaluate info
• F/s, tax return, or subjective info
  (effectiveness of internal controls)
• Criteria for f/s GAAP
• Auditors/company agree on criteria for other
  engagements (if not GAAP)

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The Nature of Auditing

• Accumulating and Evaluating Evidence
• Evidence-any info used to determine if info being
  audited is stated according to criteria
• Verbal, written, observations
• 3rd party evidence is more reliable than evidence
  from client
• Need to obtain sufficient quantity and quality of
  evidence

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The Nature of Auditing

• Competent/Independent Person
• Qualified to understand criteria used and
  competent to know the types and amounts of
  evidence to accumulate to reach the proper
  conclusion after evidence has been examined
• Independent mental attitude
• Absolute independence is impossible, auditors
  strive to maintain high level of independence to
  maintain confidence by users
• Reporting
• Communication of findings to users
• Verbal/Written

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Factors that affect demand for audits

• Businesses, government, NFP-normally require
  audits
• Banks require audits for companies with large
  loans outstanding
• Public company must have an annual audit (for
  securities exchange)
• As society becomes more complex, increased
  likelihood of unreliable info caused by
• Remoteness of information
• Bias and motives of provider
• Volume of data
• Complex exchange transactions
• Perceived cost/benefit

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Economic demand for auditing illustrates why
auditing is necessary

• Auditing can reduce information risk (the risk
  that the financial statements are inaccurate)
• The independent audit provides assurance to users
  with respect to the reliability of the financial
  statements

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Distinction between accounting and auditing

• Accounting
• Recording, classifying, and summarizing economic
  events for presentation within f/s
• Provide quantitative info that can be used to
  make decisions
• Understanding of principles/rules for preparation
  of info
• Recorded in timely basis at a reasonable cost

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Distinction between accounting and auditing

• Recorded info reflects economic events
• Auditor needs to understand accounting/possess
  experience in accumulation and interpretation of
  audit evidence
• Determine audit procedures and number and types
  of items to test and how to evaluate results
• Auditor must have a thorough understanding of the
  company and its environment
• Knowledge of industry, operating environment,
  external relationships-suppliers, customers,
  creditors
• Consider business strategy

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Types of audits

• Financial statement audit
• Determine whether the financial statements are
  stated in accordance with GAAP
• Audit balance sheet, income statement, statement
  of retained earnings, cash flow statement, and
  notes
• Perform tests to determine whether f/s contain
  material errors/misstatements
• Consider risk of errors and controls in place to
  prevent errors from occurring

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Types of audits

• Compliance audit
• Determine whether following specific procedures
  or rules
• Private and NFP-policies, contractual
  arrangements, legal requirements that may require
  compliance auditing
• Normally reported within organization rather than
  to all f/s users
• Audit for compliance with income tax act

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Types of audits

• Operational audit
• A review of any part of an organizations
  operating procedures and methods for the purpose
  of evaluating economy, efficiency and
  effectiveness
• Provide recommendations for improving operations
• Ex. Goods obtained at best price (economy)
• Not limited to accounting
• Evaluate organizational structure, computer
  operations, production methods, marketing

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Assurance Services

• Engaged to provide written communication
  expressing a conclusion concerning a subject
  matter for which the accountable party is
  responsible
• Can be performed by public accountants

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Attestation Services

• Assurance services where a public accountant
  issues a report of an assertion prepared by
  another party
• Audit of F/S
• Responsible party-company making assertions based
  on f/s being in accordance with GAAP
• External users rely on f/s and auditors report

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Attestation Services

• Review of financial statements
• Lower cost and lower assurance level (even less
  work)
• Smaller companies/non-public
• Attestation on internal controls over financial
  reporting
• US public company include managements report on
  effectiveness of internal control (along with
  audit of f/s)
• Integrate with f/s audit
• Forward-looking info because effective internal
  controls reduce likelihood of future
  misstatements
• Other attestation services
• Special reports opinion on financial information
  other than financial statements or on compliance
  with an agreement
• Ex. mall

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Non-assurance Services

• Compilations
• No assurance
• Prepare f/s from clients records
• Less extensive/costly
• Tax services
• Corporate and individual tax returns (audit and
  non-audit clients)
• Tax planning
• Management Advisory Services
• Retirement planning/financial planning
• Improve accounting systems, marketing strategies,
  computer installations
• Bookkeeping Services
• Help clients record transactions
• If complete review/audit need independence
• Management needs to approve journal entries

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Types of auditors

• Public accountant
• Normally auditor same as public accounting firm
• Completed by CAs
• Government auditor (Auditor General)
• Responsible for auditing ministries, departments,
  and agencies who report to government
• Appointed by committee or government or elected
  party
• Internal audits-f/s or compliance with
  regulations and audits to ensure operations are
  conducted in an efficient, effective, and
  economic manner
• External audits
• Efficiency/effectiveness/economy carried out
  every 5 years

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Types of auditors

• Canada Revenue Agency auditor
• Federal tax laws
• Audit returns of taxpayers (compliance with tax
  laws)
• Internal auditor
• Employed within a company to audit management
• Report directly to audit committee/BOD
• Improve organizations operations
• Help effective/efficient operations
• Less reliable than external auditors due to
  independence concerns

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What type of public accounting firms are present
in your city or town?

• International
• Largest firms
• Deloitte and Touche, KPMG, Pricewaterhouse-Coopers
  , Ernst Young
• Also Grant Thornton, BDO, Meyers Norris Penny
• Ability to serve international markets
• National
• Collins Barrow
• Offices in major cities
• Perform same services as international firms and
  compete directly with them for clients
• Maybe affiliated with firms in other countries
  (international capabilities)

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What type of public accounting firms are present
in your city or town?

• Local or Regional
• May have only 1 office or several offices in a
  province/region
• Small local-audit and related services for
  smaller businesses and NFP

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Structure of Public Accounting Firms

• Sole Proprietorship or partnership
• CAs as partners with professional staff assisting
  them
• Partner-Principle-Senior Manager-Manager-Senior
  Accountant-(Staff) Accountant

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Ensuring High-Quality Audits

• Professional Accounting Organization
• All certified members belong
• Co-ordinate examination processes, provide
  continuing education activities, fund research
  projects, provide publications, engage in
  standard setting and peer review processes
• Research and Publications
• Newsletters and magazines
• Continuing Education
• Seminars, developing and providing materials

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Ensuring High-Quality Audits

• Establishing Standards and Rules
• CICA sets accounting and auditing standards
• Accounting standards and recommendations issued
  by accounting standards board, accounting
  guidelines (also by accounting standards board),
  and emerging issues committee (EIC) which issues
  abstracts on contemporary accounting issues
• Audit handbook sections-issued by auditors and
  assurance board (AASB) S5000-S9200 or PS5000-6420
• Assurance related services guidelines
  (interpretations of existing recommendations)

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Auditing Recommendations

• No specific audit procedures
• No specific requirements for decisions such as
  sample size, selecting a sample to test or
  evaluating the results
• Some believe that need for specific defined
  guidelines for determining the extent of evidence
  to be gathered
• Eliminate difficult audit decisions and provide
  legal defence
• Technique lacks professional judgment
• GAAS and Assurance and Related Services
  Recommendation should be looked upon as minimum
  standards
• CICA Handbook silent on an issue turn to other
  authoritative sources
• AICPA, ISA, textbooks, journals, technical
  publications

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Generally Accepted Auditing Standards (GAAS)

• S5100
• Broad guidelines that help auditors in fulfilling
  their professional responsibilities in audit of
  f/s
• General qualifications and conduct
• Examination performance of the audit
• Reporting describing the results

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General qualifications and conduct

• Adequate technical training and proficiency in
  auditing
• Education in auditing and accounting, adequate
  practical experience and continuing professional
  education
• Technically qualified and experienced in industry
• If not training and proficiency-obligated to
  acquire knowledge and skills, suggest someone who
  is qualified to perform the work or decline
  engagement
• Due care
• Independence
• Objective state of mind
• Responsible for fulfilling duties diligently and
  carefully
• Making sure working papers are complete,
  sufficiency of audit evidence and appropriateness
  of auditors report
• Cant be guilty of negligence

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Examination performance of the audit

• Adequate plan and perform audit to reduce risk to
  acceptable low level
• Plan nature, timing, and extent of work
• Proper supervision and review of work
• Supervision because fieldwork completed by
  inexperienced staff

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Examination performance of the audit

• Sufficient understanding of environment and
  internal control to identify and assess the risks
  of material misstatement and to design and
  perform audit procedures
• Assess business environment and corporate
  governance
• Whether internal controls are sufficient to
  generate reliable financial info
• Good controls that provide reliable data and
  safeguard assets and records, reduces the amount
  of evidence need
• If controls are not adequate-may not be able to
  complete the audit
• Sufficient appropriate audit evidence obtained to
  draw reasonable conclusions
• Determination of how much evidence and quality of
  evidence requires judgment

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Reporting results

• Prepare a standardized report
• Identify the financial statements
• State responsibilities of management and the
  auditor
• Explain the scope of the engagement
• Provide the appropriate type of opinion (or state
  why you could not do so)
• Opinion expressed indicates whether f/s present
  fairly in all material respects, the financial
  position, results of operations and cash flows in
  accordance with CDN GAAP

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Quality control

• Methods used to make sure that the firm meets its
  professional responsibilities to clients
• Includes the organizational structure of the firm
  and its procedures
• Experienced partner review all files
• Helps to ensure that GAAS is follows on every
  audit
• Consistently perform
• Minimum standards that firms have in place

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Elements of quality control

• 1. Leadership and responsibilities within the
  firm. E.g. An organizational culture that
  promotes audit quality quality control
  procedures that are developed, documented,
  implemented, and communicated.
• 2. General ethical requirements. E.g. Address at
  the policy level general ethical principles of
  integrity, objectivity, professional competence
  and due care, confidentiality

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Elements of quality control

• 3. Independence. E.g. develop, communicate and
  monitor policies and procedures to ensure that
  the firm complies with the independence
  guidelines.
• 4. Client acceptance or continuance. E.g.
  Document annual risk assessment processes,
  including evaluation of a clients management
  integrity and auditor competence and independence.

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Elements of quality control

• 5. General human resource policies. E.g. Have
  adequate hiring policies that ensure competence
  and integrity of personnel.
• 6. Extent of professional development. E.g.
  Employees adequately trained in the skills needed
  to conduct audits.
• 7. Engagement performance. E.g. Have adequate
  processes and procedures to ensure that the audit
  is conducted in accordance with GAAS.

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Elements of quality control

• 8. Engagement quality control review. E.g. Ensure
  that quality control review takes place during
  the engagement and that monitoring occurs after
  the engagement is completed.
• 9. Documentation. E.g. Have policies that address
  the extent of documentation (hard copy or
  electronic) including retention, storage,
  security and back-up.

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Enforcement of quality control

• Quality control is enforced by means of practice
  inspection
• A practice inspection can occur by any one of
• Firm quality control staff
• By the provincial institute or ordre
• By the CPAB (Canadian Public Accountability
  Board)
• Completed every 3 years (yearly if quality
  standards are not being maintained)

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Canadian Public Accountability Board (CPAB)

• Purpose improve publics confidence in
  independent auditing
• Oversight-regular inspections of firms that audit
  public companies
• Unlike US-Canadian version doesnt help set
  auditing standards
• Auditing firm doesnt audit public company then
  not subject to quality control inspections by
  CPAB but still must have quality control
  standards in place
• Greater than 50 public company audits-annual
  inspection
• Less than 50 public company audits-every 3 years

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Canadian Public Accountability Board (CPAB)

• Benefits
• Result higher quality audits
• Improves firms practices, enhances reputation,
  and effectiveness, and reduces the likelihood of
  lawsuits
• Sanctions
• Re-inspection-next year
• Referral to professional conduct committee-take
  courses, removing right to train students, and
  expelling from CA
• Engage independent monitor or limit ability to
  audit public company