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Summary - Class notes - Assurance Services
1517266800 Lecture 1
What is accounting?Recording, classifying and summarizing of economic events in a logical manner for the purpose of providing financial information for decision making.
What are assurance services?Independent professional service that improves the quality of information for decision makers.
How is assurance services perceived?It is perceived as unbiased.
What do assurance services improve?It improves reliability and relevance of information.
What is auditing?- Accumulation and evaluation of evidence about information to determine and report on the degree of correspondence between information and established criteria.
- By competent and independent professionals
- Part of assurance services
Information and estabished criteriaTo do an audit, the information must be verifiable and some standards (criteria) must be available by which the auditor can evaluate the information. Those criteria can vary depending on the information being audited - e.g. quantifiable information, or more subjective. For more subjective information, clear criteria are harder to establish. Hence, auditors and the entities being audited agree upfront ons those standards.
EvidenceEvidence is any information used by the auditor to determine whether the information being audited is stated in accordance with the established criteria.
Accumulating and evaluating evidenceTo satisfy the purpose of the audit, evidence must be obtained that is of sufficient quality and quantity. The types and amounts necessary must be determined and this information must be evaluatied corresponding to the established criteria.
Competent, independent personThe auditor must be qualified to understand the criteria used and must be competent (i.e. skilled) to know the types and amounts of evidence to accumulate, needed for a proper conclusion, after examining the evidence. The auditor must also have an independent mental attitude, otherwise the auditor's competence is of littel value or they are biased in their gathering of evidence.
ReportingThe final stage in the auditing process is preparing the audit report, which communicates the auditor's findings to users.
Information riskInformation risk reflects the possibility that the information upon which the business risk decision was made, was inaccurate. This is most likely cuased by inaccurate financials statements. Reducing information risk can have a significant effect on the borrower's ability to obtain captial at a reasonable cost - the rate of interest may decrease.
Causes of information riskUnreliabile information can be the result of several reasons:
1. Remoteness of information
2. Biases and motives of the providor
3. Voluminous data
4. Complex exchange transactions
Remoteness of informationFor a decision maker it is almost impossible to have much firsthand knowledge about the organization and therefore he must rely on information provided by others. When information is obtained from others, the likelihood of it being (un)intentionally misstated increases.
Biased and motives of the providerIf information is provided by someone wose goals are inconsistent with those of the decsiion maker, the information may be biased in favor of the providor. The reaso can be hones optimism about future events or an intentinal emphasis designed to influence users. In either case, the result is a misstatement of information.
Voluminous dataLarger organizations have a larger volume of exchange transactions. This increases the likelihood that improperly recorded information is included in the records, perhaps buried in a large amount of other information. If many minor misstatements remain undiscoverd, the combined total can be significant.
Complex exchange transactionsThe increase in complexity of exchange transactions between organizations causes that it is also becoming more difficult to record properly. This has also resulted in increasingly complex accounting standards.
Where do you need to look at while reducing information risk?There must be a cost-benefit trade-off between the cost of hihger interest rates or costs to lower information risks, meanwhile reducing the interest rates.
What are the three main ways to reduce information risk?1. User verifies information
2. User shares information risk with management
3. Audited financial statements are provided
User verifies informationThe user may go to the business premise to examine records and obtain information about the reliability of statements. Normally this is impractical because of costs and economically inefficient. Hence, it happens only on rare occasions.
E.g. tax authorizations, due dilligence process in M&A.
User shares information risk with managementManagement is responsible for providing reliable information to users. If users rely on inaccurate financials statements and as a result incur a financial loss, they may have a basis for a lawsuit against management. A difficulty with sharing information risk with management is that users may not be able to collect on losses due to e.g. bankrupty.
Audited financial statements are providedThe most common way for users to obtain reliable information is to have an independent audit, this information is complete, accurate and unbiased.
Elements of an Assurance Service1. Three party relationship
2. Subject matter
3. Suitable criteria against which to check
5. Assurance report
1. Three-part relationship- Responsible party: prepares and provides underlying information (company)
- Practitioner: gathers evidence and conforms if it fits criteria (auditor)
- Intended user: reads report and uses it for conclusions -> A lot of the financial statements are audited because the law simply requires it, doing the audit you need to get an idea what's the expectation of the intended user.
2. Subject matter: form* Form:
- Non-/financial information: nonfinancial information can environmental subjects, number of volumes etc.
- Physical characteristics: stock-check (are products present and in the right state)
- System and processes: IT, ADP (salary checks)
- Behavior: whether people are complied with certain rules, somethime people make reports about all the (company) relationships they have and an auditor can test if this is acutally true.
* Identifiable and consistenly evaluable based on identified criteria
* Nature that can be subjected to procedures for gathering evidence
3. Suitable criteria against which to checkGAAP, IFRS, make up/define your own criteria
4. Evidence- Sufficient: enough evidence --> level of evidence
- Appropriate: relevant and reliable --> strength of the evidence to support the conclusion
Example: fake banks, bank balances are not reliable. You need confirmation from the bank and even check the confirmation.
Assurance ServicesAn assurance service is an independent professional service that improves the quality of information for decision makers. Individuals who are responsible for making business decisions seek assurance services to help improve the reliability and relevance of the information used as the basis for their decisions. The need for these services is not new and continues to grow as stakeholders seek assurances about financial and nonfinancial information in addition to information in corporate financial reports.
Types of Assurance services- Attestation services
- Other assurance services
- Non-assurance services
What is attestation services and what categories are there?Attestation service is a type of assurance service in which the CPA firm issues a report about a subject matter or assertion that is made by another party.
There are four types of attestation services:
1. Audit of historical financial statements
2. Audit of internal control over financial reporting
3. Review of historical financial statements
4. Other attestation services
Audit of historical financial statementsThe auditor issues a written report expressing an opinon about whether the financial statemetns are fairly stated in accordance with applicable accounting standards. These audits are the most common assurance service provided by CPA firms. The goal is to ensure that financial statements are free of material misstatements, a high level of assurance, which is sufficient to meet information needs.
Audit of internal control over financial reportingTo make assurance that the internal controls ahve been developed and implemented following well established criteria. This type of evaluation is integrated in the audit, and increases user confidence about future financial reporting, because effective internal controls reduce the likelihood of future misstatements.
Review of historical financial statementsThis is similar to audits (the statements are fairly stated in accorance with accounting standards) however it is provided with a lower level of assurance. A review is often adequate to meet financial statement users' needs.
Other attestation services:typically, the CPA is engaged to provide written assurance about the reliability of an assertion made by management. Many of these services are natural extensions of the audit of historical financial statements, as users seek independent assurance about other types of information.
Other assurance servicesCPAs also provide other assurance services that differ from attestation services in that the CPA is not required to issue a written report, and the assurance does not have to be about the reliability of another party’s assertion about compliance with specified criteria. These other assurance service engagements focus on improving the quality of information for decision makers, just like attestation services.
- agreed-upon procedure engagements (results in a report of factual findings)
Non-assurance services- Accounting and bookkeeping services
- Tax services
- Management consulting services
These services fall outside the scope of assurance services, although there is similarity between some consulting and assurance services. However, the primary purpose of a management consulting engagement is to generate a recommentdation to management, and not to imrove the quality of information.
Non-assurance services should not conflict with the other services offerd to the company and there is always a risk of self-review.
Types of audits1. Operational audit
2. Compliance audit
3. Financial statement audit
Operational auditAn operational audit evaluates the efficiency and effectiveness of any part of an
organization’s operating procedures and methods. At the completion of an operational audit, management normally expects recommendations for improving operations. Because of the many different areas in which operational effectiveness can be evaluated, it is impossible to characterize the conduct of a typical operational audit. Moreover, establishing criteria for evaluating the information in an operational audit is extremely subjective. In this sense, operational auditing is more like management consulting.
Compliance auditA compliance audit is conducted to determine whether the auditee is following
specific procedures, rules, or regulations set by some higher authority. Results of compliance audits are typically reported to management, rather than outside users, because management is the primary group concerned with the extent of compliance with prescribed procedures and regulations.
Financial statement auditA financial statement audit is conducted to determine whether the financial
statements are stated in accordance with specified criteria. Here, the auditor gathers evidence to determine whether the statement contains material errors or other misstatements.
What is the purpose of a financial statement audit?The purpose of an audit is to enhance the degree of confidence of intended users in the financial statements.
How is the purpose of the financial statement audit achieved?This is achieved by the expression of an opinion by the auditor on whether the financial statements are prepared, in all material respects, in accordance with an applicalbe financial reporting framework.
What's the opinion about?In the case of most general purpose frameworks, that opinion is on whether the financial statemetns are presented fairly, in all material respects, or give a true and fair view in accordance with the framework.
Types of auditors1. External/Independent auditors
2. Internal auditors
3. Government accountability officers
4. Internal revenue agents
External/Independent auditorsExternal/Independent auditors (Certified Public Accountants, CPAs) are responsible for auditing the historical financial statements of many firms. They are licensed (regulated by law: extended education, examination, experience)
Internal auditorsInternal auditors are employed by all types of organizaitons to audit for management with oversight by the board of directors. Many are invold in operational auditing and report directly to the president to remain independent.
Government accountability officersThese auditors work for the U.S. government Accountability Office (GAO), a nonpartisan agency in the legislative branch of the federal government that are responsible solely to Congress. The GAO audits much of the financial information prepared by various federal government agencies before it is submitted to congress.
Internal revenue agentsInternal revenue agents are responsible for enforcing the federal tax laws as they have been defined by the Congress and interpreted by the courts. They solely do compliance audits -> tax inspectors
How does the typical hierarchy looks like?- Partners (10+ experience)
- Managers (5-10 experience)
- Seniors and In-charge auditors (2-5)
- Staff assistents (0-2)
What are the main factors influencing the organizaitonal structure of all firms?1) The need for independence from clients
2) The importance of a structure to encourage competence
3) The increased litigation risk face by auditors
ProprietorshipOnly firms with one owner can operate this form. The owner has full liability
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2) Auditors must design the audit so as to obtain the necessary evidence
oAccuracy and valuation
oClassification and understandability
oValuation and allocation
oRights and obligation
* Accuracy: all the elements should be properly reflected
* Classification: all the elements should be classified in the right column
* Cut-off: all transactions in the year should be recorded, outside the year should not be recorded
- Financial reporting reliability
-Loss of assets (due to theft, fraud, erosion, accident, obsolescence)
-Financial risk (credit interest rate, market currency collateral, counterparty)
-Improper incentives to employees and trading partners
-Reputation loss (integrity risk)
- Environmental change:
* Customers' tastes and preferences
* New (substitute) products
* Labor, materials and capital availability and costs
* Political/cultural climate
* Laws and regulations
- Business process and asset loss risks (threat from ineffective or inefficient business processes)
- Information risks (threat from poor-quality information for decision making within the business and erroneous information provided to outsiders)
- Business operations and processes (client facilities and operations, related parties) --> what differs them from the rest?
- Management and governance (board and audit committee, code of ethics, minutes of meetings) --> you need to understand the structure, the influence of certain people
- Client objectives and strategy (indicators of possible risks) --> What are they are trying to do?
- Measurement and performance (evaluation and incentives, pay for performance?) --> How do people get their bonus? How are things are being measured? How is performance being evaluated?