ACG 4632
Introduction to Financial
Statement Auditing
Spring 2015 Section 422
Instructor: Devin Williams, CPA

1-1

Chapter 1
An Introduction to Assurance and
Financial
Statement
Auditing

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

LO# 1

The Study of Auditing
The study of auditing is different from other accounting courses that you have taken in college because …
OTHER COURSES

Rules, techniques and computations to prepare and analyze financial information AUDITING
Analytical and logical skills
Much more conceptual in nature 1-3

LO# 2

Principals and Agents
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 company’s resources.

Managers

Stockholders

Agents

Principals
1-4

Why pay for audits?


Demand for reliable information
– In 1926, before audits were required by law,
82% of NYSE firms paid for audits.
– Increased when companies needed to raise capital 

Capital market
– Owners (stockholders, aka “principals”) need to monitor managers (aka “agents”)
– Information asymmetry problem
 Agent

may use information advantage to maximize self-interest at the expense of the owner (happens at accounting firms too)

The Role of Auditing

LO# 2

Figure 1-1 Overview of the Principal-Agent Relationship Leading to the Demand for Auditing

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Lennox & Pittman 2011



Signaling with a voluntary audit.



Companies in the UK went from mandatory audits to voluntary audits 

Firms remaining audited get upgrades to their credit ratings
(2pts) while firms no longer being audited get downgraded (4 pts). This is due to both the loss of the signal and the loss of assurance. 

Costly auditing permits a separating equilibrium in which only the low-risk types appoint auditors



They look at 2 years (before and after) 67% of private firms remained audited! That says something right there.

Home Inspection Analogy
 Sellers

of old homes make assertions

 Can

you trust them?

 Hire

an inspector

 What

do you want him to do?

– Drive by?
– Take the house apart?
– Can she find everything?
 Who

hires the inspector?

When might you be willing to pay for an audit?
 Gas

station

– Gas price, accuracy of pump, quality of gas, availability of gas
 Ebay
 Craigslist
 What

assertions are being made in these cases?

LO# 2

The Role of Auditing

Table 1-2 Summary of Management Assertions by Category

1-10

LO# 3

Relationships among Auditing,
Attest, and Assurance Services

1-11

LO# 4

Auditing, Attest, and Assurance
Services Defined
Auditing

Attestation

Assurance
Services

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.
1-12

LO# 4

Auditing, Attest, and Assurance
Services Defined
Auditing

Attestation

Assurance
Services

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. (e.g., loan covenants)
1-13

LO# 4

Auditing, Attest, and Assurance
Services Defined
Auditing

Attestation

Assurance
Services

Independent professional services that improve the quality of information, or its context, for decision makers.

1-14

Overview of the Financial
Statement Audit Process

LO# 5

1-15

 https://www.youtube.com/watch?v=

LBko_3wT44Q

LO# 5

Fundamental Concepts in
Conducting a Financial Statement
Audit
Materiality
Audit
Risk

Evidence

1-17

LO# 5

Audit Risk
Audit risk is the risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated.
The auditor’s standard report states that the audit provides only reasonable assurance that