Financial Statement Auditing

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thousands of head of cattle on a ranch covering dozens of square miles. There was no stan- dard procedure manual for the auditor to refer to—he simply had to figure out an effective and efficient way to obtain persuasive evidence that the cattle existed in the numbers asserted by the ranch’s management.

In the end, the auditor decided to charter a small airplane to fly over the ranch and sys- tematically take photos—1 per 50 square acres. The auditor was able to obtain a count of the cattle from the photos. He also evaluated veterinary records to see if the number of required annual vaccinations delivered by the vet approximated the number of cattle counted in the photos. Finally, he did some calculations based on average bovine birth and death rates, taking into account recorded purchases and sales of livestock during the year. Using this combina- tion of procedures, the auditor was able to obtain persuasive evidence supporting manage- ment’s assertion regarding inventory (and got an airplane ride in the process).

We hope this example helps illustrate why you will need to approach the study of audit- ing differently from that of most other accounting courses, and how learning auditing con- cepts can benefit you even if you do not plan to become a financial statement auditor. We can promise you this—in learning the concepts and techniques of auditing, you will not only acquire the tools to become an effective financial statement auditor, you will also learn new ways of reasoning and analyzing that will be highly useful to you in many different contexts and settings.

KEY TERMS

Assurance services. Independent professional services that improve the quality of informa- tion, or its context, for decision makers. Encompasses attest services and financial statement audits. Attest services. Services provided by a practitioner engaged to issue a report on subject mat- ter, or an assertion about subject matter, that is the responsibility of another party. Encom- passes financial statement audits. Audit evidence. All the information used by the auditor in arriving at the conclusions on which the audit opinion is based. Audit evidence includes the information contained in the accounting records underlying the financial statements, as well as other information. Audit risk. The risk that the auditor expresses an inappropriate audit opinion when the finan- cial statements are materially misstated. Auditing. A systematic process of (1) objectively obtaining and evaluating evidence regard- ing assertions about economic actions and events to ascertain the degree of correspondence between those assertions and established criteria and (2) communicating the results to inter- ested users. Financial statement assertions. Expressed or implied representations by management that are reflected in the financial statement components. Information asymmetry. The concept that the manager generally has more information about the true financial position and results of operations of the entity than the absentee owner does. Materiality. The maximum amount by which the auditor believes the financial statements could be misstated and still not affect the decisions of users. Misstatement. An instance where a financial statement assertion is not in accordance with the criteria against which it is audited (e.g., GAAP). Misstatements may be classified as fraud (intentional), other illegal acts such as noncompliance with laws and regulations (intentional or unintentional), and errors (unintentional). Reasonable assurance. The concept that an audit done in accordance with auditing standards may fail to detect a material misstatement in a client’s financial statements. In an auditing context this term has been defined to mean a high but not absolute level of assurance.

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Chapter 1 An Introduction to Assurance and Financial Statement Auditing 25

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Reporting. The end product of the auditor’s work, indicating the auditing standards followed and expressing an opinion as to whether an entity’s financial statements are fairly presented in accordance with agreed-upon criteria (e.g., GAAP). Risk of material misstatement. The preaudit risk that the entity’s financial statements con- tain a material misstatement whether caused by error or fraud. Unqualified/unmodified audit report. A “clean” audit report, indicating the auditor’s opin- ion that a client’s financial statements are fairly presented in accordance with agreed-upon criteria (e.g., GAAP).

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REVIEW QUESTIONS

LO 1-1 1-1 Why is studying auditing different from studying other account