Study Guide for Regular Final Exam First focus on new material under Midterm 3 over 50 of test Gliem substantive testing FOR MIDTERM 1 2 mainly focus on the bold MGP Chapter 1 1 Topics from the First Midterm Exam s Material Information asymmetry and the role of auditing assurance services We talked about the Lemons Dilemma in class Be sure to understand the issues involved Information asymmetry evolving auditing o Occurs when the manager generally has more information about the true financial position and the results of operations of the entity than does the absentee owner o Relationship between the owner principle and the manager agent often result in information asymmetry between the parties o Because goals may not coincide there is a natural conflict of interest between the manager and the absentee owner o Because of this manager may not always act in best interest of owner managers are required to periodically report financial statements and those are checked my auditors o The auditors verification of the Financial information adds credibility to the report and reduces information risk or the risk that information circulated by the company will be false or misleading o Lemmon Dilemma Used car example If buyers cannot spot the quality difference though as is often the case in the real world there will be only one market for all used cars and buyers will be ready to pay only the average price of a good car and a lemon This result when bad quality pushes good quality from the market because of an information gap is known as adverse selection o Stewardship giving management of the corporations assets o Purpose of Financial Statement Audits To provide financial users with an opinion by the auditor that the financial statements are presented fairly in all material aspects in accordance with the applicable financial reporting framework Adding credibility o Does not provide complete assurance but enhances degree of confidence the intended users can place in financial statements o Auditors can show the public the quality of a public company s financial statements Role of Auditing Assurance 2 Differences among Audit Attest and Assurance engagements Audit Attest and Assurance engagements Audit Systematic process of objectively obtaining and evaluating evidence regarding assertions statement of fact about economic actions and events and to establish the degree of correspondence between those assertions and established criteria o Internal control Audits Compliance Audits Operational audits Forensic Audits o Very specific guidelines and standards Specialized type of attest and assurance service Attestation Practitioner CPA is engaged to issue or does issue a report on subject matter or assertion about subject matter that is the responsibility of another party o Reporting on nature of quantity of inventory stored in a warehouse so client can obtain bank note o Attesting to information beyond historical financial information traditional auditing standards did not provide for such service o Not limited to economic events or actions therefore more broad than Audit o High level of assurance more rigorous user must be confident Procedures context for decision makers performance review o Attest engagements are broken up in to 3 types Examination Review Agreed upon 2 Assurance Independent professional services that improve the quality of information or its o CPA risk advisory ElderCare Web Trusts SysTrusts healthcare effectiveness CPA o Allows reporting no only on the reliability and credibility of information but also Pertains to relevance and timeliness o Auditing is a specialized form of assurance services o Decision making can be financial or non financial most broad 3 Concepts of Materiality and Risk and why they are relevant to an audit Materiality misstatement or omission of accounting information that would influence or change shareholders decision to invest in company o Focus is on user of financial statements must be relevant to buyer s decision o In planning the auditor must asses the magnitude of a misstatement that may effect the users decision EX more then 3 to 55 of NI misstated would cause FS to be MM o A matter of auditors professional Audit Risk The risk that the auditor may unknowingly give a clean report on financial statements that are in fact materially misstated o Fail to appropriately modify their opinion on a misstated financial statement o Auditor provides only reasonable assurance that FS don t contain MM o Reasonable assurance some risk that MM could be present failed to detect o Want low lever of risk Level of risk Depends on the effectiveness and the extent of the audit work conducted 4 Understand what audit evidence is and relevance reliability trade off Evidence assists the auditor in evaluating the management s financial statement assertion o Consist of the underlying accounting data and any additional information available to the auditor whether it be from the client or external more reliable evidence of accounting data huge time spent here Relevance Is the information related to the specific assertion being tested Reliability Can the information be relied upon to signal the true state of assertion being tested Actually seeing assets vs mang just telling you they exist 5 Understand the relation between sample size and materiality as well as the relation between sample size and desired level of assurance I love to test students on conceptual relationships such as these See discussion on page 17 Sample Size Materiality Assurance Levels To deal with the problem of not being able to examine every transaction any auditors may use 1 his or her own knowledge about the transaction and or 2 samples approach that will examine a subset of transactions 1 Auditor can use his knowledge to specifically select transactions that are more likely to contain misstatements for examinations 2 Auditor uses the laws of probability to make inferences about potential misstatements based on examining a sample of transactions Sampling procedures increases the likelihood of obtaining a sample that is representative of the population of transactions Size of sample is a function of materiality and the desired level of assurance for the account There is an INVERSE relationship between sample size and materiality There is a DIRECT relationship between sample size and level of assurance 3 o Example If an auditor assesses materiality for an account to be small a larger sample will be needed than