An Introduction to Assurance and Financial Statement Auditing

We welcome you to the world of auditing, and we invite you to invest your best efforts to learn the extremely practical and useful concepts that underlie this respected profession! These concepts will be valuable to you regardless of what you plan to do in your future career. You will learn in this chapter that auditing consists of a set of practical conceptual tools that help accounting professionals find, organize, and evaluate evidence about the assertions of another party. The demand for capable accountants and auditors of high integrity has never been greater. Opportunities for auditors are plentiful and rewarding and can lead to attractive career opportunities. Those who practice as auditors often later go into financial management, becoming controllers, chief financial officers (CFOs), and even chief executive officers (CEOs). But even those who do not plan to become auditors can benefit greatly from an understanding of financial statement auditing and its underlying concepts. Learning these tools is valuable to any business decision maker.

This is a particularly exciting time to learn about auditing and to be an auditor—the profession is in the early stages of a sea change in the way audits are carried out. Advances such as audit data analytics and artificial intelligence are dramatically changing the work auditors do. These changes will place a premium not only on auditors’ ability to use technology, but also on their ability to generate penetrating insights by exercising professional judgment. Having a solid understanding of fundamental business, accounting, and auditing concepts will become even more important in a world of advancing technology. We live in a time when the amount of information available for decision makers via electronic databases, the Internet, and other sources is rapidly expanding, and there is a great need for the information to be reliable, credible, relevant, and timely. High-quality information is necessary if managers, investors, creditors, and regulatory agencies are to make informed decisions. Auditing and assurance services play an important role in ensuring the reliability, credibility, and relevance of business information.

The following examples present situations that illustrate how auditing can add value by increasing the reliability and credibility of an entity’s financial statements:

Aliyah Menendez, a local community activist, has been operating a not-for-profit center that provides assistance to abused women and their children. She has financed most of her operations from private contributions. Ms. Menendez applied to the State Health and Human Services Department requesting a large grant to expand her two shelters to accommodate more women. In completing the grant application, Ms. Menendez discovered that the state’s laws for government grants require that recipients be audited to ensure that existing funds are being used appropriately. Ms. Menendez hired a CPA to audit the center’s financial statements. Based on the center’s activities, the intended use of the funds, and the auditor’s clean report, the grant was approved.

Conway Computer Company is a wholesaler of computer products. The company was founded five years ago by George and Jimmy Steinburker. Thanks to their hard work and the help of a venture capital firm, the company was now ready to go public. However, they knew that the company’s financial statements needed to be audited by a reputable public accounting firm in order to comply with regulatory requirements and for investors to trust the stock offering. The company hired a major public accounting firm to perform its audits and the company successfully sold stock to the public.

These situations show the importance of auditing to both private and public enterprise. By adding an audit to each situation, the users of the financial statements will have additional assurance that the financial statements report honestly and accurately and will be more willing to rely on those statements. Auditors can also provide valuable assurance for the effectiveness of an entity’s internal control. Consider the following example:

EarthWear Clothiers is a successful e-commerce retailer of high-quality clothing for outdoor sports. EarthWear’s common stock is listed and traded on NASDAQ. Securities laws require company officials to certify that they have properly designed, implemented, and tested internal control over their accounting and reporting information systems. EarthWear’s public accounting firm, Willis & Adams, LLP, examines the design and documentation of EarthWear’s internal control on a yearly basis and conducts independent tests to verify that EarthWear’s controls are operating effectively. Willis & Adams, LLP issues a report to the public expressing its opinion as to whether EarthWear’s internal control is well designed and operating effectively. Thus, stockholders, creditors, and other stakeholders can have greater confidence in the financial reports issued by EarthWear’s management.

We start by helping you understand in general terms why there is a demand for auditing, a subset of the broader set of assurance services that accounting professionals can provide. We then compare auditing to a home inspection service to provide an intuitive understanding of the role auditing plays. Finally, we give you an overview of the financial statement auditing process.