 In this presentation we will take a look at an overview of the financial statement auditing process. First we'll take a look at the activities of management and then we'll take a look at support accounting instruction by clicking the link below giving you a free month membership to all of the content on our website broken out by category further broken out by course. Each course then organized in a logical reasonable fashion making it much more easy to find what you need then can be done on a youtube page. We also include added resources such as excel practice problems pdf files and more like quickbooks backup files when applicable. So once again click the link below for a free month membership to our website and all the content on it. Compare and contrast the activity of the audit or the activities performed within the audit. You'll recall that management of course is responsible for compiling the information into financial statements that being the thing that we as the auditors are then going to go in and audit see if it is in compliance is in conformity with a set of principles that it should be constructed in accordance with those typically being gap or generally uh accepted accounting principles. So management implements internal controls. Now note internal controls are going to be a huge topic when we think about audit oftentimes especially when we're thinking about a smaller type of company we often want to go in and we just say I want to just jump right in there and take a look at the balance sheet give me the balance sheet and I'll just get a dig in start testing things out. There was a time period where that basically is more similar to what we used to do we used to say hey we know give us the balance sheet we're going to go in and we're going to start digging in and testing things out as we start looking at larger companies however the larger the company is the more internal controls we're going to need we're going to need a system that's going to be set up and you can think of this similar to as a system set up for say a government that's very large where you have the checks and balances that's in essence what internal controls are the larger the company the more internal checks and balances that need to be in place and the more we need to rely on them both in the construction of the accounting system and the business system as well as within the auditing process so more and more with the growing size of companies they are becoming more reliant on internal controls and we as the auditor if we want to have an accurate audit in a time frame that's reasonable must also look into these internal controls especially when we're talking about larger companies now if you're talking about small companies note that the internal controls are going to be less because you need less internal controls with when we're talking about a smaller type of company and we as the auditor then seeing that there are less internal controls will will make adjustments for that if that's the case as well and do more testing of them but really key really important are the internal controls then the management is going to have the uh conducts the actual transactions the financial transactions that are going to happen the year is going to go by they're going to have financial transactions all year long they're going to conduct those and they're going to record and compile the information debits and credits are going to be recorded here to compile the the information accumulate transactions into account balances they're of course going to take that we can imagine this is what the company is doing this is general ledger accounting the company the management responsible for this taking those transactions compiling them into balances say a trial balance we can imagine trial balance being put together then they're going to take that information and prepare financial statements which of course is the end result that they would then be processing and use if we're talking about a publicly traded company they're required to have the financial statements that are going to be put together if they're not publicly traded they want them for internal use and possibly for to get a loan or something like that so the end result representing what something has been done in terms of financial accounting according to generally accepted accounting principles are of course financial statements balance sheet income statements statement cash flows and then the financial statements are issued to users who are the users if it's a publicly traded company we're typically thinking about the end users being potential investors because they're the people that are investing in these things in terms of their pension plans or something like that stock trading if they're getting money on a public exchange for investments into their publicly traded company then we're typically thinking about the end user being the investors now note we might be doing an audit for some other reason the end user maybe say the bank who required an audit so that they can trust the financial statements and see if they want to do business with a particular company that might well that's another common scenario for smaller types of companies that could be a more common type of scenario publicly traded companies required audit we're usually thinking about investors smaller companies might have specific need for a full audit and therefore we're thinking that the end user might be something more likely a bank or something like that all right well what does the audit do now when you think about the audit coming into play you're thinking about this having already happened management has done these things the time period has passed or is close to passing when we start to think about what the audit engagement will be doing in other words when we start to plan the audit engagement the financial statements in essence we think of as we could think of at this point being created at this point and now the auditor of course is going to be looking into the accuracy of those financial statements have they been put together in accordance with a set of rules that's what the audit is designed to do those set of rules we can imagine oftentimes being generally accepted accounting principles in a us audit so they're going to obtain evidence we're going to obtain evidence and that's how we're going to determine this and again remember the end goal is are these financial statements represented correctly in accordance with generally accepted accounting principles our goal is not to say are these financial statements good i mean is this company doing well or not or something like that we want to see if they're going concerned are they going to go out of business because and that's because that's going to violate some of the assumptions that we typically make but other than that we're not making those type of value judgments what we're trying to do is say hey this is what happened let's see what did happen are you reflecting what is happening in accordance with the set of rules that you're claiming to given the assertions that you've told us that you've put them together in accordance with typically being generally accepted accounting principles then we're going to go in and judge that based on evidence we'll put together tests to see whether or not these items have been indeed put together in accordance with generally accepted accounting principles uh test management's assertions against uh criteria that being the generally accepted accounting principles oftentimes uh determines overall fairness of financial statements we're going to make a determination that's our point is that you know what's the what's the determination after we've gotten the evidence once we make that determination we're going to issue audit reports to uh accompany financial statements so we're actually going to then of course issue our opinion on the financial statement so obviously we're going to have terms of engagement between the management and the auditor uh at the get go so when we think about the process of course we're going to have some kind of planning of the process the person that hires the auditor which and this is going to be a problem in some ways because you would think that there would be an independence type of problem happening here is going to be the company the company for some reason needs an audit to judge the fairness of the work that they did and they're paying the auditor so note there's kind of an issue there with regards to the person that's getting paid to do the job to judge the person who's paying them is a bit of a problem that's going to be one of the reasons we focus in on things like independence uh at a later time so once so first we're going to have this engagement management needs an audit why possibly they're a publicly traded company and they have to have an audit and so the company actually has to pay for an audit because they're publicly traded but they might need an audit because they're a bank or something like that and then they need to get an audit because the bank wants an audit so they need to hire an auditor the bank doesn't hire the auditor the management hires the auditor the company hires the auditor to audit but the auditors being independent in nature CPA firms regulated then they have more assurance or reliability in the eyes of the bank in the eyes of investors so we have to have that engagement agreement of terms what are the terms agreement on the management saying that I have created created these in accordance with a set of rules compiled everything together all the assertions we've seen in a prior presentation and the auditor then saying hey you you provide me with this information so that I can do the tests necessary for me to gather the evidence necessary for me to determine whether or not you have indeed put these into in accordance with that engagement or with the criteria so we're going to gather evidence so the evidence is going to be on the internal controls the transactions and the accumulation transactions into the balances that's what we're going to test and note that internal controls is important here because we're not just going to test the transactions we're going to test the controls and hopefully if we're looking at a large company those controls need to be strong because we're not going to be able to test enough transactions in many conditions in order to have enough evidence all the time without relying to some extent on the internal controls on the checks and balances of the system then we have the assertions which is related to the preparation of the financial statements in accordance with the assertions generally accepted accounting principles we're going to test management's assertions against the criteria that being generally accepted accounting principles and then of course we're going to determine overall fairness of the financial statements we then having made our opinion are going to issue our audit report to the users of the financial statements key concepts in conducting an audit we have the concept of materiality audit risk and evidence these are going to come up all the time we want to have a firm grasp of these type of items materiality audit risk evidence what are those items let's start with materiality the size of an omission or misstatement of accounting information that makes it probable that the judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement so that's a lot of information right there let's kind of break that down we could think about it intuitively we'll break it down by the definition we'll think about it intuitively now the reason materiality is going to be really important is because one that we're talking about often a lot of information if you're talking about a publicly traded company you're talking about a lot of information so it's not going to be the case that we can eliminate all errors or say hey you know anytime any kind of question test question happens all the time which says that we guarantee this we guarantee that there's no errors in the financial statement or no we guarantee there's no been no fraud we guarantee that there's no any guarantee is not something an auditor would say just like that's not something a lawyer would say it's you just can't ever guarantee anything because it's it's factually inaccurate and it would be liability wise not wise type of wording to say so any test question that says that the auditor is guaranteeing anything is probably false that's that's just not going to be the case so we're always going to be seeing this term materiality materiality materiality and and when we think about the financial statements materiality you'll hear the same kind of idea as a reasonable person type of idea remember what the end result is the users were typically thinking possibly investors we want to make sure that there's not a material misstatement or we're looking to reduce the likelihood of a material misstatement being present which would result in something like investors making decisions to say invest when when they would not have made that decision had that mistake not been there so that's in essence what we're thinking about with materiality we're saying hey we audited the financial statement we have a degree of risk that we didn't catch the material material misstatement but we're giving some degree of assurance that the audit would then have picked up a material error and therefore there's a higher degree of assurance for the users of the financial statements to depend on the numbers that actually have been provided and therefore a higher likelihood that business will be conducted transactions will happen due to a higher degree of trust so given that let's go through this definition one more time the size of so materiality the size of omission or misstatement so either something was misstated stated incorrectly or it wasn't stated and it should have been stated also a mistake of course of accounting information that it makes it probable so obviously probable we have this term again that's not specific it's kind of a judgment term that the judgment of a reasonable person so now we have this reasonable person term so we're taking common sense logic kind of concept into play relying on the information so they're going to be relying on the financial statements would have been changed or influenced by the omission so we're imagining they're relying on the information for something such as investment there what if there was an omission or some kind of change that was material they then would change their decision now if you're talking about a publicly traded company that's making you know millions to billions of dollars a year you can have an omission that a problem an error that could be you know a hundred thousand dollars of revenue that wasn't stated or was stated and given given the size of the company you may still say that that was in material which seems amazing but it could be possible because you if you're looking at financial statements these big numbers even up to a million dollars if you're talking about really multi-million dollar uh companies you could have a million dollar error that if you were thinking about investing probably wouldn't be something that would influence your decision so when we start to think about these big numbers just realize that you could talk about big dollar terms that could be in material because we're looking at relationships with with the other numbers being being involved and what we would think in terms of an investment decision with regards to large very large numbers could result in an omission that's quite large that would still not influence a regional person's decision-making process so we'll get into more ideas and later on in terms of when materiality applies how do we know what a material number is how do we come up with that number these are types of things we'll talk about later at this point in time we want to talk about the definition or the concept or the term of audit risk audit risk risk of auditor expressing a clean audit opinion when the financial statements are materially misstated so the audit risk then is something that's always going to be present we always want to note that there are there is going to be audit risk and we're we're always going to say that if they ask us it comes down to this guarantee again is there a guarantee that you have eliminated all even material misstatements no because there is some audit risk what's the audit risk risk of an auditor expressing a clean audit good opinion the audit basically clean meaning there's no problem with it the financial statements are clean the management has indeed reported them in accordance with what they said they were reported them they have expressed the assertions that they said they were going to express in accordance with what other format they have said they were going to express it in accordance with say generally accepted accounting principles so that would be the auditor the risk of the auditor expressing that clean opinion when financial statements are materially misstated that means they could indeed be misstated to the point at which a reasonable person might make a decision that would be influenced by the side by the error that has been in essence missed so there is still going to be audit risk related to that of course our goal within the audit is to get that audit risk as low as possible but again auditors never going to say that there's no audit risk all we can do is reduce the audit risk to reasonable levels and audit provides reasonable assurance that the financial statements do not contain material misstatements so notice again the terminology what are we doing in an audit are we eliminating audit risk not at all we're not eliminating audit risk there could still be a material misstatement what we're doing is providing reasonable assurance again lawyerly type of term but that's that's what you're going to basically expect there are there are no guarantees within these types of things it's always going to have some type of of recent out reasonable alloties type of term here reasonable assurance reasonable assurance means that there is some risk that a material misstatement could be present in the financial statements and not be detected by a competent auditor so notice what that's saying it's saying hey the audit could have been done in a competent way and it's still possible that a material misstatement one that would influence someone's decision and be a mistake is there even though the audit tour was competent again the risk is going to be low we're going to try to keep that down to a reasonable level but we're never going to say it has been removed there's always going to be some audit risk