S-1 An independent audit is a means of satisfying the need for reliable information on the part of decision makers. Factors of a complex society which contribute to this need are:

1. Remoteness of information

a. Owners (stockholders) divorced from management

b. Directors not involved in day-to-day operations or decisions

c. Dispersion of the business among numerous geographic

locations and complex corporate structures

2. Biases and motives of provider

a. Information will be biased in favor of the provider when his or her goals are inconsistent with the decision maker's goals.

3. Voluminous data

a. Possibly millions of transactions processed daily via sophisticated computerized systems

b. Multiple product lines

c. Multiple transaction locations

4. Complex exchange transactions

a. New and changing business relationships lead to innovative accounting and reporting problems

b. Potential impact of transactions not quantifiable, leading to increased disclosures

S-2.

OPERATIONAL

COMPLIANCE

AUDITS

AUDITS

PURPOSE

To evaluate whether operating

procedures are

efficient and effective

To determine

whether the client is

following specific

procedures set by

higher authority

USERS OF

AUDIT

REPORT

Management of

organization

Authority setting

down procedures,

internal or external

NATURE

Highly

Not standardized,

nonstandard;

but specific and

often subjective

usually objective

AUDITS OF

FINANCIAL

STATEMENTS

PURPOSE

To determine whether the

overall financial statements are presented in accordance with specified criteria (usually GAAP)

USERS OF

AUDIT

REPORT

Different groups for different

purposes — many outside

entities

NATURE

Highly

standardized

S-3 Five examples of specific operational audits that could be conducted by an internal auditor in a manufacturing company are:

1. Examine employee time cards and personnel records to determine if sufficient information is available to maximize the effective use of personnel.

2. Review the processing of sales invoices to determine if it could be done more efficiently.

3. Review the acquisitions of goods, including costs, to determine if they are being purchased at the lowest possible cost considering the quality needed.

4. Review and evaluate the efficiency of the manufacturing process.

5. Review the processing of cash receipts to determine if they are deposited as quickly as possible.

S-4

The four major services that CPAs provide are:

1.

Assurance services .

Assurance services are independent professional services that improve the quality of information for decision makers. Assurance services include attestation services, which are any services in which the CPA firm issues a report that expresses a conclusion about the reliability of an assertion that is the responsibility of another party. The four categories of attestation services are audits of historical financial statements, attestation on the effectiveness of internal control over financial reporting, reviews of historical financial statements, and other attestation services.

2.

Accounting and bookkeeping services

Accounting services involve preparing the client's financial statements from the client's records. Bookkeeping services include the preparation of the client's journals and ledgers as well as financial statements.

3.

Tax services

Tax services include preparation of corporate, individual, and estate returns as well as tax planning assistance.

4.

Management consulting services

These services range from suggestions to improve the client's accounting system to computer installations.

S-5 Independence in fact exists when the auditor is actually able to maintain an unbiased attitude throughout the audit, whereas independence in appearance is dependent on others' interpretation of this independence and hence their faith in the auditor.

Activities which may not affect independence in fact, but which are likely to affect independence in appearance are: (Notice that the first two are violations of the Code of Professional Conduct.)

1. Ownership of a financial interest in the audited client.

2. Directorship or officer of an audit client.

3. Performance of management advisory or bookkeeping or accounting services and audits for the same company.

4. Dependence upon a client for a large percentage of audit fees.

5. Engagement of the CPA and payment of audit fees by management.

S-6 A CPA firm has several options when it decides it is not competent to perform an audit:

1. Withdraw from the engagement.

2. Obtain the expertise through continuing education and self-studies.

3. Hire someone who has the expertise.

4. Work on a consulting basis with another CPA firm.

S-7 Misappropriation of assets represents the theft of assets by employees. Fraudulent financial reporting is the intentional misstatement of financial information by management or a theft of assets by management, which is covered up by misstating financial statements.

Misappropriation of assets ordinarily occurs either because of inadequate internal controls or a violation of existing controls. The best way to prevent theft of assets is through adequate internal controls that function effectively. Many times theft of assets is relatively small in dollar amounts and will have no effect on the fair presentation of financial statements. There are also the cases of large theft of assets that result in bankruptcy to the company. Fraudulent financial reporting is inherently difficult to uncover because it is possible for one or more members of management to override internal controls. In many cases the amounts are extremely large and may affect the fair presentation of financial statements.

S-8

CHARACTERISTIC

AUDIT STEPS

1.

Management’s characteristics and influence over the control environment.

Investigate the past history of the firm and its management.

Discuss the possibility of fraudulent financial reporting with previous auditor and company legal counsel after obtaining permission to do so from management.

2.

Industry conditions.

Research current status of industry and compare industry financial ratios to the company’s ratios. Investigate any unusual differences.

Consider the impact of specific risks that are identified on the conduct of the audit.

3.

Operating characteristics and financial stability.

Perform analytical procedures to evaluate the possibility of business failure. Investigate whether material transactions occur close to year-end.

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