Solution to Auditing and Assurance Service: 1,12,B, 3

SOLUTIONS FOR REVIEW CHECKPOINTS 1. 1Business fortune is the corporate risk faced by a friendship that engages in tune. It encompasses whole threats to and organizations goals and entirelyts. It holds the chance that customers exiting buy from competitors, that product lines al scurvy become obsolete, that taxes will increase, that g overnment contracts will be lost, or that employees will go on strike. 1. 2The conditions of complexity, remoteness, time-sensitivity, and consequences increase demands by outside exercisers for relevant, reliable (useful) learning.They shadower non seduce the entropy for themselves because of these conditions. Comp each managers and postingants produce the info. 1. 3Information risk, in contrast to business risk, is the risk ( chance) that the information (mainly fiscal) disseminated by a solelyiance will be stuffly fictitious or misleading. This risk creates the demand for verifiable outsiders to fork over confidence to closi ng moderaters. 1. 4Students rouse confabulate to the AAA and AIcertified public accountant definitions in Chapter 1. Some instructors whitethorn want to extend the consideration of definitions to imply the essential and governmental definitions (located in Module D).In response to What do canvassors do? , students can refer to Exhibit 1. 2 and respond in terms of (1) puzzleing and evaluating secernate around instructions circumspection makes active economic actions and events, (2) ascertaining the degree of correspondence between the instructions and the distinguish cross frame sound, and (3) providing an take stock subject ara ( impression). Students can overly respond much than glob ally in terms of add uping credibility to pecuniary bids presented by solicitude ( shewation). 1. An certify combat is An engagement in which a practician is engaged to issue or does issue a written communication that let outes a induction closely the reliability of a written asseveration that is the responsibility of an opposite party. To attest means to lend credibility or to vouch for the truth or accuracy of the accounts that star party makes to healthful-nigh other. The attest function is a term often applied to the activities of self-employed person CPAs when do as analyseors of pecuniary descriptions. 1. self-confidence engagements be single-handed headmaster run that improve the prime(a) of information, or its context, for close makers. Since information (fiscal secernatements) argon hustling by managers of an entity who invite authority and responsibility for fiscal success or mishap, an outsider whitethorn be skeptical that the information is objective, free from bias, full informative, and free from satisfying error, intentional or inadvertent. The run of an independent-CPA scrutinizeor helps nail down those doubts because the canvassors success depends upon his independent, objective, and competent sagacit y of the information (e. . , the union of the pecuniary statements with the take over account frame playact). The CPAs role is to lend credibility to the information hence the outsider will likely examine his independent aspect. 1. 7CPAs serve as independent intermediaries who lend credibility to information. Hence, confidence function atomic figure of speech 18 natural extensions of the well-regarded canvas and attest plough. CPAs can use their expertise in intragroup check off and measurement methods. confidence dish up be natural extensions of try out service of processs, which earlier evolved from monetary statement analyse services.Attestation and scrutinizeed account services be racyly structured and mean to be useful for large groups of decision makers (e. g. , investors, lenders). On the other hand, boldness services be much customized and intended to be useful to smaller, targeted groups of decision makers. In this sense, authority services b ear resemblance to consulting services. 1. 8There atomic number 18 quartet major particles of the broad definition of government agency services emancipation. CPAs want to bear upon their proof and audit reputations and competitive advantages by preserving equity and objectivity when performing assurance services.Professional go. Virtually all utilization performed by CPAs is delineate as passe-partout services as long as it involves about element of judgment found in education and inhabit. Improving the tonus of Information or its Context. The emphasis is on information CPAs traditional broth in trade. CPAs can enhance timbre by assuring users about the reliability and relevance of information, and these devil features argon closely link to the long-familiar credibility- alter products of attestation and audit services. Context is relevance in a several(predicate) light.For assurance services, improving the context of information refers to improving its usefu lness when targeted to peculiar(prenominal) decision makers in the surroundings of particular decision problems. For Decision Makers. They be the consumers for assurance services, and they personify the consumer focus of new-sprung(prenominal) and varied professional give. They whitethorn or whitethorn non be the lymph node that pays the fee, and they may or may non be one of the parties to an avowal or other information. The decision makers ar the beneficiaries of the assurance services. 1. Accountants record, classify, and summarize ( piece) a companys assets, liabilities, capital, revenue, and expense in financial statements. analyzeors pick up picture cerebrate to the af tautenations vigilance makes in financial statements and render a cogitation. Accountants produce the financial statements auditors audit them. 1. 10There be three major compartmentalisations of ASB assertions with several assertions in each classification Transaction Assertions Occurrence a ssertion The objective is to bring in with prove that effective proceeding bragging(a) rise to assets, liabilities, sales and expenses actually transcendred. advert questions include Did the preserve sales proceeding really occur? Completeness and cutoff assertion The objective is to clear with leaven that all executions of the power point are in the financial statements and all transactions that correctly belong in the former or undermentioned postering periods are excluded. Completeness as well as refers to straight-laced comprehension in financial statements of all assets, liabilities, revenue, expense and think disclosures. get a line questions tied to completeness include atomic number 18 the financial statements (including footnotes) complete? and Were all the transactions enter in the right period? Accuracy assertion The objective is to establish with show up that transactions experience been recorded at the make better amount. happen upon questi ons relate to where the expenses recorded at the proper dollar amount? motley assertion The objective is to establish with record that transactions were posted to the correct accounts. disagreeentiate questions relate to was this expense recorded in the sequester account/ Balance AssertionsExistence assertion The objective is to establish with evidence that equilibrise represents assets, liabilities, sales, and expenses that are real and in human race at the ratio tatter date. Key questions relate to does this number truly represent assets that existed at the proportion sheet date? Rights and contracts assertion The objectives related to rights and obligations are to establish with evidence that assets are owned (or rights such as capitalized leases are shown) and liabilities are owed. Key questions related to this assertion include Does the company really own the assets? nd Are related legal responsibilities identified? Completeness assertion The objective is to estab lish with evidence that all balances of the period are in the financial statements. Key questions related to completeness include Are the financial statements (including footnotes) complete? Valuation assertion The objective is to establish with evidence that balances have been valued correctly. Key questions include Are the accounts valued correctly? and Are expenses allocated to the period(s) benefited? Presentation and Disclosure assertionOccurrence assertion The objective is to establish with evidence that transactions giving rise to assets, liabilities, sales and expenses actually occurred. Key questions include are we powerful presenting and disclosing transactions that occurred during this period. Rights and obligations assertion The objectives related to establishing with evidence the proper presentation of assets, liabilities, revenues and expenses to which the company has a legal right or a legal obligation Key questions related to this assertion include Has the compan y mighty presented the assets in its possession? nd Are related legal responsibilities identified and properly disclosed? Completeness assertion The objective is to establish with evidence that all balances of the period are presented and/or disclosed in the financial statements. Key questions related to completeness include Are the financial statements (including footnotes) complete? Accuracy and valuation assertion The objectives are to establish with evidence that balances presented and disclosed in the financial statements have been recorded accurately and have been valued correctly.Key questions include Are the accounts valued correctly? and Are expenses allocated to the period(s) benefited? Classification and belowstandability assertion The objective is to establish with evidence that presentation and disclosures are properly classified on the financial statements and that financial statements including footnotes are understandable to the financial statement users. Key q uestions relate to Is this account properly presented in the correct financial statement category and are the footnote disclosures presented to promote an disposition of the constitution of the account . 11The ASBs assertions are main(prenominal) to auditors because they are the focal points for audit procedures. Further much(prenominal), audit procedures are the means to answer the key questions posed by managements assertions. The ASB assertions are in more detail than the PCAOB assertions and are categorise into transaction assertions, balance assertions, and presentation and disclosure assertions. They include the followers superfluous assertions cutoff, accuracy, valuation, classification, and understandability. Exhibit 1. 4 explains the difference between ASB and PCAOB assertions. . 12Holding a belief that a authority conflict of occupys always exists causes auditors to perform procedures to search for errors or spoofs that would have a veridical effect on financi al statements. This tends to make audits more extensive for the auditor and more expensive for the customer. The situation is not a desirable one in the vast majority of audits where no errors or inventions exist. However, errors and financial composingage frauds have happened too often. Users of financial statements and audit deals inquire auditors to detect square misstatements. . 13Some examples of assurance engagements include Internet Website certification (CPA WebTrust) Accounts receivable review and cash enhancement Third-party reimbursement maximization renting property trading operations review Customer satis concomitantion surveys Benchmarking/best practices Evaluation of investment management policies Fraud and illegal acts prevention and deterrence Information systems security reviews (SysTrust) upcountry audit strategic review . 14Major areas of public account services Assurance services (including audit services and other attestation engagements) valuate consulting services Consulting services 1. 15Operational auditing is the study of business operations for the purpose of do recommendations about the economic and efficient use of resources, effective masterment of business objectives, and entry with company policies. The AICPA views operational auditing as a type of management advisory service offered by public accountancy firms. 1. 6The elements of expanded-scope auditing include (1) financial and sub missionary station audits, (2) economy and susceptibility audits, and (3) program results audits. 1. 17Compliance auditing involves a study of an organizations policies, procedures, and writ of execution in following laws, rules, and regulations. An example is a schools policies, procedures, and death penalty in determining eligibility for a free meal program. 1. 18Other kinds of auditors include IRS agents/auditors, state and federal bank examiners, state insurance department auditors, and fraud auditors. 1. 9The purpose of inveterate education is to ensure that CPAs in practice claim their expertise at a competently high train in light of evolving business conditions and new regulations. For CPAs in public practice, 120 hours of continuing education is mandatory all(prenominal) three old age, with no less(prenominal) than 20 hours in any one year. For CPAs not in public practice, the general beseechment is 120 or fewer (90 in virtually states) every three years. 1. 20Everything cannot be learned in the classroom, and some on-the-job experience is helpful before a person is foisted off on the public as a licensed professional.Also, the experience weeds out some persons who do not want to take the trouble to be intricate in write up work. 1. 21State boards administer the state accountancy laws. State boards make physical arrangements to give the CPA examination, collect the examinations, receive the grades from the AICPA grading activity, and inform candidates whether they passed o r failed. After satisfying state pick upments for education and experience, successful candidates are awarded the CPA certificate by a state board. At the akin time, new CPAs must(prenominal)(prenominal) pay a fee to obtain a state license to practice.Thereafter, state boards of accountancy regulate the behavior of CPAs under their jurisdiction (enforcing state rules of conduct) and supervise the continuing education requirements. 1. 22After becoming a CPA licensed in one state, a person can obtain a CPA certificate and license in other state. The process is known as reciprocity. CPAs can file the proper natural covering with another state board of accountancy, meet the states requirements, and obtain another CPA certificate. Many CPAs hold certificates and licenses in several states. From a global perspective, individuals must be licensed in each country. connatural to CPAs in the United States, Chartered Accountants (CAs) practice in Australia, Canada, Great Britain, and Ind ia. Efforts are currently underway through NASBA to streamline the reciprocity process so that CPAs can practice across state lines without having to have 50 different licenses. SOLUTIONS FOR MULTIPLE CHOICE-QUESTIONS 1. 23a. IncorrectThis is an attestation to the prize promoters claims. b. IncorrectThis is an audit engagement to give an opinion on financial statements. c. IncorrectThis is an assurance engagement on newspapers circulation information. . IncorrectThis is an assurance engagement on the performance of golf balls. e. defineSince attestation and audit engagements are subsets of assurance engagements, all are assurance engagements. 1. 24a. CorrectThis statement characterizes professional agnosticism. b. IncorrectExclusively an auditor is not an predilection that seems to speak of skepticism. c. IncorrectProfessional obligations is not an idea that seems to speak of skepticism. d. IncorrectThis is more an assumption of destiny than of skepticism. 1. 25a.Incorrect W hile work on a forecast is cover by the attestation banals, the auditors should give assurance or a disclaimer. b. Correct This is the basic definition of attestationgiving a report on reliability of an assertion one party makes to another. c. Incorrect Tax work is not an attestation service. d. Incorrect Litigation and expert witness services are not attestation services. 1. 26a. IncorrectThe objective of environsal auditing is to help achieve and maintain configuration with environmental laws and regulations and to help identify and correct unregulated environmental hazards b.IncorrectThe objective of financial auditing is to obtain assurance on the configuration of financial statements with in general trus devilrthy accounting system linguistic rules. c. Incorrect The objective of compliance auditing is the entitys compliance with laws and regulations. d. CorrectOperational auditing refers to the study of business operations for the purpose of making recommendations abou t the economic and efficient use of resources, effective achievement of business objectives, and compliance with company policies. 1. 27a.IncorrectWhile not the primary objective of an operational audit, auditors should hitherto be concerned about compliance with financial accounting standards. b. CorrectThis statement is part of the basic definition of operational auditing. c. IncorrectAn operational audit does not focus on the financial statements. d. IncorrectAnalytical tools and skills are an important part of financial auditing. 1. 28a. CorrectThe proper reference is to the appropriate account framework. b. IncorrectThe AICPA does not refer scarcely to the FASB for the appropriate reporting framework. c.IncorrectThe reference to the SEC is wrong. d. IncorrectThis is an abstract of the AAA definition. 1. 29d. CorrectWhile complexity, remoteness, and consequences are good answers, skepticism, or potential conflict of interest, generally drives the demand for audited financial statements. 1. 30d. CorrectSarbanes-Oxley prohibits the provision of all of the services constituteed in answers a, b, and c, therefore, d (all of the above) is the best response. 1. 31a. IncorrectAuditors do not reduce business risk. b. CorrectAuditors give some assurance that the information risk is low. c.IncorrectComplexity creates demand for accounting services, but is not an audit objective. d. IncorrectAuditors yet in at present check the timeliness of financial statements. 1. 32d. CorrectAnswers a, b, and c refer to a financial statement audit, an native controls attestation engagement, and an operational audit, respectively. Compliance refers to following laws, rules, regulations, and policies. 1. 33d. CorrectWhile answers a, b, and c are true, experience, education, and successful completion of the Uniform CPA are all necessary to be licensed as a CPA. 1. 34d. CorrectThe mission of the U. S.Government Accountability place is to ensure that public officials are utili se public funds efficiently, effectively, and economically. 1. 35b,d CorrectThe ii categories of performance audits are economy and dexterity audit and program audits. 1. 36c. CorrectReview of credit ratings of customers gives indirect evidence of the collectibility (valuation) of accounts receivable. 1. 37a. IncorrectRhondas representations are not commensurate evidence to support assertions made in the financial statements. b. IncorrectDespite Rhondas representations, Jones must gather additional evidence to corroborate Rhondas assertions. . IncorrectRhondas representations are a form of evidence (albeit weak) that should neither be disregarded, nor blindly regarded without professional skepticism. d. CorrectRhondas assertions want corroboration. 1. 38a. IncorrectAlthough there is a high level of risk associated with lymph gland acceptance, this phrase was created by the authors. b. CorrectInformation risk is the prospect that the information circulated by a company will be false or misleading. c. IncorrectMoral hazard is the risk that the existence of a contract will change the behavior of one or both parties to the contract. d.IncorrectBusiness risk is the probability an entity will fail to meet its objectives and, ultimately, fail. 1. 39a. CorrectCompleteness includes cutoff which refers to accounting for revenue, expense, and other transactions in the proper period (neither postponing some recordings to the next period nor accelerating next-period transactions into the current-year accounts). 1. 40d. CorrectThe objective related to rights and obligations is to establish with evidence that amounts reported as assets of the company represent its property rights and that the amounts reported as liabilities represent its obligations. . 41b. Correct directions existence assertion states that reported assets, liabilities, and equities actually exist. 1. 42a. IncorrectUnder Sarbanes-Oxley, professional service firms are prevented from playing in a manage rial decision making role for an audit knob. b. IncorrectUnder Sarbanes-Oxley, professional service firms are prevented from auditing the firms own work on an audit customer. c. IncorrectUnder Sarbanes-Oxley, professional service firms may only furnish tax consulting service to an audit lymph node with the audit committees approval. d.CorrectSarbanes-Oxley prevents professional service firms from engaging in any of the above listed capacities. 1. 43 d. CorrectReciprocity refers to the process through which CPAs licensed in one state can obtain a CPA certificate and license in another state. 1. 44a. CorrectAuditing is a subset of attestation engagements that focuses on the certification of financial statements. b. IncorrectAuditing is a subset of attestation that provides high assurance than that provided by an attestation engagement. c. IncorrectConsulting engagements focus on providing customers with advice and decision support. d.IncorrectAssurance engagements are shapeed to improve the quality of information, or its context, for decision makers. 1. 45d. CorrectAlthough auditing is a subset of attestation, and attestation is a subset of assurance, the focus of the engagements tends to be very specific. 1. 46d. CorrectCredibility, advancement, and monetary rewards are all reasons to become certified. SOLUTIONS FOR EXERCISES AND PROBLEMS 47. Audit, Attestation, and Assurance Services Students may encounter some difficulty with this twinned because the Special Committee on Assurance Services listed many things that heretofore ave been considered attestation services (long before assurance services were invented). Maybe this is a good vehicle for discussing the considerable overlap between attestation services (attestation standards) and assurance services. Real estate demand studies Assurance service (listed by SCAS but not in the textbook chapter) right to vote for awards show Assurance service (listed by SCAS but not in the textbook chapter) But PwC attested to the Academy Awards ballot results long before assurance services were invented Utility rate applications Attestation service (or maybe a consulting service Im somewhat surprised the SCAS did not list it as an assurance service. ) Newspaper circulation audits Assurance service (listed by SCAS but not in the textbook chapter) But this work has appeared in prior years in examples of attestation services Third-party reimbursement maximization Assurance service (listed by SCAS and listed in the textbook chapter) Annual financial report to stockholders Audit service Rental property operations review Assurance service (listed by SCAS and listed in the textbook chapter) Examination of financial forecasts and projections Attestation service (but also listed by SCAS as an assurance service) Customer satisfaction surveys Assurance service (listed by SCAS and listed in the textbook chapter) Compliance with contractual requirements Attestation service (but also liste d by SCAS as an assurance service) Benchmarking/best practices Assurance service (listed by SCAS and listed in the textbook chapter) Evaluation of investment management policies Assurance service (listed by SCAS and listed in the textbook chapter) Information systems security reviews Assurance service (listed by SCAS and listed in the textbook chapter) Productivity statistics Attestation service (but also listed by SCAS as an assurance service under various descriptions) national audit strategic review Assurance service (listed by SCAS and listed in the textbook chapter) pecuniary statements submitted to a bank loan officer Audit service 1. 49 ASB Assertions PCAOB Assertion Corresponding ASB assertion Nature of assertion Existence or Occurrence Existence Balance Occurrence minutes Disclosures Rights and Obligations Rights and Obligations Balances Disclosures Completeness Completeness proceeding Balances Disclosures Cutoff Transactions Valuation and Allocation Accuracy Transactions Disclosures Valuation Balances Disclosures Presentation and Disclosure Classification Transactions Disclosures Understandability Disclosures 1. 52Identification of Audits and Auditors The responses to this matching type of question are ambiguous. The engagement examples are real examples of international, inseparable and governmental audit situations. You talent point out to students that the distinctions among compliance, economy and efficiency and program results audits are not always clear. The solution is shown below in matrix form, showing some engagement numbers in two or three cells. The required schedule follows. Type of Audit Financial Statement Economy, Efficiency curriculum Auditor Compliance Results commutative CPA 2, 10 inwrought Auditor 6, 8 4, 8 political (GAO) 1, 3 1, 3, 9 IRS Auditor 5 deposit Examiner 7 proprietary schools training expenses Economy and Efficiency Program Result s Governmental (GAO) Advertising agency financial statements Financial statement Independent CPAs Dept. f Defense launch vehicle Economy and Efficiency or Program Results Governmental (GAO) Municipal services Economy and Efficiency inbred auditors Tax shelters Compliance IRS auditors Test pilot reporting Compliance Internal auditors Bank solvency Compliance Bank examiners Materials inspection by manufacturer Compliance or Economy and Efficiency Internal auditors States reporting chemical use data Program goal Governmental (GAO) Sports complex forecast Financial statement Independent CPAs SOLUTIONS FOR REVIEW CHECKPOINTS 2. 1For independent ( external) auditors of financial statements, practice standards are issued by the AICPA Auditing specimens Board (in the form of Statements on Auditing Standards) and the Public Company Accounting unmindfulness Board (in the form of Auditing Standards). Statements on Auditing Standards are appropriate for the audits of nonpublic entit ies, musical composition Auditing Standards are appropriate for the audits of public entities. For governmental auditors, the Government Accountability Office issues Government Auditing Standards (also known as the Yellow Book). For internal auditors, the contribute of Internal Auditors issuesStatements of Internal Auditing Standards (also known as the Red Book). For fraud auditors, the Association of Certified Fraud Examiners issues Professional Standards and Practices for Certified Fraud Examiners. For auditors in other countries, the IFAC International Auditing and Assurance Standards Board issues International Standards on Auditing and Assurance. 2. 2 in general original auditing standards are standards that identify necessary qualifications and characteristics of auditors and guide the conduct of the audit examination. Generally accepted accounting principles represent the requirements for the preparation and presentation of financial statements and nonessential footnote di sclosures.These two types of standards are related to one another because a primary objective of a GAAS audit is to allow auditors to conclude whether an entitys financial statements are prepared and presented in conformity with GAAP. 2. 3The three entire principles are 1. Responsibilities, which involves having appropriate competence and capabilities, complying with relevant ethical requirements, maintaining professional skepticism and exercising professional judgment. 2. Performance, which requires auditors to obtain honest assurance about whether the financial statements as a whole are free of material misstatement by (1) planning the work and properly supervising assistants (2) determining and applying appropriate material levels (3) identifying and treasureing the risk of material misstatement and, (4) obtaining sufficient appropriate audit evidence. 3.Reporting, which requires the auditor to express an opinion as to whether the financial statements are prepared in symmetr y with the applicable financial reporting framework. Auditing procedures relate to acts to be performed during the engagement. Auditing standards deal with measures of the quality of performance of those acts and the objectives to be attained. Auditing standards are less subject to change and provide the criteria for rejecting, accepting, or modifying auditing procedures in a given circumstance. An example of the relative perceptual constancy of standards and procedures is found in the change from non- information processing systemized information systems to computerized information systems.New auditing procedures were required to evaluate computerized information systems, but auditing standards remained unchanged and were the criteria for determining the adequacy of the new auditing procedures. 2. 4Independence in fact represents auditors mental attitudes (do auditors truly act in an impartial and impartial fashion with respect to the client and fairness of its financial statemen ts? ). Independence in display relates to financial statement users perceptions of auditors independence. Auditors can be independent in fact but not perceived to be independent. For example, self-possession of a small interest in a public client would probably not influence auditors behavior with respect to the client. However, it is likely that third-party users would not perceive auditors to be independent. 2. Due circumspection reflects a level of performance that would be exercised by credible auditors in similar circumstances. Auditors are expect to have the skills and noesis of others in their profession (known as that of a provident auditor) and are not expected to be infallible. 2. 6Professional skepticism is a state of mind that is characterized by appropriate questioning and a critical sagacity of audit evidence. Professional judgment is the auditors application of relevant training, knowledge, and experience in making informed decisions about appropriate courses o f action during the audit engagement. Auditors are required to demonstrate professional skepticism and professional judgment passim the entire audit process. 2. Reasonable assurance recognizes that a GAAS audit may not detect all material misstatements and auditors are not insurers or guarantors regarding the fairness of the companys financial statements. The following characteristics of an audit do not permit auditors to provide absolute assurance Mistakes and misinterpretations may occur Management judgments and estimates affect financial reporting Audit procedures cannot always be relied upon to detect misstatements Audit engagements must be conducted in spite of appearance a reasonable period of time and so as to achieve a balance between benefit and cost. 2. 8Three elements of planning and supervision considered essential in audit practice are A written audit plan. An misgiving of the clients (auditees) business. Policies to allow an audit team process to document dis agreements with accounting or auditing conclusions and disassociate him or herself from the matter. 2. 9The timing of the auditors appointment is important because auditors need time to properly plan the audit and perform the necessary work without undue pressure from tight deadlines. 2. 10Materiality is the dollar amount that would influence the lending or investing decisions of users this pattern recognizes that auditors should focus on matters that are important to financial statement users. Materiality should be considered in planning the audit, performing the audit, and evaluating the effect of misstatements on the entitys financial statements. 2. 1Auditors obtain an understanding of a client, including its internal control, as a part of the control risk sound judgement process primarily in order to plan the nature, timing and point of substantive audit procedures. A secondary purpose is because of auditors responsibilities for reporting on clients internal controls under Au diting Standard No. 5. 2. 12As the clients internal control is more effective (a lower level of control risk), auditors may use less effective substantive procedures (a higher level of detection risk). Conversely, when the clients internal control is less effective (a higher level of control risk), auditors must use more effective substantive procedures (a lower level of detection risk). 2. 13Audit evidence is define as the information use by auditors in arriving at the conclusion on which the audit opinion is based. 2. 4External documentary evidence is audit evidence obtained from another party to an arms-length transaction or from outside independent agencies. External evidence is received at once by auditors and is not svelte through the clients information processing system. External-internal documentary evidence is documentary material that originates outside the bounds of the clients information processing system but which has been received and processed by the client. Inte rnal documentary evidence consists of documentary material that is produced, circulates, and is finally stored at bottom the clients information processing system. Such evidence is either not circulated to outside parties at all or is several steps outback(a) from third-party attention. 2. 5In general, evidence that is completely external in nature is just about reliable, because the client has not influenced its processing. In contrast, evidence that is completely internal in nature is least reliable, as it may represent a fictitious transaction created or modified by client military group to enhance perceptions of the clients financial statements. 2. 16As auditors need to achieve lower levels of detection risk, more appropriate evidence needs to be obtained. Thus, auditors should gather higher quality evidence (more reliable evidence). For example, auditors may choose to obtain evidence from external sources rather than internal sources.In addition, for lower levels of detecti on risk, auditors need to gather more sufficient evidence. Because sufficiency relates to the quantity of evidence, a greater number of transactions or components of an account balance should be examined. 2. 17A financial reporting framework is a set of criteria used to restrain the measurement, recognition, presentation, and disclosure of material items in the financial statements. The financial reporting framework is related to auditors reporting responsibilities because this framework serves as the nates against which the financial statements are evaluated and the auditors opinion on the financial statements is expressed. 2. 18Four types of opinions and their conclusions Type Conclusion Unqualified opinion Financial statements are presented in conformity with GAAP. Adverse opinion Financial statements are not presented in conformity with GAAP. Qualified opinion Financial statements are presented in conformity with GAAP, except for one or more departures or issues of c oncern. disclaimer of opinion An opinion cannot be issued on the financial statements. 2. 19The auditors report is date at the point when all meaningful procedures have been accomplished by auditors and auditors have gathered sufficient appropriate evidence.This date is referred to as the audit completion date. 2. 20Public accountants should issue a report when they are associated with financial statements because users may mistakenly assume that an audit has been conducted and that the entitys financial statements are evenhandedly presented according to GAAP. 2. 21The purpose served by the attestation standards is to guide work in attestation areas and engagements other than audits of financial statements. 2. 22The major differences between attestation standards and generally accepted auditing standards (GAAS) lie in the areas of practitioner competence, corporality and the risk of material misstatement, and reporting.GAAS presume knowledge of accounting and require competen ce and capabilities as auditors (meaning auditors of financial statements). The attestation standards are more general, requiring training and proficiency in the attest function and knowledge of the subject matter of the assertions. The attestation standards have no specific requirement for determining materiality levels or obtaining and understanding of the entity and its environment to assess the risk of material misstatement. Because attestation engagements may cover information not confined to accounting and financial assertions, these activities may not be appropriate for all attest engagements.Reporting is different because attestations on nonfinancial information do not depend upon generally accepted accounting principles. In addition, GAAS do not address two reporting issues (stating significant reservations about the engagement and indicating that the report is only intended for specified parties) that are important reporting aspects for attestation engagements. 2. 23A sys tem of quality control provides firms with reasonable assurance that the firm and its personnel (1) comply with professional standards and applicable restrictive and legal requirements and (2) issue reports that are appropriate in the circumstances. The six elements of a system of quality control are . Leadership responsibilities for quality within the firm (tone at the top) 2. applicable ethical requirements 3. espousal and continuance of clients 4. Human resources 5. Engagement performance 6. Monitoring 24. In decision making whether to accept or continue an engagement with a client, firms should consider The truth of the client and the identity and business reputation of its owners, key management, related parties, and those aerated with governance. Whether the firm possesses the competency, capability, and resources to perform the engagement. Whether the firm can comply with the necessary legal and ethical requirements.If firms decide to withdraw from an engagement, the firm should document significant issues, consultations, conclusions, and the basis for any conclusions related to the decision to withdraw. 25. Typically, firms that audit nonpublic companies have helpmate reviews conducted through the AICPAs Center for Public Company Audit Firms compeer Review Program. While firms that are subject to PCAOB review requirements can pick to have peer reviews conducted under this program, most choose not to do so. 2. 26The PCAOBs monitoring role for firms providing auditing services to public entities includes registering public accounting firms and conducting inspections of registered public accounting firms (similar to peer reviews). 2. 7The frequency of PCAOB inspections depends upon the number of audits conducted by member firms. For firms performing audits for more than 100 public companies, inspections are required on an annual basis. For those performing audits for fewer than 100 public companies, inspections are conducted every three years. SOLUTIONS FOR MULTIPLE-CHOICE QUESTIONS 2. 28a. CorrectGathering audit evidence is a component of the performance principle. b. IncorrectWhile reasonable assurance is related to gathering audit evidence, this is not one of the categories of principles c. IncorrectThe reporting principle relates to the contents of the auditors report d.IncorrectThe responsibilities principle relates to the personal integrity and professional qualifications of auditors. 2. 29a. IncorrectThis practice relates to accountants competence and capabilities, not due care. b. IncorrectThis practice relates to the reporting principle. c. IncorrectSufficiency of evidence relates to the performance principle and not due care. d. CorrectThese practices are a part of due care. 2. 30a. IncorrectGAAS relates to the conduct of audit engagements and not overall professional services. b. CorrectStandards within a system of quality control are firm- (rather than auditor-) related. c. IncorrectGAAP relates to accounting and financial reporting, rather than auditing practices. d.IncorrectInternational auditing standards govern the conduct of audits conducted across international borders. 2. 31a. IncorrectRelying more extensively on external evidence is related to the appropriateness (or quality) of evidence. b. IncorrectFocusing on items with more significant financial effects on the financial statements is related to materiality. c. CorrectProfessional skepticism is characterized by appropriate questioning and a critical assessment of audit evidence. d. IncorrectFinancial interests are most closely related to auditors independence. 2. 32a. CorrectAuditors study internal control to determine the nature, timing, and point of substantive tests. b.IncorrectConsulting suggestions are secondary objectives in an audit. c. IncorrectInformation about the entitys internal control is, at best, indirect evidence about assertions in the financial statements. d. IncorrectInformation about the entitys internal c ontrol provides auditors with little opportunity to learn about changes in accounting principles. 2. 33a. IncorrectExternal evidence is considered to be relatively reliable. b. CorrectManagement representations should least affect auditors conclusions, as they have not been validated or corroborated by external parties. c. IncorrectAuditor-prepared evidence is considered to be the most reliable form of evidence. d.IncorrectAlthough a representation of a client employee, doubt of the entitys legal counsel is considered more reliable than that of entity management. 2. 34a. IncorrectInquiry of management should least affect auditors conclusions. b. IncorrectAlthough very persuasive, auditors personal knowledge ( superior d) provides the most persuasive evidence c. IncorrectObservation of a clients procedures provides evidence on the effectiveness of the clients internal control, but not the existence assertion for newly-acquired computer equipment. d. CorrectAuditors personal knowledg e provides the most persuasive evidence. 2. 35a. IncorrectInquires of client personnel are the least reliable form of evidence. b.IncorrectWhile more reliable than inquiries (choice a), inspection of internal documents is relatively low in terms of reliability. c. IncorrectWhile sales invoices are documents created by external parties, the fact that these documents were received from client personnel decreases their reliability. d. CorrectBecause the statements were received directly from outside parties, this is a more reliable form of evidence than choice (c). 2. 36a. IncorrectDocumentation of this nature would not be related to independence. b. IncorrectWhile the quality of the financial backing and the conclusions include in the corroboration might provide information about competence and capabilities, choice (c) is more appropriate. c.Correct Initials of the preparer and reviewer provide evidence that the documentation was reviewed, which relates to planning and supervision. d. IncorrectWhile the quality of the documentation and the conclusions include in the documentation might provide information about sufficient appropriate evidence, choice (c) is more appropriate 2. 37NOTE TO INSTRUCTOR Since this question asks students to identify the requirement that is not include in attestation standards, the response labeled correct is not included in attestation standards and those labeled incorrect are included in attestation standards. a. IncorrectAttestation standards require adequate knowledge of the subject matter. b.CorrectAn understanding of the clients environment (including internal control) is not required under attestation standards, because internal control may not always be relevant to the subject matter of the attestation. c. IncorrectAttestation standards require sufficient evidence to be gathered. d. IncorrectAttestation standards require independence in mental attitude. 2. 38NOTE TO INSTRUCTOR Since this question asks students to identify the concept that is least related to due care, the response labeled correct is least related to due care and those labeled incorrect are more related to due care. a. IncorrectDue care requires the level of skills and knowledge of others in the auditors profession, which would require independence in fact. b. IncorrectSee choice (a) above. c. IncorrectDue care refers to the performance of a circumspect auditor. d.CorrectDue care recognizes that mistakes and misinterpretations may occur during the audit. 2. 39a. IncorrectInternal documents are a relatively low quality of evidence. b. IncorrectManagement representations (and the related verbal inquiries) are the lowest quality of evidence. c. IncorrectWhile direct, external evidence is of reasonable quality, it is of lower quality than direct personal knowledge of the auditor (choice d). d. CorrectDirect, personal knowledge of auditors is the most appropriate form of evidence. 2. 40a. IncorrectWhile it may increase auditors knowledge abou t the client, obtaining an understanding of a clients internal control does not directly influence auditors competence and capabilities. b.IncorrectObtaining an understanding of a clients internal control does not directly influence auditors independence. c. IncorrectObtaining an understanding of a clients internal control does not directly help satisfy the quality control standard about audit staff professional development. d. CorrectThe primary purpose of obtaining an understanding of a clients internal control is to plan the nature, timing, and extent of substantive audit procedures on an engagement. 2. 41d. CorrectIndependence substantiations would ensure that all firm personnel are independent with respect to that firms clients, which is related to the relevant Ethical Requirements element of a system of quality control.It would not relate to acceptance and continuance of clients (a), engagement performance (b), or monitoring (c). 2. 42b. CorrectGovernment auditing standards a re issued by the Government Accountability Office (GAO). Governmental accounting standards are issued by the Governmental Accounting Standards Board. 2. 43a. CorrectConsultation with a specialist demonstrates due care if auditors do not have expertise in the area in question. b. IncorrectAuditors are experts in financial matters, not areas of art (and other collectibles) valuation. c. IncorrectGAAS applies to all audit engagements, including audit engagements for not-for-profit organizations. d. IncorrectSince (a) is correct, (d) cannot be correct. 2. 4NOTE TO INSTRUCTOR Since this question asks students to identify the thing that is not been address in the auditors report, the response labeled correct is not addressed in the auditors report and those labeled incorrect are addressed in the auditors report. a. IncorrectThe responsibilities of the auditor and management are provided in the introductory paragraph. b. CorrectAuditors provide reasonable (but not absolute) assurance in a n audit engagement (this is state in the scope paragraph of the auditors report). c. IncorrectA description of the audit engagement is provided in the scope paragraph of the auditors report. d. IncorrectThe auditors opinion on internal control over financial reporting is provided in the internal control paragraph of the auditors report. 2. 45a.CorrectAttestation standards differ from generally accepted auditing standards in that they apply to engagements other than those on historic audited financial statements. b. IncorrectAttestation standards require that the practitioner be independent. c. IncorrectAttestation standards may apply to future what if financial statements. d. IncorrectAttestation standards include requirements related to evidence. SOLUTIONS FOR EXERCISES AND PROBLEMS 2. 47Performance Principle The important elements of the performance principle and their relation to the C. Reis Company audit are 1. Auditors must plan the work and appropriately supervise any assist ants.Fulfilling this element would include the preparation of an audit plan for accounts receivable and reviewing it with the assistant prior to beginning the examination. These tasks were not done. Also, the completed audit documentation should have been reviewed to determine whether an adequate examination was performed. The fiction states that this procedure was followed. 2. Auditors must determine and apply appropriate materiality levels end-to-end the audit. This scenario did not address the process through which materiality levels were determined, so potential strengths and weaknesses related to materiality cannot be assessed. 3. Auditors must identify and assess risks of material misstatement.This element requires auditors to obtain a sufficient understanding of the entity and its environment, including its internal control, to assess the risk of material misstatement of the financial statements whether due to error or fraud, and to design the nature, timing, and extent of further audit procedures. The case presented did not reference any work on the internal control. Complete reliance upon prior-year audit documentation in lieu of an evaluation of the existing internal control is improper, because changes may have been implemented to the system and controls by the client. 4. Auditors must obtain sufficient appropriate audit evidence.The assistants preparation of audit documentation, confirmation requests, and other procedures seem to fulfill the requirements of this standard if the audit work is properly performed and is of sufficient scope. 2. 48Time of Appointment and Planning From a theoretical viewpoint (and, in fact, from a practical viewpoint as well) such short apprisal of a request for an audit causes difficulties with planning the audit work, establishing staffing requirements, and reviewing the work all of these features are important elements in the exercise of due care. The December 26 January 20 period is a serious time constraint for an sign audit engagement.The greatest difficulties involve due care as well as the ability to appropriately perform the engagement (planning and supervision, determining materiality levels, identifying and assessing risks of material misstatement, and obtaining sufficient appropriate evidence). In view of the short circular and the time constraint, there may be some question as to whether an audit could be adequately completed by January 20. 2. 55Principles Case issue Responsibilities 1.Auditors are responsible for appropriate competence and 1. It was inappropriate for Holmes to hire the two students to capabilities to perform the audit. conduct the audit. The examination must be conducted by persons with proper education and experience in the field of auditing. Inexperienced persons can assist, if they are supervised. 2. Auditors are responsible for complying with relevant ethical 2. To satisfy the independence requirement, Holmes must be requiremen ts. without bias with respect to the client under audit. Because of the financial interest in the bank loan, Holmes is neither independent in fact nor appearance with respect to the assignment undertaken. In addition, because of a number of actions (hiring unqualified individuals, failure to supervise those individuals, etc. ), Holmes did not appear to exhibit due care. 3. The fact that Holmes merely accepted the financial statements without questioning any evidence demonstrates neglect of professional 3. Auditors are responsible for maintaining professional skepticism (as well as a lack of good professional judgment). skepticism and exercising professional judgment throughout the planning and performance of the audit. Performance 1. The auditor must adequately plan the work and must properly 1. This element recognizes that primaeval appointment of auditors has supervise any assistants. advantages for auditors and th e client. Holmes accepted the engagement without considering the availability of staff. In addition, Holmes failed to supervise the assistants. The work performed was not adequately planned. 2. The auditor must determine and apply appropriate materiality 2.There was no discussion that appropriate materiality levels level or levels. were determined or applied for the audit by either Holmes or the two accounting students. Thus, compliance with this element is difficult to assess. 3. The auditor must assess the risk of material misstatement based 3. Holmes did not study the clients internal control nor did the on the entity and its environment. assistants. There appears to have been no audit examination at all.The work performed was more an accounting service than it was an auditing service. 4. The auditor must obtain sufficient appropriate audit evidence 4. No evidence was obtained to support the financial statements. about whether mate rial misstatements exist. The auditors merely checked the mathematical accuracy of the records and summarized the accounts. Standard audit procedures and techniques were not performed. Reporting 1. Based on evaluation of the evidence obtained, the auditor 1. Because a proper examination was not conducted, the report expresses an opinion in accordance with the auditors findings, or should indicate that no opinion can be expressed as to the fair states that an opinion cannot be expressed, in the form of a written presentation of the financial statements in accordance with report. The opinion states whether the financial statements are generally accepted accounting principles. prepared, in all material respects, in accordance with the appropriate financial reporting framework. 2. 57System of Quality Control a. Leadership responsibilities for quality within the firm b. Engagement performance c. Human resources d. Monitoring e. Human resources f. Relevant ethical requirements g. Acceptance and continuance of clients h. Leadership responsibilities for quality within the firm i. Engagement performance SOLUTIONS FOR REVIEW CHECKPOINTS 12. Management prepares a report on the effectiveness of internal control over financial reporting. The auditors prepare reports on (1) the entitys financial statement and other disclosures and (2) the effectiveness of the entitys internal control over financial reporting. These can be presented as two separate reports or a combined report. 2. Managements report on internal control over financial reporting consists of the following major components A statement indicating that management is responsible for establishing and maintaining adequate internal control over financial reporting. A statement identifying the framework used by management to assess the effectiveness of the entitys internal control. Managements opinion on the effectiveness of the entitys internal control, including an manifes t statement as to whether the internal control over financial reporting is effective. A statement that the registered accounting firm auditing the financial statements (auditor) has issued an attestation report on the entitys internal control over financial reporting. 12. 3The auditors report serves to communicate to users three specific statements with respect to the financial statements, the conduct of the audit, and the entity in general. First, the report indicates whether the financial statements are presented in conformity with GAAP. Second, auditors use their report to indicate any unusual aspects of the audit examination.Third, even if the financial statements are fairly presented and no problems were noted in the conduct of the audit, the auditors can use the report to communicate information useful to decision makers that may not appear on the face of the financial statements. 12. 4Nine important elements of the auditors standard report are 1. Title. The title should cont ain the word independent, as in Independent Registered Public Accounting Firm or Independent Auditors. 2. Address. The report shall be addressed to the client, which occasionally may be different from the auditee. 3. Notice of Audit. A sentence should identify the financial statements and indicate that they were audited. This appears in the introductory paragraph. 4. Responsibilities.The report should state managements responsibility for the financial statements and the auditors responsibility for the report. These statements are also in the introductory paragraph. 5. Description of the Audit. The second paragraph (scope paragraph) should harbour that the audit was conducted in accordance with the standards of the Public Company Accounting anxiety Board (PCAOB) and describe the principal characteristics of an audit, including a statement of belief that the audit provided a reasonable basis for the opinion. 6. Opinion. The report shall express an opinion (opinion paragraph) regardi ng conformity of the financial statements with accounting principles generally accepted in the United States of America. 7. Internal Control.The report should reference the auditors examination, report, and opinion on the clients internal control over financial reporting. 8. Signature. The auditors (partner of the audit team) shall sign the report, manually or otherwise. 9. Date. The report shall be dated using the date