Auditing and Assurance Services 6th Edition Solution Manual

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Chapter 01-Auditing and Assurance Services1-1CHAPTER01Auditing and Assurance ServicesLEARNING OBJECTIVESReviewCheckpointsMultipleChoiceExercises, Problems,and Simulations1.Defineinformation riskand explain how thefinancial statement auditing process helps toreduce this risk, thereby reducing the cost ofcapital for a company.1, 2, 329, 31, 3857*2.Define and contrastfinancial statementauditing, attestation,andassurance typeservices.4, 5, 6, 7, 823, 25, 28, 44,5052, 57*3.Describe and define the assertions thatmanagement makes about the recognition,measurement, presentation, and disclosure ofthe financial statements and explain whyauditors use them as a focal point of the audit.9, 10, 1136, 39, 40, 41, 45,46, 47, 48, 4954,55, 594.Define professional skepticism and explain itskey characteristics.1224, 37535.Describe the organization of public accountingfirms and identify the various services thatthey offer.13, 1430, 4256*,626.Describe the audits and auditors ingovernmental, internal, and operationalauditing.15, 16, 17, 1826, 27, 32, 34, 3556*, 587.List and explain the requirements forbecoming acertified public accountant (CPA)and other certifications available to anaccounting professional.19, 20, 21, 2233, 43,5160,61(*) Item relates to multiple learning objectives

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Chapter 01-Auditing and Assurance Services1-2SOLUTIONS FOR REVIEW CHECKPOINTS1.1Business risk isthe risk that an entity will fail to meet itsbusinessobjectives.When assessing businessrisk, a professional must considerallpossiblethreats to anentity’s goals and objectives.Some illustrativeexamplesinclude theriskthat: 1)its existingcustomers willstartbuying products or services from itsprimarycompetitors; 2) itsproduct lines will become obsolete; 3) itstaxes will increase; 4) keygovernmentcontracts will be lost; 5) keyemployees willleave the entity; and manyother examples exist.1.2To help minimize business risk and take advantage of other opportunities presented in today’s competitivebusiness environment, decision makers such as chief executive officers (CEOs) demand timely, relevant,and reliable information. There are at least four environmental conditions that increase demand for reliableinformation. First, is complexity which implies that events and transactions in today’s global businessenvironment can be complicated. Most investors do not have the level of expertise needed to properlyaccount for complex transactions. Second is remoteness which implies that decision makers are oftenseparated from current and potential business relationships due to distance and time. For example, investorsmay not be able to visit distant locations to check up on their investments. Third is time-sensitivity whichimplies that in today’s economic environment, investors and other users of financial statements need tomake decisions more rapidly than ever before. As a result, the ability to promptly obtain high-qualityinformation is essential. Fourth isa consequencewhich implies that decisions may very well involvesignificant investments. As a result, the consequences can be severe if information cannot be obtained1.3Of all the different risks discussed in the chapter up to this point, information risk is the one that is mostlikely to create the demand for independent and objective assurance services is information risk or theprobability that the information circulated by an entity will be false or misleading. Because the primarysource of information for investors and creditors is the company itself, an incentive exists for thatcompany’s management to make their business or service appear to be better than it actually may be, to puttheir best foot forward.As a result, preparers and issuers of financial information (directors, managers,accountants, and other people employed in a business) might benefit by giving false, misleading, or overlyoptimistic information. This potential conflict of interest between information providers and users whichprovides the underlying basis for the demand for reliable information.1.4According to the American Accounting Association,“Auditingis a systematic process of objectivelyobtaining and evaluating evidence regarding assertions about economic actions and events to ascertain thedegree of correspondence between the assertions and established criteria and communicating the results tointerested users.”In effect, auditors add reliability to the information that is provided to interested users.Of course, this definition is focused on an external reporting context. Students may also discuss howgovernmental and internal auditors operate as well.In response to “What do auditors do?” students can respond by stating that auditors (1) obtain and evaluateevidence about assertions made by management about economic actions and events, (2) ascertain thedegree of correspondence between the assertions and the appropriate reporting framework, and (3) issue anaudit report (opinion). Students can also respond more generally by stating that auditors essentially lendcredibility to the financial statements presented by management.1.5An attestationengagement is “an engagement in which a practitioner is engaged to issue or does issue awritten communication that expresses a conclusion about the reliability of a written assertion that is theresponsibility of another party”(SSAE 10, AT 101.01). To attest means to lend credibility or to vouch forthe truth or accuracy of the statements that one party makes to another. The attest function is a term oftenapplied to the activities of independent CPAs when acting as auditors of financial statements.1.6Anassuranceservicesengagementis any assignment that improves the quality of information, or itscontext, for decision makers. Because information (e.g., financial statements) are prepared by managers ofan entity who have authority and responsibility for financial success or failure, an outsider may be skepticalthat the information truly is objective, free from bias, fully informative, and free from material error,intentional or inadvertent. The services of an independent auditor helps resolve those doubts because theauditor’s success depends upon his or her independent, objective, and competent assessment of the

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Chapter 01-Auditing and Assurance Services1-3information (e.g., the conformity of the financial statements with the appropriate reporting framework).The independent auditor’s role is to lend credibility to the information; hence, the outsider will likely seekhis or her independent opinion about the financial statements.1.7An assurance service engagement is one that improves the quality of information, or its context, fordecision makers. Thus, an attestation service engagement isone typeof an assurance service.Anotherway of thinking about the issue is to remember thatthe financial statement audit engagement isone typeofan attestation service.Please see exhibit 1.3in the text whichdepicts the relationship among assurance,attestation, and auditing engagements.1.8The four major elements of the broad definition of assurance services areIndependence. CPAs want to preserve their reputation and competitive advantage by always preservingintegrity and objectivity when performing assurance services.Professional services. Virtually all work performed by CPAs is defined as “professional services” as longas it involves some element of judgment based on education and experience.Improving the quality of information or its context. The emphasis is on “information,” CPAs’ traditionalarea of expertise. CPAs can enhance quality by assuring users about the reliability and relevance ofinformation, and these two features are closely related to the familiar credibility-lending products ofattestation and audit services. “Context” is relevance in a different light. For assurance services,improvingthe context of informationrefers to improving its usefulness when targeted to particular decision makers inthe surroundings of particular decision problems.For decision makers. As the “consumers” of assurance services, decision makers are the beneficiaries of theassurance services. Decision makers may or may not be the “client” that pays the fee and may or may notbe one of the parties to an assertion or other information, but they personify the consumer focus of new anddifferent professional work.1.9Financial accounting refers to the process of recording, classifying, summarizing and reporting about acompany’s assets, liabilities, capital, revenues, and expenses in the financial statements in accordance withthe applicable financial reporting framework (e.g., GAAP). In so doing, the management team is making anumber of assertions about the financial statements. The financial accounting process is the responsibilityof the management team. Financial statement auditing refers to the process whereby professional auditorsgather evidence related to the assertions that management makes in the financial statements, evaluates theevidence and concludes on the fairness of the financial statements in a report.They differ because accountants produce the financial statements in accordance with the applicablefinancial reporting framework. After this is complete, financial statement auditors then perform proceduresto ascertain whether the financial statements have been prepared in accordance with the applicable financialreporting framework.1.10The three major classifications of ASB assertions with several assertions in each classification are:Transaction AssertionsOccurrence assertion:The objective is to establish with evidence that transactions giving rise to assets,liabilities, sales, and expenses actually occurred. Key questions include “Did the recorded salestransactions really occur?”Completeness and cutoff assertion:The objective is to establish with evidence that all transactions of theperiod are in the financial statements and all transactions that properly belong in the preceding or followingaccounting periods are excluded. Completeness also refers to proper inclusion in financial statements ofallassets, liabilities, revenue, expense, and related disclosures. Key questions related to completeness include

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Chapter 01-Auditing and Assurance Services1-4“Are the financial statements (including footnotes) complete?” and “Were all the transactions recorded inthe right period?”Accuracy assertion:The objective is to establish with evidence that transactions have been recorded at thecorrect amount. Key questions include “Were the expenses recorded at the proper dollar amount?”Classification assertion:The objective is to establish with evidence that transactions were posted to thecorrect accounts. Key questions include “Was this expense recorded in the appropriate account?”Balance AssertionsExistence assertion:The objective is to establish with evidence that the balance represents assets,liabilities, sales, and expenses that are real and in existence at the balance sheet date. Key questionsinclude “Does this number truly represent assets that existed at the balance sheet date?”Rights and obligations assertion: The objectives related to rights and obligations are to establish withevidence that assets areowned(or rights such as capitalized leases are shown) and liabilities areowed.Keyquestions related to this assertion include “Does the company really own the assets?And“Are related legalresponsibilities identified?”Completeness assertion:The objective is to establish with evidence that all balances of the period are in thefinancial 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 AssertionsOccurrence 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 properly presenting anddisclosing transactions that occurred during this period?”Rights and obligations assertion: The objectives related to establishing with evidence the properpresentation of assets, liabilities, revenues and expenses to which the company has a legal right or a legalobligation Key questions related to this assertion include: “Has the company properly presented the assetsin its possession? And, “Are related legal responsibilities identified and properly disclosed?”Completeness assertion:The objective is to establish with evidence that all balances of the period arepresented and/or disclosed in the financial statements. Key questions related to completeness include: “Arethe financial statements (including footnotes) complete?”Accuracy and valuation assertion:The objectives are to establish with evidence that balances presentedand 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 understandability assertion:The objective is to establish with evidence thatpresentation and disclosures are properly classified on the financial statements and that financial statementsincluding footnotes are understandable to the financial statement users. Key questions relate to “Is thisaccount properly presented in the correct financial statement category” And, “are the footnote disclosurespresented to promote an understanding of the nature of the account?”

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Chapter 01-Auditing and Assurance Services1-51.11The ASB set of management financial statement assertions are important to auditors because they are usedwhen assessing risks by determining the different types of misstatements that could occur for eachassertion. Next, auditors use the assertions to develop audit procedures that are appropriate to mitigate therisk of material misstatement for each assertion. In essence, the key questions that must be answered abouteach of the relevant assertions become thefocal pointsfor audit procedures. Audit procedures are themeans to answer the key questions posed by management’s financial statement assertions. In fact, theprocedures are completed to provide the evidence necessary to persuade the auditor that there is no materialmisstatement related to each of the relevant assertions identified for an engagement.The ASB assertions differ from the PCAOB assertions in that they provide greater detail and clarity forauditors to conceptualize the type of misstatements that may exist in the financial statements. Thus, thePCAOB assertions are more general than the ASB assertions. Importantly, the PCAOB recognizes thattheir assertions are more general and do allow auditors to use the more granular and specific ASBassertions when completing the audit. As a result,largely all of the firms auditing public companies withinternational operations feature the ASB assertions to guide their auditing processes. Importantly, a studentof auditing will note that the ASB assertions are in direct alignment with the PCAOB assertions. This isillustrated in the text in Exhibit 1.41.12Holding a belief that a potential conflict of interest always exists between the auditor and the managementteam causes auditors to always be skeptical when completing the audit. Indeed, even though the vastmajority of audits do not contain fraud, auditors have no choice but to consider the possibility of fraud onevery audit. Stated simply, errors and financial reporting frauds have happened in the past, and users offinancial statements and audit reports expect auditors to detect material misstatements if they exist.Indeed, auditing firms have long recognized the importance of exercising professional skepticism whenmaking professional judgments. As a student of auditing, you can definitely expect to encounter difficulteconomic transactions as an auditor. When a difficult transaction is encountered, auditors must take thetime to fully understand the economic substance of that transaction and then critically evaluate, withskepticism, the evidence provided by the client to justify its accounting treatment. There are no shortcutsallowed. Rather, auditors must always hold a belief that a potential conflict of interest exist between theauditor and management and they must be unbiased and objective when making their professionaljudgments.1.13Generally speaking, assurance services involve the lending of credibility to information, whether financialor nonfinancial. CPAs have assured vote counts (Academy Awards), dollar amounts of prizes thatsweepstakes have claimed to award, accuracy of advertisements, investment performance statistics, andcharacteristics claimed for computer software programs. Some specificexamples of assurance serviceengagementsperformed onnonfinancial informationinclude•eXtensible Business Reporting Language (XBRL) reporting.•Enterprise risk management assessment.•Information risk assessment and assurance.•Third-party reimbursement maximization.•Rental property operations review.•Customer satisfaction surveys.•Evaluation of investment management policies.•Fraud and illegal acts prevention and deterrence.•Internal audit outsourcing.

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Chapter 01-Auditing and Assurance Services1-61.14There are three major areas of public accounting services•Financial Statement Audit and other types ofAssurance services.•Tax services.•Consulting and Advisory services.1.15Operational auditingis the study of business operations for the purpose of making recommendations aboutthe economic and efficient use of resources, effective achievement of business objectives, and compliancewith company policies. The AICPA views operational auditing as a type ofconsulting oradvisory serviceoffered by public accounting firms.1.16The GAO is very clear on this point. Specifically, the elements ofexpanded-scope auditinginclude (1)financial and compliance audits, (2) economy and efficiency audits, and (3) program results audits.1.17Compliance auditinginvolves a study of an organization’s policies, procedures, and, ultimately, itsperformance in following applicable laws, rules, and regulations. An examplewould bea schooldistrict’spoliciesandproceduresrelated to ameal program for its students. In thesetypesof situations, there wouldbe a demand for a compliance audit which would be designed to insure that the school district complieswith the stated policies and procedures of the program.1.18Other kinds of auditors include Internal Revenue Service auditorswho are required to audit thetaxableincomeand deductions takenby taxpayers in tax returns and determine their correspondence with thestandardsfound in the Internal Revenue Code. They alsomight have toaudit for fraud and tax evasion.Other examples include state and federal bank examinerswho are responsible forauditingbanks, savingsand loan associations, and otherfinancial institutions for evidence of solvency and compliance withbanking and otherrelated lawsand regulations.1.19The purpose of the continuing education requirement is to ensure that CPAs in practice maintain theirexpertise at a sufficiently high level in light of evolving business conditions and new regulations. ForCPAs in public practice, 120 hours of continuing education is required every three years with no less than20 hours in any one year. For CPAs not in public practice, the general requirement is 120 or fewer (90 insome states) every three years.1.20Not everything can be learned in the classroom, and some on-the-job experience is helpful before a personis able to be held out to the public as a licensed professional. Also, the experience requirement tends to“weed out” those individuals who are just looking to become certified without ever being involved in actualaccounting work.1.21State boards administer the state accountancy laws and are responsible for ensuring that candidates havepassed the CPA examination and satisfied the state requirements for education and experience before beingawarded a CPA certificate. At the same time, new CPAs must pay a fee to obtain a state license to practice.Thereafter, state boards of accountancy regulate the behavior of CPAs under their jurisdiction (enforcingstate rules of conduct) and supervise the continuing education requirements. As a result, the state boardsplay an important role in the CPA certification and licensure process.1.22After becoming a CPA licensed in one state, a person can obtain a CPA certificate and license in anotherstate. The process is known asreciprocity. CPAs can file the proper application with another state board ofaccountancy, meet the state’s requirements, and obtain another CPA certificate. Many CPAs holdcertificates and licenses in several states. From a global perspective, individuals must be licensed in eachcountry. Similar to CPAs in the United States, chartered accountants (CAs) practice in Australia, Canada,Great Britain, and India.

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Chapter 01-Auditing and Assurance Services1-7SOLUTIONS FOR MULTIPLE CHOICE-QUESTIONS1.23a.IncorrectThis is an attestation to the prize promoter’s claims. Because attestation andaudit engagements are subsets of assurance engagements, this is an example ofan assurance engagement. However, each response is an example of anassurance engagement; thus, the answer is (e).b.IncorrectThis is an audit engagement to give an opinion on financial statements. Becauseattestation and audit engagements are subsets of assurance engagements, this isan example of an assurance engagement. However, each response is an exampleof an assurance engagement; thus, the answer is (e).c.IncorrectThis is an assurance engagement onanewspaper’s circulation data. Becauseattestation and audit engagements are subsets of assurance engagements, all areassurance engagements. Thus, the answer is (e).d.IncorrectThis is an assurance engagement on the performance of golf balls. Becauseattestation and audit engagements are subsets of assurance engagements, all areassurance engagements. Thus, the answer is (e).e.CorrectBecause attestation and audit engagements are subsets of assuranceengagements, allof the responsesareexamples ofassurance engagements.1.24a.CorrectThe management team is generally trying to put its “best foot forward” whenreporting their financial statement information. The auditor must make sure thatthe management team does not violate the accounting rules when doing so. INessence, this statement characterizeswhyprofessional skepticismis required tobe exercised by auditors.b.Incorrect“Exclusively in the capacity of an auditor” is not an idea thatrelates to anattitude of professionalskepticism.c.IncorrectProfessional obligationsarenotrelated to an attitude of professionalskepticism.d.IncorrectWhile it is true that financial statement and financial data are verifiable, thisdoes not related to the reasons why an auditor needs to begin an audit with anattitude of professionalskepticism.1.25a.IncorrectWhile work on a forecastwould potentially becovered by the attestationstandards, the auditorsmust provide assurance about some type of managementassertion in an attestation engagement.b.CorrectThis is the basic definition ofanattestationservice, as articulated in the bookand the professional standards.c.IncorrectSince there is no assurance about any management assertion when preparing atax return with information that has not been reviewed or audited, this type oftax work is notconsideredan attestation service.d.IncorrectSince there is no assurance about any management assertion when giving experttestimony about particular facts in an income tax case, this type of work is notconsidered an attestation service.1.26a.IncorrectThe objective of environmental auditing is to help achieve and maintaincompliance with environmental laws and regulations and to help identify andcorrect unregulated environmental hazards. This answer is therefore incorrect.b.IncorrectThe objective of financial auditing is to obtain assurance on the conformity offinancial statements with generally accepted accounting principles. This answeris therefore incorrect.c.IncorrectThe objective of compliance auditing is the entity’s compliance with laws andregulations. This answer is therefore incorrect.d.CorrectOperational auditing refers to the study of business operations for the purpose ofmaking recommendations about the economic and efficient use of resources,effective achievement of business objectives, and compliance with companypolicies.

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Chapter 01-Auditing and Assurance Services1-81.27a.IncorrectThis is not the primary objective of an operational audit. However, whilecompleting anoperational audit,a professionally skepticalauditor should still beconcerned about compliance with financial accounting standards.b.CorrectThis statementexactly characterizes the goal of an operational audit. Inaddition, the statementis part of the basic definition of operational auditing.c.IncorrectAn operational audit does not focus on the financial statementsof an entity.d.IncorrectWhile analytical tools and skillsmay be used during an operational audit, theyare also a very important aspect offinancial auditing.1.28a.CorrectAccording to the AICPA definition found in AU 200 (paragraph 11) and in yourbook, “the purpose of an audit is to enhance the degree of confidence thatintended users can place in the financial statements. This is achieved by theexpression of an opinion by the auditor on whether the financial statements areprepared, in all material respects, in accordance with an applicable financialreporting framework. As a result, this is the correct response.b.IncorrectThe AICPAdefinition is not limited tothe FASB for the appropriate reportingframeworkthat is used as the benchmark when completing an audit. Thedefinition is general enough to include other financial reporting frameworks aswell, such as IFRS.c.IncorrectThe AICPA definition does not focus on the SEC as an appropriate reportingframework to be used as a benchmark when completing an audit. The definitionis focused on the “applicable” financial reporting framework, such as GAAP orIFRS.The reference to the SEC is wrong.d.IncorrectThisphrase is not referenced in the AICPA definition found in the auditingstandards. Thisphrase is found in theAAA definitionof the audit found in thisbook.1.29a.IncorrectWhile complexity is an important condition that increases the demand forreliable information, the potential conflict of interest between management andthe bank is far and away the biggest factor driving the demand for auditedfinancial statements.b.IncorrectWhileremotenessis an important condition that increases the demand forreliable information, the potential conflict of interest between management andthe bank is far and away the biggest factor driving the demand for auditedfinancial statements.c.IncorrectWhile the consequences of making a bad decision are an important conditionthat increases the demand for reliable information, the potential conflict ofinterest between management and the bank is far and away the biggest factordriving the demand for audited financial statements.d.CorrectThe potential conflict of interest between management and the bank is far andaway the biggest factor driving the demand for audited financial statements.Consider for example a company that was desperate for cash in order to survive.Would it be possible that the management team would present unreliablefinancial statements to the bank in order to get a desperation loan? Because ofthis possibility, a financial statement audit is needed to add credibility to thefinancial statements.1.30a.IncorrectAccording to Section 201 of the Sarbanes-Oxley Act, bookkeeping services areprohibited.b.IncorrectAccording to Section 201 of the Sarbanes-Oxley Act, internal audit services areprohibited.c.IncorrectAccording to Section 201 of the Sarbanes-Oxley Act, valuation services areprohibited.d.CorrectSarbanes-Oxley prohibits the provision of all of the services listed in answers a,b, and c; therefore, d (all of the above) is the best response.

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Chapter 01-Auditing and Assurance Services1-91.31a.IncorrectFinancial statement auditors do not reduce business risk.b.CorrectAfter completing a financial statement audit, information risk has been reducedfor investors.c.IncorrectComplexity creates demand for accounting services but is not an objectiveof thefinancial statement audit.d.IncorrectAuditorsdo notdirectly control the timeliness of financial statements.Management must first provide the information to be audited.1.32a.IncorrectA financial statement opinion is the objective of a financial statement audit, nota compliance audit.b.IncorrectA basis for a report on internal control is the objective of an internal controlaudit under Section 404 of the Sarbanes-Oxley Act, not a compliance audit.c.IncorrectA study of effective and efficient resources is the objective of an operationalaudit, not a compliance audit.d.CorrectAcompliance audit referstoprocedures that are designed to ascertain that thecompany’s personnel arefollowing laws, rules, regulations, and policies.1.33a.IncorrectWhile successful completion of the Uniform CPA is necessary to be licensed asa CPA, a candidate also requires the proper experience and proper education.Thus, letter (d.) is correct.b.IncorrectWhile proper experience is necessary to be licensed as a CPA, a candidate alsorequires the successful completion of the Uniform CPA and proper education.Thus, letter (d.) is correct.c.IncorrectWhile proper education is necessary to be licensed as a CPA, a candidate alsorequires the successful completion of the Uniform CPA and proper experience.Thus, letter (d.) is correct.d.CorrectA candidate requires the successful completion of the Uniform CPA, properexperience and proper educationto be licensed as a CPA.1.34a.IncorrectThe GIAA is not responsible for monitoring the use of public funds by publicofficials. This is the responsibility of the GAO.b.IncorrectThe CIA is not responsible for monitoring the use of public funds by publicofficials. This is the responsibility of the GAO.c.IncorrectThe SEC is not responsible for monitoring the use of public funds by publicofficials. This is the responsibility of the GAO.d.CorrectThe mission of the U.S. Government Accountability Office is to ensure thatpublic officials are using public funds efficiently, effectively, and economically.1.35a.IncorrectA financial audit is typically not included as part of a performance audit.b. (&d)CorrectThe two categories of performance audits are economy and efficiency audits andprogram audits.c.IncorrectA compliance audit is typically not included as part of a performance audit.d. (&b)CorrectThe two categories of performance audits are economy and efficiency audits andprogram audits.1.36a.IncorrectA review of credit ratings of customers would not provide evidence about thecompleteness of accounts receivable. Because GAAP requires the accountsreceivable balance to be valued at the amount expected to be collected fromcustomers, the review of credit ratings relates to valuation.b.IncorrectA review of credit ratings of customers would not provide evidence about theexistence of accounts receivable. Because GAAP requires the accountsreceivable balance to be valued at the amount expected to be collected fromcustomers, the review of credit ratings relates to valuation.c.CorrectA review of credit ratings ofcustomers’gives indirect evidence of thecollectability of accounts receivable. Because GAAP requires the accounts

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Chapter 01-Auditing and Assurance Services1-10receivable balance to be valued at the amount expected to be collected fromcustomers, the review of credit ratings relates to valuation.d.IncorrectA review of credit ratings of customers would not provide evidence about therights of accounts receivable.Because GAAP requires the accounts receivablebalance to be valued at the amount expected to be collected from customers, thereview of credit ratings relates to valuation.e.IncorrectA review of credit ratings of customers would not provide evidence about theoccurrence of accounts receivable. Because GAAP requires the accountsreceivable balance to be valued at the amount expected to be collected fromcustomers, the review of credit ratings relates to valuation.1.37a.IncorrectRhonda’s representations are not sufficient evidence to support assertions madein the financial statements.b.IncorrectDespite Rhonda’s representations, Jones must gather additional evidence tocorroborate Rhonda’s assertions.c.IncorrectRhonda’s representations are a form of evidence (albeit weak) that shouldneither be disregarded nor blindly regarded without professional skepticism.d.CorrectRhonda’s assertions are nice. However, to be considered as sufficient toconclude that all expenses have been recorded, they will need corroboration withdocumentary evidence.Thus, this is the correct response.1.38a.IncorrectAlthough there is a high level of risk associated with client acceptance, thisphrase was created by the authors.b.CorrectBy definition, information risk is the probability that the information circulatedby a company will be false or misleading.c.IncorrectMoral hazard is the risk that the existence of a contract will change the behaviorof one or both parties to the contract.d.IncorrectBusiness risk is the probability an entity will fail to meet itsstrategicobjectives.1.39a.CorrectThis is clearly a test of the completenessas the assertion alwaysincludesanyissues of transactioncutoff, whichmeans that the recording of allrevenue,expense, and other transactionsmust be includedin the proper periodinaccordance with GAAP.b.IncorrectThis is not an existence test. This is clearly a test of the completeness as theassertion always includes any issues of transaction cutoff, which means that therecording of all revenue, expense, and other transactions must be included in theproper period in accordance with GAAP.c.IncorrectThis is not a test of valuation. This is clearly a test of the completeness as theassertion always includes any issues of transaction cutoff, which means that therecording of all revenue, expense, and other transactions must be included in theproper period in accordance with GAAP.d.IncorrectThis is not a test of rights and obligations. This is clearly a test of thecompleteness as the assertion always includes any issues of transaction cutoff,which means that the recording of all revenue, expense, and other transactionsmust be included in the proper period in accordance with GAAP.e.IncorrectThis is not an occurrence test. This is clearly a test of the completeness as theassertion always includes any issues of transaction cutoff, which means that therecording of all revenue, expense, and other transactions must be included in theproper period in accordance with GAAP.1.40a.IncorrectThis is not a completeness test. This is clearly a test related to rights andobligations as the question that must be answered with evidence is to establishthat amounts reported as assets of the company represent true assets that it reallydoes own and that the amounts reported as liabilities truly represent itsobligations. Goods on consignment, by definition, are not owned by the

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Chapter 01-Auditing and Assurance Services1-11company. Thus, there is a risk that the company is recording assets that they donot own on their balance sheet.b.IncorrectThis is not an existence test. This is clearly a test related to rights andobligations as the question that must be answered with evidence is to establishthat amounts reported as assets of the company represent true assets that it reallydoes own and that the amounts reported as liabilities truly represent itsobligations. Goods on consignment, by definition, are not owned by thecompany. Thus, there is a risk that the company is recording assets that they donot own on their balance sheet.c.IncorrectThis is not a test of valuation. This is clearly a test related to rights andobligations as the question that must be answered with evidence is to establishthat amounts reported as assets of the company represent true assets that it reallydoes own and that the amounts reported as liabilities truly represent itsobligations. Goods on consignment, by definition, are not owned by thecompany. Thus, there is a risk that the company is recording assets that they donot own on their balance sheet.d.CorrectThis is clearly a test related to rights and obligations as the question that must beanswered with evidence is to establish that amounts reported as assets of thecompany represent true assets that it really does own and that the amountsreported as liabilities truly represent its obligations. Goods on consignment, bydefinition, are not owned by the company. Thus, there is a risk that thecompany is recording assets that they do not own on their balance sheet.e.IncorrectThis is not an occurrence test.This is clearly a test related to rights andobligations as the question that must be answered with evidence is to establishthat amounts reported as assets of the company represent true assets that it reallydoes own and that the amounts reported as liabilities truly represent itsobligations. Goods on consignment, by definition, are not owned by thecompany. Thus, there is a risk that the company is recording assets that they donot own on their balance sheet.1.41a.IncorrectThis is not a test of completeness. This is a test of existence which is completedby auditors to answer the question as to whether the transactions recorded as anasset really represent assets that exist and did add value to the company’sequipment as compared to routine repair and maintenance expenses underGAAP. Management’s existence assertion states that the reported assetsactually exist. If an addition to the equipment account cannot be located oridentified as adding value to the equipment balance, it is possible that theamount should have been classified as repair and maintenance expenses underGAAP.b.CorrectThis is a test of existence. This test is completed by auditors to answer thequestion as to whether the transactions recorded as an asset really representassets that exist and did add value to the company’s equipment as compared toroutine repair and maintenance expenses under GAAP. Management’sexistence assertion states that the reported assets actually exist. If an addition tothe equipment account cannot be located or identified as adding value to theequipment balance, it is possible that the amount should have been classified asrepair and maintenance expenses under GAAP.c.IncorrectThis is not a test ofvaluation. This is a test of existence which is completed byauditors to answer the question as to whether the transactions recorded as anasset really represent assets that exist and did add value to the company’sequipment as compared to routine repair and maintenance expenses underGAAP. Management’s existence assertion states that the reported assetsactually exist. If an addition to the equipment account cannot be located oridentified as adding value to the equipment balance, it is possible that theamount should have been classified as repair and maintenance expenses underGAAP.

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Chapter 01-Auditing and Assurance Services1-12d.IncorrectThis is not a test of rights and obligations. This is a test of existence which iscompleted by auditors to answer the question as to whether the transactionsrecorded as an asset really represent assets that exist and did add value to thecompany’s equipment as compared to routine repair and maintenance expensesunder GAAP. Management’s existence assertion states that the reported assetsactually exist. If an addition to the equipment account cannot be located oridentified as adding value to the equipment balance, it is possible that theamount should have been classified as repair and maintenance expenses underGAAP.e.IncorrectThis is not a test of occurrence. This is a test of existence which is completed byauditors to answer the question as to whether the transactions recorded as anasset really represent assets that exist and did add value to the company’sequipment as compared to routine repair and maintenance expenses underGAAP. Management’s existence assertion states that the reported assetsactually exist. If an addition to the equipment account cannot be located oridentified as adding value to the equipment balance, it is possible that theamount should have been classified as repair and maintenance expenses underGAAP.1.42a.IncorrectUnder Sarbanes-Oxley, public accountingfirms are prevented from acting in amanagerial decision-making role for an audit client.b.IncorrectUnder Sarbanes-Oxley, public accountingfirms are prevented from auditing thefirm’s own work on an audit client.c.IncorrectUnder Sarbanes-Oxley, public accountingfirms mayonlyprovide tax consultingservicesto an audit client with the audit committee’s approval.d.CorrectSarbanes-Oxley prevents public accounting firmsfromserving an audit client inany of the preceding listedroles. As a result, each of the responsesa, b, and cisincorrect andletter d isthe correct response.1.43a.IncorrectSubstantialequivalencydoesnotrefertothefinancialstatementauditingprocess.The term relates to the practice of public accountancy in states otherthan a CPA’s state of licensure.b.IncorrectSubstantial equivalency does not refer to consulting services.The term relatesto the practice of public accountancy in states other than a CPA’s state oflicensure.c.IncorrectSubstantial equivalency does not refer to other professional organizations.Theterm relates to the practice of public accountancy in states other than a CPA’sstate of licensure.d.CorrectSubstantial equivalency relates to the practice of public accountancy in statesother than a CPA’s state of licensure.Under the concept ofsubstantialequivalency, as long as the licensing (home) state requires (1) 150 hours ofeducation, (2) successful completion of the CPA exam, and (3) one year ofexperience, a CPA can practice (either in person or electronically) in anothersubstantial equivalency state without having to obtain a license in that state.1.44a.CorrectAuditing isasubset of attestation engagements that focuses on the certificationof financial statements.The subject matter is the set of financial statementsfrom management and the criteria is GAAP in the United States.b.IncorrectThat is not true.Auditing isone example of an attest engagement.The level ofassurance provided is not lower for an attestation engagement.c.IncorrectThat is not true. The auditor is not allowed to provide management support forits audit clients. Rather, consulting engagementscanfocus on providing clientswith advice and decision support.d.IncorrectThe definition provided is the one for assurance engagements, which is quitebroad and includes all engagements that aredesigned to improve the quality ofinformation, or its context, for decision makers.

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Chapter 01-Auditing and Assurance Services1-131.45a.CorrectManagement is more likely to overstate assets and understate liabilities. As aresult, when auditing an asset balance, the most relevant assertions are likely tobe either existenceor valuation. In this situation, because of the nature of cashand the fact that is no foreign currency translation calculation, the existenceassertion is clearly the most important assertion.b.IncorrectAlthough rights and obligations is an important assertion, it is not the mostrelevant assertion for the cash balance. Since management is more likely tooverstate assets, when auditing an asset balance, the most relevant assertions arelikely to be either existence or valuation. In this situation, because of the natureof cash and the fact that is no foreign currency translation calculation, theexistence assertion is clearly the most important assertion.c.IncorrectAlthough valuation is an important assertion, it is not the most relevant assertionfor the cash balance. In this situation, because of the nature of cash and the factthat is no foreign currency translation calculation, the existence assertion isclearly the most important assertion. If however, there was a foreign currencytranslation adjustment, valuation of cash would also be relevant.d.IncorrectAlthough occurrence is an important assertion, it is not the most relevantassertion for any balance sheet account. Rather, the occurrence assertion is moreclosely related to income statement accounts because the question that needs tobe answered with evidence is whether the transaction really did occur inaccordance with GAAP. In this situation, because of the nature of cash and thefact that is no foreign currency translation calculation, the existence assertion isclearly the most important assertion.1.46a.IncorrectThis evidence would provide evidence about management’s assertion aboutrights and obligations and perhaps existence. However, this evidence would nothelp to value the investmentin accordance with GAAP.b.IncorrectWhile thisevidence would potentially be helpful to value an investment inanother company, it is not the best answer. If a quote was available from anindependent source, this would be a better form of evidence for valuation.c.IncorrectThis evidence would provide evidence about management’s assertion aboutexistence and perhaps rights and obligations. However, this evidence would nothelp to value the investment in accordance with GAAP.d.CorrectAlways remember that management is more likely to overstate assets. As aresult, when auditing an asset balance like investments, a relevant assertion islikely to be valuation. In this situation, to answer the question of what theinvestment should be valued at in the balance sheet, an auditor would first seekto obtain a market quotation from an independent source like the Wall StreetJournal.1.47a.IncorrectThis test is not related to presentation and disclosure. A cutoff testis clearly atest of the completeness assertionas the test is designed to insure that alltransactionsthat should have been includedin accordance with GAAPhavebeen recorded.b.CorrectA cutoff test is clearly a test of the completeness assertion as the test is designedto insure that all transactions that should have been included in accordance withGAAP have been recorded.c.IncorrectThis test is not related to rights and obligations. A cutoff test is clearly a test ofthe completeness assertion as the test is designed to insure that all transactionsthat should have been included in accordance with GAAP have been recorded.d.IncorrectThis test is not related to existence. A cutoff test is clearly a test of thecompleteness assertion as the test is designed to insure that all transactions thatshould have been included in accordance with GAAP have been recorded.

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Chapter 01-Auditing and Assurance Services1-141.48a.IncorrectThistest is designed to test the completeness assertion for the inventory account.It does not provide any evidence related to the rights and obligations assertion.b.CorrectThis is clearly a test related to rights and obligations as the question that must beanswered with evidence is to establish that the inventory reported as assets reallyis owned by the company. Goods on consignment, by definition, are not ownedby the company. Thus, there is a risk that the company is recording assets thatthey do not own on their balance sheet.c.IncorrectThistest is designed to test the completeness assertion for sales revenue. It doesnot provide evidence related to the rights and obligations assertion for inventory.d.IncorrectThis test is designed to test the presentation and disclosure assertion forinventory purchase commitments. It does not provide evidence related to therights and obligations assertion for inventory.1.49a.IncorrectManagement isfarmore likely to understate liabilitiesthan to overstate them.As a result, when auditing the accrued liabilities account,existence oroccurrence is not as likely to be violated. Rather,the most relevant assertionislikely to be completeness.b.CorrectManagement is more likely to understate liabilities. As a result, when auditingthe accrued liabilities account, the most relevant assertion is likely to becompleteness.c.IncorrectManagement is far more likely to understate liabilities. As a result, whenauditing the accrued liabilities account, the most relevant assertion is likely to becompleteness. Presentation and disclosure may be relevant. However, it is notas likely to contain a material misstatement as completeness.d.IncorrectManagement is far more likely to understate liabilities than to overstate them.As a result, when auditing the accrued liabilities account, the most relevantassertion is likely to be completeness. Valuation may be relevant. However, it isnot as likely to contain a material misstatement as completeness.1.50a.IncorrectThis is not correct as an auditing engagement refers to an examination of thefinancial statements to determine whether the information has been presented inaccordance with GAAP.Also, a consulting engagement is one where theprofessional provides advice and decision support.b.IncorrectThis is not correct as a consulting engagement is one where the professionalprovides advice and decision support. Also, an assurance engagement caninclude many more types of information than just the financial statements.c.IncorrectThis is not correct as an auditing engagement refers to an examination of thefinancial statements to determine whether the information has been presented inaccordance with GAAP. Also, a consulting engagement is one where theprofessional provides advice and decision support.d.CorrectThis is correct as an auditing engagement refers to an examination of thefinancial statements to determine whether the information has been presented inaccordance with GAAP and an attestation engagement can include a financialstatement audit. In addition, An assurance engagement can apply to all types ofinformation and a consulting engagement is one where the professional providesadvice and decision support.1.51a.IncorrectCredibility is a reason to become certified. Because all three responses arereasons, (d) is correct.b.IncorrectAdvancement and promotion are reasons to become certified. Because all threeresponses are reasons, (d) is correct.c.IncorrectMonetary reward is a reason to become certified. Because all three responses arereasons, (d) is correct.d.CorrectCredibility, advancement, and monetary rewards are all reasons to becomecertified.

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Chapter 01-Auditing and Assurance Services1-15SOLUTIONS FOR EXERCISES AND PROBLEMS1.52Audit, Attestation, and Assurance ServicesStudents may encounter some difficulty with this matching question because the Special Committee onAssurance Services (SCAS) listed many things that heretofore have been considered “attestation services”(long before assurance services were invented). As a result, we believe that this question is a good vehiclefor discussing the considerable overlapthat existsbetween attestation and assurance services.•Real estate demand studies: Assurance service•Ballot for awards show: Assurance service•Utility rates applications: Assurance service•Newspaper circulation audits: Assurance service•Third-party reimbursement maximization: Assurance service•Annual financial report to stockholders: Audit service•Rental property operations review: Assurance service•Examination of financial forecasts and projections: Attestation service•Customer satisfaction surveys: Assurance service•Compliance with contractual requirements: Attestation service•Benchmarking/best practices: Assurance service•Evaluation of investment management policies: Assurance service•Information systems security reviews: Assurance service•Productivity statistics: Assurance service•Internal audit strategic review: Assurance service•Financial statements submitted to a bank loan officer: Audit service1.53Controller as AuditorWhen Hughes Corporation hired the CPA, she or he can no longer be considered independent with respectto the annual audit and, as a result, can no longer perform an independent audit of the financial statements.It is true that the in-house CPA can perform all procedural analyses that would be required of anindependent audit; however, it is extremely unlikely that the CPA could inspire the confidence of users offinancial statements outside the company. Because she or he is no longer independent of the company, theCPA cannot modify the perception of potential conflict of interest that creates demand for the independentaudit. As a matter of ethics rules, this CPA would be prohibited from signing the standard unqualifiedattest opinion. Moreover, if Hughes were a public company, under Sarbanes-Oxley, it would be restrictedfrom hiring one of its auditors into a senior accounting position for a full year under Section 206 of the law.

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