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Solution Manual For Auditing: A Practical Approach with Data Analytics, 1st Edition

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    1 CHAPTER 1 Introduction and Overview of Audit Assurance Learning Objectives 1. D ifferentiate among assurance, attestation, and audit services . 2. D escribe the different types of assurance services . 3. Explain the demand for audit and assurance services . 4. Dis cuss the different roles of the financial statement preparer and the auditor . 5. Identify the roles of different regulators and organizations that affect the audit profession . 6. E xplain the concepts of reasonable assurance, materiality, and the nature of an unqualified/unmodified report on the audit of financial statements . 7. Explain the concept of reasonable assurance and the nature of an unqualified report on internal controls over financial reporting. 8. Discuss the audit expectation gap. ANSWERS TO MULTIPLE - CHOICE QUESTIONS 1. C LO 1, BT: C , Difficulty: Easy , TOT: 2 min., AACSB: None , AICPA A C: Risk Assessment, Analysis and Management , Section: Assurance, Attestation, and Audit Services 2. A LO 2 , BT: C , Difficulty: Easy , TOT: 2 min., AACSB: None , AICPA A C: Risk Assessment, Analysis and Management , Section: Different Assurance Services 3. B LO 2 , BT: C , Difficulty: Easy , TOT: 2 min., AACSB: None , AICPA A C: Risk Assessment, Analysis and Management , Section: Different Assurance Services 4. C LO 2 , BT: C , Difficulty: Medium , TOT: 2 min., AACSB: None , AICPA A C: Risk Assessment, Analysis and Management , Section: Different Assurance Services 5. C LO 3 , BT: C , Difficulty: Medium , TOT: 2 min., AACSB: None , AICPA A C: Risk Assessment, Analysis and Management , Section: Demand for Audit and Assurance Services 6. B LO 4 , BT: C , Difficulty: Easy, TOT: 2 min., AACSB: None , AICPA A C: Risk Assessment, Analysis and Management , Section: Preparers and Auditors 7. A LO 5 , BT: C , Difficulty: Easy , TOT: 2 min., AACSB: None , AICPA A C: Reporting , Section: The Role of Regulators and Regulations 8. D LO 5 , BT: C , Difficulty: Easy , TOT: 2 min., AACSB: None , AICPA B C: Governance Perspective , Section: The Role of Regulators and Regulations

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    2 9. D LO 6 , BT: C , Difficulty: Easy , TOT: 2 min., AACSB: None , AICPA A C: Risk Assessment, Analysis and Management , Section: Audit Report on Financial Statements 10. C LO 6 , BT: C , Difficulty: Easy, TOT: 2 min., AACSB: None , AICPA A C: R eporting , Section: Audit Report on the Financial Statements 11. B LO 7 , BT: C , Difficulty: Easy, TOT: 2 min., AACSB: None , AICPA A C: Reporting , Section: Audit R eport on Internal Controls over Financial Reporting 12. B LO 8 , BT: C , Difficulty: Medium , TOT: 2 min., AACSB: None , AICPA P C : Professional Behavior , Section: The Audit Expectation Gap ANSWERS TO REVIEW QUESTIONS 1 .1 An a ssurance service is any service provided by a n independent practitioner that improves the quality of information that was prepared by someone else . An independent practitioner can verify that the information meets relevant criteria, which provides assurance to users who intend to use the information for decision making. An assurance engagement has three parties: the assurance provider (auditor /practitioner ), the party responsible for providing the information (client), and the intended users of the information (investors/lenders /others who rely on the information ) . LO 1, BT: C , Difficulty: Easy , TOT: 5 min., AACSB: None , AICPA A C: Risk Assessment, Analysis and Management , Section: Assurance, Attestation, and Audit Services 1.2 The criterion used in a financial statement audit to measure and evaluate subject matter is the applicable financial reporting framework used by the client. The most common framework used in the U.S. is GAAP. LO 1, BT: C , Difficulty: Easy, TOT: 5 min., AACSB: None , AICPA A C: Measurement Analysis and Interpretation , Section: Assurance, Attestation, and Audit Services 1 .3 Financial statements are not guaranteed to be free from error or fraud due to several limitations. These limitations include the nature of financial reporting, the nature of audit procedures and the need for the audit to be conducted within a reasonable pe riod of time and within a reasonable budget. The nature of financial reporting causes limitations because it includes management’s judgment when applying accounting standards and estimates. The nature of the audit procedures is a limitation because the aud itors have to rely on management to provide all the necessary documentation needed for the audit. The auditor may arrive at an inappropriate conclusion if information is tampered with or excluded. The last limitation refers to the limited resources of time and money for an audit engagement. It would be impractical for auditors to examine every transaction. Therefore, auditors rely on sampling measures to provide an accurate representation of the population, and sampling can not provide absolute assurance. LO 2 , BT: C , Difficulty: Medium , TOT: 15 min., AACSB: None , AICPA A C: Risk Assessment, Analysis and Management , Section: Different Assurance Services 1 .4 Management and those charged with governance can request an operational audit to help improve the efficiency and effectiveness of a company’s operations. An organization’s internal audit department typically conducts operational audits. LO 2 , BT: C , Difficulty: Easy, TOT: 5 min., AACSB: None , AICPA B C: Governance Perspective , Section: Different Assurance Services 1 .5 Investors are interested in the information that financial statements can provide about their investment. This includes, but is not limited to, information regarding the profitability of the company, return on investment, going concern/continuity of operat ions, and dividend distributions. An independent audit helps to ensure that the information in the financial statements is credible and of high quality . LO 3 , BT: C , Difficulty: Easy , TOT: 1 0 min., AACSB: None , AICPA B C: Governance Perspective , Section: Demand for Audit and Assurance Services

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    3 1 .6 Both the preparer and the auditor have responsibilities regarding the company’s financial statements. Management (the preparer) is in charge of preparing the financial statements. This includes ensur ing the information is presented fairly and in compliance with GAAP , or other applicable financial reporting framework . Management is responsible for designing, implementing, and maintaining internal control over financial reporting, as well as providing auditors with all the necessary documentation and personnel needed to complete the audit. Auditors are responsible for providing an opinion on whether the financial statements are presented fairly and in accordance with the applicable financial reporting frame work. The three responsibilities of auditors are to conduct the audit in accordance with the appropriate audit standards, plan and perform the audit with professional skepticism, and exercise professional judgment. LO 4 , BT: C , Difficulty: Medium , TOT: 1 5 min., AACSB: None , AICPA A C: Reporting , Section: Preparers and Auditors 1 .7 The SOX Act of 2002, which emphasized a need for better governance over financial reporting, created the Public Accounting Oversight Board (PCAOB). The PCAOB is a non - profit corporation established to oversee the audits of public companies. The SEC is a federal government agency whose role is to enforce and interpret securities laws. The SEC approves each new auditing standard established by the PCAOB before it can be implemented. The SEC and PCAOB work closely together to ensure standards are in place for both public companies and auditors to safeguard investors. LO 5 , BT: C , Difficulty: Medium , TOT: 1 0 min., AACSB: None , AICPA A C: Reporting , Section: The Role of Regulators and Regulations 1 .8 Some functions of the state boards of accountancy include issuing CPA licenses, adopting and enforcing professional conduct rules for CPAs, enforcing continuing professional education requirements, and administering disciplinary actions. NASBA is a profess ional organization that works to unite the interests of the 55 jurisdictions of state boards with regulative and legislative bodies. LO 5 , BT: AP, Difficulty: Easy , TOT: 1 0 min., AACSB: Analytic , AICPA P C: Professional Behavior , Section: The Role of Regulators and Regulations 1 .9 The principles of GAAS start with the purpose of an audit, which is to provide an opinion on whether a company’s financial statements are presented fairly and in accordance with GAAP. The next principle describes the premise upon which an audit is conducte d. This outlines management’s responsibility to prepare the financial statements in accordance with the applicable framework, manage and maintain internal controls over financial reporting, and provide the auditor with access to all documentation relev ant to conduct the audit. The next principle outlines the responsibilities of the auditor, which explicitly states auditors have to be competent, comply with auditing standards, maintain professional skepticism and exercise professional judgment during an audit. While performing an audit, an auditor must obtain reasonable assurance that the financial statements are free from material misstatement, but also recognize it is not an absolute assurance due to several limitations. The last principle states that auditors must report the results of the audit in a formalized written report. LO 5 , BT: C , Difficulty: Easy, TOT: 1 0 min., AACSB: None , AICPA A C: Reporting , S ection: The Role of Regulators and Regulations 1 . 1 0 Audit reports for private and public companies are very similar in content. Both reports contain the essential components: a title with the word “independent,” an address to the shareholders /owners and board, identification of which financial statements were audited , a description of the responsibilities of the parties involved, a description of the conduct of an audit, an opinion on the outcome, a signature with the firm’s name and a date indicating the end of fieldwork. However, there are a few difference s between the two. The title for an audit report of a public company includes the term “registered” indicating the firm is registered with the PCAOB. Audit reports for public companies state the auditor is required to be independent from the company in accordance with U.S. federal securities laws and with regulations of the SEC and PCAOB. One of the biggest differences between the reports is that public companies include a paragraph referencing the audit of the firm’s internal controls over financial repor ting. P ublic companies are required to have two audits, one for financial statements and the other for ICFR; whereas, private companies are not required to have an audit of ICFR. Also, auditors must provide a statement about auditor tenure at the bottom of the audit report public companies. Finally, the order of the paragraphs in

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    4 the two reports is different. The audit report for a public company begins with the auditor’s opinion in the first paragraph. In the audit report for a private company, the opinion is given in the last paragraph. LO 6 , BT: AN , Difficulty: M edium , TOT: 15 min., AACSB: Analytic , AICPA A C: R eporting , Section: Audit Report on Financial Statements 1.11 The components of an auditor’s report on internal controls over financial reporting include the title, address, opinion, reference to the financial statement audit, basis for opinion paragraph, scope paragraph, definition and limitations paragraph, si gnature and date. The title must include two important terms — “independent” and “registered” — signifying the auditor’s independence and that the firm is registered with the PCAOB. The report is addressed to the board and shareholders of the company. The opin ion paragraph states that an audit of the company’s internal controls was conducted using the COSO Internal Control - Integrated Framework as the criteria, and then states whether or not the company maintained effective internal control. The next paragraph references the audit of the company’s financial statements since public companies require two audits. The basis for opinion paragraph br iefly describes the responsibilities of management and the auditor and mentions that auditors are required to be indepen dent from the company. The scope paragraph briefly describes how an audit of ICFR is conducted. The definition and inherent limitations paragraph defines ICFR for users unfamiliar with the terminology and emphasizes that internal controls will not be able to prevent or detect all misstatements or errors. The report is signed by the firm and dated to represent the end of the fieldwork. LO 7 , BT: C , Difficulty: Medium , TOT: 15 min., AACSB: None , AICPA A C: R eporting , Section: Audit Report on Internal Controls over Financial Reporting 1.12 The audit expectation gap occurs when the auditor’s professional responsibilities do not align with the financial statement users’ beliefs. This gap is created when the user has unrealistic expectations for the audit. Some examples of unrealistic expe ctations are as follows:  the user may believe the auditor is providing absolute assurance instead of reasonable assurance,  the user may believe the auditor is guaranteeing future viability of the company,  the user may believe a favorable audit conclusion indicates complete accuracy instead of no material misstatements,  the user may believe the auditor will find any and all fraud when that is simply impossible, and  the user may believe the auditor has tested every transaction instead of a sample. It is impossible for professional auditing standards to give users what they want because of inherent limitations with the conduct of an audit. Auditors sometimes do not meet professional standards because of time constraints in completing the audit (possibly being short staffed) , not exercising enough professional skepticism, and not maintaining professional competence through continuing professional education. LO 8 , BT: AN , Difficulty: Medium , TOT: 1 0 min., AACSB: Analytic , AICPA A C: Risk Assessment, Analysis and Management , Section: The Audit Expectation Gap SOLUTIONS TO ANALYSIS PROBLEMS AP 1 .1 Although internal and external audit are different professional fields, they share some similar responsibilities. Both fields follow rules and regulations made by their respective professional organizations, the Institute of Internal Auditors (IIA) and the American Institute of Certified Public Accountants (AICPA). Additionally, external auditors of public companies must adhere to regulations set forth by the PCAOB and SEC. Internal auditors are typically employees of the organization and therefore

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    5 cannot have the same level of independence from the organization as an external auditor can. Nevertheless, internal auditors are required to maintain independence from management to ensure objectivity and an unbiased attitude. External auditors cannot be e mployees of the audit client, and they must adhere to strict independence guidelines to ensure there are no conflicts of interest in performing the audit engagement. The most common role for internal auditors is to monitor internal controls and improve the effectiveness of controls, governance, and risk management strategies. Internal auditors report their results to those charged with governance and typically do not report findings to the public. The role of the external auditors is to express an opinion on the fair presentation of the client’s financial statements in accordance with the applicable financial reporting framework. For certain public company clients, external auditors also provide an opinion on the effectiveness of the client’s internal controls over financial reporting. The external auditors report their opinion(s) to those charged with governance, and for public company clients, to interested users outside of the client. LO 1, 2 BT: A N , Difficulty: Easy, TOT: 15 min., AACSB: Analytic, Technology , AICPA A C: Research , Section: Assurance, Attestation, and Audit Services, Different Assurance Services AP1.2 Users demand audited financial statements for various reasons. If the accounting firm performing the audit is perceived as incompetent, not independent, or unethical, then the value of the audit service is lost. Users will not be confident that the information management is presents in the financial statements is unbiased and reliable. If users think the financial statements are unreliable, then they may not invest in the company, do business with the company, or lend money to the company. Therefore, a company does not want to be associated with an accounting firm that has a poor reputation or that is in violation of professional standards. That is why clients dropped Arthur Andersen after charges were brought against the firm. LO 3 , BT: AP , Difficulty: Hard , TOT: 1 5 min., AACSB: Analytic , AICPA P C: Professional Behavior , Section: Demand for Audit and Assurance Services AP 1 .3 The solution will depend on the accounting firm chosen and the date of the analysis. However, the answers should show for the Big 4: greater geographic coverage, larger numbers of staff and broader range of skills offered, greater claims to speciali z ation and industry coverage, more publications available (particularly from the international offices), more consistent and sophisticated marketing. LO 3,4, BT: AN , Difficulty: Medium , TOT: 20 min., AACSB: Analytic, Technology , AICPA A C: Research , Section: Demand for Audit and Assurance Services, Preparers and Auditors AP 1 .4 a. Financial statement audits are mandatory for public companies, so overall demand is largely fixed or determined by economic conditions affecting the number of companies. However, for organi z ations that are not required by legislation to have an audit, there are two opposing pressures in times of economic recession. First, cost - cutting would result in fewer audits. Second, organi z ations with less credible financial statements will face the most difficulty in borrowing during a credit squeeze. This suggests that demand for audi ting will increase in difficult times, because an audit will increase the credibility of the financial statements and thus increase access to external finance. b. S hifting from a mid - tier auditor to a Big 4 auditor would increase both costs and financial statement credibility for a company. Therefore, it can be argued that companies with greater need to reduce costs will shift “ down ” from Big 4 auditors to mid - tier auditors, but companies with greater need for credibility (and financial advice) will shift “ up ” from mid - tier auditors to Big 4 auditors. LO 3 , 4 BT: AP, Difficulty: Hard , TOT: 15 min., AACSB: Analytic , AICPA B C: Customer Perspective , Section: Demand for Audit and Assurance Services, Preparers and Auditors AP1.5 The solution will vary based on the states selected by the student to research. In general, most states require a bachelor’s degree and relevant accounting and business courses. Some states, such as Texas and Colorado, require an ethics course. Some sta tes allow candidates to sit for the CPA exam after completing a bachelor’s degree with the relevant accounting courses, but a total of 150 hours of college credits are

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    6 required to be licensed as a CPA. In addition to passing the CPA exam and meeting the education requirements, most states require 1 - 2 years of work experience in public accounting to be licensed. LO 5 , BT: A N , Difficulty: Basic , TOT: 20 min., AACSB: Technology , AICPA A C: R esearch , Section: The Role of Regulators and Regulations AP 1 .6 To be registered with the PCAOB, a firm must complete a 27 - page application (Form 1) and pay the required fees. The purpose of Form 1 is to capture information about the firm including contact information, number of employees, types of clients serviced by the firm, any on - going or pending criminal or civil actions against the firm, quality control procedures, and names of issuers that the firm expects to provide audit services to in the current year. Form 1 is signed by a partner or authorized officer of the firm. The application fee is $500 for a firm that audits less than 50 issuers , $3,000 for a firm that audits 50 - 100 issuers, $29,000 for a firm that audits 101 - 1000 issuers, and $390,000 for a firm that audits 1001 or more issuers. Once a firm is registered, annual fees are $100,000 for firms with more than 500 issuer audit clients and more than 10, 0000 personnel, $25,000 for firms with more than 200 issuer clients and more than 1,000 personnel, and $500 for all other firms. Registered firms have to file an annual report with the PCAOB on Form 2. Form 2 captures any updated information related to the firm and its audit clients, affiliations with other firms, and on - going or pending criminal or civil actions against the firm. Registered firms must abide by PCAOB regulations and consent to be inspected on a regular basis. Firms that audit 100 or more issuers per year are inspected annually. Firms that audit less than 100 issuers per year are inspected once every three years. LO 5 , BT: C , Difficulty: Basic , TOT: 2 0 min., AACSB: Technology , AICPA A C: R esearch , Section: The Role of Regulators and Regulations AP 1 .7 a. Answers may vary depending on which year is accessed to review the audit reports of The Boeing Company and Starbucks. Most likely both companies will have unqualified opinions on both the financial statements and internal controls. b. All accounting firms follow the standard audit report formats provided by the ASB (for private company audits) and the PCAOB (for public company audits). Having a uniform report format promotes consistency in the profession and is easier for financial statement users to understand. LO 6 , 7 , BT: A N , Difficulty: Easy, TOT: 20 min., AACSB: Analytic, Technology , AICPA A C: R esearch , Reporting, Section: Audit Report on Financial Statements, Audit Report on Internal Controls over Financial Reporting AP 1 .8 Dear Kim, I enjoyed eating dinner with you the other night, old friend. I am writing to you because you had a difficult time understanding the audit profession and a few of its important aspects. I will describe to you the concept of “ reasonable assurance ” and how it is determined, the “professional skepticism” that all auditors must practice, and why your perceptions are a great example of what is called the “expectations gap.” As auditor s of a company , we are required to give our opinion on the level of confidence we have in the reliability that the financial statements are free of material misstatement. This confidence level is called “ reasonable assurance. ” It is determined by using our professional judgment and by acquiring a significant amount of evidence to support this assurance. We cannot offer absolute assurance because there are several factors that make it impossible for us to detect every misstatement. First, we have a limited time to conduct the audit, therefore we cannot audit everything. We focus our time on the most impactful, or material, items on the financial statements. Second, there is a risk that m anagement can collude to hide information or provide false information to us , but fraud is not a common occurrence .

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    7 Finally, some items on the financial statements are subjective and can be very complex to audit. We cannot provide absolute assurance on an item that is subjective. “Professional skepticism” is a concept that means auditors must have a state of awareness about the factors that could lead to material misstatement, be critical of the evidence and documents they receive from an organization’s management, and have a quest ioning attitude overall. Although we are skeptical of management, this does not mean that we believe they are constantly trying to deceive us. There are many situations where we must rely on the information provided to us by the client’s management team. The perceptions that you had during dinner about the audit profession are a perfect example of the “expectations gap.” We define the expectations gap as the difference between what the public believes auditors are providing and what the auditing profession i s actually capable of doing. Now that you have read my explanations of reasonable assurance and professional skepticism, I hope I have provided you with a more realistic impression of my profession. Hope we can get together for dinner again soon! Sincerely, LO 4 , 6, 8 BT: S, Difficulty: Medium, TOT: 30 min., AACSB: Analytic, Communication , AICPA P C: Communication , Section: Prepares and Auditors, Audit Report on Financial Statements, The Audit Expectations Gap AP 1 .9 a. A n audit is limited due to several factors. T he nature of financial reporting causes a limitation of the audit. This refers to the subjectivity involved when a company is deciding which accounting methods or estimat e s to use. It can be difficult to audit an item that has been created based on judgment. Another limitation is t he nature of audit procedures. A uditors select audit procedures that will detect material misstatements, as it is too costly to try and detect all misstatements. Also, auditors use sampling techniques when gathering evidence related to some financial statement items. A limitation of sampling is that the sample may not be representative of the population and the auditor will draw an incorrect conclusion. Finally , one of the bigger limitations auditor s face is that of time. There is a need for an audit to be conducted within a reasonable period of time and at a reasonable cost. This time constraint on the audit can cause auditor s to perhaps rush their work and not b e as diligent as they would be otherwise. b. When looking at the reports in figures 1.6, 1.7, and 1.9 in Chapter 1, you can see these limitations referenced. The reports mention the reasonableness of accounting estimates, which refers to the subjectivity limitation. Also, you see the word “material” in all three of these audit reports. Auditors are only concerned with material misstatements that could affect the decisions of financial statement users. Reasonable assurance is mentioned in every report. It is because of these limitations that audit ors provide only reasonable assurance. Defined as a high, but not absolute, level of assurance, reasonable assurance means the auditor does not “guarantee” that the financial statements are 100% accurate. Finally, the audit report for a public company in Illustration 1.7 includes the phrase “procedures included examining, on a test basis,” which refers to the limitation of using sampling. The auditor does not test all information , ; therefore, sampling risk exists. LO 2, 4, 6, 7, 8 BT: A N , Difficulty: Hard , TOT: 3 0 min., AACSB: Analytic , AICPA A C: Risk Assessment, Analysis and Management , Reporting, Section: Different Assurance Services, Preparers and Auditors, Audit Report on Financial Statements, Audit Report on Internal Controls over Financial Reporting, The Audit Expectation Gap AP 1 .10 a. The auditors for GSK are PricewaterhouseCoopers (for the 12/31/17 audit). b. The UK auditor’s report model has some similarities to the US report model, but also some significant differences. Some similarities include: - a title that includes the word “independent” - the opinion is stated in the first sentence of the first paragraph

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    8 - a basis for opinion paragraph that states the audit standards that were followed and that audit evidence obtained is sufficient and appropriate to provide a basis for the opinion - discussion of both management and auditor responsibilities - disclosure of auditor tenure Some differences of the UK auditor’s report are: - the title also includes the addressee - the report references the IFRS standards (GAAP is referenced in the US report) and UK laws and regulations - includes expanded discussion of the auditor’s independence - states the materiality amount used for the audit and how it was calculated, and specific areas of audit focus - includes expanded discussion of the scope of the audit - defines “key audit matters,” which are comparable to “critical audit matters” in the US - listed seven key audit matters and how they were addressed in the audit (for the 12/31/17 audit) - includes expanded discussion of going concern and how auditors addressed it - includes a discussion of reporting on other information - includes a section titled “use of this report” c. Student answers will vary based on preference. But a notable issue that students will probably recognize is the difference in the length of the UK report. The report for the 12/31/17 audit of GSK is eight pages in length. The US report is one page; however , that will change once the requirement to report CAMs goes into effect in the US. Would all types of users prefer the UK report? It depends on the sophistication of the user. Lenders and investment analysts, who are knowledgeable about financial statements, most likely prefer the UK report because there is more detail provided about key areas addressed during the audit. Preparers of financial statements (management) and auditors might prefer the shorter US report. Management and auditors may not feel comfortabl e disclosing so much detailed information about the audit, especially since it requires professional judgment to determine what is a CAM. Auditors have also feared increased litigation based on what will be disclosed as a CAM in the auditor’s report. LO 6 , BT: A N , Difficulty: Hard , TOT: 45 min., AACSB: Analytic, Technology , AICPA A C: Reporting , Section: Audit Report on Financial Statements Cloud 9 a. A financial statement audit only focuses on determining if the financial statements are prepared according to the applicable financial reporting framework. A financial statement audit must be performed by an independent accounting firm under the supervision of a CPA. A compliance audit is performed to determine if an entity has followed rules, laws, or regulations with which it is required to conform. A compliance audit does not have to be performed by a CPA, but it must be performed by someone designate d or approved by the body that enforces the rules, laws, or regulations. An operational audit focuses on the efficiency and effectiveness of an entity’s activities. Typically, an operational audit is performed by employees of the company, but it can be o utsourced. The individual(s) performing the audit does not have to be independent and does not have to be a CPA. b. Reasonable assurance is a high level of assurance, but it is not absolute assurance. Absolute assurance implies a level of service that is akin to a guarantee or a certification. Because of the limitations of an audit (time constraints, subjectivity, and the nature of audit procedures), auditors can only provide reasonable assurance. c. An audit is more in depth and broader in scope than a review. An audit also provides a higher level of assurance, reasonable assurance, than a review , which only provides limited assurance. Since Chip is

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    9 considering purchasing McLellan’s shoes, he requires more assurance that the financial statements are fairly presented and the information in the financial statements is reliable . d. Ron should consider the reputation of the firm and whether the firm has the expertise to conduct an audit of a company in the sports footwear industry. Since Ron’s company is small, he would most likely consider using a regional or mid - tier firm becaus e their work is tailored to companies of his size. LO 1, 2, 3, 4, 6, BT: AN, Difficulty: Medium, TOT: 30 min., AACSB: Analytic , AICPA A C: Reporting, Section : Assurance, Attestation, and Audit Services, Different Assurance Services, Demand for Audit and Assurance Services, Preparers and Auditors, Audit Report on Financial Statements

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    Before You Go On Solut ions CHAPTER 1 Introduction and Overview of Audit Assurance 1.1 The intended users of assurance services are decision makers , such as investors, creditors, and regulators . 1.2 Within the context of assurance services, “independent” means that the person performing the service is not involved with the creation of the information and is objective in the evaluation of the information. 1.3 Examples of “applicable financial reporting frameworks” are GAAP, IFRS, and a federal income tax basis of accounting. 2.1 The objective of a financial statement audit is to provide financial statement users with an opinion by the auditor on whether the financial statements are presented fairly in accordance with an applicable financial reporting framework. 2.2 An inherent limitation of a financial statement audit is the nature of financial reporting whereby auditors use judgment when preparing financial statements due to the subjectivity required when arriving at accounting estimates. Another inherent limitation is the nature of audit procedures which refers to the reliance on evidence provided by the client and its management . Also, auditors often use sampling techniques rather than auditing an entire population of items, therefore there is a risk of arriving a t an incorrect conclusion . The final inherent limitation is the need for the audit to be conducted within a reasonable period of time at a reasonable cost. 2.3 The three elements of operational audits are economy, efficiency, and effectiveness of an organization’s activities. 2.4 The most common functions of internal audit or s are evaluating and improving risk management, internal control procedures, and elements of the governance process. 3.1 The main users of company financial statements are current and potential investors, suppliers, customers, lenders, employees, governments, and the general public. 3.2 Financial statement users demand an audit because of remoteness of the company, complexity of financial statements, competing incentives among management and users , and reliability of information. 3.3 Auditors are the appropriate professionals to conduct an audit because they have the knowledge and expertise to assess the fairness of the information being presented by the preparers. They have access to company records, so they are not remote. Auditors h ave little incentive to aid the company in presenting the results in the best possible light because their work is regularly reviewed by regulators. 4.1 Management is responsible for ensuring the information included in the financial statements is presented fairly and complies with the applicable financial reporting framework. Management is also responsible for designing, implementing, and maintaining inte rnal control relevant to the preparation and fair presentation of the financial statements. Management provides the auditors with access to all

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    records, documentation, and personnel relevant to the preparation and fair presentation of financial statements and any additional information the auditors may consider relevant to complete the audit. 4.2 Professional skepticism is an attitude adopted by auditors when conducting an audit that includes a questioning mind, being alert to conditions that may indicate possible misstatement due to fraud or error, and a critical assessment of audit evidence. 4.3 Non - audit services are not assurance services , therefore, the CPA does not need to be independent . Examples include management consulting, business valuation, mergers and acquisitions, tax, and accounting. 5.1 The SEC i s a federal government agency whose mission is to protect investors, maintain fair and efficient markets, and facilitate capital formation. The SEC enforces and interprets securities laws. 5.2 The PCAOB is the organization that sets standards for the audits of public companies. The ASB sets the standards for the audits of private companies. 5.3 The main functions of the state board of accountancy are issuing CPA licenses to individuals who meet all the requirements, adopting and enforcing rules of professional conduct for CPAs, adopting and enforcing rules regarding continuing professional ed ucation requirements, investigating complaints against CPAs, conducting hearings , and taking appropriate disciplinary actions, such as suspension or revocation of the CPA license. 6.1 Auditors provide reasonable assurance because they give their opinions on whether the financial statements are presented fairly. An opinion is defined as a judgment about matters that are subjective. Also, an audit could not be completed in a reasonable am ount of time if auditors had to provide absolute assurance. 6.2 Materiality is an aspect of a financial statement that is significant enough to influence or make a difference in the judgment of consequential activities of a financial statement user. Materiality relates to reasonable assurance because auditors desig n an audit to provide reasonable assurance that the financial statements are free of material misstatement. 6.3 The term unqualified is used in the context of an audit report for a public company client. It means in the auditor’s opinion, the financial statements are presented fairly, in all material respects, in accordance with the applicable financial reporting framework. The term unqualified is equivalent to the term unmodified which is used for the private company audit report. 7.1 Having effective internal controls over financial reporting provides r easonable assurance that the financial statements will be reliable and free of material misstatement . An effective internal control system may not prevent all misstatements, therefore, it can only provide reasonable assurance. Similar to an audit of the financial statements, auditors can only provide reasonable assurance that a company’s internal controls are effective.

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    7.2 According to the audit report on the effectiveness of internal controls , management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. 7.3 The date used on the audit report on the effectiveness of internal controls represents the end of fieldwork. The date represents the conclusion of gatherin g and evaluating evidence for the audit and it should be the same date as the audit report on the financial statements . 8.1 The audit expectation gap occurs when there is a difference between the expectations of auditors , as dictated by auditing standards, and financial statement users. The performance gap is the difference between auditor performance and auditing standards and regulations. 8.2 The audit expectation gap is caused by unrealistic user expectations such as:  Auditor is providing absolute assurance.  Auditor is guaranteeing future viability of the entity.  An unmodified opinion is an indicator of complete accuracy of financial statements.  Auditor will definitely find fraud.  Auditor has checked all transactions. In reality, the auditor does not fulfill these unrealistic user expectations. 8.3 The audit expectation gap can be reduced by:  Auditing standards being reviewed and updated on a regular basis to enhance the work being done by auditors.  Education of users as to the responsibilities of preparers and auditors of financial statements. The performance gap can be reduced by:  Auditors performing their duties appropriately and complying with auditing standards.  Inspections of audits to ensure that auditing standards have been correctly applied.  Assurance providers reporting accurately the level of assurance being provided.

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    1 CHAPTER 2 Professionalism and Professional Responsibilities Learning Objectives 1. Explain what it means to be a professional and how these traits apply to auditors 2. Explain the structure of the AICPA Code of Professional Conduct . 3. Apply the conceptual framework approach to ethical decision making for members in public practice 4. Evaluate the ethical behavior needed to comply with rules of conduc t on integrity and objectivity 5. Evaluate the ethical behavior needed to comply with rules of conduct on independence 6. Evaluate the ethical behavior needed to comply with rules of conduct on general standards 7. Evaluate the ethical behavior needed to comply with other rules of conduct for members in public practice 8. Evaluate an auditor’s legal liability under common law 9. Evaluate an auditor’s legal liability under statutory law ANSWERS TO MULTIPLE - CHOICE QUESTIONS 1. B LO 1, BT: C , Difficulty: Medium , TOT: 2 min., AACSB: Ethics , AICPA PC: Ethics 2. D LO 2, BT: C, Difficulty: Easy, TOT: 2 min., AACSB: Ethics , AICPA PC: Ethics 3. A LO 3 , BT: C, Difficulty: Easy , TOT: 2 min., AACSB: Ethics , AICPA PC: Ethics 4. D LO 4 , BT: C, Difficulty: Easy, TOT: 2 min., AACSB: Ethics , AICPA PC: Ethics 5. A LO 5 , BT: E , Difficulty: Medium , TOT: 2 min., AACSB: Ethics , AICPA PC: Ethics, Decision Making 6. C LO 5 , BT: E , Difficulty: Medium , TOT: 2 min., AACSB: Ethics , AICPA PC: Ethics, Decision Making 7. D

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    2 LO 5, BT: C , Difficulty: Easy , TOT: 2 min., AACSB: Ethics , AICPA PC: Ethics 8. C LO 5, BT: C , Difficulty: Medium , TOT: 2 min., AACSB: Ethics , AICPA PC: Ethics 9. D LO 6 , BT: C , Difficulty: Easy , TOT: 2 min., AACSB: Ethics, AICPA PC: Ethics 10. B LO 7 , BT: C , Difficulty: Easy, TOT: 2 min., AACSB: Ethics , AICPA PC: Professional Behavior 11. D LO 8 , BT: C , Difficulty: Easy, TOT: 2 min., AACSB: None, AICPA PC: Professional Behavior 12. C LO 8, BT: AP , Difficulty: Medium , TOT: 2 min., AACSB: None AICPA PC: Professional Behavior 13. B LO 9 , BT: C, Difficulty: Medium, TOT: 2 min., AACSB: None, AICPA PC: Professional Behavior 14. A LO 9 , BT: C, Difficulty: Medium, TOT: 2 min., AACSB: None, AICPA PC: Professional Behavior ANSWERS TO REVIEW QUESTIONS R 2 .1 An A uditor ’ s concern for the public interest comes from the work that practitioners perform and the recognition by practitioners of an obligation to society . Upon becoming licensed as a CPA, individuals also agree to accept the responsibility to follow professional standards (e.g., accounting and auditing standards), and a code of professional conduct (usually written into state rules or law). It is also im portant for auditors to be independent of management when serving the public interest. The public e xpects auditor to provide reasonable assurance that financial statements are free of material misstatement. LO 1, BT: C , Difficulty: Medium , TOT: 1 0 min., AACSB: Ethics , AICPA PC: Ethics R 2.2 The question is answered in the table below:

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    3 Architecture Public Accounting Recognized by a specialized body of knowledge Knowledge of building codes and how to build structures Auditing or Tax knowledge A formal education process To become a licensed architect a candidate must graduate from an accredited architecture program (or its equivalent) To become a CPA a candidate must complete d 150 semester hours of education including requirements in accounting and business Standards governing admission to the profession To become a licensed architect a candidate must complete an education requirement, pass a professional exam, and complete an experience requirement To become a licensed CPA a candidate must complete the state’s education requirement, pass the CPA exam, and complete an experience requirement Adherence to a code of ethics Architects must follow the Code of Ethics and Professional Conduct of the American Institute of Architects CPAs must follow the Code of Ethics of the state where they are licensed. AICPA members must also follow the AICPA Code of Professional Conduct . Recognized status indicated by a license State governments (through state boards of architect examiner) grant a license to practice architecture State governments (through state boards of accountancy) grant a CPA license practice public accounting A public interest in the work that practitioners perform The public interest in the work of architects relates to building safety The public interest in the work of auditors relates to the public ’ s reliance on the opinion of auditor about the fair presentation of financial information. Tax accountants have a duty to the public regarding compliance with tax laws. Recognition by practitioners of an obligation to society Architects recognize an obligation to follow building codes and at times put the public safety ahead of the wishes of their clients Accountants have an obligation to fair presentation in financial statements that supersedes their obligation to their clients. The same is true for compliance with tax laws. LO 1, BT: S , Difficulty: Difficult , TOT: 2 0 min., AACSB: Ethics , AICPA PC: Ethics R 2.3 The AICPA’s Code of Professional Conduct (the Code) provides guidance to all members of the AICPA with respect to performance of their responsibilities. The Code consists of principles, rules, interpretations, and other guidance for AICPA members.

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