@PROFDOCDIGITALLIBRARIES
SOLUTION MANUAL FOR
TE
Auditing & Assurance Services: A Systematic Approach 12e by Messier
Chapter 1-21
S
CHAPTER 1
AN INTRODUCTION TO ASSURANCE AND FINANCIAL
TB
STATEMENT AUDITING
Answers to Review Questions
A
1-1 The study of auditing is more conceptual in nature as compared to other accounting
courses. Rather than focusing on learning the rules, techniques, and computations required
to prepare financial statements, auditing emphasizes learning a framework of analytical
N
and logical skills. This framework enables auditors to evaluate the relevance and
reliability of the systems and processes responsible for financial information as well as the
information itself. To be successful, students must learn the framework and then learn to
KS
use logic and common sense in applying auditing concepts to various circumstances and
situations. Understanding auditing can improve the decision-making ability of consultants,
business managers, and accountants by providing a framework for evaluating the
usefulness and reliability of information—an important task in many different business
contexts.
O
1-2 There is a demand for auditing in a free-market economy because the agency relationship
between an absentee owner and a manager produces a natural conflict of interest due to
the information asymmetry that exists between these two parties. As a result, the agent
LU
agrees to be monitored as part of his/her employment contract. Auditing appears to be a
cost-effective form of monitoring. The empirical evidence suggests that auditing was
demanded prior to government regulation. In 1926, before it was required by law,
independent auditors audited 82 percent of the companies on the New York Stock
Exchange. Additionally, many private companies and municipalities not subject to
TI
government regulations, such as the Securities Act of 1933 and Securities Exchange Act
of 1934, also purchase various forms of auditing and assurance services. Many private
companies seek out financial statement audits in order to secure financing for their
operations. Companies preparing to go public also benefit from having an audit.
O
1-3 The agency relationship between an owner and manager produces a natural conflict of
interest because of differences in the two parties’ goals and because of the information
N
asymmetry that exists between them. That is, the manager likely has different goals than
the owner, and generally has more information about the "true" financial position and
results of operations of the entity than the absentee owner does. If both parties seek to
S
maximize their own self-interest, the manager may not act in the best interest of the owner
and may manipulate the information provided to the owner accordingly.
, @PROFDOCDIGITALLIBRARIES
1-4 Independence is a bedrock principle for auditors. If an auditor is not independent of the
client, users may lose confidence in the auditor’s ability to report objectively and
truthfully on the financial statements, and the auditor’s work loses its value. From an
TE
agency perspective, if the principal (owner) knows that the auditor is not independent, the
owner will not trust the auditor’s work. Thus, the agent will not hire the auditor because
the auditor’s report will not be effective in reducing information risk from the perspective
of the owner. Auditor independence is also a regulatory requirement.
1-5 Auditing (broadly defined) is a systematic process of (1) objectively obtaining and
S
evaluating evidence regarding assertions about economic actions and events to ascertain
the degree of correspondence between those assertions and established criteria and (2)
communicating the results to interested users.
TB
Attest services occur when a practitioner issues a report on subject matter, or an assertion
about subject matter, that is the responsibility of another party.
Assurance services are independent professional services that improve the quality of
information, or its context, for decision makers.
A
1-6 Auditing is a specific form of ―attest service,‖ which in turn is a specific category of
―assurance service.‖ In other words, the phrase ―assurance services‖ constitutes the
broadest category of professional services provided by CPAs that serve to improve the
N
quality or context of information for decision making for other parties. Attest services
constitute a more specific category of assurance that CPAs can provide. These services are
intended to reduce information risk to parties relying on information provided by a party
KS
that is creating, or making assertions about, subject matter of interest. CPAs can provide
attest services relating to a wide variety of subject matter (or assertions about that subject
matter) to reduce the information risk to third parties. One such subject matter is a set of
financial statements. When a CPA provides a very in-depth, detailed attest service that
follows relevant standards to constitute a complete examination of a set of financial
O
statements and related assertions, this is called a financial statement ―audit.‖
1-7 Audit risk is defined as the risk that the auditor may unknowingly fail to appropriately
LU
modify his or her opinion on financial statements that are materially misstated (AS 1101).
Materiality is defined as "the magnitude of an omission or misstatement of accounting
information that, in the light of surrounding circumstances, makes it probable that the
judgment of a reasonable person relying on the information would have been changed or
influenced by the omission or misstatement" (FASB Statement of Financial Accounting
TI
Concepts No. 8, Chapter 3: Qualitative Characteristics of Useful Accounting Information,
which is pending revision at the time of the writing of this book per the Board’s
November 2017 decision to revert to a definition of materiality similar to the one found in
superseded Concept No. 2).
O
The concept of materiality is reflected in the wording of the auditor's standard audit
report through the phrase "the financial statements present fairly in all material respects."
This is the manner in which the auditor communicates the notion of materiality to the
N
users of the auditor's report. The auditor's standard report states that the audit provides
only reasonable assurance that the financial statements do not contain material
misstatements. The term "reasonable assurance" implies that there is some risk that a
S
material misstatement could be present in the financial statements and the auditor will fail
, @PROFDOCDIGITALLIBRARIES
to detect it.
1-8 The major phases of the audit are:
TE
• Client acceptance/continuance
• Preliminary engagement activities
• Plan the audit
• Consider and audit internal control
• Audit business processes and related accounts
S
• Complete the audit
• Evaluate results and issue audit report
TB
1-9 Plan the audit: During this phase of the audit, the auditor uses knowledge about the client
and any controls in place to plan the audit and perform preliminary analytical procedures.
The outcome of the planning process is a written audit plan that sets forth the nature,
extent, and timing of the audit procedures to be performed. The purpose of this phase is to
A
plan an effective and efficient audit.
1-10 The auditor's standard unqualified report for a public company client includes the
N
following sections: (1) opinion on the financial statements, (2) basis for opinion, and (3)
critical audit matters, as illustrated in this chapter.
KS
1-11 The emergence of advanced audit technologies will help remove many of the tedious tasks
that are usually performed by junior auditors. Thus, auditors of all positions and
experience will be required to spend additional time reasoning through fundamental
business, accounting, and auditing concepts. An auditors’ knowledge in these areas will
enable them to provide greater benefit to clients by asking the right questions and
O
identifying new, more effective ways to collect, analyze, and interpret results. In using
audit data analytics, for example, auditors must understand the client and its industry, as
well as the fundamentals of accounting and auditing, in order to ask the right questions in
querying the data and in interpreting the results obtained.
LU
1-12 Auditors frequently face situations where no standard audit procedure exists, such as the
example from the text of verifying the inventory of cattle. Such circumstances require that
the auditor exercise creativity and innovation when planning and administering audit
procedures where little or no guidance or precedent exists. Every client is different, and
TI
applying auditing concepts in different situations requires logic and common sense, and
frequently creativity and innovation.
O
Answers to Multiple-Choice Questions
1-13 b 1-19 a
N
1-14 b 1-20 d
1-15 c 1-21 d
1-16 c 1-22 d
S
1-17 c 1-23 b
, @PROFDOCDIGITALLIBRARIES
1-18 c
TE
Solutions to Problems
1-24 There are two major factors that may make an audit necessary for Greenbloom Garden
Centers. First, the company may require long-term financing for its expansion into other
cities in Florida. Entities such as banks or insurance companies are likely to be the sources
S
of the company's debt financing. These entities normally require audited financial
statements before lending significant funds and generally require audited financial
statements during the time period the debt is outstanding. There is information asymmetry
TB
between the lender of funds and the owner of the business, and this asymmetry results in
information risk to the lender. Even if the business could get funding without an audit, a
clean audit report by a reputable auditor might very well reduce the lender’s information
risk and make the terms of the loan more favorable to the owner. Second, as the company
grows, the family will lose control over the day-to-day operations of the stores. An audit
A
can provide an additional monitoring activity for the family in controlling the expanded
operations of the company.
N
1-25 a. Evidence that assists the auditor in evaluating financial statement assertions consists
of the underlying accounting data and any additional information available to the
auditor, whether originating from the client or externally.
KS
b. Management makes assertions about components of the financial statements. For
example, an entity's financial statements may contain a line item that accounts
receivable amount to $1,750,000. In this instance, management is asserting, among
other things, that the receivables exist, the entity owns the receivables, and the
receivables are properly valued. Audit evidence helps the auditor determine whether
management’s assertions are being met. If the auditor is comfortable that he or she
O
can provide reasonable assurance that all assertions are met for all accounts, he or she
can issue a clean audit report. In short, the assertions are a conceptual tool to help the
auditor ensure that she or he has ―covered all the bases.‖
LU
c. In searching for and evaluating evidence, the auditor should be concerned with the
relevance and reliability of evidence. If the auditor mistakenly relies on evidence that
does not relate to the assertion being tested, an incorrect conclusion may be reached
about the management assertion. Reliability refers to the ability of evidence to signal
the true state of the assertion, i.e., whether it is actually being met or not.
TI
1-26 a. As the chapter explains, a financial statement audit reduces the information risk
born by investors and creditors, because an audit reduces the risk that the company’s
financial statements are materially misstated. In this example, Community Bank can
O
rely on information in Young’s financial statements to make decisions on whether to
provide a loan, with assurance that the information (which is produced by Young
Company) is fairly presented. The risk the bank faces in providing a loan is thus
N
reduced by a clean audit opinion on Young’s financials, leading to a lower interest
rate.
S
SOLUTION MANUAL FOR
TE
Auditing & Assurance Services: A Systematic Approach 12e by Messier
Chapter 1-21
S
CHAPTER 1
AN INTRODUCTION TO ASSURANCE AND FINANCIAL
TB
STATEMENT AUDITING
Answers to Review Questions
A
1-1 The study of auditing is more conceptual in nature as compared to other accounting
courses. Rather than focusing on learning the rules, techniques, and computations required
to prepare financial statements, auditing emphasizes learning a framework of analytical
N
and logical skills. This framework enables auditors to evaluate the relevance and
reliability of the systems and processes responsible for financial information as well as the
information itself. To be successful, students must learn the framework and then learn to
KS
use logic and common sense in applying auditing concepts to various circumstances and
situations. Understanding auditing can improve the decision-making ability of consultants,
business managers, and accountants by providing a framework for evaluating the
usefulness and reliability of information—an important task in many different business
contexts.
O
1-2 There is a demand for auditing in a free-market economy because the agency relationship
between an absentee owner and a manager produces a natural conflict of interest due to
the information asymmetry that exists between these two parties. As a result, the agent
LU
agrees to be monitored as part of his/her employment contract. Auditing appears to be a
cost-effective form of monitoring. The empirical evidence suggests that auditing was
demanded prior to government regulation. In 1926, before it was required by law,
independent auditors audited 82 percent of the companies on the New York Stock
Exchange. Additionally, many private companies and municipalities not subject to
TI
government regulations, such as the Securities Act of 1933 and Securities Exchange Act
of 1934, also purchase various forms of auditing and assurance services. Many private
companies seek out financial statement audits in order to secure financing for their
operations. Companies preparing to go public also benefit from having an audit.
O
1-3 The agency relationship between an owner and manager produces a natural conflict of
interest because of differences in the two parties’ goals and because of the information
N
asymmetry that exists between them. That is, the manager likely has different goals than
the owner, and generally has more information about the "true" financial position and
results of operations of the entity than the absentee owner does. If both parties seek to
S
maximize their own self-interest, the manager may not act in the best interest of the owner
and may manipulate the information provided to the owner accordingly.
, @PROFDOCDIGITALLIBRARIES
1-4 Independence is a bedrock principle for auditors. If an auditor is not independent of the
client, users may lose confidence in the auditor’s ability to report objectively and
truthfully on the financial statements, and the auditor’s work loses its value. From an
TE
agency perspective, if the principal (owner) knows that the auditor is not independent, the
owner will not trust the auditor’s work. Thus, the agent will not hire the auditor because
the auditor’s report will not be effective in reducing information risk from the perspective
of the owner. Auditor independence is also a regulatory requirement.
1-5 Auditing (broadly defined) is a systematic process of (1) objectively obtaining and
S
evaluating evidence regarding assertions about economic actions and events to ascertain
the degree of correspondence between those assertions and established criteria and (2)
communicating the results to interested users.
TB
Attest services occur when a practitioner issues a report on subject matter, or an assertion
about subject matter, that is the responsibility of another party.
Assurance services are independent professional services that improve the quality of
information, or its context, for decision makers.
A
1-6 Auditing is a specific form of ―attest service,‖ which in turn is a specific category of
―assurance service.‖ In other words, the phrase ―assurance services‖ constitutes the
broadest category of professional services provided by CPAs that serve to improve the
N
quality or context of information for decision making for other parties. Attest services
constitute a more specific category of assurance that CPAs can provide. These services are
intended to reduce information risk to parties relying on information provided by a party
KS
that is creating, or making assertions about, subject matter of interest. CPAs can provide
attest services relating to a wide variety of subject matter (or assertions about that subject
matter) to reduce the information risk to third parties. One such subject matter is a set of
financial statements. When a CPA provides a very in-depth, detailed attest service that
follows relevant standards to constitute a complete examination of a set of financial
O
statements and related assertions, this is called a financial statement ―audit.‖
1-7 Audit risk is defined as the risk that the auditor may unknowingly fail to appropriately
LU
modify his or her opinion on financial statements that are materially misstated (AS 1101).
Materiality is defined as "the magnitude of an omission or misstatement of accounting
information that, in the light of surrounding circumstances, makes it probable that the
judgment of a reasonable person relying on the information would have been changed or
influenced by the omission or misstatement" (FASB Statement of Financial Accounting
TI
Concepts No. 8, Chapter 3: Qualitative Characteristics of Useful Accounting Information,
which is pending revision at the time of the writing of this book per the Board’s
November 2017 decision to revert to a definition of materiality similar to the one found in
superseded Concept No. 2).
O
The concept of materiality is reflected in the wording of the auditor's standard audit
report through the phrase "the financial statements present fairly in all material respects."
This is the manner in which the auditor communicates the notion of materiality to the
N
users of the auditor's report. The auditor's standard report states that the audit provides
only reasonable assurance that the financial statements do not contain material
misstatements. The term "reasonable assurance" implies that there is some risk that a
S
material misstatement could be present in the financial statements and the auditor will fail
, @PROFDOCDIGITALLIBRARIES
to detect it.
1-8 The major phases of the audit are:
TE
• Client acceptance/continuance
• Preliminary engagement activities
• Plan the audit
• Consider and audit internal control
• Audit business processes and related accounts
S
• Complete the audit
• Evaluate results and issue audit report
TB
1-9 Plan the audit: During this phase of the audit, the auditor uses knowledge about the client
and any controls in place to plan the audit and perform preliminary analytical procedures.
The outcome of the planning process is a written audit plan that sets forth the nature,
extent, and timing of the audit procedures to be performed. The purpose of this phase is to
A
plan an effective and efficient audit.
1-10 The auditor's standard unqualified report for a public company client includes the
N
following sections: (1) opinion on the financial statements, (2) basis for opinion, and (3)
critical audit matters, as illustrated in this chapter.
KS
1-11 The emergence of advanced audit technologies will help remove many of the tedious tasks
that are usually performed by junior auditors. Thus, auditors of all positions and
experience will be required to spend additional time reasoning through fundamental
business, accounting, and auditing concepts. An auditors’ knowledge in these areas will
enable them to provide greater benefit to clients by asking the right questions and
O
identifying new, more effective ways to collect, analyze, and interpret results. In using
audit data analytics, for example, auditors must understand the client and its industry, as
well as the fundamentals of accounting and auditing, in order to ask the right questions in
querying the data and in interpreting the results obtained.
LU
1-12 Auditors frequently face situations where no standard audit procedure exists, such as the
example from the text of verifying the inventory of cattle. Such circumstances require that
the auditor exercise creativity and innovation when planning and administering audit
procedures where little or no guidance or precedent exists. Every client is different, and
TI
applying auditing concepts in different situations requires logic and common sense, and
frequently creativity and innovation.
O
Answers to Multiple-Choice Questions
1-13 b 1-19 a
N
1-14 b 1-20 d
1-15 c 1-21 d
1-16 c 1-22 d
S
1-17 c 1-23 b
, @PROFDOCDIGITALLIBRARIES
1-18 c
TE
Solutions to Problems
1-24 There are two major factors that may make an audit necessary for Greenbloom Garden
Centers. First, the company may require long-term financing for its expansion into other
cities in Florida. Entities such as banks or insurance companies are likely to be the sources
S
of the company's debt financing. These entities normally require audited financial
statements before lending significant funds and generally require audited financial
statements during the time period the debt is outstanding. There is information asymmetry
TB
between the lender of funds and the owner of the business, and this asymmetry results in
information risk to the lender. Even if the business could get funding without an audit, a
clean audit report by a reputable auditor might very well reduce the lender’s information
risk and make the terms of the loan more favorable to the owner. Second, as the company
grows, the family will lose control over the day-to-day operations of the stores. An audit
A
can provide an additional monitoring activity for the family in controlling the expanded
operations of the company.
N
1-25 a. Evidence that assists the auditor in evaluating financial statement assertions consists
of the underlying accounting data and any additional information available to the
auditor, whether originating from the client or externally.
KS
b. Management makes assertions about components of the financial statements. For
example, an entity's financial statements may contain a line item that accounts
receivable amount to $1,750,000. In this instance, management is asserting, among
other things, that the receivables exist, the entity owns the receivables, and the
receivables are properly valued. Audit evidence helps the auditor determine whether
management’s assertions are being met. If the auditor is comfortable that he or she
O
can provide reasonable assurance that all assertions are met for all accounts, he or she
can issue a clean audit report. In short, the assertions are a conceptual tool to help the
auditor ensure that she or he has ―covered all the bases.‖
LU
c. In searching for and evaluating evidence, the auditor should be concerned with the
relevance and reliability of evidence. If the auditor mistakenly relies on evidence that
does not relate to the assertion being tested, an incorrect conclusion may be reached
about the management assertion. Reliability refers to the ability of evidence to signal
the true state of the assertion, i.e., whether it is actually being met or not.
TI
1-26 a. As the chapter explains, a financial statement audit reduces the information risk
born by investors and creditors, because an audit reduces the risk that the company’s
financial statements are materially misstated. In this example, Community Bank can
O
rely on information in Young’s financial statements to make decisions on whether to
provide a loan, with assurance that the information (which is produced by Young
Company) is fairly presented. The risk the bank faces in providing a loan is thus
N
reduced by a clean audit opinion on Young’s financials, leading to a lower interest
rate.
S
