Solution Manual for Principles of Auditing and Other Assurance Services 22nd Edition by Ray Whittington, Kurt Pany

CHAPTER 1 g




The Role of the g g g




g Public Accountant in the g g g




American Economy g




Review Questions
g




1-1 The ―crisis of credibility‖ largely arose from the number of companies that restated their previously
g g g g g g g g g g g g g g


issued financial statements as a result of accounting irregularities and fraud. Especially responsible
g g g g g g g g g g g g g


were the very visible Enron and WorldCom fraud cases. Both companies filed for bankruptcy and
g g g g g g g g g g g g g g g


constituted the largest companies in American history to do so. The extent of the accounting
g g g g g g g g g g g g g g g


irregularities and fraud being investigated and disclosed brought into question the effectiveness of
g g g g g g g g g g g g g


financial statement audits. In addition, the criminal conviction of Arthur Andersen, LLP, one of the
g g g g g g g g g g g g g g g


then Big 5 accounting firms, on charges of destroying documents related to the Enron case brought into
g g g g g g g g g g g g g g g g g


question the ethics standards of the profession.
g g g g g g g




1-2 Assurance services are professional services that enhance the quality of information, or its context, for
g g g g g g g g g g g g g g


decision-making. The two types are: (a) those that increase the reliability of information and (b)
g g g g g g g g g g g g g g g


those that involve putting information in a form or context that facilitates decision-making.
g g g g g g g g g g g g g




1-3 A financial statement audit is, by far, the most common type of attest engagement. The overall
g g g g g g g g g g g g g g g


assertion, made by management, most frequently is that the financial statements follow generally
g g g g g g g g g g g g g


accepted accounting principles.
g g g




1-4 A large corporation with securities listed on a stock exchange is required by the rules of the stock
g g g g g g g g g g g g g g g g g


exchange and by the rules of the Securities and Exchange Commission to provide an audit report with
g g g g g g g g g g g g g g g g g


the annual financial statements furnished to its stockholders. It also is required to engage the auditors to
g g g g g g g g g g g g g g g g g


provide an opinion on its internal control. Apart from legal requirements, however, a large listed
g g g g g g g g g g g g g g g


corporation recognizes that it must maintain investor confidence in the reliability of its financial
g g g g g g g g g g g g g g


gstatements and internal control over financial reporting if it is to continue to be able to secure
g g g g g g g g g g g g g g g g


capital from the public. The report by a firm of certified public accountants adds credibility to the
g g g g g g g g g g g g g g g g g


financial statements prepared by the corporation. When a small family-owned enterprise elects to
g g g g g g g g g g g g g


have an audit, the purpose usually is to use the auditors' report to support an application for a bank loan.
g g g g g g g g g g g g g g g g g g g g




Solutions Manual, Chapter 6, Page 1 of 445 g g g g g g g

,1-5 A report by an independent public accountant concerning the fairness of a company's financial
g g g g g g g g g g g g g


statements is commonly required in the following situations:
g g g g g g g g




(1) Application for a bank loan. g g g g


(2) Establishing credit for purchase of merchandise, equipment, or other assets. g g g g g g g g g


(3) Reporting operating results, financial position, and cash flows to absentee owners (stockholders
g g g g g g g g g g g


gor partners). g


(4) Issuance of securities by a corporation. g g g g g


(5) Annual financial statements by a corporation with securities listed on a stock exchange or traded
g g g g g g g g g g g g g g


gover the counter. g g


(6) Sale of an ongoing business.g g g g


(7) Termination of a partnership. g g g




1-6 To add credibility to financial statements is to increase the likelihood that they have been prepared
g g g g g g g g g g g g g g g


following the appropriate criteria, usually generally accepted accounting principles. As such, an
g g g g g g g g g g g g


increase in credibility results in financial statements that can be believed and relied upon by third
g g g g g g g g g g g g g g g g


parties.
g




1-7 Business risk is the risk that the investment will be impaired because a company invested in is unable
g g g g g g g g g g g g g g g g g


to meet its financial obligations due to economic conditions or poor management decisions.
g g g g g g g g g g g g g


gInformation risk is the risk that the information used to assess business risk is not accurate. Auditors
g g g g g g g g g g g g g g g g


can directly reduce information risk, but have only limited effect on business risk.
g g g g g g g g g g g g g




1-8 At the beginning of the century, the principal objective of auditing was the prevention and detection of
g g g g g g g g g g g g g g g g


fraud. Audit work centered on the balance sheet, because the income statement was regarded as highly
g g g g g g g g g g g g g g g g


confidential and not for public disclosure. Today, the principal objective of auditing is to form an
g g g g g g g g g g g g g g g g


opinion on the fairness of financial statements and their conformity with generally accepted accounting
g g g g g g g g g g g g g g


principles. But the professional standards also require that an audit be designed to provide reasonable
g g g g g g g g g g g g g g g


assurance of detecting material misstatements, due to errors or fraud. Particular emphasis is placed
g g g g g g g g g g g g g g


on the income statement which is of great importance to investors. Auditing today also has the
g g g g g g g g g g g g g g g g


objectives of meeting the requirements of the Securities and Exchange Commission (SEC) and the
g g g g g g g g g g g g g g


Public Company Accounting Oversight Board for public companies.
g g g g g g g g




1-9 The statement is incorrect. The increasing integrated databases of today, along with available audit
g g g g g g g g g g g g g


procedures make audited entire populations a possibility in many situations.
g g g g g g g g g g




1-10 An operational audit attempts to measure the effectiveness and efficiency of a specific unit of an
g g g g g g g g g g g g g g g


organization. It involves more subjective judgments than a compliance audit or an audit of financial
g g g g g g g g g g g g g g g


statements because the criteria of effectiveness and efficiency of departmental performance are not
g g g g g g g g g g g g g


as clearly established as are many laws and regulations or generally accepted accounting principles.
g g g g g g g g g g g g g g


The report prepared after completion of an operational audit is usually directed to management
g g g g g g g g g g g g g


of the organization in which the audit work was done.
g g g g g g g g g g




1-11 A compliance audit is an audit to determine whether financial reports or other assertions are in
g g g g g g g g g g g g g g g


compliance with established criteria. The necessary ingredients are verifiable data and the existence of
g g g g g g g g g g g g g g


standards established by an authoritative body. An operational audit, on the other hand, is a review of
g g g g g g g g g g g g g g g g g


a department or other unit of a business or governmental organization to measure the effectiveness and
g g g g g g g g g g g g g g g g


efficiency of operations. Internal auditors often perform operational audits as do auditors employed by
g g g g g g g g g g g g g g


the Government Accountability Office (GAO) of the federal government.
g g g g g g g g g




1-12 Internal auditors must be independent of the department heads and other line executives whose work
g g g g g g g g g g g g g g


gthey review. However, internal auditors are not independent in the same sense as a public accounting
g g g g g g g g g g g g g g g



Solutions Manual, Chapter 6, Page 2 of 445 g g g g g g g

,firm.
g




Solutions Manual, Chapter 6, Page 3 of 445
g g g g g g g

, The public accounting firm serves many clients and the revenue obtained from any one client is only a
g g g g g g g g g g g g g g g g g


small part of the revenue of the firm. Internal auditors, on the other hand, are employees of one
g g g g g g g g g g g g g g g g g g


company, and are subject to the restraints inherent in the employer-employee relationship. Internal
g g g g g g g g g g g g g


auditors can achieve a great deal of independence by reporting to the audit committee of the board of
g g g g g g g g g g g g g g g g g g


directors, but they cannot achieve the same degree of independence as is possessed by the external
g g g g g g g g g g g g g g g g


public accounting firm.
g g g




1-13 The internal auditors are employees of Spacecraft, Inc., and may be influenced by corporate management.
g g g g g g g g g g g g g g


The public accounting firm is independent of the company and is in a better position to take positions
g g g g g g g g g g g g g g g g g


opposed to those of company management. The work of the internal audit staff emphasizes
g g g g g g g g g g g g g g


measurement of the efficiency and effectiveness of various operating units of the company and
g g g g g g g g g g g g g g


compliance with all types of controls, whereas the public accounting firm is primarily concerned with
g g g g g g g g g g g g g g g


determining the fairness of Spacecraft's financial statements.
g g g g g g g




1-14 The Government Accountability Office (GAO) is a staff of professional auditors which reports to
g g g g g g g g g g g g g


Congress. Its function is to determine that programs carried out by federal agencies conform to the
g g g g g g g g g g g g g g g g


financial authorization of the Congress. It is also concerned with the cost-effectiveness of government
g g g g g g g g g g g g g g


programs. The audit activities include investigation of the costs and performance of corporations
g g g g g g g g g g g g g


holding government contracts.
g g g




1-15 Among the many important contributions to auditing literature by the AICPA are the series of Statements
g g g g g g g g g g g g g g g


on Auditing Standards (SASs), Statements on Standards for Attestation Engagements (SSAEs), Industry
g g g g g g g g g g g g


Audit and Accounting Guides, Audit Guides, Audit Risk Alerts, Statements on Standards for Accounting
g g g g g g g g g g g g g g


and Review Services (SSARSs), , and the Code of Professional Conduct (only two required).
g g g g g g g g g g g g g g




1-16 A peer review is a critical review of a public accounting firm's practices by another public accounting
g g g g g g g g g g g g g g g g


firm (or other CPAs functioning as a peer review team). The purpose of a peer review is to
g g g g g g g g g g g g g g g g g g


encourage adherence to quality control standards established by the accounting firm and the
g g g g g g g g g g g g g


profession.
g




1-17 The Securities and Exchange Commission (SEC) is an agency of the federal government and is
g g g g g g g g g g g g g g


gresponsible for administering a number of acts, including the Securities Act of 1933 and the Securities
g g g g g g g g g g g g g g g


Exchange Act of 1934. In meeting this responsibility, the SEC reviews financial statements of
g g g g g g g g g g g g g g


companies offering securities for sale to the public. It is particularly concerned with requiring full
g g g g g g g g g g g g g g g


disclosure of financial information and with preventing misrepresentation. Through the Public Company
g g g g g g g g g g g g


Accounting Oversight Board, the SEC now oversees public accounting firms that audit public
g g g g g g g g g g g g g


companies. Included in this oversight process includes development of auditing, independence, and
g g g g g g g g g g g g


quality control standards; inspection of performance; and enforcement of the standards.
g g g g g g g g g g g


The AICPA is the national organization of certified public accountants. It has long been a
g g g g g g g g g g g g g g


leader in accounting and auditing research, in publication of authoritative accounting and auditing
g g g g g g g g g g g g g


pronouncements and studies, and in promoting high professional standards of practice.
g g g g g g g g g g g




1-18 Services offered by public accounting firms in addition to auditing include other forms of attestation,
g g g g g g g g g g g g g g


tax work, consulting services, litigation support services, fraud investigation services, personal financial
g g g g g g g g g g g g


planning and accounting services. This last category includes preparation of financial statements for
g g g g g g g g g g g g g


smaller companies that have limited accounting personnel and various types of write-up work. Public
g g g g g g g g g g g g g g


accounting firms also perform a variety of other services. Consulting services include aiding clients in
g g g g g g g g g g g g g g g


the design of accounting systems, conversion to Information Technology (IT) systems, preparation of
g g g g g g g g g g g g g


budgets, planning business combinations with other companies, executive search, and numerous other
g g g g g g g g g g g g


projects. Public accounting firms are restricted as to the consulting services that they may provide to
g g g g g g g g g g g g g g g g


audit clients that are public companies.
g g g g g g




Solutions Manual, Chapter 6, Page 4 of 445 g g g g g g g