ACCT 4301 Exam 1 Practice Questions and Correct Answers

What is auditing? A systematic process of objectively obtaining and evaluating evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between those assertions and established criteria and communicating the results to interested users. What is the principal-agent problem? How does the modern capital markets structure create the principal-agent problem? - The principal-agent problem is a conflict in priorities between the owner of an asset and the person to whom control of the asset has been delegated. - The problem can occur in many situations, from the relationship between a client and a lawyer to the relationship between stockholders and a CEO. - The risk that the agent will act in a way that is contrary to the principal's best interest can be defined as agency costs. - Resolving a principal-agent problem may require changing the system of rewards in order to align priorities or improving the flow of information, or both. Why is there demand for auditing services? Understand how information asymmetry and conflicts of interest between managers and investors result in demand for auditing. How does the audit function mitigate the moral hazard problem that exists between management and outside stakeholders (e.g., investors and lenders)? How does the audit reduce information risk for outside stakeholders? - Information asymmetry: The concept that the manager generally has more information about the true financial position and results of operations of the entity than the absentee owner does. - Reporting: The end product of the auditor's work, indicating the auditing standards followed and expressing an opinion as to whether an entity's financial statements are fairly presented in accordance with agreed-upon criteria (e.g., GAAP). Be able to recap key takeaways from the Enron video. What was going on during that time in the accounting industry that eventually led to SOX? - The Sarbanes-Oxley Act of 2002 was passed by Congress in response to widespread corporate fraud and failures. The act implemented new rules for corporations, such as setting new auditor standards to reduce conflicts of interest and transferring responsibility for the complete and accurate handling of financial reports. -The various misdeeds and crimes that Enron's officers and employees committed were extensive and ongoing. Particularly damaging misrepresentations produced inflated earnings reports for shareholders, many of whom eventually suffered devastating losses when the company failed. Many other instances of dishonesty and fraud also occurred, including embezzlement of corporate funds by Enron executives and illegal manipulations of the energy market.