ACCOUNTING 4301 EXAM 1 REVIEW WITH
VERIFIED ANSWERS
How does the audit function mitigate the
problem that exists between managements
and outside stakeholders (e.g., investors and
lenders)
Audits add credibility to the financial
statements
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 audit risk?
Audit risk is the risk that the auditor
mistakenly expresses a clean audit opinion
,when the financial statements are materially
misstated
What is materiality?
the magnitude of an omission or misstatement
of accounting information that, in light of
surrounding circumstances, make it probable
that the judgement of a reasonable
person relying on the information Ould have
been changed or influenced by the omission or
misstatement
What is the principal-agent problem?
Information asymmetry and conflicts of
interest lead to information risk for the
principal
Why is there a demand for audit services?
Auditing is demanded because it plays a
valuable role in monitoring the contractual
relationships between the entity and its
stockholders, managers, employees, and debt
holders. Certified public accountants have been
charged with providing audit services because
,of their traditional reputation of competence,
independence, objectivity, and concern for the
public interest. As a result, they are able to add
credibility to information produced and
reported by management to outside parties.
How does information asymmetry and conflicts
of interest between managers and investors
rest in the demand for auditing?
In this setting, the managers serve as agents
for the owners (who are sometimes referred to
as principals) and fulfill a stewardship function
by managing the corporation's assets.
Accounting and auditing play important roles in
this principal-agent relationship. We first
explain the roles of accounting and auditing
from a conceptual perspective. Then we'll use
an analogy involving a house inspector to
illustrate the concepts. First, it is important to
understand that the relationship between an
owner and manager often results in
information asymmetry between the two
parties. Information asymmetry means that the
, manager generally has more information about
the "true" financial position and results of
operations of the entity than does the absentee
owner.
The owner likely will be willing to invest more
in the business and to pay the manager more if
the manager can be held accountable for how
he or she uses the owner's invested resources.
As the amount of capital involved and the
number of potential owners increase, the
potential impact of accountability also
increases. The auditor's role is to determine
whether the reports prepared by the manager
conform to the contract's provisions. Thus, the
auditor's verification of the financial
information adds credibility to the report and
reduces information risk, or the risk that
information circulated by a company's
management will be false or misleading.
Reducing information risk potentially benefits
both the owner and the manager.
Pre-2002 Environment
VERIFIED ANSWERS
How does the audit function mitigate the
problem that exists between managements
and outside stakeholders (e.g., investors and
lenders)
Audits add credibility to the financial
statements
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 audit risk?
Audit risk is the risk that the auditor
mistakenly expresses a clean audit opinion
,when the financial statements are materially
misstated
What is materiality?
the magnitude of an omission or misstatement
of accounting information that, in light of
surrounding circumstances, make it probable
that the judgement of a reasonable
person relying on the information Ould have
been changed or influenced by the omission or
misstatement
What is the principal-agent problem?
Information asymmetry and conflicts of
interest lead to information risk for the
principal
Why is there a demand for audit services?
Auditing is demanded because it plays a
valuable role in monitoring the contractual
relationships between the entity and its
stockholders, managers, employees, and debt
holders. Certified public accountants have been
charged with providing audit services because
,of their traditional reputation of competence,
independence, objectivity, and concern for the
public interest. As a result, they are able to add
credibility to information produced and
reported by management to outside parties.
How does information asymmetry and conflicts
of interest between managers and investors
rest in the demand for auditing?
In this setting, the managers serve as agents
for the owners (who are sometimes referred to
as principals) and fulfill a stewardship function
by managing the corporation's assets.
Accounting and auditing play important roles in
this principal-agent relationship. We first
explain the roles of accounting and auditing
from a conceptual perspective. Then we'll use
an analogy involving a house inspector to
illustrate the concepts. First, it is important to
understand that the relationship between an
owner and manager often results in
information asymmetry between the two
parties. Information asymmetry means that the
, manager generally has more information about
the "true" financial position and results of
operations of the entity than does the absentee
owner.
The owner likely will be willing to invest more
in the business and to pay the manager more if
the manager can be held accountable for how
he or she uses the owner's invested resources.
As the amount of capital involved and the
number of potential owners increase, the
potential impact of accountability also
increases. The auditor's role is to determine
whether the reports prepared by the manager
conform to the contract's provisions. Thus, the
auditor's verification of the financial
information adds credibility to the report and
reduces information risk, or the risk that
information circulated by a company's
management will be false or misleading.
Reducing information risk potentially benefits
both the owner and the manager.
Pre-2002 Environment
