AUDIT BUSLEPP EXAM 1 QUESTIONS
WITH COMPLETE ANSWERS [GRADED
A+]
Information Asymmetry - ✔✔One party in a transaction has more
information than another party
1970: economist George Akerlof wrote a paper called "Lemons: Quality
Uncertainty and the Market Mechanism" describes problem associated with
information asymmetry
Principals - ✔✔Shareholders--rely on management to manage business
wisely and protect corporate assets
*Absentee
Agent - ✔✔Manager
©morren2026/2027.Year published 2026.
,Principals do not know true state of company, managers use earnings
management to - ✔✔1. Increase bonus
2. Avoid bankruptcy
3. Stay employed
4. Avoid debt covenants
Earnings Management - ✔✔Use of accounting techniques to produce
financial reports that present an overly positive view of a company's
business activities and financial position
Information Risk - ✔✔Probability that information circulated by a company
will be false or misleading
Purpose of auditing - ✔✔1. Reduce information asymmetry
2. Reduce information risk
Definition of 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
©morren2026/2027.Year published 2026.
,assertions and established criteria and communicating the results to
interested users
Established criteria - ✔✔GAAP
Results - ✔✔Audit opinion
Auditing redefined - ✔✔A well-planned approach of objectively obtaining
and evaluating evidence regarding the financial statements of a company
to ascertain the degree of correspondence between the financial
statements and GAAP and communicating the results in an audit opinion to
creditors and investors
Manager responsibilities - ✔✔Produce financial statements
Auditor responsibilities - ✔✔Audit report: States whether those financial
statements are in accordance with GAAP
If auditor produces financial statements - ✔✔Independence violation
©morren2026/2027.Year published 2026.
, Audit risk - ✔✔Risk that the auditor may unknowingly fail to appropriately
modify his or her opinion on financial statements that are MATERIALLY
misstated
Materiality - ✔✔The magnitude of an omission or misstatement of
accounting information that, in 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
3-5% of income before tax
Materiality is ______ - ✔✔Relative, not absolute. Depends on:
1. Size of the client
2. Nature of the item
3. Cause of the error
Evidence - ✔✔Auditor collects it to assess whether the financial
statements are fairly stated. Provides basis for audit opinion
©morren2026/2027.Year published 2026.
WITH COMPLETE ANSWERS [GRADED
A+]
Information Asymmetry - ✔✔One party in a transaction has more
information than another party
1970: economist George Akerlof wrote a paper called "Lemons: Quality
Uncertainty and the Market Mechanism" describes problem associated with
information asymmetry
Principals - ✔✔Shareholders--rely on management to manage business
wisely and protect corporate assets
*Absentee
Agent - ✔✔Manager
©morren2026/2027.Year published 2026.
,Principals do not know true state of company, managers use earnings
management to - ✔✔1. Increase bonus
2. Avoid bankruptcy
3. Stay employed
4. Avoid debt covenants
Earnings Management - ✔✔Use of accounting techniques to produce
financial reports that present an overly positive view of a company's
business activities and financial position
Information Risk - ✔✔Probability that information circulated by a company
will be false or misleading
Purpose of auditing - ✔✔1. Reduce information asymmetry
2. Reduce information risk
Definition of 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
©morren2026/2027.Year published 2026.
,assertions and established criteria and communicating the results to
interested users
Established criteria - ✔✔GAAP
Results - ✔✔Audit opinion
Auditing redefined - ✔✔A well-planned approach of objectively obtaining
and evaluating evidence regarding the financial statements of a company
to ascertain the degree of correspondence between the financial
statements and GAAP and communicating the results in an audit opinion to
creditors and investors
Manager responsibilities - ✔✔Produce financial statements
Auditor responsibilities - ✔✔Audit report: States whether those financial
statements are in accordance with GAAP
If auditor produces financial statements - ✔✔Independence violation
©morren2026/2027.Year published 2026.
, Audit risk - ✔✔Risk that the auditor may unknowingly fail to appropriately
modify his or her opinion on financial statements that are MATERIALLY
misstated
Materiality - ✔✔The magnitude of an omission or misstatement of
accounting information that, in 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
3-5% of income before tax
Materiality is ______ - ✔✔Relative, not absolute. Depends on:
1. Size of the client
2. Nature of the item
3. Cause of the error
Evidence - ✔✔Auditor collects it to assess whether the financial
statements are fairly stated. Provides basis for audit opinion
©morren2026/2027.Year published 2026.
