,
,CHAPTER 1 a
The Role of the
Public Accountant in the
American Economy
Reviewa Questions
1-1 Thea―crisisaofacredibility‖alargelyaaroseafromatheanumberaofacompanies thatarestatedatheirapreviouslyaissuedaf
F
inancialastatementsaasaaaresultaofaaccountingairregularitiesaandafraud.aEspeciallyaresponsibleaweretheaveryavi
sibleaEnronaandaWorldComafraudacases.aBothacompaniesafiledaforabankruptcyaandaconstituted thealargestaco F
mpaniesainaAmerican historyatoadoaso.aTheaextent ofatheaaccountingairregularities andafraudabeingainvestiagat
F F F
edaand disclosedabroughtaintoaquestionatheaeffectivenessaofafinancialastatementaaudits.aInaaddition,atheacraimi
F
nalaconvictionaofaArthuraAndersen,aLLP,aoneaofatheathen Biga5aaccountingafirms,aonachargesaofadestroyiangad
F
ocumentsarelated toatheaEnronacaseabrought intoaquestionatheaethicsastandardsaofatheaprofession.
F F
1-2 Assuranceaservicesaareaprofessionalaservicesathat enhanceatheaqualityaofainformation,aoraitsacontext,aforadae
F
cision-
making.aTheatwoatypesaare:a(a)athose that increaseatheareliabilityaofainformationaanda(b)athoseathatainvolvaea
F F
puttingainformationainaaaformaoracontextathatafacilitatesadecision-making.
1-3 Aafinancialastatementaauditais,abyafar,atheamostacommonatype ofaattestaengagement.aTheaoverallaassertion,maa
F
deabyamanagement,amostafrequentlyaisathatatheafinancialastatementsafollowagenerallyaacceptedaaccountingapr
inciples.
1-4 Aalargeacorporationawithasecuritiesalistedaonaaastockaexchangeais requiredabyathe rulesaofatheastockaexchangeaa
F F
ndabyathearulesaofatheaSecuritiesaandaExchangeaCommissionatoaprovideaanaauditareport awithatheannualafinaanc F
ialastatementsafurnishedatoaitsastockholders.aIt alsoaisarequiredatoaengageatheaauditorsatoaprovideaanaopinioan o
F F
n itsainternalacontrol.aApart from legalarequirements,ahowever,aaalargealistedacorporationarecognizesathaa tait
F F F F
mustamaintainainvestoraconfidenceainatheareliabilityaofaitsafinancialastatementsaandainternalacontrolaoverafainan
cialareportingaifaitaisatoacontinue toabe able toasecure capitalafrom theapublic.aThe reportabyaaafirmaofaceratifieda
F F F F F F
publicaaccountantsaaddsacredibilityatoatheafinancialastatementsapreparedabyatheacorporation.a Whenaaasamallafa
mily-
ownedaenterpriseaelectsatoahaveaanaaudit,atheapurposeausuallyaisatoauseatheaauditors'areportatoasupportaanaappliac
ationaforaaabank loan.
F
, 1-5 Aareportabyaanaindependentapublicaaccountant concerningatheafairnessaofaaacompany'safinancial statementsisac
F F
ommonlyarequiredainatheafollowingasituations:
(1) Applicationaforaa bank loan. F F
(2) Establishingacredit forapurchaseaofamerchandise,aequipment,aoraotheraassets.
F
(3) Reportingaoperatingaresults,afinancialaposition,aandacashaflows atoaabsenteeaownersa(stockholdersoa F
rapartners).
(4) Issuanceaofasecuritiesabyaaacorporation.
(5) Annualafinancialastatementsabyaaacorporationawithasecuritiesalistedaonaaastockaexchangeaoratradedoav
eratheacounter.
(6) Saleaofaan ongoing business.
F F
(7) Terminationaofaa partnership. F
1-6 Toaaddacredibilityatoafinancialastatementsaisatoaincreaseathealikelihoodathatatheyahaveabeenaprepared followinag F
athe appropriate criteria,ausuallyagenerallyaacceptedaaccounting principles.aAs such,aanaincreaseinacredibilait
F F F F
yaresultsainafinancialastatementsathatacanabeabelievedaandareliedauponabyathirdaparties.
1-7 Business riskaisathe riskathatatheainvestmentawillabeaimpairedabecauseaaacompanyainvestedainaisaunableatomae
F F
et its financialaobligationsadueatoaeconomic conditionsaorapooramanagementadecisions.aInformationarisk iasa
F F F F
theariskathat theainformationausedatoaassessabusinessarisk isanotaaccurate.aAuditorsacan directlyareduceaianfor
F F F
mationarisk,abutahaveaonlyalimitedaeffect onabusinessarisk. F
1-8 Atatheabeginningaofatheacentury,atheaprincipalaobjectiveaofaauditing wasatheapreventionaandadetectionaofafrau F
d.aAudit workacentered onatheabalance sheet,abecause the income statementawasaregardedaasahighlyaconfidea
F F F F F F
ntialaandanot aforapublicadisclosure.a Today,atheaprincipalaobjective ofaauditingaisatoaformaanaopinion onathe faa
F F F F
irnessaofafinancialastatementsaandatheiraconformityawithagenerallyaaccepted accountingaprinciples.aBut theapr F F
ofessionalastandards alsoarequireathataanaauditabeadesignedatoaprovideareasonable assuranceaofadetectingamat
F F
erialamisstatements,adueatoaerrorsaorafraud.a Particularaemphasisaisaplacedaonatheaincomeastatementawhicahais o F
fagreataimportanceatoainvestors.aAuditingatodayaalsoahasatheaobjectivesaofmeetingathearequirementsaofatheaSe
curities andaExchangeaCommissiona(SEC)a andatheaPublicaCompanyaAccountingaOversight Board foarapubli
F F F
cacompanies.
1-9 The statementais incorrect.aTheaincreasing integratedadatabases ofatoday,aalong withaavailableaauditpar
F F F F F
oceduresamakeaauditedaentireapopulationsaaapossibilityainamanyasituations.
1-10 Anaoperationalaauditaattemptsatoameasureatheaeffectiveness andaefficiencyaofaaaspecificaunitaofaanaorganiaz F
ation.aIt involvesamoreasubjectiveajudgmentsathan a complianceaaudit oraanaaudit ofafinancialastatemenatsa
F F F F F
becauseatheacriteriaaofaeffectivenessaand efficiencyaofadepartmentalaperformance are not aasclearlyaestaab
F F F F
lishedaasaareamanyalawsaandaregulationsaoragenerallyaacceptedaaccountingaprinciples.
The reportapreparedaafteracompletion ofaanaoperationalaauditaisausuallyadirectedatoamanagement ofat
F F F
heaorganizationainawhichatheaauditaworkawasadone.
1-11 Aacomplianceaauditaisaanaauditatoadetermineawhetherafinancialareportsaoraotheraassertionsaareainacompliancaea
with establishedacriteria.aThe necessaryaingredientsaareaverifiableadataaandatheaexistenceaofastandardsaestaab
F F
lishedabyaanaauthoritativeabody.aAnaoperationalaaudit,aonatheaotherahand,aisaaareviewaofaadepartmentaoraothe
raunitaofaaabusinessaoragovernmentalaorganizationatoameasureatheaeffectivenessaandaefficiencyaofaoperaations.
aInternalaauditorsaoftenaperformaoperationalaauditsaasadoaauditorsaemployed bya theaGovernmentaAcacounta F
bilityaOfficea(GAO)aofatheafederalagovernment.
1-12 Internalaauditorsamustabeaindependentaofatheadepartmentaheadsaandaotheralineaexecutivesawhoseawork theyreav F
iew.aHowever,ainternalaauditorsaareanotaindependentain theasameasenseaasaaapublic accountingafirm. F F
,CHAPTER 1 a
The Role of the
Public Accountant in the
American Economy
Reviewa Questions
1-1 Thea―crisisaofacredibility‖alargelyaaroseafromatheanumberaofacompanies thatarestatedatheirapreviouslyaissuedaf
F
inancialastatementsaasaaaresultaofaaccountingairregularitiesaandafraud.aEspeciallyaresponsibleaweretheaveryavi
sibleaEnronaandaWorldComafraudacases.aBothacompaniesafiledaforabankruptcyaandaconstituted thealargestaco F
mpaniesainaAmerican historyatoadoaso.aTheaextent ofatheaaccountingairregularities andafraudabeingainvestiagat
F F F
edaand disclosedabroughtaintoaquestionatheaeffectivenessaofafinancialastatementaaudits.aInaaddition,atheacraimi
F
nalaconvictionaofaArthuraAndersen,aLLP,aoneaofatheathen Biga5aaccountingafirms,aonachargesaofadestroyiangad
F
ocumentsarelated toatheaEnronacaseabrought intoaquestionatheaethicsastandardsaofatheaprofession.
F F
1-2 Assuranceaservicesaareaprofessionalaservicesathat enhanceatheaqualityaofainformation,aoraitsacontext,aforadae
F
cision-
making.aTheatwoatypesaare:a(a)athose that increaseatheareliabilityaofainformationaanda(b)athoseathatainvolvaea
F F
puttingainformationainaaaformaoracontextathatafacilitatesadecision-making.
1-3 Aafinancialastatementaauditais,abyafar,atheamostacommonatype ofaattestaengagement.aTheaoverallaassertion,maa
F
deabyamanagement,amostafrequentlyaisathatatheafinancialastatementsafollowagenerallyaacceptedaaccountingapr
inciples.
1-4 Aalargeacorporationawithasecuritiesalistedaonaaastockaexchangeais requiredabyathe rulesaofatheastockaexchangeaa
F F
ndabyathearulesaofatheaSecuritiesaandaExchangeaCommissionatoaprovideaanaauditareport awithatheannualafinaanc F
ialastatementsafurnishedatoaitsastockholders.aIt alsoaisarequiredatoaengageatheaauditorsatoaprovideaanaopinioan o
F F
n itsainternalacontrol.aApart from legalarequirements,ahowever,aaalargealistedacorporationarecognizesathaa tait
F F F F
mustamaintainainvestoraconfidenceainatheareliabilityaofaitsafinancialastatementsaandainternalacontrolaoverafainan
cialareportingaifaitaisatoacontinue toabe able toasecure capitalafrom theapublic.aThe reportabyaaafirmaofaceratifieda
F F F F F F
publicaaccountantsaaddsacredibilityatoatheafinancialastatementsapreparedabyatheacorporation.a Whenaaasamallafa
mily-
ownedaenterpriseaelectsatoahaveaanaaudit,atheapurposeausuallyaisatoauseatheaauditors'areportatoasupportaanaappliac
ationaforaaabank loan.
F
, 1-5 Aareportabyaanaindependentapublicaaccountant concerningatheafairnessaofaaacompany'safinancial statementsisac
F F
ommonlyarequiredainatheafollowingasituations:
(1) Applicationaforaa bank loan. F F
(2) Establishingacredit forapurchaseaofamerchandise,aequipment,aoraotheraassets.
F
(3) Reportingaoperatingaresults,afinancialaposition,aandacashaflows atoaabsenteeaownersa(stockholdersoa F
rapartners).
(4) Issuanceaofasecuritiesabyaaacorporation.
(5) Annualafinancialastatementsabyaaacorporationawithasecuritiesalistedaonaaastockaexchangeaoratradedoav
eratheacounter.
(6) Saleaofaan ongoing business.
F F
(7) Terminationaofaa partnership. F
1-6 Toaaddacredibilityatoafinancialastatementsaisatoaincreaseathealikelihoodathatatheyahaveabeenaprepared followinag F
athe appropriate criteria,ausuallyagenerallyaacceptedaaccounting principles.aAs such,aanaincreaseinacredibilait
F F F F
yaresultsainafinancialastatementsathatacanabeabelievedaandareliedauponabyathirdaparties.
1-7 Business riskaisathe riskathatatheainvestmentawillabeaimpairedabecauseaaacompanyainvestedainaisaunableatomae
F F
et its financialaobligationsadueatoaeconomic conditionsaorapooramanagementadecisions.aInformationarisk iasa
F F F F
theariskathat theainformationausedatoaassessabusinessarisk isanotaaccurate.aAuditorsacan directlyareduceaianfor
F F F
mationarisk,abutahaveaonlyalimitedaeffect onabusinessarisk. F
1-8 Atatheabeginningaofatheacentury,atheaprincipalaobjectiveaofaauditing wasatheapreventionaandadetectionaofafrau F
d.aAudit workacentered onatheabalance sheet,abecause the income statementawasaregardedaasahighlyaconfidea
F F F F F F
ntialaandanot aforapublicadisclosure.a Today,atheaprincipalaobjective ofaauditingaisatoaformaanaopinion onathe faa
F F F F
irnessaofafinancialastatementsaandatheiraconformityawithagenerallyaaccepted accountingaprinciples.aBut theapr F F
ofessionalastandards alsoarequireathataanaauditabeadesignedatoaprovideareasonable assuranceaofadetectingamat
F F
erialamisstatements,adueatoaerrorsaorafraud.a Particularaemphasisaisaplacedaonatheaincomeastatementawhicahais o F
fagreataimportanceatoainvestors.aAuditingatodayaalsoahasatheaobjectivesaofmeetingathearequirementsaofatheaSe
curities andaExchangeaCommissiona(SEC)a andatheaPublicaCompanyaAccountingaOversight Board foarapubli
F F F
cacompanies.
1-9 The statementais incorrect.aTheaincreasing integratedadatabases ofatoday,aalong withaavailableaauditpar
F F F F F
oceduresamakeaauditedaentireapopulationsaaapossibilityainamanyasituations.
1-10 Anaoperationalaauditaattemptsatoameasureatheaeffectiveness andaefficiencyaofaaaspecificaunitaofaanaorganiaz F
ation.aIt involvesamoreasubjectiveajudgmentsathan a complianceaaudit oraanaaudit ofafinancialastatemenatsa
F F F F F
becauseatheacriteriaaofaeffectivenessaand efficiencyaofadepartmentalaperformance are not aasclearlyaestaab
F F F F
lishedaasaareamanyalawsaandaregulationsaoragenerallyaacceptedaaccountingaprinciples.
The reportapreparedaafteracompletion ofaanaoperationalaauditaisausuallyadirectedatoamanagement ofat
F F F
heaorganizationainawhichatheaauditaworkawasadone.
1-11 Aacomplianceaauditaisaanaauditatoadetermineawhetherafinancialareportsaoraotheraassertionsaareainacompliancaea
with establishedacriteria.aThe necessaryaingredientsaareaverifiableadataaandatheaexistenceaofastandardsaestaab
F F
lishedabyaanaauthoritativeabody.aAnaoperationalaaudit,aonatheaotherahand,aisaaareviewaofaadepartmentaoraothe
raunitaofaaabusinessaoragovernmentalaorganizationatoameasureatheaeffectivenessaandaefficiencyaofaoperaations.
aInternalaauditorsaoftenaperformaoperationalaauditsaasadoaauditorsaemployed bya theaGovernmentaAcacounta F
bilityaOfficea(GAO)aofatheafederalagovernment.
1-12 Internalaauditorsamustabeaindependentaofatheadepartmentaheadsaandaotheralineaexecutivesawhoseawork theyreav F
iew.aHowever,ainternalaauditorsaareanotaindependentain theasameasenseaasaaapublic accountingafirm. F F
