Solution manual for
n n
n principles of auditing and other as
n n n n nn
surance services n n
22nd editionn n
by ray whittington kurt
n n n
,CHAPTER 1 n
The Role of the Publi
n n n n
c Accountant in the
n n n
American Economy n
ReviewnQuestions
1-1 Then ―crisisn ofn credibility‖n largelynarosen fromnthen numbernofncompaniesn thatn restatedn theirn previouslyn issu
edn financialn statementsn asn an resultn ofn accountingn irregularitiesn andn fraud. n Especiallynresponsiblen weren then
veryn visiblen Enronn andn WorldComnfraudncases. n Bothn companiesn filednfornbankruptcynandn constitutedn thenl
argestn companiesn inn Americann historyn ton donso. nThen extentn ofnthen accountingn irregularitiesn andn fraudn bein
gn investigatedn andn disclosedn broughtn inton questionn theneffectivenessn ofnfinancialn statementn audits. nInnaddit
ion, n then criminaln convictionn ofn ArthurnAndersen, n LLP, n onenofnthen thenn Bign 5naccountingn firms, nonn charges
n of n destroyingn documentsn relatedn tonthen Enronn casen broughtnintonquestionn thenethicsn standardsn of nthen profe
ssion.
1-2 Assurancen servicesn aren professionaln servicesn thatn enhancen then qualityn ofn information,n orn itsn context, nforn
decision-
making. n Then twon typesn are:n(a)n thosen thatn increasen then reliabilityn ofn informationn andn (b)n thosen thatn involv
en puttingn informationn inn an formn orn contextn thatn facilitatesn decision-making.
1-3 An financialn statementn auditn is, n bynfar,n thenmostn commonntypenofnattestn engagement. n Then overalln assertion, n
maden byn management, n mostn frequentlyn isn thatn thenfinancialn statementsn followngenerallyn acceptedn accounti
ngn principles.
1-4 An largen corporationn withn securitiesn listedn onnan stockn exchangen isn requiredn bynthenrulesn ofn thenstockn exchang
en andn byn then rulesn ofn then Securitiesn andnExchangen Commissionn tonproviden annauditn reportnwithn then annualn fi
nancialn statementsn furnishedn ton itsn stockholders. n Itn alson isn requiredn ton engagen thenauditorsn tonprovidenann opi
nionn onn itsn internaln control.n Apartnfromn legaln requirements, nhowever, nan largen listedn corporationn recognizesn
thatn itn mustn maintainn investorn confidencen innthenreliabilitynofnitsn financialn statementsn andn internaln controln o
vern financialn reportingn ifn itn isn ton continuentonben ablen tonsecuren capitaln fromnthen public. nThen reportnbyn anfirm
n of n certifiedn publicn accountantsn addsn credibilityntonthen financialn statementsn preparedn bynthen corporation.n W
henn an smalln family-
ownedn enterprisen electsn ton haven ann audit, n thenpurposen usuallyn isnton usen thenauditors'n reportntonsupportnann app
licationn forn an bankn loan.
,1-5 An reportn bynann independentn publicnaccountantn concerningn thenfairnessn ofnan company'sn financialnstatementsn i
sn commonlyn requiredn inn then followingn situations:
(1) Applicationn forn an bankn loan.
(2) Establishingncreditn forn purchasen ofn merchandise, n equipment, n orn othern assets.
(3) Reportingn operatingn results, n financialn position, nandn cashn flowsn ton absenteen ownersn (stockholdersn
orn partners).
(4) Issuancen ofn securitiesn byn an corporation.
(5) Annualn financialn statementsn byn an corporationn withnsecuritiesn listedn onnanstockn exchangen orn tradedn
overn then counter.
(6) Salen ofn ann ongoingn business.
(7) Terminationn ofn an partnership.
1-6 Ton addn credibilityn ton financialn statementsn isn ton increasen then likelihoodn thatn theyn haven beenn preparedn follo
wingn then appropriaten criteria,n usuallyngenerallynacceptedn accountingn principles. nAsn such, n ann increasen inn cr
edibilityn resultsn inn financialn statementsn thatn cann ben believedn andn reliedn uponn byn thirdn parties.
1-7 Businessn riskn isn then riskn thatn then investmentn willnbenimpairednbecausen an companyn investedn inn isn unablen ton
meetn itsn financialn obligationsn duen ton economicn conditionsnornpoornmanagementn decisions. n Informationnris
kn isn then riskn thatn then informationnusedn tonassessn businessn riskn isn notn accurate. n Auditorsncann directlynreduce
n informationn risk, n butn haven onlyn limitedn effectn onn businessn risk.
1-8 Atn then beginningn ofn then century,nthen principaln objectiven ofn auditingnwasn thenpreventionn andn detectionn ofn fr
aud. n Auditn workn centeredn onn then balancen sheet, n becausen then incomenstatementn wasn regardedn asn highlynconf
identialn andn notn forn publicndisclosure. n Today, n then principaln objectivenofnauditingn isn tonformnann opinionn onnt
hen fairnessn ofn financialn statementsn andn theirn conformitynwithn generallynacceptedn accountingn principles. nBu
tn then professionaln standardsn alson requiren thatn annauditn ben designedn ton providen reasonablen assurancen ofn dete
ctingn materialn misstatements, n duen ton errorsn orn fraud. n Particular nemphasisn isn placedn onn then incomen stateme
ntn whichn isn ofn greatnimportancenton investors. n Auditingntodaynalson hasn thenobjectivesn ofnmeetingn then require
mentsn ofn then Securitiesn andn Exchangen Commissionn (SEC)nandn thenPublicn CompanynAccountingn Oversight
n Boardn for n publicn companies.
1-9 Then statementn isn incorrect. n Then increasingn integratedn databasesn ofn today, nalongnwithn availablen auditn
proceduresn maken auditedn entiren populationsn an possibilityn inn manyn situations.
1-10 Ann operationaln auditn attemptsn ton measuren then effectivenessn andn efficiencyn ofnan specificn unitn ofn ann orga
nization. n Itn involvesn moren subjectiven judgmentsn thann an compliancen auditn orn annauditn ofn financialn statem
entsn becausen then criterian ofn effectivenessn andn efficiencynofndepartmentaln performancen arennotnasn clearly
n establishedn asn aren manyn lawsn andn regulationsn or n generallyn acceptedn accountingn principles.
Then reportn preparedn aftern completionnofnannoperationalnauditn isnusuallyn directednton managementno
fn then organizationn inn whichn then auditn workn wasn done.
1-11 An compliancen auditn isn ann auditn tondeterminen whethernfinancialn reportsn orn othernassertionsn aren inncomplian
cen withn establishedn criteria. n Then necessaryn ingredientsn aren verifiablen datan andnthen existencen ofn standardsn
establishedn byn ann authoritativen body. n Annoperationalnaudit, nonnthen othernhand, nisn anreviewnofnan departmen
tn orn othern unitnofnan businessn orn governmentalnorganizationn ton measuren theneffectivenessn andn efficiencynofn
operations. n Internaln auditorsn oftenn performnoperationalnauditsn asn donauditorsn employednbyn then Governme
ntn Accountabilityn Officen (GAO)n ofn then federaln government.
1-12 Internaln auditorsn mustn ben independentn ofnthen departmentnheadsn andn othern linen executivesn whosen workn theyn
review. n However, n internaln auditorsn aren notn independentn inn then samen sensen asn an publicn accountingn firm.
, Then publicn accountingn firmn servesn manyn clientsn andn then revenuen obtainednfromnanynonen clientnisn onlyn an sm
alln partn ofn thenrevenuen ofnthenfirm. nInternalnauditors, nonnthenother nhand, narenemployeesn ofnonen company,n and
n aren subjectn ton then restraintsn inherentn inn then employer-
employeen relationship. n Internaln auditorsn cann achieven an greatn dealn ofn independencen byn reportingntonthen audit
n committeen of n then boardnof ndirectors, nbutn theyn cannotn achieven then samen degreen of n independencen asn isn posse
ssedn byn then externaln publicn accountingn firm.
1-13 Theninternaln auditorsn aren employeesn ofn Spacecraft, n Inc., n andn maynben influencedn byncorporaten management.
Then publicn accountingn firmn isn independentn ofn thencompanyn andnisn innan betternpositionn ton takenpositionsn opp
osedn ton thosen ofn companyn management. n Then worknofnthen internaln auditnstaffnemphasizesn measurementn ofn th
en efficiencyn andn effectivenessn ofn variousn operatingn unitsn ofnthen companynandn compliancen withnalln typesn ofn
controls, n whereasn then publicn accountingn firmnisn primarilynconcernednwithn determiningnthenfairnessn ofnSpace
craft'sn financialn statements.
1-14 Then Governmentn Accountabilityn Officen (GAO)n isn anstaffn ofn professionaln auditorsn whichn reportsn ton Congre
ss. n Itsn functionn isn ton determinenthatn programsn carriednoutnbyn federaln agenciesn conformnton then financialn auth
orizationn ofn then Congress. n Itn isn alson concernedn withn then cost-
effectivenessn ofn governmentn programs. n Then auditnactivitiesn includen investigationn ofnthen costsn andnperforma
ncen ofn corporationsn holdingn governmentn contracts.
1-15 Amongn then manyn importantn contributionsn ton auditingn literaturen byn then AICPAn aren then seriesn ofn Statementsn o
nn Auditingn Standardsn (SASs),n Statementsn onnStandardsn forn AttestationnEngagementsn (SSAEs),n Industryn Au
ditn andn Accountingn Guides, n Auditn Guides, n Auditn Riskn Alerts,n Statementsn onn Standardsnforn Accountingn andn
Reviewn Servicesn (SSARSs), n , n andn then Coden ofn Professionaln Conductn (onlyn twon required).
1-16 An peernreviewnisn an criticaln reviewn ofn an publicn accountingn firm'sn practicesn bynanothern publicn accountingn f
irmn(orn othern CPAsnfunctioningn asn an peern reviewn team).n Then purposen ofn an peernreviewnisn ton encouragen a
dherencen ton qualityn controln standardsn establishedn byn then accountingn firmn andn then profession.
1-17 Then Securitiesn andn Exchangen Commissionn (SEC) n isn ann agencyn ofn then federaln governmentn andn isn responsibl
en forn administeringn an numbernofnacts, n includingnthen Securitiesn Actn ofn 1933nandn then Securitiesn Exchangen Ac
tn ofn 1934. n Inn meetingn thisn responsibility, n then SECn reviewsn financialn statementsn ofn companiesn offeringnse
curitiesn forn salen ton then public. nItn isnparticularlynconcernedn withnrequiringnfulln disclosuren ofnfinancialn informa
tionn andn withn preventingn misrepresentation. n Throughnthen Publicn Companyn AccountingnOversightn Board,n th
en SECn nown overseesn publicn accountingnfirmsnthatn auditnpublicncompanies. n Includedninn thisn oversightn proces
sn includesn developmentn ofn auditing, n independence, n andn qualityncontroln standards;n inspectionn ofn performa
nce;n andn enforcementn ofn then standards.
Then AICPAn isn then nationaln organizationnofncertifiednpublicnaccountants. n Itnhasn longnbeennan leadern
inn accountingn andn auditingn research, n inn publicationn ofnauthoritativen accountingn andn auditingnpronouncem
entsn andn studies, n andn inn promotingn highn professionaln standardsn ofn practice.
1-18 Servicesn offeredn byn publicn accountingnfirmsn innadditionntonauditingnincluden othernformsn ofn attestation, n taxn
work, n consultingn services, n litigationn supportn services, nfraudninvestigationn services, n personaln financialn plan
ningn andn accountingn services. n Thisn lastn categoryn includesn preparationn ofnfinancialn statementsn forn smallernc
ompaniesn thatn haven limitedn accountingn personneln andn variousn typesn ofn write-
upn work. n Publicn accountingn firmsn alson performnan varietyn ofn othernservices. n Consultingn servicesn includen ai
dingn clientsn inn then designn ofn accountingn systems, n conversionnton InformationnTechnologyn (IT)nsystems, n pre
parationn ofn budgets, n planningn businessn combinationsn withn otherncompanies, n executiven search, nandn numero
usn othern projects. n Publicn accountingn firmsn arenrestrictedn asn tonthenconsultingn servicesn thatn theynmayn provid
en ton auditn clientsn thatn aren publicn companies.
n n
n principles of auditing and other as
n n n n nn
surance services n n
22nd editionn n
by ray whittington kurt
n n n
,CHAPTER 1 n
The Role of the Publi
n n n n
c Accountant in the
n n n
American Economy n
ReviewnQuestions
1-1 Then ―crisisn ofn credibility‖n largelynarosen fromnthen numbernofncompaniesn thatn restatedn theirn previouslyn issu
edn financialn statementsn asn an resultn ofn accountingn irregularitiesn andn fraud. n Especiallynresponsiblen weren then
veryn visiblen Enronn andn WorldComnfraudncases. n Bothn companiesn filednfornbankruptcynandn constitutedn thenl
argestn companiesn inn Americann historyn ton donso. nThen extentn ofnthen accountingn irregularitiesn andn fraudn bein
gn investigatedn andn disclosedn broughtn inton questionn theneffectivenessn ofnfinancialn statementn audits. nInnaddit
ion, n then criminaln convictionn ofn ArthurnAndersen, n LLP, n onenofnthen thenn Bign 5naccountingn firms, nonn charges
n of n destroyingn documentsn relatedn tonthen Enronn casen broughtnintonquestionn thenethicsn standardsn of nthen profe
ssion.
1-2 Assurancen servicesn aren professionaln servicesn thatn enhancen then qualityn ofn information,n orn itsn context, nforn
decision-
making. n Then twon typesn are:n(a)n thosen thatn increasen then reliabilityn ofn informationn andn (b)n thosen thatn involv
en puttingn informationn inn an formn orn contextn thatn facilitatesn decision-making.
1-3 An financialn statementn auditn is, n bynfar,n thenmostn commonntypenofnattestn engagement. n Then overalln assertion, n
maden byn management, n mostn frequentlyn isn thatn thenfinancialn statementsn followngenerallyn acceptedn accounti
ngn principles.
1-4 An largen corporationn withn securitiesn listedn onnan stockn exchangen isn requiredn bynthenrulesn ofn thenstockn exchang
en andn byn then rulesn ofn then Securitiesn andnExchangen Commissionn tonproviden annauditn reportnwithn then annualn fi
nancialn statementsn furnishedn ton itsn stockholders. n Itn alson isn requiredn ton engagen thenauditorsn tonprovidenann opi
nionn onn itsn internaln control.n Apartnfromn legaln requirements, nhowever, nan largen listedn corporationn recognizesn
thatn itn mustn maintainn investorn confidencen innthenreliabilitynofnitsn financialn statementsn andn internaln controln o
vern financialn reportingn ifn itn isn ton continuentonben ablen tonsecuren capitaln fromnthen public. nThen reportnbyn anfirm
n of n certifiedn publicn accountantsn addsn credibilityntonthen financialn statementsn preparedn bynthen corporation.n W
henn an smalln family-
ownedn enterprisen electsn ton haven ann audit, n thenpurposen usuallyn isnton usen thenauditors'n reportntonsupportnann app
licationn forn an bankn loan.
,1-5 An reportn bynann independentn publicnaccountantn concerningn thenfairnessn ofnan company'sn financialnstatementsn i
sn commonlyn requiredn inn then followingn situations:
(1) Applicationn forn an bankn loan.
(2) Establishingncreditn forn purchasen ofn merchandise, n equipment, n orn othern assets.
(3) Reportingn operatingn results, n financialn position, nandn cashn flowsn ton absenteen ownersn (stockholdersn
orn partners).
(4) Issuancen ofn securitiesn byn an corporation.
(5) Annualn financialn statementsn byn an corporationn withnsecuritiesn listedn onnanstockn exchangen orn tradedn
overn then counter.
(6) Salen ofn ann ongoingn business.
(7) Terminationn ofn an partnership.
1-6 Ton addn credibilityn ton financialn statementsn isn ton increasen then likelihoodn thatn theyn haven beenn preparedn follo
wingn then appropriaten criteria,n usuallyngenerallynacceptedn accountingn principles. nAsn such, n ann increasen inn cr
edibilityn resultsn inn financialn statementsn thatn cann ben believedn andn reliedn uponn byn thirdn parties.
1-7 Businessn riskn isn then riskn thatn then investmentn willnbenimpairednbecausen an companyn investedn inn isn unablen ton
meetn itsn financialn obligationsn duen ton economicn conditionsnornpoornmanagementn decisions. n Informationnris
kn isn then riskn thatn then informationnusedn tonassessn businessn riskn isn notn accurate. n Auditorsncann directlynreduce
n informationn risk, n butn haven onlyn limitedn effectn onn businessn risk.
1-8 Atn then beginningn ofn then century,nthen principaln objectiven ofn auditingnwasn thenpreventionn andn detectionn ofn fr
aud. n Auditn workn centeredn onn then balancen sheet, n becausen then incomenstatementn wasn regardedn asn highlynconf
identialn andn notn forn publicndisclosure. n Today, n then principaln objectivenofnauditingn isn tonformnann opinionn onnt
hen fairnessn ofn financialn statementsn andn theirn conformitynwithn generallynacceptedn accountingn principles. nBu
tn then professionaln standardsn alson requiren thatn annauditn ben designedn ton providen reasonablen assurancen ofn dete
ctingn materialn misstatements, n duen ton errorsn orn fraud. n Particular nemphasisn isn placedn onn then incomen stateme
ntn whichn isn ofn greatnimportancenton investors. n Auditingntodaynalson hasn thenobjectivesn ofnmeetingn then require
mentsn ofn then Securitiesn andn Exchangen Commissionn (SEC)nandn thenPublicn CompanynAccountingn Oversight
n Boardn for n publicn companies.
1-9 Then statementn isn incorrect. n Then increasingn integratedn databasesn ofn today, nalongnwithn availablen auditn
proceduresn maken auditedn entiren populationsn an possibilityn inn manyn situations.
1-10 Ann operationaln auditn attemptsn ton measuren then effectivenessn andn efficiencyn ofnan specificn unitn ofn ann orga
nization. n Itn involvesn moren subjectiven judgmentsn thann an compliancen auditn orn annauditn ofn financialn statem
entsn becausen then criterian ofn effectivenessn andn efficiencynofndepartmentaln performancen arennotnasn clearly
n establishedn asn aren manyn lawsn andn regulationsn or n generallyn acceptedn accountingn principles.
Then reportn preparedn aftern completionnofnannoperationalnauditn isnusuallyn directednton managementno
fn then organizationn inn whichn then auditn workn wasn done.
1-11 An compliancen auditn isn ann auditn tondeterminen whethernfinancialn reportsn orn othernassertionsn aren inncomplian
cen withn establishedn criteria. n Then necessaryn ingredientsn aren verifiablen datan andnthen existencen ofn standardsn
establishedn byn ann authoritativen body. n Annoperationalnaudit, nonnthen othernhand, nisn anreviewnofnan departmen
tn orn othern unitnofnan businessn orn governmentalnorganizationn ton measuren theneffectivenessn andn efficiencynofn
operations. n Internaln auditorsn oftenn performnoperationalnauditsn asn donauditorsn employednbyn then Governme
ntn Accountabilityn Officen (GAO)n ofn then federaln government.
1-12 Internaln auditorsn mustn ben independentn ofnthen departmentnheadsn andn othern linen executivesn whosen workn theyn
review. n However, n internaln auditorsn aren notn independentn inn then samen sensen asn an publicn accountingn firm.
, Then publicn accountingn firmn servesn manyn clientsn andn then revenuen obtainednfromnanynonen clientnisn onlyn an sm
alln partn ofn thenrevenuen ofnthenfirm. nInternalnauditors, nonnthenother nhand, narenemployeesn ofnonen company,n and
n aren subjectn ton then restraintsn inherentn inn then employer-
employeen relationship. n Internaln auditorsn cann achieven an greatn dealn ofn independencen byn reportingntonthen audit
n committeen of n then boardnof ndirectors, nbutn theyn cannotn achieven then samen degreen of n independencen asn isn posse
ssedn byn then externaln publicn accountingn firm.
1-13 Theninternaln auditorsn aren employeesn ofn Spacecraft, n Inc., n andn maynben influencedn byncorporaten management.
Then publicn accountingn firmn isn independentn ofn thencompanyn andnisn innan betternpositionn ton takenpositionsn opp
osedn ton thosen ofn companyn management. n Then worknofnthen internaln auditnstaffnemphasizesn measurementn ofn th
en efficiencyn andn effectivenessn ofn variousn operatingn unitsn ofnthen companynandn compliancen withnalln typesn ofn
controls, n whereasn then publicn accountingn firmnisn primarilynconcernednwithn determiningnthenfairnessn ofnSpace
craft'sn financialn statements.
1-14 Then Governmentn Accountabilityn Officen (GAO)n isn anstaffn ofn professionaln auditorsn whichn reportsn ton Congre
ss. n Itsn functionn isn ton determinenthatn programsn carriednoutnbyn federaln agenciesn conformnton then financialn auth
orizationn ofn then Congress. n Itn isn alson concernedn withn then cost-
effectivenessn ofn governmentn programs. n Then auditnactivitiesn includen investigationn ofnthen costsn andnperforma
ncen ofn corporationsn holdingn governmentn contracts.
1-15 Amongn then manyn importantn contributionsn ton auditingn literaturen byn then AICPAn aren then seriesn ofn Statementsn o
nn Auditingn Standardsn (SASs),n Statementsn onnStandardsn forn AttestationnEngagementsn (SSAEs),n Industryn Au
ditn andn Accountingn Guides, n Auditn Guides, n Auditn Riskn Alerts,n Statementsn onn Standardsnforn Accountingn andn
Reviewn Servicesn (SSARSs), n , n andn then Coden ofn Professionaln Conductn (onlyn twon required).
1-16 An peernreviewnisn an criticaln reviewn ofn an publicn accountingn firm'sn practicesn bynanothern publicn accountingn f
irmn(orn othern CPAsnfunctioningn asn an peern reviewn team).n Then purposen ofn an peernreviewnisn ton encouragen a
dherencen ton qualityn controln standardsn establishedn byn then accountingn firmn andn then profession.
1-17 Then Securitiesn andn Exchangen Commissionn (SEC) n isn ann agencyn ofn then federaln governmentn andn isn responsibl
en forn administeringn an numbernofnacts, n includingnthen Securitiesn Actn ofn 1933nandn then Securitiesn Exchangen Ac
tn ofn 1934. n Inn meetingn thisn responsibility, n then SECn reviewsn financialn statementsn ofn companiesn offeringnse
curitiesn forn salen ton then public. nItn isnparticularlynconcernedn withnrequiringnfulln disclosuren ofnfinancialn informa
tionn andn withn preventingn misrepresentation. n Throughnthen Publicn Companyn AccountingnOversightn Board,n th
en SECn nown overseesn publicn accountingnfirmsnthatn auditnpublicncompanies. n Includedninn thisn oversightn proces
sn includesn developmentn ofn auditing, n independence, n andn qualityncontroln standards;n inspectionn ofn performa
nce;n andn enforcementn ofn then standards.
Then AICPAn isn then nationaln organizationnofncertifiednpublicnaccountants. n Itnhasn longnbeennan leadern
inn accountingn andn auditingn research, n inn publicationn ofnauthoritativen accountingn andn auditingnpronouncem
entsn andn studies, n andn inn promotingn highn professionaln standardsn ofn practice.
1-18 Servicesn offeredn byn publicn accountingnfirmsn innadditionntonauditingnincluden othernformsn ofn attestation, n taxn
work, n consultingn services, n litigationn supportn services, nfraudninvestigationn services, n personaln financialn plan
ningn andn accountingn services. n Thisn lastn categoryn includesn preparationn ofnfinancialn statementsn forn smallernc
ompaniesn thatn haven limitedn accountingn personneln andn variousn typesn ofn write-
upn work. n Publicn accountingn firmsn alson performnan varietyn ofn othernservices. n Consultingn servicesn includen ai
dingn clientsn inn then designn ofn accountingn systems, n conversionnton InformationnTechnologyn (IT)nsystems, n pre
parationn ofn budgets, n planningn businessn combinationsn withn otherncompanies, n executiven search, nandn numero
usn othern projects. n Publicn accountingn firmsn arenrestrictedn asn tonthenconsultingn servicesn thatn theynmayn provid
en ton auditn clientsn thatn aren publicn companies.
