SOLUTIONS MANUAL
PRINCIPLES OF AUDITING & OTHER ASSURANCE SERVICES
2024 EVERGREEN RELEASE
CHAPTER NO. 01: THE ROLE OF THE PUBLIC ACCOUNTANT IN THE
AMERICAN ECONOMY
REVIEW QUESTIONS
1-1 The “crisis of credibility” largely arose from the number of companies that restated their
previously issued financial statements as a result of accounting irregularities and fraud.
Especially responsible were the very visible Enron and WorldCom fraud cases. Both
companies filed for bankruptcy and constituted the largest companies in American history to
do so. The extent of the accounting irregularities and fraud being investigated and disclosed
brought into question the effectiveness of financial statement audits. In addition, the criminal
conviction of Arthur Andersen, LLP, one of the then Big 5 accounting firms, on charges of
destroying documents related to the Enron case brought into question the ethics standards of
the profession.
1-2 Assurance services are professional services that enhance the quality of information, or its
context, for decision-making. The two types are: (a) those that increase the reliability of
information and (b) those that involve putting information in a form or context that facilitates
decision-making.
1-3 A financial statement audit is, by far, the most common type of attest engagement. The
overall assertion, made by management, most frequently is that the financial statements
follow generally accepted accounting principles.
1-4 A large corporation with securities listed on a stock exchange is required by the rules of the
stock exchange and by the rules of the Securities and Exchange Commission to provide an
audit report with the annual financial statements furnished to its stockholders. It also is
required to engage the auditors to provide an opinion on its internal control. Apart from legal
, requirements, however, a large listed corporation recognizes that it must maintain investor
confidence in the reliability of its financial statements and internal control over financial
reporting if it is to continue to be able to secure capital from the public. The report by a firm
of certified public accountants adds credibility to the financial statements prepared by the
corporation. When a small family-owned enterprise elects to have an audit, the purpose
usually is to use the auditors' report to support an application for a bank loan.
1-5 A report by an independent public accountant concerning the fairness of a company's
financial statements is commonly required in the following situations:
(1) Application for a bank loan.
(2) Establishing credit for purchase of merchandise, equipment, or other assets.
(3) Reporting operating results, financial position, and cash flows to absentee owners
(stockholders or partners).
(4) Issuance of securities by a corporation.
(5) Annual financial statements by a corporation with securities listed on a stock
exchange or traded over the counter.
(6) Sale of an ongoing business.
(7) Termination of a partnership.
1-6 To add credibility to financial statements is to increase the likelihood that they have been
prepared following the appropriate criteria, usually generally accepted accounting principles.
As such, an increase in credibility results in financial statements that can be believed and
relied upon by third parties.
1-7 Business risk is the risk that the investment will be impaired because a company invested in
is unable to meet its financial obligations due to economic conditions or poor management
decisions. Information risk is the risk that the information used to assess business risk is not
accurate. Auditors can directly reduce information risk, but have only limited effect on
business risk.
,1-8 At the beginning of the century, the principal objective of auditing was the prevention and
detection of fraud. Audit work centered on the balance sheet, because the income statement
was regarded as highly confidential and not for public disclosure. Today, the principal
objective of auditing is to form an opinion on the fairness of financial statements and their
conformity with generally accepted accounting principles. But the professional standards
also require that an audit be designed to provide reasonable assurance of detecting material
misstatements, due to errors or fraud. Particular emphasis is placed on the income statement
which is of great importance to investors. Auditing today also has the objectives of meeting
the requirements of the Securities and Exchange Commission (SEC) and the Public Company
Accounting Oversight Board for public companies.
1-9 The statement is incorrect. The increasing integrated databases of today, along with available
audit procedures make audited entire populations a possibility in many situations.
1-10 An operational audit attempts to measure the effectiveness and efficiency of a specific unit of
an organization. It involves more subjective judgments than a compliance audit or an audit
of financial statements because the criteria of effectiveness and efficiency of departmental
performance are not as clearly established as are many laws and regulations or generally
accepted accounting principles. The report prepared after completion of an operational audit
is usually directed to management of the organization in which the audit work was done.
1-11 A compliance audit is an audit to determine whether financial reports or other assertions are
in compliance with established criteria. The necessary ingredients are verifiable data and the
existence of standards established by an authoritative body. An operational audit, on the
other hand, is a review of a department or other unit of a business or governmental
organization to measure the effectiveness and efficiency of operations. Internal auditors
often perform operational audits as do auditors employed by the Government Accountability
Office (GAO) of the federal government.
1-12 Internal auditors must be independent of the department heads and other line executives
whose work they review. However, internal auditors are not independent in the same sense
as a public accounting firm. The public accounting firm serves many clients and the revenue
, obtained from any one client is only a small part of the revenue of the firm. Internal auditors,
on the other hand, are employees of one company, and are subject to the restraints inherent in
the employer-employee relationship. Internal auditors can achieve a great deal of
independence by reporting to the audit committee of the board of directors, but they cannot
achieve the same degree of independence as is possessed by the external public accounting
firm.
1-13 The internal auditors are employees of Spacecraft, Inc., and may be influenced by corporate
management. The public accounting firm is independent of the company and is in a better
position to take positions opposed to those of company management. The work of the
internal audit staff emphasizes measurement of the efficiency and effectiveness of various
operating units of the company and compliance with all types of controls, whereas the public
accounting firm is primarily concerned with determining the fairness of Spacecraft's financial
statements.
1-14 The Government Accountability Office (GAO) is a staff of professional auditors which
reports to Congress. Its function is to determine that programs carried out by federal
agencies conform to the financial authorization of the Congress. It is also concerned with the
cost-effectiveness of government programs. The audit activities include investigation of the
costs and performance of corporations holding government contracts.
1-15 Among the many important contributions to auditing literature by the AICPA are the series
of Statements on Auditing Standards (SASs), Statements on Standards for Attestation
Engagements (SSAEs), Industry Audit and Accounting Guides, Audit Guides, Audit Risk
Alerts, Statements on Standards for Accounting and Review Services (SSARSs), , and the
Code of Professional Conduct (only two required).
1-16 A peer review is a critical review of a public accounting firm's practices by another public
accounting firm (or other CPAs functioning as a peer review team). The purpose of a peer
review is to encourage adherence to quality management standards established by the
accounting firm and the profession.
PRINCIPLES OF AUDITING & OTHER ASSURANCE SERVICES
2024 EVERGREEN RELEASE
CHAPTER NO. 01: THE ROLE OF THE PUBLIC ACCOUNTANT IN THE
AMERICAN ECONOMY
REVIEW QUESTIONS
1-1 The “crisis of credibility” largely arose from the number of companies that restated their
previously issued financial statements as a result of accounting irregularities and fraud.
Especially responsible were the very visible Enron and WorldCom fraud cases. Both
companies filed for bankruptcy and constituted the largest companies in American history to
do so. The extent of the accounting irregularities and fraud being investigated and disclosed
brought into question the effectiveness of financial statement audits. In addition, the criminal
conviction of Arthur Andersen, LLP, one of the then Big 5 accounting firms, on charges of
destroying documents related to the Enron case brought into question the ethics standards of
the profession.
1-2 Assurance services are professional services that enhance the quality of information, or its
context, for decision-making. The two types are: (a) those that increase the reliability of
information and (b) those that involve putting information in a form or context that facilitates
decision-making.
1-3 A financial statement audit is, by far, the most common type of attest engagement. The
overall assertion, made by management, most frequently is that the financial statements
follow generally accepted accounting principles.
1-4 A large corporation with securities listed on a stock exchange is required by the rules of the
stock exchange and by the rules of the Securities and Exchange Commission to provide an
audit report with the annual financial statements furnished to its stockholders. It also is
required to engage the auditors to provide an opinion on its internal control. Apart from legal
, requirements, however, a large listed corporation recognizes that it must maintain investor
confidence in the reliability of its financial statements and internal control over financial
reporting if it is to continue to be able to secure capital from the public. The report by a firm
of certified public accountants adds credibility to the financial statements prepared by the
corporation. When a small family-owned enterprise elects to have an audit, the purpose
usually is to use the auditors' report to support an application for a bank loan.
1-5 A report by an independent public accountant concerning the fairness of a company's
financial statements is commonly required in the following situations:
(1) Application for a bank loan.
(2) Establishing credit for purchase of merchandise, equipment, or other assets.
(3) Reporting operating results, financial position, and cash flows to absentee owners
(stockholders or partners).
(4) Issuance of securities by a corporation.
(5) Annual financial statements by a corporation with securities listed on a stock
exchange or traded over the counter.
(6) Sale of an ongoing business.
(7) Termination of a partnership.
1-6 To add credibility to financial statements is to increase the likelihood that they have been
prepared following the appropriate criteria, usually generally accepted accounting principles.
As such, an increase in credibility results in financial statements that can be believed and
relied upon by third parties.
1-7 Business risk is the risk that the investment will be impaired because a company invested in
is unable to meet its financial obligations due to economic conditions or poor management
decisions. Information risk is the risk that the information used to assess business risk is not
accurate. Auditors can directly reduce information risk, but have only limited effect on
business risk.
,1-8 At the beginning of the century, the principal objective of auditing was the prevention and
detection of fraud. Audit work centered on the balance sheet, because the income statement
was regarded as highly confidential and not for public disclosure. Today, the principal
objective of auditing is to form an opinion on the fairness of financial statements and their
conformity with generally accepted accounting principles. But the professional standards
also require that an audit be designed to provide reasonable assurance of detecting material
misstatements, due to errors or fraud. Particular emphasis is placed on the income statement
which is of great importance to investors. Auditing today also has the objectives of meeting
the requirements of the Securities and Exchange Commission (SEC) and the Public Company
Accounting Oversight Board for public companies.
1-9 The statement is incorrect. The increasing integrated databases of today, along with available
audit procedures make audited entire populations a possibility in many situations.
1-10 An operational audit attempts to measure the effectiveness and efficiency of a specific unit of
an organization. It involves more subjective judgments than a compliance audit or an audit
of financial statements because the criteria of effectiveness and efficiency of departmental
performance are not as clearly established as are many laws and regulations or generally
accepted accounting principles. The report prepared after completion of an operational audit
is usually directed to management of the organization in which the audit work was done.
1-11 A compliance audit is an audit to determine whether financial reports or other assertions are
in compliance with established criteria. The necessary ingredients are verifiable data and the
existence of standards established by an authoritative body. An operational audit, on the
other hand, is a review of a department or other unit of a business or governmental
organization to measure the effectiveness and efficiency of operations. Internal auditors
often perform operational audits as do auditors employed by the Government Accountability
Office (GAO) of the federal government.
1-12 Internal auditors must be independent of the department heads and other line executives
whose work they review. However, internal auditors are not independent in the same sense
as a public accounting firm. The public accounting firm serves many clients and the revenue
, obtained from any one client is only a small part of the revenue of the firm. Internal auditors,
on the other hand, are employees of one company, and are subject to the restraints inherent in
the employer-employee relationship. Internal auditors can achieve a great deal of
independence by reporting to the audit committee of the board of directors, but they cannot
achieve the same degree of independence as is possessed by the external public accounting
firm.
1-13 The internal auditors are employees of Spacecraft, Inc., and may be influenced by corporate
management. The public accounting firm is independent of the company and is in a better
position to take positions opposed to those of company management. The work of the
internal audit staff emphasizes measurement of the efficiency and effectiveness of various
operating units of the company and compliance with all types of controls, whereas the public
accounting firm is primarily concerned with determining the fairness of Spacecraft's financial
statements.
1-14 The Government Accountability Office (GAO) is a staff of professional auditors which
reports to Congress. Its function is to determine that programs carried out by federal
agencies conform to the financial authorization of the Congress. It is also concerned with the
cost-effectiveness of government programs. The audit activities include investigation of the
costs and performance of corporations holding government contracts.
1-15 Among the many important contributions to auditing literature by the AICPA are the series
of Statements on Auditing Standards (SASs), Statements on Standards for Attestation
Engagements (SSAEs), Industry Audit and Accounting Guides, Audit Guides, Audit Risk
Alerts, Statements on Standards for Accounting and Review Services (SSARSs), , and the
Code of Professional Conduct (only two required).
1-16 A peer review is a critical review of a public accounting firm's practices by another public
accounting firm (or other CPAs functioning as a peer review team). The purpose of a peer
review is to encourage adherence to quality management standards established by the
accounting firm and the profession.
