solution manual
Principles of Auditing & Other Assurance Services
RAY WHITTINGTON, KURT PANY
22nd edition
1|Page
, Table of Contents
Chapter 1: The Role of the Public Accountant in the AmericanEconomy
Chapter 2: Professional Standards
Chapter 3: Professional Ethics
Chapter 4: Legal Liability of CPAs
Chapter 5: Audit Evidence and Documentation
Chapter 6: Audit Planning, Understanding the Client, AssessingRisks, and Responding
Chapter 7: Internal Control
Chapter 8: Consideration of Internal Control in an InformationTechnology Environment
Chapter 9: Audit Sampling
Chapter 10: Cash and Financial Investments
Chapter 11: Accounts Receivable, Notes Receivable, andRevenue
Chapter 12: Inventories and Cost of Goods Sold
Chapter 13: Property, Plant, and Equipment: Depreciation andDepletion
Chapter 14: Accounts Payable and Other Liabilities
Chapter 15: Debt and Equity Capital
Chapter 16: Auditing Operations and Completing the Audit
Chapter 17: Auditors’ Reports
Chapter 18: Integrated Audits of Public Companies
Chapter 19: Additional Assurance Services: Historical FinancialInformation
Chapter 20: Additional Assurance Services: Other Information
Chapter 21: Internal, Operational, and Compliance Auditing
2|Page
,CHAPTER 1
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.
3|Page
, 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
4|Page
Principles of Auditing & Other Assurance Services
RAY WHITTINGTON, KURT PANY
22nd edition
1|Page
, Table of Contents
Chapter 1: The Role of the Public Accountant in the AmericanEconomy
Chapter 2: Professional Standards
Chapter 3: Professional Ethics
Chapter 4: Legal Liability of CPAs
Chapter 5: Audit Evidence and Documentation
Chapter 6: Audit Planning, Understanding the Client, AssessingRisks, and Responding
Chapter 7: Internal Control
Chapter 8: Consideration of Internal Control in an InformationTechnology Environment
Chapter 9: Audit Sampling
Chapter 10: Cash and Financial Investments
Chapter 11: Accounts Receivable, Notes Receivable, andRevenue
Chapter 12: Inventories and Cost of Goods Sold
Chapter 13: Property, Plant, and Equipment: Depreciation andDepletion
Chapter 14: Accounts Payable and Other Liabilities
Chapter 15: Debt and Equity Capital
Chapter 16: Auditing Operations and Completing the Audit
Chapter 17: Auditors’ Reports
Chapter 18: Integrated Audits of Public Companies
Chapter 19: Additional Assurance Services: Historical FinancialInformation
Chapter 20: Additional Assurance Services: Other Information
Chapter 21: Internal, Operational, and Compliance Auditing
2|Page
,CHAPTER 1
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.
3|Page
, 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
4|Page
