SOLUTION MANUAL
Principles of Auditing & Other Assurance Services
RAY WHITTINGTON, KURT PANY
22nd edition
Table of Contents
,Chapter 1: The Role of the Public Accountant in the American Economy
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, Assessing Risks, and Responding
Chapter 7: Internal Control
Chapter 8: Consideration of Internal Control in an Information Technology Environment
Chapter 9: Audit Sampling
Chapter 10: Cash and Financial Investments
Chapter 11: Accounts Receivable, Notes Receivable, and Revenue
Chapter 12: Inventories and Cost of Goods Sold
Chapter 13: Property, Plant, and Equipment: Depreciation and Depletion
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
,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.
, 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.
Principles of Auditing & Other Assurance Services
RAY WHITTINGTON, KURT PANY
22nd edition
Table of Contents
,Chapter 1: The Role of the Public Accountant in the American Economy
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, Assessing Risks, and Responding
Chapter 7: Internal Control
Chapter 8: Consideration of Internal Control in an Information Technology Environment
Chapter 9: Audit Sampling
Chapter 10: Cash and Financial Investments
Chapter 11: Accounts Receivable, Notes Receivable, and Revenue
Chapter 12: Inventories and Cost of Goods Sold
Chapter 13: Property, Plant, and Equipment: Depreciation and Depletion
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
,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.
, 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.
