ACCT 4301 Exam 1 Review UPDATED ACTUAL QUESTIONS AND CORRECT
ANSWERS
What is auditing? A systematic process of objectively obtaining and evaluating evidence
regarding assertions about economic actions and events to ascertain the degree
of correspondence between those assertions and established criteria and
communicating the results to interested users.
What is audit risk? Audit risk is the risk that the auditor mistakenly expresses a clean audit opinion
when the financial statements are materially misstated
What is materiality? the magnitude of an omission or misstatement of accounting information that, in
light of surrounding circumstances, make it probable that the judgement of a
reasonable person relying on the information Ould have been changed or
influenced by the omission or misstatement
What is the principal-agent problem? Information asymmetry and conflicts of interest lead to information risk for the
principal
, Why is there a demand for audit services? Auditing is demanded because it plays a valuable role in monitoring the
contractual relationships between the entity and its stockholders, managers,
employees, and debt holders. Certified public accountants have been charged
with providing audit services because of their traditional reputation of
competence, independence, objectivity, and concern for the public interest. As a
result, they are able to add credibility to information produced and reported by
management to outside parties.
How does information asymmetry and conflicts of In this setting, the managers serve as agents for the owners (who are sometimes
interest between managers and investors rest in the referred to as principals) and fulfill a stewardship function by managing the
demand for auditing? corporation's assets. Accounting and auditing play important roles in this
principal-agent relationship. We first explain the roles of accounting and auditing
from a conceptual perspective. Then we'll use an analogy involving a house
inspector to illustrate the concepts. First, it is important to understand that the
relationship between an owner and manager often results in information
asymmetry between the two parties. Information asymmetry means that the
manager generally has more information about the "true" financial position and
results of operations of the entity than does the absentee owner.
The owner likely will be willing to invest more in the business and to pay the
manager more if the manager can be held accountable for how he or she uses
the owner's invested resources. As the amount of capital involved and the number
of potential owners increase, the potential impact of accountability also increases.
The auditor's role is to determine whether the reports prepared by the manager
conform to the contract's provisions. Thus, the auditor's verification of the financial
information adds credibility to the report and reduces information risk, or the risk
that information circulated by a company's management will be false or
misleading. Reducing information risk potentially benefits both the owner and the
manager.
How does the audit function mitigate the problem that Audits add credibility to the financial statements
exists between managements and outside stakeholders
(e.g., investors and lenders)
ANSWERS
What is auditing? A systematic process of objectively obtaining and evaluating evidence
regarding assertions about economic actions and events to ascertain the degree
of correspondence between those assertions and established criteria and
communicating the results to interested users.
What is audit risk? Audit risk is the risk that the auditor mistakenly expresses a clean audit opinion
when the financial statements are materially misstated
What is materiality? the magnitude of an omission or misstatement of accounting information that, in
light of surrounding circumstances, make it probable that the judgement of a
reasonable person relying on the information Ould have been changed or
influenced by the omission or misstatement
What is the principal-agent problem? Information asymmetry and conflicts of interest lead to information risk for the
principal
, Why is there a demand for audit services? Auditing is demanded because it plays a valuable role in monitoring the
contractual relationships between the entity and its stockholders, managers,
employees, and debt holders. Certified public accountants have been charged
with providing audit services because of their traditional reputation of
competence, independence, objectivity, and concern for the public interest. As a
result, they are able to add credibility to information produced and reported by
management to outside parties.
How does information asymmetry and conflicts of In this setting, the managers serve as agents for the owners (who are sometimes
interest between managers and investors rest in the referred to as principals) and fulfill a stewardship function by managing the
demand for auditing? corporation's assets. Accounting and auditing play important roles in this
principal-agent relationship. We first explain the roles of accounting and auditing
from a conceptual perspective. Then we'll use an analogy involving a house
inspector to illustrate the concepts. First, it is important to understand that the
relationship between an owner and manager often results in information
asymmetry between the two parties. Information asymmetry means that the
manager generally has more information about the "true" financial position and
results of operations of the entity than does the absentee owner.
The owner likely will be willing to invest more in the business and to pay the
manager more if the manager can be held accountable for how he or she uses
the owner's invested resources. As the amount of capital involved and the number
of potential owners increase, the potential impact of accountability also increases.
The auditor's role is to determine whether the reports prepared by the manager
conform to the contract's provisions. Thus, the auditor's verification of the financial
information adds credibility to the report and reduces information risk, or the risk
that information circulated by a company's management will be false or
misleading. Reducing information risk potentially benefits both the owner and the
manager.
How does the audit function mitigate the problem that Audits add credibility to the financial statements
exists between managements and outside stakeholders
(e.g., investors and lenders)
