Solution Manual for Auditing and Assurance Services, 17th edition By Alvin A. Arens, Randal J. Elder, Mark S. Beasley, Chris E. Hogan

Chapter 1

The Demand for Audit and Other Assurance Services
 Concept Checks

P. 8

1. To do an audit, there must be information in a verifiable form and some
standards (criteria) by which the auditor can evaluate the information.
Determining the degree of correspondence between information and
established criteria is determining whether a given set of information is in




S
accordance with the established criteria. For an audit of a company’s
financial statements the criteria are U.S. generally accepted accounting




R
principles or International Financial Reporting Standards.




VE
2. The four primary causes of information risk are remoteness of information,
biases and motives of the provider, voluminous data, and the existence of
complex exchange transactions.

1. User verifies the information.
IE
The three main ways to reduce information risk are:

2. User shares the information risk with management.
H
3. Audited financial statements are provided.
AC

P. 16

1. The three main types of audits are operational audits, compliance audits, and
M



financial statement audits. The table below summarizes the purposes and
nature of each type of audit.
EA




AUDITS OF
OPERATIONAL COMPLIANCE FINANCIAL
R




AUDITS AUDITS STATEMENTS
D




PURPOSE To evaluate To determine To determine
whether whether the client is whether the
operating following specific overall financial
procedures are procedures set by a statements are
efficient and higher authority presented in
effective accordance with
specified criteria
(usually GAAP)




1-1

,Concept Checks (continued)

AUDITS OF
OPERATIONAL COMPLIANCE FINANCIAL
AUDITS AUDITS STATEMENTS
USERS OF Management of Authority that Different groups
AUDIT organization established rules, for different
REPORT regulations, and purposes — many
procedures, either outside entities
internal or external to
auditee




S
NATURE Highly Not standardized, Highly
nonstandard; but specific and standardized




R
often subjective usually objective




VE
PERFORMED
BY: Almost
CPAs Frequently Occasionally universally
GAO
AUDITORS Frequently IE
Frequently Occasionally
H
IRS
AUDITORS Never Universally Never
AC

INTERNAL
AUDITORS Frequently Frequently Frequently*
* Internal auditors may assist CPAs in the audit of financial statements. Internal
M



auditors may also audit internal financial statements for use by management.

2. The major differences in the scope of audit responsibilities for CPAs, GAO
EA




auditors, IRS agents, and internal auditors are:

 CPAs perform audits of financial statements prepared using U.S.
R




GAAP or IFRS in accordance with auditing standards.
 GAO auditors perform compliance or operational audits in order to
D




assure the Congress of the expenditure of public funds in accordance
with its directives and the law.
 IRS agents perform compliance audits to enforce the federal tax laws
as defined by Congress, interpreted by the courts, and regulated by the
IRS.
 Internal auditors perform compliance or operational audits in order to
assure management or the board of directors that controls and policies
are properly and consistently developed, applied, and evaluated.




1-2

, Review Questions

1-1 To do an audit, there must be information in a verifiable form and some
standards (criteria) by which the auditor can evaluate the information. The
information for Jones Company's tax return is the federal tax returns filed by the
company. The established criteria are found in the Internal Revenue Code
and all interpretations. For the audit of Jones Company's financial
statements the information is the financial statements being audited and the
established criteria are U.S. GAAP or IFRS.

1-2 This apparent paradox arises from the distinction between the function of
auditing and the function of accounting. The accounting function is the recording,




S
classifying, and summarizing of economic events to provide relevant information
to decision makers. The rules of accounting are the criteria used by the auditor




R
for evaluating the presentation of economic events for financial statements and
he or she must therefore have an understanding of accounting standards, as well




VE
as auditing standards. The accountant need not, and frequently does not,
understand what auditors do, unless he or she is involved in doing audits, or has
been trained as an auditor.

1-3
IE
An independent audit is a means of satisfying the need for reliable
information on the part of decision makers. Recent changes in accounting and
business operations include:
H
1. Increased global activities of many businesses
AC

a. Multiple product lines and transaction locations
b. Foreign exchange affects transactions
2. Complex accounting and exchange transactions
a. Increasing use of derivatives and hedging activities
M



b. Increasingly complex accounting standards in areas such as
revenue recognition
EA




3. More complex information systems
a. Possibly millions of transactions processed daily through on-
line and traditional sales channels
b. Voluminous data requires interpretation
R




1-4 1. Risk-free interest rate This is approximately the rate the bank could
D




earn by investing in U.S. treasury notes for the same length of time
as the business loan.
2. Business risk for the customer This risk reflects the possibility that the
business will not be able to repay its loan because of economic or
business conditions such as a recession, poor management
decisions, or unexpected competition in the industry.
3. Information risk This risk reflects the possibility that the information
upon which the business risk decision was made was inaccurate. A
likely cause of the information risk is the possibility of inaccurate
financial statements.


1-3

, 1-4 (continued)

Auditing has no effect on either the risk-free interest rate or business risk.
However, auditing can significantly reduce information risk.

1-5 The three main ways to reduce information risk are:
1. User verifies the information.
2. User shares the information risk with management.
3. Audited financial statements are provided.
The advantages and disadvantages of each are as follows:




S
ADVANTAGES DISADVANTAGES




R
USER VERIFIES 1. User obtains information 1. High cost of obtaining
INFORMATION desired. information.




VE
2. User can be more confident 2. Inconvenience to the
of the qualifications and person providing the
activities of the person information because
getting the information. large number of users

USER SHARES
IE
1. No audit costs incurred.
would be on premises.
1. User may not be able
H
INFORMATION to collect on losses.
RISK WITH
AC

MANAGEMENT
AUDITED 1. Multiple users obtain the 1. May not meet needs
FINANCIAL information. of certain users.
STATEMENTS 2. Information risk can usually 2. Cost may be higher
M



ARE PROVIDED be reduced sufficiently to than the benefits in
satisfy users at reasonable some situations, such
EA




cost. as for a small
3. Minimal inconvenience to company.
management by having
only one auditor.
R
D




1-6 Information risk is the risk that information upon which a business decision is
made is inaccurate. Fair value accounting is often based on estimates and requires
judgment. Fair value can be estimated using multiple methods with some estimates
being more subjective than others. Fair value estimates are made at a point in time,
but can also change rapidly, depending on market conditions. All of these factors
increase information risk.

1-7 An assurance service is an independent professional service to improve the
quality of information for decision makers. An attestation service is a form of
assurance service in which the CPA firm issues a report about the reliability of an
assertion that is the responsibility of another party.

1-4