1
,• Tableof Contents
Chapter 1: An Introduction to Assurance and Financial Statement Auditing
Chapter 2: The Financial StatementfAuditing Environment
Chapter 3: Audit Planning, Types of Audit Tests, and Materiality
Chapter : Risk Assessment
k
Chapter 5: Evidence and Documentation
Chapter 6: Internal Control infa Financial StatementfAudit
Chapter 7: Auditing Internal Control over Financial Reporting
Chapter 8: Audit Sampling: An Overview and ApplicationftofTests of Controls
Chapter 9: Audit Sampling: An Application to Substantive Tests of Account Balances
Chapter 10: Auditingfthe Revenue Process
Chapter 11: Auditingfthe Purchasing Process
Chapter 12: Auditing the HumanfResource Management Process
Chapter 13: Auditing the Inventory Management Process
Chapter 14: Auditing the Financing/Investing Process:Prepaid Expenses, Intangible Assets, and Property, Plant, and Equip
ment
Chapter 15: Auditingfthe Financing/Investing Process:Long-
Term Liabilities, Stockholders’ Equity, and Income Statement Accounts
Chapter 16: Auditing the Financing/Investing Process: Cashand Investments
Chapter 17: Completing thefAuditfEngagement
Chapter 18: Reports onfAudited Financial Statements
Chapter 19: Professional Conduct, Independence, and Quality Management
Chapter 20: Legal Liability
Chapter 21: Assurance, Attestation, and Internal Auditing Services
2
,CHAPTERf1
AN INTRODUCTION TO ASSURANCE AND FINANCIAL STATEMENT AUDITING
Answers to Review Questions
1-1 The study of auditing is more conceptual in nature compared to other accounting courses. R
ather than focusing on learning the rules, techniques, and computations required tofprepare financia
lstatements, auditing emphasizes learning aframeworkfof analytical andlogicalskillsfto evaluate the
relevance and reliability of the systems and processes responsible for financial information, as well
asfthe information itself. To be successful, students mustflearn the framework and then learn to usefl
ogicfand common sense in applying auditing concepts tofvariousfcircumstances and situations.
Understanding auditing canimprovefthedecision making ability ofconsultants, businessma
nagers, and accountants by providing a frameworkffor evaluating the usefulness andreliabil
ity of information.
1-2 There is a demand for auditing in a free-
market economy because the agency relationship between an absentee owner and a manager pro
duces a natural conflict of interestfdue to thefinformation asymmetry that exists between the owner
and manager. As a result, theagentfagrees to be monitored asfpart of his/her employmentfcontract.
Auditing appears to befacost-effective form of monitoring.
Theempirical evidence suggestsauditing was demandedprior togovernmentfregulationsuc
h as statutory auditfrequirements. Additionally, many private companies and other entities not subje
ctfto government auditing regulations also demand auditing.
1-3 The agency relationship between an owner and manager produces a natural conflict of inte
rest because of differencesfin the two parties’ goals and because of informationfasymmetrythatfexi
sts between them. That is, the manager generally hasfmore information aboutfthe ‘true’financial po
sition and resultsfof operations of thefentity than the absentee owner does. If both parties seek to m
aximize their own self-
interest, itfisflikely thatfthe manager will not act in the best interestfof the owner and may manipulate t
he information provided to the owner accordingly.
1-4 Independence isfan importantfstandard for auditors. If an auditor is not independent ofthe c
lient, users may losefconfidence in the auditor’s ability to report truthfully on the financial statements
, and the auditor’s workfloses its value. From an agency perspective, if the principal (owner) knowsft
hatftheauditor is notfindependent, the owner will not trust thefauditor’s work.
Thus, theagentwillnot hire theauditor becausethefauditor’s reportfwillnotfbeeffective inreducing inf
ormation riskffrom thefperspective of the owner.
1-5 Auditing (broadly defined) is a systematic process of objectively obtaining and evaluatin
gevidence regarding assertions aboutfeconomicfactionsfand eventstoascertain thedegree of cor
respondence between those assertions and established criteria and communicating the results t
o interested users.
Assurancefis engagement in which a practitioner expresses a conclusion designed to enha
ncethedegreeofconfidence of theintended users other thantheresponsible party aboutthe outcom
e of the evaluation or measurementfof a subject matter againstfcriteria.
Examples of assurance services arefassurance (audit) of financial statements, assurance o
f prospective financial information, assurance of reporting oninternal control,assurance of sustaina
bility reporting, and assurance of electronicfcommerce.
3
, 1-6 The phrase systematic process impliesfthatfthere should befa well-
planned, logical approachforconducting anauditfthat involves objectivelyfobtainingfand evaluati
ngevidence.
1-7 Materiality: "Omissions or misstatements of itemsfare material if they could, individuallyor c
ollectively, influence the economic decisions of users taken on the basisfof the financial statements.
Materiality depends on the sizefand nature of the omission or misstatement judged inthesurroundin
g circumstances. The size or nature of theitem, oracombination of both, couldbefthe determining fac
tor." (IASB).
Auditfriskfisfdefined asthe riskfthat thefauditor expresses aninappropriate auditfopinionwhe
n the financial statements arefmaterially misstated (ISA 200).
The auditfreportfstates thatfthe auditor obtains “reasonable assurance” whether the financia
l statements are freeffrom “material” misstatement. Thefterm reasonable assurance informs the rea
der that there is some level of riskfthatfthe auditfdid notfdetect all material misstatements. In addition,
the auditor’s opinion commonly uses thefwording thatfthe financial statements present fairly, “in all m
aterial respects.” These phrases communicate tothird partiesfthat the audit reportfis limited to materi
al information.
1-8 On most audits, it is notffeasiblefor cost-
effective to audit all transactions. For example, in a small business, the auditor might be able to exam
ine all transactions that occurred during the period. However, itfis unlikely that the owner of the busin
ess could afford to pay for such an extensive audit. For a large organization, thefsheer volume of tran
sactions prevents the auditor from examining every transaction. Thus, there is a trade-
off between the exactness or precisionof the auditfand its cost.
1-9 Themajor phases of thefauditfare:
Client acceptance/continuance and establishing engagementf terms
Preplanning
Assessfrisks andestablish materiality
Planthefaudit
Consider internal control
Audit business processes andrelated accounts
Complete thefaudit
Evaluate results andissueaudit report
1-10 The auditor’sfunderstanding of the entity and itsfenvironmentfincludes knowledge abo
ut: (1) thenature of theentity, (2) itsobjectivesfand strategies, (3) its industry, regulatory,and othe
r external factors, (4) its management, (5) its governance, (6) its measurementfand performance
process, and (7)fits business processes.
1-11 Sometimesfauditors will face situations wherenostandard audit procedureexists, suchas t
he example from the text of verifying the inventory of reindeer. Such circumstances require that thef
auditor possessfcreativity and innovation when planning and administering auditfprocedures wher
e little or no precedent exists. Every clientfis different, and applying auditing concepts in differentfsit
uationsfrequires logic and common sense, and frequently creativity and innovation.
Solutions to Problems
1-12 The memoshould cite thefollowing facts:
Thereisa historical relationshipfbetween accounting andauditing.
4
,• Tableof Contents
Chapter 1: An Introduction to Assurance and Financial Statement Auditing
Chapter 2: The Financial StatementfAuditing Environment
Chapter 3: Audit Planning, Types of Audit Tests, and Materiality
Chapter : Risk Assessment
k
Chapter 5: Evidence and Documentation
Chapter 6: Internal Control infa Financial StatementfAudit
Chapter 7: Auditing Internal Control over Financial Reporting
Chapter 8: Audit Sampling: An Overview and ApplicationftofTests of Controls
Chapter 9: Audit Sampling: An Application to Substantive Tests of Account Balances
Chapter 10: Auditingfthe Revenue Process
Chapter 11: Auditingfthe Purchasing Process
Chapter 12: Auditing the HumanfResource Management Process
Chapter 13: Auditing the Inventory Management Process
Chapter 14: Auditing the Financing/Investing Process:Prepaid Expenses, Intangible Assets, and Property, Plant, and Equip
ment
Chapter 15: Auditingfthe Financing/Investing Process:Long-
Term Liabilities, Stockholders’ Equity, and Income Statement Accounts
Chapter 16: Auditing the Financing/Investing Process: Cashand Investments
Chapter 17: Completing thefAuditfEngagement
Chapter 18: Reports onfAudited Financial Statements
Chapter 19: Professional Conduct, Independence, and Quality Management
Chapter 20: Legal Liability
Chapter 21: Assurance, Attestation, and Internal Auditing Services
2
,CHAPTERf1
AN INTRODUCTION TO ASSURANCE AND FINANCIAL STATEMENT AUDITING
Answers to Review Questions
1-1 The study of auditing is more conceptual in nature compared to other accounting courses. R
ather than focusing on learning the rules, techniques, and computations required tofprepare financia
lstatements, auditing emphasizes learning aframeworkfof analytical andlogicalskillsfto evaluate the
relevance and reliability of the systems and processes responsible for financial information, as well
asfthe information itself. To be successful, students mustflearn the framework and then learn to usefl
ogicfand common sense in applying auditing concepts tofvariousfcircumstances and situations.
Understanding auditing canimprovefthedecision making ability ofconsultants, businessma
nagers, and accountants by providing a frameworkffor evaluating the usefulness andreliabil
ity of information.
1-2 There is a demand for auditing in a free-
market economy because the agency relationship between an absentee owner and a manager pro
duces a natural conflict of interestfdue to thefinformation asymmetry that exists between the owner
and manager. As a result, theagentfagrees to be monitored asfpart of his/her employmentfcontract.
Auditing appears to befacost-effective form of monitoring.
Theempirical evidence suggestsauditing was demandedprior togovernmentfregulationsuc
h as statutory auditfrequirements. Additionally, many private companies and other entities not subje
ctfto government auditing regulations also demand auditing.
1-3 The agency relationship between an owner and manager produces a natural conflict of inte
rest because of differencesfin the two parties’ goals and because of informationfasymmetrythatfexi
sts between them. That is, the manager generally hasfmore information aboutfthe ‘true’financial po
sition and resultsfof operations of thefentity than the absentee owner does. If both parties seek to m
aximize their own self-
interest, itfisflikely thatfthe manager will not act in the best interestfof the owner and may manipulate t
he information provided to the owner accordingly.
1-4 Independence isfan importantfstandard for auditors. If an auditor is not independent ofthe c
lient, users may losefconfidence in the auditor’s ability to report truthfully on the financial statements
, and the auditor’s workfloses its value. From an agency perspective, if the principal (owner) knowsft
hatftheauditor is notfindependent, the owner will not trust thefauditor’s work.
Thus, theagentwillnot hire theauditor becausethefauditor’s reportfwillnotfbeeffective inreducing inf
ormation riskffrom thefperspective of the owner.
1-5 Auditing (broadly defined) is a systematic process of objectively obtaining and evaluatin
gevidence regarding assertions aboutfeconomicfactionsfand eventstoascertain thedegree of cor
respondence between those assertions and established criteria and communicating the results t
o interested users.
Assurancefis engagement in which a practitioner expresses a conclusion designed to enha
ncethedegreeofconfidence of theintended users other thantheresponsible party aboutthe outcom
e of the evaluation or measurementfof a subject matter againstfcriteria.
Examples of assurance services arefassurance (audit) of financial statements, assurance o
f prospective financial information, assurance of reporting oninternal control,assurance of sustaina
bility reporting, and assurance of electronicfcommerce.
3
, 1-6 The phrase systematic process impliesfthatfthere should befa well-
planned, logical approachforconducting anauditfthat involves objectivelyfobtainingfand evaluati
ngevidence.
1-7 Materiality: "Omissions or misstatements of itemsfare material if they could, individuallyor c
ollectively, influence the economic decisions of users taken on the basisfof the financial statements.
Materiality depends on the sizefand nature of the omission or misstatement judged inthesurroundin
g circumstances. The size or nature of theitem, oracombination of both, couldbefthe determining fac
tor." (IASB).
Auditfriskfisfdefined asthe riskfthat thefauditor expresses aninappropriate auditfopinionwhe
n the financial statements arefmaterially misstated (ISA 200).
The auditfreportfstates thatfthe auditor obtains “reasonable assurance” whether the financia
l statements are freeffrom “material” misstatement. Thefterm reasonable assurance informs the rea
der that there is some level of riskfthatfthe auditfdid notfdetect all material misstatements. In addition,
the auditor’s opinion commonly uses thefwording thatfthe financial statements present fairly, “in all m
aterial respects.” These phrases communicate tothird partiesfthat the audit reportfis limited to materi
al information.
1-8 On most audits, it is notffeasiblefor cost-
effective to audit all transactions. For example, in a small business, the auditor might be able to exam
ine all transactions that occurred during the period. However, itfis unlikely that the owner of the busin
ess could afford to pay for such an extensive audit. For a large organization, thefsheer volume of tran
sactions prevents the auditor from examining every transaction. Thus, there is a trade-
off between the exactness or precisionof the auditfand its cost.
1-9 Themajor phases of thefauditfare:
Client acceptance/continuance and establishing engagementf terms
Preplanning
Assessfrisks andestablish materiality
Planthefaudit
Consider internal control
Audit business processes andrelated accounts
Complete thefaudit
Evaluate results andissueaudit report
1-10 The auditor’sfunderstanding of the entity and itsfenvironmentfincludes knowledge abo
ut: (1) thenature of theentity, (2) itsobjectivesfand strategies, (3) its industry, regulatory,and othe
r external factors, (4) its management, (5) its governance, (6) its measurementfand performance
process, and (7)fits business processes.
1-11 Sometimesfauditors will face situations wherenostandard audit procedureexists, suchas t
he example from the text of verifying the inventory of reindeer. Such circumstances require that thef
auditor possessfcreativity and innovation when planning and administering auditfprocedures wher
e little or no precedent exists. Every clientfis different, and applying auditing concepts in differentfsit
uationsfrequires logic and common sense, and frequently creativity and innovation.
Solutions to Problems
1-12 The memoshould cite thefollowing facts:
Thereisa historical relationshipfbetween accounting andauditing.
4
