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Chapter 1
Concept Checks
P. 8
1. To do an audit, there must be information in a verifiable form and some
accordance with the established criteria. For an audit of a company’s
principles or International Financial Reporting Standards.
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.
P. 17
1. The three main types of audits are operational audits, compliance audits, and
OPERATIONAL
AUDITS
COMPLIANCE
AUDITS
AUDITS OF
FINANCIAL
STATEMENTS
PURPOSE
To evaluate
whether
operating
procedures are
efficient and
effective
To determine
whether the client is
following specific
procedures set by a
higher authority
To determine
whether the
overall financial
statements are
presented in
accordance with
specified criteria
(usually GAAP)
1-2
Concept Checks (continued)
OPERATIONAL
AUDITS
COMPLIANCE
AUDITS
AUDITS OF
FINANCIAL
STATEMENTS
USERS OF
AUDIT
REPORT
Management of
organization
Authority setting
down procedures,
internal or external
Different groups
for different
purposes — many
outside entities
NATURE
Highly
nonstandard;
often subjective
Not standardized,
but specific and
usually objective
Highly
standardized
PERFORMED
BY:
CPAs
Frequently
Occasionally
Almost
universally
GAO
AUDITORS
Frequently
Frequently
Occasionally
IRS
AUDITORS
Never
Universally
Never
INTERNAL
AUDITORS
Frequently
Frequently
Frequently*
* Internal auditors may assist CPAs in the audit of financial statements. Internal
auditors may also audit internal financial statements for use by management.
2. The major differences in the scope of audit responsibilities for CPAs, GAO
auditors, IRS agents, and internal auditors are:
CPAs perform audits of financial statements prepared using U.S.
with its directives and the law.
IRS agents perform compliance audits to enforce the federal tax laws
Internal auditors perform compliance or operational audits in order to
1-3
Review Questions
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,
been trained as an auditor.1-3 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:
1. Increased global activities of many businesses
2. Complex accounting and exchange transactions
revenue recognition
3. More complex information systems
a. Possibly millions of transactions processed daily through on-
1-4 1. Risk-free interest rate This is approximately the rate the bank could
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
3. Information risk This risk reflects the possibility that the information
upon which the business risk decision was made was inaccurate. A
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:
ADVANTAGES
DISADVANTAGES
USER VERIFIES
INFORMATION
1. User obtains information
desired.
2. User can be more confident
of the qualifications and
activities of the person
getting the information.
1. High cost of obtaining
information.
2. Inconvenience to the
person providing the
information because
large number of users
would be on premises.
USER SHARES
INFORMATION
RISK WITH
MANAGEMENT
1. No audit costs incurred.
1. User may not be able
to collect on losses.
AUDITED
FINANCIAL
STATEMENTS
ARE PROVIDED
1. Multiple users obtain the
information.
2. Information risk can usually
be reduced sufficiently to
satisfy users at reasonable
cost.
3. Minimal inconvenience to
management by having
only one auditor.
1. May not meet needs
of certain users.
2. Cost may be higher
than the benefits in
some situations, such
as for a small
company.
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
1-5
1-7 (continued)
related to business performance measurement, health care performance, and
information system reliability.
1-8 The primary evidence the internal revenue agent will use in the audit of
electronic funds transfers, vendors' invoices, and other supporting
documentation.
1-9 Five examples of specific operational audits that could be conducted by an
internal auditor in a manufacturing company are:
personnel.
2. Review the processing of sales invoices to determine if it could be
done more efficiently.
3. Review the acquisitions of goods, including costs, to determine if
1-10 When auditing historical financial statements, an auditor must have a
technology, including such things as purchases and sales via the Internet.
Similarly, a practitioner performing a consulting engagement to evaluate the
1-6
Concepts.
Multiple Choice Questions From CPA Examinations
1-12 a. (3) b. (2) c. (1)
1-13 a. (2) b. (4) c. (2)
1-14 a. (4) b. (1) c. (3)
Discussion Questions And Problems
b. 1. (2) An attestation service other than an audit service
2. (1) An audit of historical financial statements
3. (3) An assurance or nonassurance service that is not an
attestation service
6. (2) An attestation service other than an audit service
7. (2) An attestation service other than an audit service
8. (2) An attestation service other than an audit service
1-16 a. The interest rate for the loan that requires a review report is lower
than the loan that did not require a review because of lower
information risk. A review report provides moderate assurance to
1-7
1-16 (continued)
b. Given these circumstances, Busch should select the loan from First
City Bank that requires an annual audit. In this situation, the
LENDER
CPA
SERVICE
COST OF CPA
SERVICES
ANNUAL
INTEREST
ANNUAL
LOAN COST
Existing loan
None
0
$ 360,000
$ 360,000
United National Bank
Review
$ 35,000
$ 300,000
$ 335,000
First City Bank
Audit
$ 60,000
$ 240,000
$ 300,000
costs for each loan:
LENDER
CPA
SERVICE
COST OF CPA
SERVICES
ANNUAL
INTEREST
ANNUAL
LOAN COST
Existing loan
None
0
$ 360,000
$ 360,000
United National Bank
Review
$ 35,000
$ 270,000
$ 305,000
First City Bank
Audit
$ 80,000
$ 240,000
$ 320,000
management that will improve efficiency or effectiveness.
e. The auditor must have a thorough understanding of the client and its
environment, including the client’s e-commerce technologies, industry,
regulatory and operating environment, suppliers, customers, creditors,
providing added value to the audit function.
