978-0134065823 Chapter 2 Solution Manual

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Chapter 2

The CPA Profession

 Concept Checks

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1. The four major services that CPAs provide are:

a. Audit and assurance services Assurance services are independent

responsibility of another party. The four categories of attestation

services are audits of historical financial statements, attestation on the

Bookkeeping services include the preparation of the client’s journals and

ledgers as well as financial statements.

system to advice on risk management or on computer installations.

2. The six organizational structures available to CPA firms are proprietorship,

general partnership, general corporation, professional corporation, limited

liability company, and limited liability partnership. CPA firms are typically not

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1. The Public Company Accounting Oversight Board provides oversight for

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Concept Checks (continued)

2. The AICPA is the organization that sets professional requirements for

and grades the CPA examinations, provides continuing education to its

3. International Standards on Auditing (ISAs) are issued by the International

Auditing and Assurance Standards Board (IAASB) of the International

entities within the United States. As a result of efforts by the Auditing

Standards Board of the AICPA to converge U.S. standards with international

established by the Auditing Standards Board as interim auditing standards,

standards for audits of U.S. public and private companies are mostly similar.

 Review Questions

function competently and independently are:

1. Organizational form A CPA firm exists as a separate entity to avoid

endangering the firm’s independence.

2. Conduct A CPA firm employs a professional staff of sufficient size

3. Peer review This practice evaluates the performance of CPA firms

2–2 The Public Company Accounting Oversight Board (PCAOB) was

established by the Sarbanes–Oxley Act of 2002 in the wake of multiple

accounting scandals and alleged audit failures, including those of Enron and

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2–3 The purpose of the Securities and Exchange Commission is to assist in

providing investors with reliable information upon which to make investment

decisions. Since most reasonably large CPA firms have clients that must file

The SEC has considerable influence in setting generally accepted

accounting principles and disclosure requirements for financial statements

2–4 Statements on Standards for Attestation Engagements provide a framework

2–5 The PCAOB has responsibility for establishing auditing standards for U.S.

public companies, while the Auditing Standards Board (ASB) of the AICPA

establishes auditing standards for U.S. private companies. Prior to the creation of

2–6 International Standards on Auditing (ISAs) are issued by the International

Auditing and Assurance Standards Board (IAASB) of the International Federation

of Accountants (IFAC) and are designed to improve the uniformity of auditing

2–7 Auditing standards represent the combination of the four principles and all

the Statements on Auditing Standards (SASs) that are codified in the AU-C sections.

Generally accepted accounting principles are specific rules for accounting

for transactions occurring in a business enterprise. Examples may be any of the

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2–8 Auditors develop their competency and capabilities for performing an audit

through formal education in auditing and accounting, adequate practical

2–9 For the most part, auditing standards, including SASs, are general rather

than specific. Many practitioners along with critics of the profession believe the

standards should provide more clearly defined guidelines as an aid in

determining the extent of evidence to be accumulated. This would eliminate

2–10 Quality controls are the procedures used by a CPA firm that help it meet its

2–11 The element of quality control is personnel management. The purpose of

2–12 A peer review is a review, by CPAs, of a CPA firm’s compliance with its

quality control system. A mandatory peer review means that such a review is

required periodically. AICPA member firms are required to have a peer review

every three years. Registered firms with the PCAOB are subject to quality

effectiveness, and reduces the likelihood of lawsuits. Of course, peer reviews are

costly. There is always a trade–off between cost and benefits.

 Multiple Choice Questions From CPA Examinations

2–13 a. (2) b. (3) c. (3)

2–14 a. (1) b. (2) c. (1)

2–15 a. (1) b. (4) c. (3)

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 Discussion Questions And Problems

reporting framework.

b. No. In an audit of the financial statements, the auditor performs

audit procedures to obtain reasonable assurance about whether the

financial statements contain material misstatements. While a high

are accurate with certainty.

c. No. Fraud is a broad legal concept that describes any intentional

deceit meant to deprive another person or party of their property or

rights. The auditor does not take responsibility for detecting all

types of fraud, given many types of fraud do not impact the financial

d. Each entity faces a number of risks unique to the nature of its

business and industry. The types of operations, the extent of

regulation, how the organization obtains capital to fund its business

model, and the nature of accounts in the financial statements,

financial statements when planning the audit.The auditor is

responsible for obtaining sufficient appropriate audit evidence

about whether the financial statements are free of material

misstatements. In addition to understanding whether the amounts

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2–16 (continued)

accounting standards.

2–17 a. Engagement performance

b. Leadership responsibilities

c. Monitoring

d. Engagement performance

2–18 a. The AICPA Auditing Standards Board (ASB) is responsible for

issuing standards in the U.S. to be used by auditors when auditing

the financial statements of all entities other than U.S. publicly

with the SEC (e.g., broker–dealers).

b. The International Auditing and Assurance Standards Board (IAASB)

of the International Federation of Accountants (IFAC) is responsible

appropriate for the U.S. environment.

e. The PCAOB develops and issues its standards. While the PCAOB

considers existing international standards, it does not start with

the ISA standard as the base.

but may also require the auditor to perform additional procedures

required by one, but not the other, set of standards.

2–19 a. AICPA auditing standards.

b. International auditing standards.

c. PCAOB auditing standards.

international auditing standards).

e. AICPA auditing standards.

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BRIEF DESCRIPTION

OF PRINCIPLE

HOLMES’ ACTIONS RESULTING IN

FAILURE TO COMPLY WITH PRINCIPLE

RESPONSIBILITIES

PRINCIPLES

The auditor must possess the

competency and capabilities

to perform the audit.

It was inappropriate for Holmes to hire the two

students to conduct the audit. The audit must

be conducted by persons with proper

education and experience in the field of

auditing. Although a junior assistant has not

completed his formal education, he may help in

the conduct of the audit as long as there is

proper supervision and review.

The auditor must comply

with ethical requirements, which

include maintaining

independence in mental attitude

in all matters relating to the

audit.

To satisfy this principle, Holmes must be without

bias with respect to the client under audit.

Holmes has an obligation for fairness to the

owners, management, and creditors who may

rely on the report. Because of the financial

interest in whether the bank loan is granted to

Ray, Holmes is independent in neither fact nor

appearance with respect to the assignment

undertaken.

The auditor must maintain

professional skepticism and

exercise professional judgment

in the performance of the audit

and the preparation of the

report.

This principle requires Holmes to perform the

audit with due care, which imposes on Holmes

and everyone in Holmes’ organization a

responsibility to observe the principles of

performance and reporting. Maintaining

professional skepticism and exercising

professional judgment require critical review at

every level of supervision of the work done and

the judgments exercised by those assisting in

the audit. Holmes did not review the work or

the judgments of the assistants and clearly

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BRIEF DESCRIPTION

OF PRINCIPLE

HOLMES’ ACTIONS RESULTING IN

FAILURE TO COMPLY WITH PRINCIPLE

PERFORMANCE

PRINCIPLES

The auditor must adequately plan

the work and must properly

supervise any assistants.

This principle recognizes that early appointment

of the auditor has advantages for the auditor

and the client. Holmes accepted the

engagement without considering the

availability of competent staff. In addition,

Holmes failed to supervise the assistants. The

work performed was not adequately planned.

The auditor must identify and

assess the risks of material

misstatement based on a

sufficient understanding of the

entity and its environment,

including its internal control, to

design the nature, timing, and

extent of further audit

procedures.

Holmes did not obtain an understanding of the

entity or its internal control, nor did the

assistants obtain such an understanding.

There appears to have been no audit at all.

The work performed was more an accounting

service than it was an auditing service.

The auditor must obtain sufficient

appropriate audit evidence by

performing audit procedures to

afford a reasonable basis for an

opinion regarding the financial

statements under audit.

Holmes acquired no evidence that would

support the financial statements. Holmes

merely checked the mathematical accuracy of

the records and summarized the accounts.

Standard audit procedures and techniques

were not performed.

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BRIEF DESCRIPTION

OF PRINCIPLE

HOLMES’ ACTIONS RESULTING IN

FAILURE TO COMPLY WITH PRINCIPLE

REPORTING

PRINCIPLES

The auditor must express an

opinion in a written report about

whether the financial statements

are presented in accordance

with the applicable financial

reporting framework.

The auditor must either express

an opinion regarding the

financial statements, taken as a

whole, or state that an opinion

cannot be expressed in the

auditor’s report. When the

auditor cannot express an

overall opinion, the auditor

should state the reasons

therefor in the auditor’s report.

In all cases where an auditor’s

name is associated with

financial statements, the auditor

should clearly indicate the

character of the auditor’s work,

if any, and the degree of

responsibility the auditor is

taking, in the auditor’s report.

Holmes’ report made no reference to generally

accepted accounting principles. Because

Holmes did not conduct a proper audit, the

report should state that no opinion can be

expressed as to the fair presentation of the

financial statements in accordance with

generally accepted accounting principles.

Although Holmes’ report contains an expression

of opinion, such opinion is not based on the

results of a proper audit. Holmes should

disclaim an opinion because he failed to

conduct an audit in accordance with auditing

standards.

The auditor must assess whether

the financial statements are

Holmes’ improper audit would not enable him to

determine whether generally accepted

accounting principles.

Management is primarily responsible for

adequate disclosures in the financial

statements, but when the statements do

not contain adequate disclosures the auditor

should make such disclosures in

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2–21 a. The objective of the IAASB is to serve the public interest by setting

high–quality auditing and assurance standards and by facilitating

their auditing standards

b. The IAASB follows a due process in setting standards.

 The standards–setting Public Interest Activity Committees (PIAC)

identify new projects based on review of international developments

in English.

 The PIAC is responsible for consulting with the PIAC Consultative

Advisory Group (CAG) on the identification and prioritization

of projects to be undertaken by the PIAC.

 The project may be assigned to a task force, which considers

of the exposure draft.

 Draft pronouncements are exposed for a minimum of 90 days.

 When the Project Task Force is satisfied that it has a proposed

pronouncement.

c. The IAASB is committed to transparency. Where practicable, meetings

are broadcast over the Internet or recorded. Meeting agendas and

minutes are published on the International Federation of Accountants

public.