Accounting Chapter 1 Homework Aicpa Sets Audit Standards For Auditors Public

Auditing: A Risk Based Approach to Conducting a Quality Audit, 10e

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Solutions for Chapter 1

True/False Questions

1-1 T

1-2 T

1-3 F

1-4 F

Multiple Choice Questions

1-15 B

1-16 B

1-17 E

Review and Short Case Questions

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The objective of external auditing is to provide opinions on the reliability of the financial

statements and, as part of an integrated audit, provide opinions on internal control effectiveness.

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The value of the external auditing profession is affirmed when the public has confidence in its

objectivity and the accuracy of its opinions. The capital markets depend on accurate, reliable,

and objective (neutral) data that portray the economic nature of an entity’s business and in turn

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The special function performed by the external auditing profession is the attestation to the

fairness of the financial statements of clients. The special function helps ensure the reliability

and integrity of the financial reporting system. The auditing profession exists to serve the users

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Audit services are demanded because there is a:

• Potential bias in providing information.

• Remoteness between a user and the organization or trading partner.

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The audit enhances the quality of financial statements because the user has the assurance that an

independent, qualified professional has examined the financial statements and has rendered an

opinion on their fairness. The independence and expertise of the auditor serve as a quality control

function to overcome the potential bias of management in presenting the financial statements in a

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Independence means objectivity and freedom from bias. The auditor can favor neither the client

nor the third party in evaluating the fairness of the financial statements. The auditor must be

independent in fact and in appearance. Independence in fact means the auditor is unbiased and

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a. An organization’s financial statements should reflect a true and fair view of the

organization’s financial results. The statements should not favor one user over another. However,

the interests of the various users can conflict. By having rules that encourage auditor

b.

Management

Review performance, make operational decisions, report results to

capital markets

Stockholders

Buy or sell stock

Bondholders

Buy or sell bonds

Financial Institutions

Evaluate loan decisions, considering interest rates, terms, and risk

Taxing Authorities

Determine taxable income and tax due

Regulatory Agencies

Develop regulations and monitor compliance

Labor Unions

Make collective bargaining decisions

Court System

Assess the financial position of a company in litigation

Vendors

Assess credit risk

Retired Employees

Protect employees from surprises concerning pensions and other post-

retirement benefits

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a. Susan Birkert had a friend purchase $5,000 of stock in the company that she was

auditing. She lied to KPMG when responding to the firm’s yearly written requirements to

comply with the firm’s independence policies.

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a. Management may want an independent audit because:

• An independent assessment of the fairness of presentation enhances the perceived

reliability of the financial report and assists the company in obtaining loans or new

capital because the investing and lending public will have confidence in the financial

figures.

b. Some of the points that might be discussed by management in determining the nature of

the audit firm to engage to conduct the audit:

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• The reputation of the auditor in the community and potential impact of auditor reputation

in securing loans or capital.

• The ability of the auditor to assist the firm in expanding the scope of its operations

beyond the immediate geographic area.

• The industry-specific knowledge of the potential auditors.

c. Several users might be interested in McIver’s financial results, including: management

itself, existing or potential creditors, and potential takeover or merger distributorship partners.

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Primary Parties Involved in Preparing

Audited Financial Statements

Role

Management

Maintains internal controls and prepares

reports

Internal Auditor

Provides internal assurance on internal

controls and reports

Audit Committee

Provides oversight of the reporting process

and other parties

External Auditor

Provides independent audit of internal

controls and financial statements

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There exist various types of audit service providers, and they are each suited to auditing different

types of clients:

• Large, multi-national audit firms are best suited to auditing large multi-national

companies, both publicly traded and privately held.

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The requirements of those entering the auditing profession are demanding. Audits are performed

in teams where each auditor is expected to complete tasks requiring considerable technical

knowledge and expertise. Auditors also need well-developed skills in leadership, teamwork,

communication, decision making, and other professional areas. In terms of technical knowledge

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Larger Audit Firms

Smaller Audit Firms

Working in a team

environment

• multiple teams that

typically disband after

each audit engagement

• teams that overlap

across engagements

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Organization Affecting External

Auditing Profession

Nature of Effects

a. Congress

Passed Sarbanes-Oxley Act of 2002

b. PCAOB

Sets audit standards for auditors of public companies

and regulates and enforces the external audit

profession for auditors of public companies listed on

U.S. stock exchanges

c. SEC

Regulates and provides enforcement of the capital

market system participants, including external

auditors and public companies; has the authority to

establish GAAP

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d. AICPA

Sets audit standards for auditors of privately held

companies and administers the CPA exam

e. Center for Audit Quality

Works to enhance investor confidence and trust in

the financial markets; is affiliated with the AICPA

f. IAASB

Sets audit standards for auditors of public companies

internationally.

g. COSO

Provides guidance on internal control, enterprise risk

management, and fraud deterrence.

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PCAOB

AICPA

a)

Sets auditing standards for

audits of public companies

Does not set auditing

standards for the audits of

public firms anymore. It does

set standards for audits of

non-public companies.

b)

Does not set accounting

standards; this responsibility

is delegated to the FASB and

the SEC.

Does not set accounting

standards; this responsibility

is delegated to the FASB and

the SEC.

Performs inspections of all

firms that are registered with

it. Note that all firms that

Requires peer reviews of

firms enrolled in the AICPA

Peer Review Program to

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a. On the “pro” side, having different standards makes audits more tailored to the nature of

the company (e.g., the nature of auditing for a large, public company may be very different from

auditing for a small, private company). On the “con” side, this dual structure can create various

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b. Examples could include the following: (1) public companies might have auditing

standards that are more applicable to larger and more complex entities, (2) non-public companies

might have auditing standards that adjust for weaker internal controls (e.g., lack of segregation of

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The requirement that no more than two of the PCAOB board members may be CPAs was put

into place to ensure that the Board is not unduly dominated by members of the external audit

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Audit quality involves performing an audit in accordance with generally accepted auditing

standards (GAAS) to provide reasonable assurance that the audited financial statements and

related disclosures are presented in accordance with generally accepted accounting principles

(GAAP) and providing assurance that those financial statements are not materially misstated

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a. Audit firm culture affects audit quality because when it is positive it:

– Creates an environment where achieving quality is valued, invested in and rewarded.

– Emphasizes the importance of ‘doing the right thing’ in the public interest and the effect

of doing so on the reputation of both the firm and individual auditors.

-Ensures partners and staff have sufficient time and resources to deal with difficult issues

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-Ensures audit quality is monitored within firms and across international networks and

appropriate consequential action is taken.

Expert Skills and Qualities of the Audit Partner and Engagement team affect audit quality

because they:

–Affect whether partners and staff understand their clients’ business and adhere to the

principles underlying auditing and ethical standards.

-Affect the ability of partners and staff to exercise professional skepticism in their work

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Independence is vitally important to the auditing profession. Audits exist to create confidence in

the public that financial statements are free from material misstatement. When auditors are not

independent, the public cannot necessarily trust that the statements are free from material

misstatement, because the public would believe that auditors could have incentives to allow

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a. Auditor independence requirements help to avoid situations in which auditor

independence may be impaired, including situations in which the auditor has a relationship that:

• Creates a mutual or conflicting interest between the accountant and the audit client

b. Review programs include:

• external inspections/peer reviews, which include inspections by the PCAOB and peer

reviews by other audit firms facilitated by the AICPA

• engagement quality reviews, which involves having an audit partner not otherwise

c. Engagement letters state the scope of the work to be performed on the audit so that there

is no doubt on the part of the client, auditor, or court system as to the expectations agreed to by

the external auditor and the client.

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The seven threats to independence are:

1. Self-review threat – occurs when the audit firm also provides non-audit work for the client,

such as preparing source documents used to generate the client’s financial statements.

Independence is threatened because it may appear that the auditor is reviewing his or her own

work.

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3. Adverse interest threat – occurs when the auditor and the client are in opposition to one

another, such as when either party has initiated litigation against the other. Independence is

4. Familiarity threat – occurs when the auditor has some longstanding relationship with an

important person associated with the client. Examples include:

• The audit partner’s close relative is employed in a key position at the client.

• The audit partner has been assigned to the client for a long period of time and has

developed very close personal relationships with top management.

5. Undue influence threat – occurs when client management attempts to coerce or provide

excessive influence over the auditor. Examples include:

• Top management threatens to replace the auditor or the audit firm because of a

disagreement over an accounting issue.

• Top management pressures the auditor to reduce the amount of work they do on the audit

6. Financial self-interest threat – occurs when the auditor has a direct financial relationship with

the client, such as owning stock in the client company, owing money to the client company,

or when the audit client makes up the vast majority of the audit firm’s total revenue.