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OVERVIEW OF AUDITING
I. Review Questions
2. This apparent paradox arises from the distinction between the function of auditing and
the function of accounting.
The rules of accounting are the criteria used by the auditor for evaluating the
presentation of economic events for financial statements and he or she must therefore
have an understanding of generally accepted accounting principles (GAAP), as well as
generally accepted auditing standards (GAAS).
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.
2-2 Solutions Manual - Principles of Auditing and Other Assurance Services
3.
Audits of Financial Compliance Operational
Statements Audits Audits
Performed by:
CPAs Almost universally Occasionally Frequently
COA Auditors Occasionally Frequently Frequently
BIR Auditors Never Universally Never
Internal Auditors Frequently Frequently Frequently
5. An independent audit is a means of satisfying the need for reliable information on the
part of decision makers. Factors of a complex society which contribute to this need are:
1. remoteness of information
a. owners (stockholders) divorced from management
b. directors not involved in day-to-day operations or decisions
c. dispersion of the business among numerous geographic locations and
complex corporate structures
6. The four primary causes of information risk are remoteness of information, bias in
motives of the provider, voluminous data, and existence of complex exchange
transactions.
Advantages Disadvantages
User verifies 1. User obtains information desired. 1. High cost of obtaining information.
information 2. User can be more confident of the 2. Inconvenience to the person
qualifications and activities of the providing the information because
person getting the information. large number of users would be on
premises.
Users share 1. No audit costs incurred. 1. Users may not be able to collect on
information risk losses.
with
management
Audited financial 1. Multiple users obtain the information. 1. May not meet needs of certain users.
statements are 2. Information risk can usually be 2. Cost may be higher than the benefits
prepared reduced sufficiently to satisfy users at in some situations, such as for a
reasonable cost. small company.
3. Minimal inconvenience to
management by having only one
auditor.
7. Information risk is the possibility that information upon which a business decision is
made is inaccurate. Four causes of information risk are:
remoteness of information,
2-4 Solutions Manual - Principles of Auditing and Other Assurance Services
biases and motives of the provider,
voluminous data, and
complex exchange transactions.
8. Three primary ways users of information can reduce information risk are:
users can verify the information themselves,
users can share information risk with management, and
users can obtain audited financial statements.
9. Four factors that are likely to significantly reduce information risk in the next five to ten
years are:
technological advances,
more companies will go on–line, reducing the risk of investors obtaining outdated
information,
new accounting and auditing standards, and
auditors will find more efficient and effective audit techniques.
12. To add credibility to financial statements is to increase the likelihood that they have
been prepared following the appropriate criteria, usually the relevant and applicable
SFAS. As such, an increase in credibility results in financial statements that can be
believed and relied upon by third parties.
13. Business risk is the risk that the investment will be impaired because a company
invested in is unable to meet its financial obligations due to economic conditions or poor
management decisions. Information risk is the risk that the information used to assess
business risk is not accurate. Auditors can directly reduce information risk, but have
only limited effect on business risk.
14. An operational audit attempts to measure the effectiveness and efficiency of a specific
unit of an organization. It involves more subjective judgments than a compliance audit
or an audit of financial statements because the criteria of effectiveness and efficiency of
departmental performance are not as clearly established as are many laws and
regulations or generally accepted accounting principles.
Overview of Auditing 2-5
For a small business concern, the primary need for annual financial statements is to
support an application for a bank loan. If a small business does not need to borrow, or
can obtain borrowed funds without providing audited statements, the cost of an audit
may not be justified.
Often a small business can obtain from a CPA firm specialized services other than an
audit, which are more useful and may cost less. Examples are the review or
compilation of financial statements, installation of a computer based accounting system,
or a study of internal control. Thus, the second quoted sentence, as well as the first, is
too sweeping to be correct. A decision not to have an audit is not always “false
economy.”
17. (a) An example of possible bias on the part of the provider of financial information is the
situation in which an individual or business entity applies for a bank loan. In such
circumstances, there is an incentive to overstate assets, income, and owner’s
equity, and to overlook or minimize liabilities. Distortions of this type give the
appearance of greater financial strength.
(b) A bank loan officer may insist that a prospective borrower provide audited financial
statements. This provides assurance that the data in the financial statements have
been examined by independent competent persons.
Case 1. a. The major advantages and disadvantages of a career as a BIR agent, CPA, or
an internal auditor are:
Case 2. The most likely type of auditor and the type of audit for each of the examples are:
Example Type of Auditor Type of Audit
1. COA Compliance
2. CPA; Internal Auditor Operational
3. Internal auditor; CPA Compliance
4. CPA Financial statements
5. CPA Tax audit; FS audit
6. COA Financial statements
7. CPA Financial statements
8. COA Operational audit
9. CPA; Internal Auditor Financial statements
10. Internal auditor or CPA Operational audit
11. CPA or COA Operational audit
12. CPA; BIR Compliance