31.Discuss the similarities and differences between the roles of independent auditors, GAO auditors, internal revenue agents, and internal auditors.

•        The roles of all four types of auditors are similar in that they involve the accumulation and evaluation of evidence about information to ascertain and report on the degree of correspondence between the information and established criteria. The differences in their roles center around the information audited and the criteria used to evaluate that information. Independent auditors primarily audit companies’ financial statements. GAO auditors’ primary responsibility is to perform the audit function for Congress. IRS auditors are responsible for the enforcement of federal tax laws. Internal auditors primarily perform operational and compliance audits for their employing company.

28.Two types of attestation services provided by CPA firms are audits and reviews. Discuss the similarities and differences between these two types of attestation services. Which type provides the least assurance?

 

Two primary types of attestation services are: audits of historical financial statements and reviews of historical financial statements. While both services involve the accumulation and evaluation of evidence regarding assertions made by management in the company’s financial statements, a review involves a less extensive examination and provides a lower level of assurance about the client’s financial statements than an audit.

 

33.To do an audit, it is necessary for information to be in a verifiable form and some criteria by which the auditor can evaluate the information. (A) What information and criteria would an independent CPA firm use when auditing a company’s historical financial statements? (B) What information and criteria would an Internal Revenue Service auditor use when auditing that same company’s tax return? (C) What information and criteria would an internal auditor use when performing an operational audit to evaluate whether the company’s computerized payroll processing system is operating efficiently and effectively?

 

(A) The information used by a CPA firm in a financial statement audit is the financial information in the company’s financial statements. The most commonly used criteria are accounting principles generally accepted in the United States.
(B) The information used by an IRS auditor is the financial information in the company’s federal tax return. The criteria are the internal revenue code and interpretations.
(C) The information used by an internal auditor when performing an operational audit of the payroll system could include various items such as the number of errors made, costs incurred by the payroll department, and number of payroll records processed each month. The criteria would consist of company standards for departmental efficiency and effectiveness.

 

36.Discuss the relationship between quality control and generally accepted auditing standards.

 

For a CPA firm, quality control encompasses the methods used to make sure that the firm meets its professional responsibilities to clients. Quality control is closely related to, but distinct from, GAAS. A CPA firm must make sure that GAAS are followed on every audit. Quality controls are the procedures used by the CPA firm that help it meet requirements demanded by GAAS on every engagement in a consistent manner.
85.Discuss how materiality affects audit reporting decisions.      

When determining the appropriate audit report to issue, the auditor considers three levels of materiality for a given condition. These three levels are (1) immaterial, (2) material without overshadowing the financial statements as a whole, and (3) highly material. For conditions involving a GAAP violation, the materiality level of the violation influences whether an unqualified, qualified, or adverse opinion is issued. For conditions involving a scope restriction, the materiality of the restriction influences whether an unqualified report, a qualified scope and opinion report, or a

 

 

 

disclaimer of opinion is issued.

87.There are three conditions requiring a departure from an unqualified audit report. Discuss each of these three conditions and state the appropriate audit report for each condition.

 

The three conditions requiring a departure from an unqualified report are:

a scope restriction imposed by the client or by circumstances beyond the auditor’s or client’s control which prevents the auditor from accumulating sufficient evidence to reach a conclusion regarding whether financial statements are stated in accordance with GAAP. In this condition, the auditor would issue either a qualified scope and opinion report, or a disclaimer of opinion.
the financial statements were not prepared in accordance with GAAP. In this condition, the auditor would issue a qualified opinion if the GAAP violation were moderately material, or an adverse opinion if the GAAP violation were highly material.

the auditor is not independent. In this condition, the auditor must issue a disclaimer of opinion.

88.In certain circumstances, an auditor will issue an unqualified report, but the wording will differ from that of a standard unqualified report. Discuss each of the five circumstances when an auditor would issue an unqualified report with an explanatory paragraph or modified wording.

 

An unqualified report with an explanatory paragraph or modified wording is appropriate in the following circumstances:
Lack of consistent application of GAAP. When the client has not followed generally accepted accounting principles consistently in the current period in relation to the preceding period, an unqualified opinion with an explanatory paragraph following the opinion paragraph is appropriate.
Substantial doubt about continuing as a going concern. When an auditor concludes there is substantial doubt about the client’s ability to continue as a going concern, an unqualified opinion with an explanatory paragraph following the opinion paragraph is appropriate. The auditor also has the option of issuing a disclaimer of opinion.
A departure from GAAP with which the auditor concurs. If adherence to GAAP would result in misleading financial statements, an unqualified opinion with an explanatory paragraph is appropriate.
Emphasis of a matter.If the auditor wants to emphasize specific matters in the audit report, an explanatory paragraph discussing those matters may be added to an unqualified report.
Reports involving other auditors. When an auditor relies upon a different CPA firm to perform part of the audit, the auditor can indicate that responsibility for the audit is shared with another CPA firm by modifying the wording of an unqualified report.

 

 

74.Explain why there is a special need for ethical conduct in the auditing profession. Since users (e.g., the general public) of services provided by an auditor generally cannot evaluate the quality of the auditor’s performance, it is critical to the auditing profession that the public have a high degree of confidence in the quality of the services provided by the auditor. Public confidence in the quality of professional services is enhanced when the profession encourages high standards of performance and ethical conduct by all its members. If users of auditing services were to lack confidence in the quality of those services, then the value of CPA firms’ audits would be diminished, as would the demand for audits.

 

78.Distinguish between ordinary negligence and gross negligence.

 

Ordinary negligence is the absence of reasonable care, whereas gross negligence is the absence of even slight care that can be expected of a person in a set of circumstances.

 

84.Distinguish between “joint and several liability” and “separate and proportionate liability.”

 

Under joint and several liability, the defendant can be assessed the full loss suffered by the plaintiff, regardless of the extent to which other parties shared in the wrongdoing. In contrast, under separate and proportionate liability, the defendant is assessed that portion of the plaintiff’s loss caused by the defendant’s wrongdoing.

 

73. Discuss the differences between errors, frauds, and illegal acts. Give an example of each.

 

The primary difference between errors and frauds is that errors are unintentional misstatements of the financial statements, whereas frauds are intentional misstatements. Illegal acts are violations of laws or government regulations, other than frauds. An example of an error is a mathematical mistake when footing the columns in the sales journal. An example of a fraud is the creation of fictitious accounts receivable. An example of an illegal act is the dumping of toxic waste in violation of the federal environmental protection laws.

 

76. Briefly explain each management assertion related to classes of transactions and events for the period under audit.

 

Occurrence. Transactions and events that have been recorded have occurred and pertain to the entity.
Completeness. All transactions and events that should have been recorded have been recorded.

 

Accuracy. Amounts and other data relating to recorded transactions and events have been recorded appropriately.
Classification. Transactions and events have been recorded in the proper accounts.
Cutoff. Transactions and events have been recorded in the correct accounting period.

 

81. In the context of the audit of sales, distinguish between the existence and completeness transaction-related audit objectives. State the effect on the sales account (overstatement or understatement) of a violation of each objective.

 

When testing the existence objective for sales, the auditor’s focus is on whether the sales that have been recorded in the sales journal actually occurred. In contrast, tests of the completeness objective are concerned with determining whether all sales that actually occurred have been recorded in the sales journal. Violations of the existence objective result in overstatements of sales; violations of the completeness objective result in understatements of sales.

 

82. Discuss the differences in the auditor’s responsibilities for discovering (1) material errors, (2) material fraud (3) direct-effect illegal acts, and (4) indirect-effect illegal acts.

 

Auditing standards make no distinction between the auditor's responsibilities for searching for errors and fraud. In either case, the auditor must obtain reasonable assurance about whether the statements are free of material misstatements. The standards also recognize that fraud is often more difficult to detect because management or the employees perpetrating the fraud attempt to conceal the fraud. Still, the difficulty of detection does not change the auditor's responsibility to properly plan and perform the audit to detect material misstatements, whether caused by error or fraud. The auditor’s responsibility for uncovering direct-effect illegal acts is the same as for errors and fraud. However, the auditor is not required to search for indirect-effect illegal acts unless there is reason to believe they exist.

83.A financial statement audit typically consists of four phases. Identify each of these four phases of an audit and discuss the major activities performed by the auditor in each phase.

 

Phase I: Plan and design an audit approach. In this phase, the auditor obtains an understanding of the client’s entity and its environment. In addition, the auditor obtains an understanding of the client’s internal control and assesses the risk of material misstatement.
       Phase II: Perform tests of controls and substantive tests of transactions. In this phase, the auditor tests those internal controls he/she believes may be effective at preventing or detecting misstatements. In addition, the auditor performs substantive tests of transactions to verify the monetary amounts of transactions.

 

 

       Phase III: Perform analytical procedures and tests of details of balances. In this phase, the auditor performs analytical procedures to assess the overall reasonableness of transactions and balances. In addition, tests of details of balances are performed to test for monetary misstatements in the financial statements.
       Phase IV: Complete the audit and issue an audit report. In the last phase of the audit, the information obtained in the previous phases is combined to reach an overall conclusion as to whether the financial statements are fairly presented. An audit report is then issued based on this conclusion.
66.Distinguish between internal documentation and external documentation as types of audit evidence. Give two examples of each. Which type is considered more reliable?   

 

Internal documentation involves the auditor’s examination of documents that have been prepared and used within the client’s organization and are retained without ever going to an outside party. Examples would include duplicate sales invoices, employees’ time reports, and inventory receiving reports.
              External documentation involves the auditor’s examination of documents that have been in the hands of someone outside the client’s organization. Examples include vendors’ invoices, cancelled checks, cancelled notes payable, and insurance policies.
              External documents are regarded as more reliable evidence than internal documents.
64. Describe the audit risk model and each of its components. The planning form of the audit risk model is stated as follows:
       PDR      =       AAR    
                 (IR x CR)
          where:   PDR      =     planned detection risk
              AAR     =     acceptable audit risk
              IR   =     inherent risk
              CR  =     control risk
       Planned detection risk is a measure of the risk that audit evidence for an account will fail to detect misstatements exceeding a tolerable amount, should such misstatements exist. Planned detection risk determines the amount of substantive evidence that the auditor plans to accumulate.
       Acceptable audit risk is a measure of how willing the auditor is to accept that the financial statements may be materially misstated after the audit is completed and an unqualified opinion has been issued. It is influenced primarily by the degree to which external users will rely on the statements, the likelihood that a client will have financial difficulties after the audit report is issued, and the auditor’s evaluation of management’s integrity.

 

 

 

 

 

       Inherent risk is a measure of the auditor’s assessment of the likelihood that there are material misstatements in an account before considering the effectiveness of internal control.

 

       Control risk is a measure of the auditor’s assessment of the likelihood that misstatements exceeding a tolerable amount in an account will not be prevented or detected by the client’s internal controls.

57. Management and the board of directors are responsible for setting the “tone at the top.” What is meant by “tone at the top?”

 

Management cannot act one way and expect others in the company to behave differently. Through its actions and communications, management can show that dishonest or unethical behavior is not tolerated, even if the results benefit the company. Statements by management about the absolute need to meet operating and financial targets create undue pressures that may lead employees to commit fraud to achieve them. In contrast, statements indicating management’s desire to aggressively pursue entity’s goals and targets while at the same time requiring honest and ethical actions to achieve those goals clearly indicates to employees that integrity is a requirement. Whichever course management pursues, its actions establish the “tone at the top.”

 

80. What types of reports may be issued by a service organization auditor? Which of these is likely to be used by an auditor performing an audit of a public company?

 

Service organization auditors may issue two types of reports:
reports on controls that have been implemented, and
reports on controls that have been implemented and tested for operating effectiveness.
       Auditors of a public company would likely use the latter type of report because they have   to provide a report on the internal control over financial reporting.

 

56.Describe the five types of audit tests. Identify which of the five types are substantive tests, and which are used to reduce assessed control risk. The five types of audit tests used to determine whether financial statements are fairly stated are: procedures to obtain an understanding of internal control, tests of controls, substantive tests of transactions, analytical procedures, and tests of details of balances. Substantive tests of transactions, analytical procedures, and tests of details of balances are substantive tests, whereas procedures to obtain an understanding of internal control and tests of controls are used to reduce assessed control risk.

 

 

 

 

60.Discuss the major determinants of the extent of tests of details of balances.      

 

Major determinants of the extent of tests of details of balances include: the results of tests of controls, substantive tests of transactions, and analytical procedures; the amount of tolerable misstatement; and the levels of inherent risk and acceptable audit risk.

 

68.State the five classes of transactions that comprise the sales and collection cycle.      The five classes of transactions that comprise the sales and collection cycle are:
Sales (cash and sales on account)
Cash receipts
Sales returns and allowances
Charge-off of uncollectible accounts
Bad debt expense.