Copyright 2024 Pearson Education, Inc.

1-1 Copyright © 2024 Pearson Education, Inc. Concept Checks

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• To do an audit, there must be information in a verifiable form and some

standards (criteria) by which the auditor can evaluate the information.Determining the degree of correspondence between information an d established criteria is determining whether a given set of information is in accordance with the established criteria. For an audit of a company’s financial statements the criteria are U.S. generally accepted accounting principles or International Financial Reporting Standards.

• 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.

The three main ways to reduce information risk are:

• User verifies the information.
• User shares the information risk with management.
• Audited financial statements are provided.
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• The three main types of audits are operational audits, compliance audits, and

financial statement audits. The table below summarizes the purposes and nature of each type of audit.

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) Auditing and Assurance Services, 18e Alvin Arens, Arens, Randal Elder, Mark Beasley, Chris Hogan (Solutions Manual All Chapters. 100% Original Verified, A+ Grade) Chapter 1 The Demand for Audit and Other Assurance Services 1 / 4

1-2 Copyright © 2024 Pearson Education, Inc.Concept Check, P. 16 (continued)

OPERATIONAL

AUDITS

COMPLIANCE

AUDITS

AUDITS OF

FINANCIAL

STATEMENTS

USERS OF

AUDIT

REPORT

Management of organization Authority that established rules, regulations, and procedures, either internal or external to auditee 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.

• 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.GAAP or IFRS in accordance with auditing standards. GAO auditors perform compliance or operational audits in order to assure the Congress of the expenditure of public funds in accordance with its directives and the law. IRS agents perform compliance audits to enforce the federal tax laws as defined by Congress, interpreted by the courts, and regulated by the IRS. Internal auditors perform compliance or operational audits in order to assure management or the board of directors that controls and policies are properly and consistently developed, applied, and evaluated.

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1-3 Copyright © 2024 Pearson Education, Inc. Review Questions

1-1 To do an audit, there must be information in a verifiable form and some standards (criteria) by which the auditor can evaluate the information. The information for Jones Company's tax return is the federal tax returns filed by the company. The established criteria are found in the Internal Revenue Code and all interpretations. For the audit of Jones Company's finan cial statements the information is the financial statements being audited and the 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, classifying, and summarizing of economic events to provide relevant information to decision makers. The rules of accounting are the criteria used by the auditor for evaluating the presentation of economic events for financial statements and they must therefore have an understanding of accounting standards, as well as auditing standards. The accountant need not, and frequently does not, understand what auditors do, unless they are involved in doing audits, or have 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:

• Increased global activities of many businesses
• Multiple product lines and transaction locations
• Foreign exchange affects transactions
• Complex accounting and exchange transactions
• Increasing use of derivatives and hedging activities
• Increasingly complex accounting standards in areas such as

revenue recognition

• More complex information systems
• Possibly millions of transactions processed daily through on-

line and traditional sales channels

• Voluminous data requires interpretation

1-4 1. Risk-free interest rate This is approximately the rate the bank could earn by investing in U.S. treasury notes for the same length of time as the business loan.

• Business risk for the customer This risk reflects the possibility that

the business will not be able to repay its loan because of economic or business conditions such as a recession, poor management decisions, or unexpected competition in the industry.

• Information risk This risk reflects the possibility that the information

upon which the business risk decision was made was inaccurate. A likely cause of the information risk is the possibility of inaccurate financial statements.

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1-4 Copyright © 2024 Pearson Education, Inc.1-4 (continued)

Auditing has no effect on either the risk-free interest rate or business risk.However, auditing can significantly reduce information risk.

1-5 The three main ways to reduce information risk are:

• User verifies the information.
• User shares the information risk with management.
• Audited financial statements are provided.

The advantages and disadvantag es of each are as follows:

ADVANTAGES DISADVANTAGES

USER VERIFIES

INFORMATION

• User obtains information

desired.

• User can be more confident

of the qualifications and activities of the person getting the information.

• High cost of obtaining

information.

• Inconvenience to the

person providing the information because large number of users would require access to information.

USER SHARES

INFORMATION

RISK WITH

MANAGEMENT

• No audit costs incurred. 1. User may not be able

to collect on losses.

AUDITED

FINANCIAL

STATEMENTS

ARE PROVIDED

• Multiple users obtain the

information.

• Information risk can usually

be reduced sufficiently to satisfy users at reasonable cost.

• Minimal inconvenience to

management by having only one auditor.

• May not meet needs

of certain users.

• Cost may be higher

than the benefits in some situations, such as for a small company.1-6 Information risk is the risk that information upon which a business decision is made is inaccurate. Fair value accounting is often based on estimates and requires judgment. Fair value can be estimated using multiple methods with some estimates being more subjective than others. Fair value estimates are made at a point in time, but can also change rapidly, depending on market conditions. All of these factors 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 assertion that is the responsibility of another party.

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