LEARNING OBJECTIVES - consent of McGraw-Hill Education. Auditing and ...

© 2018 by McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.Auditing and Assurance Services, Louwers et al., 7/e 2-1

CHAPTER 2

Professional Standards

LEARNING OBJECTIVES

Review Checkpoints Multiple Choice Exercises and Problems

• Understand the development and source

of generally accepted auditing standards.

1, 2, 3, 4 47, 48 52, 53

• Describe the fundamental principle of

responsibilities and how this principle relates to the characteristics and qualifications of auditors.

5, 6, 7 27, 29, 35, 39,

40

54, 55, 56, 57,

62, 64, 65, 66,

67

• Describe the fundamental principle of

performance and identify major activities performed in an audit.

8, 9, 10, 11, 12,

13, 14, 15, 16,

17, 18

26, 30, 31, 32,

33, 34, 36, 37,

42, 43, 44, 45

58, 59, 60, 61,

62, 64, 65, 66,

67

• Understand the fundamental principle of

reporting and identify the basic contents of the auditors’ report.

19, 20 41, 49, 50, 51 63, 64, 65, 66,

67

• Understand the role of a system of quality

control and monitoring efforts in enabling public accounting firms to meet appropriate levels of professional quality.

21, 22, 23, 24,

25

28, 38, 46 52, 68, 69, 70

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© 2018 by McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.2-2 Solutions Manual

SOLUTIONS FOR REVIEW CHECKPOINTS

2.1 Generally accepted auditing standards are auditing standards that identify necessary qualifications and characteristics of auditors and guide the conduct of the audit examination.The purpose of generally accepted auditing standards is to meet the following objectives of an audit

examination:

• To obtain reasonable assurance about whether the financial statements as a whole are free of material misstatement, whether due to error or fraud.• To issue a report on the financial statements 2.2 Currently, the PCAOB is responsible for developing standards for the audits of public entities, while the AICPA is responsible for developing standards for the audits of nonpublic entities.

2.3 The AICPA (through the Auditing Standards Board) has responsibility for setting standards for the audits of nonpublic entities. This is done through the issuance of Statements on Auditing Standards.The PCAOB has responsibility for setting standards for the audits of public entities. This is done through the PCAOB’s issuance of Auditing Standards.While the SEC does not have responsibility for setting auditing standards per se, all PCAOB standards must be approved by the SEC.

2.4 The three fundamental principles are:

• Responsibilities, which involves having appropriate competence and capabilities, complying with

relevant ethical requirements, maintaining professional skepticism and exercising professional judgment.

• Performance, which requires auditors to obtain reasonable assurance about whether the financial

statements as a whole are free of material misstatement by: (1) planning the work and properly supervising assistants; (2) determining and applying appropriate material levels; (3) identifying and assessing the risk of material misstatement; and, (4) obtaining sufficient appropriate audit evidence.

• Reporting, which requires the auditor to express an opinion (or state that an opinion cannot be

expressed) as to whether the financial statements are presented fairly in accordance with the applicable financial reporting framework.

2.5 Independence in fact represents auditors’ mental attitudes (do auditors truly act in an unbiased and impartial fashion with respect to the client and fairness of its financial statements?). Independence in appearance relates to financial statement users’ perceptions of auditors’ independence.Auditors can be independent in fact but not perceived to be independent. For example, ownership of a small interest in a public client would probably not influence auditors’ behavior with respect to the client.However, it is likely that third-party users would not perceive auditors to be independent.

2.6 Due carereflects a level of performance that would be exercised by reasonable auditors in similar circumstances. Auditors are expected to have the skills and knowledge of others in their profession (known as that of a prudent auditor) and are not expected to be infallible.

© 2018 by McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.Auditing and Assurance Services, Louwers et al., 7/e 2-3 2.7 Professional skepticismis a state of mind that is characterized by appropriate questioning and a critical assessment of audit evidence.Professional judgmentis the auditors’ application of relevant training, knowledge, and experience in making informed decisions about appropriate courses of action during the audit engagement.Auditors are required to demonstrate professional skepticism and professional judgment throughout the entire audit process.

2.8 Reasonable assurancerecognizes that a GAAS audit may not detect all material misstatements and auditors are not “insurers” or “guarantors” regarding the fairness of the entity’s financial statements.The audit team provides reasonable assurance by considering various risks relating to the likelihood of material misstatements and performing audit procedures to control this risk to an acceptably low level.

2.9 An audit plan is a list of audit procedures that are performed to gather sufficient appropriate evidence on which auditors base their opinion on the financial statements.Audit plans are prepared during the planning stages of the audit.

2.10 The timing of the auditors’ appointment is important because auditors need time to properly plan the audit and perform the necessary work without undue pressure from tight deadlines.

2.11 Materialityis the dollar amount that would influence the lending or investing decisions of users; this concept recognizes that auditors should focus on matters that are important to financial statement users.Materiality should be considered in planning the audit, performing the audit, and evaluating the effect of misstatements on the entity’s financial statements.

2.12 Auditors obtain an understanding of a client, including its internal control, as a part of the control risk assessment process primarily in order to plan the nature, timing and extent of further audit procedures. A secondary purpose is because of auditors’ responsibilities for reporting on client’s internal controls.

2.13 As the client’s internal control is more effective (a lower level of control risk), auditors may use less effective substantive procedures (a higher level of detection risk). Conversely, when the client’s internal control is less effective (a higher level of control risk), auditors must use more effective substantive procedures (a lower level of detection risk).

2.14 Audit evidence is defined as the information used by auditors in arriving at the conclusion on which the audit opinion is based.

2.15 External documentary evidence is audit evidence obtained from another party to an arm’s-length transaction or from outside independent agencies. External evidence is received directly by auditors and is not processed through the client’s information processing system.External-internal documentary evidence is documentary material that originates outside the bounds of the client’s information processing system but which has been received and processed by the client.Internal documentary evidence consists of documentary material that is produced, circulates, and is finally stored within the client’s information processing system. Such evidence is either not circulated to outside parties at all or is several steps removed from third-party attention.

© 2018 by McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.2-4 Solutions Manual 2.16 Relevancerefers to the nature of information provided by the audit evidence; that is, what assertion(s) related to the account balance or class of transactions does the evidence support? Reliability refers to the extent of trust that auditors can place in evidence and is primarily influenced by the source of the evidence.The appropriateness of audit evidence is related to both relevance and reliability; that is, as evidence is more relevant and reliable, it is considered to have a higher level of appropriateness.

2.17 The source of evidence affects its reliability as follows (from most to least reliable): (1) evidence directly obtained by auditors, (2) evidence obtained from external sources, and (3) evidence obtained from internal sources.

2.18 As auditors need to achieve lower levels of detection risk, more appropriate evidence needs to be obtained.Thus, auditors should gather higher quality evidence (more reliable evidence). For example, auditors may choose to obtain evidence from external sources rather than internal sources.In addition, for lower levels of detection risk, auditors need to gather more sufficient evidence. Because sufficiency relates to the quantity of evidence, more transactions or components of an account balance should be examined.

2.19 A financial reporting frameworkis a set of criteria used to determine the measurement, recognition, presentation, and disclosure of material items in the financial statements. The financial reporting framework is related to auditors’ reporting responsibilities because this framework serves as the basis against which the financial statements are evaluated and the auditors’ opinion on the financial statements is expressed.

2.20 Four types of opinions and their conclusions:

Type Conclusion Unmodified opinion Financial statements are presented in conformity with GAAP.Adverse opinion Financial statements are not presented in conformity with GAAP.Qualified opinion Financial statements are presented in conformity with GAAP, except for one or more departures or issues of concern.Disclaimer of opinion An opinion cannot be issued on the financial statements.

2.21 A system of quality controlprovides firms with reasonable assurance that the firm and its personnel (1) comply with professional standards and applicable regulatory and legal requirements and (2) issue reports that are appropriate in the circumstances.

The six elements of a system of quality control are:

• Leadership responsibilities for quality within the firm (“tone at the top”)
• Relevant ethical requirements
• Acceptance and continuance of client relationships and specific engagements
• Human resources
• Engagement performance
• Monitoring