Review Questions - Copyright © 2016 McGraw-Hill Education. All ri...

Solutions Manual, Chapter 2, Page 1 of 14

Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

CHAPTER 2

Professional Standards

Review Questions

2-1 The Sarbanes-Oxley Act of 2002 created the PCAOB and gave this body authority to develop auditing standards for the audits of public companies. The AICPA has the authority, based on general acceptance (and adoption by state boards of accountancy and other regulatory bodies), to develop auditing standards for audits of nonpublic companies.

2-2 Generally accepted accounting principles are accounting principles which have substantial authoritative support, such as approval by the Governmental Accounting Standards Board or the Financial Accounting Standards Board. These standards provide the criteria (financial reporting framework) for financial reporting, including the nature and content of financial statements. Generally accepted auditing standards are those issued by the AICPA’s Auditing Standards Board (ASB).GAAS are the standards for the auditor’s work in fulfilling the overall objectives of a financial statement audit. GAAS address the general responsibilities of the auditor, as well as the auditor’s further considerations relevant to the application of those responsibilities.

2-3 A financial reporting framework is a set of criteria used to determine measurement, recognition, representation, and disclosure of all material items appearing in the financial statements; for example United States GAAP or IFRS. It is important to an audit because it is through consideration of that framework on which the auditor basis his or her opinion on the financial statements.

2-4 Generally accepted auditing standards are the Statements on Auditing Standards issued by the Auditing Standards Board.

2-5 In the context of the audit of financial statements, professional skepticism includes maintaining a questioning mind, being alert to conditions that may indicate possible misstatement due to fraud or error, and a critical assessment of audit evidence. Throughout the audit the auditors should be alert for: (1) audit evidence that contradicts other audit evidence, (2) information that raises a question about the reliability of documents and responses to inquiries, (3) conditions indicating possible fraud, and (4) circumstances suggesting the need for additional audit procedures beyond those ordinarily required.Principles of Auditing and Other Assurance Services 20th Edition Whittington Solutions Manual Visit TestBankDeal.com to get complete for all chapters

Solutions Manual, Chapter 2, Page 2 of 14

Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.2-6 The auditors' responsibilities concerning the detection of noncompliance with laws by clients depends on the relationship of the law or regulation to the financial statements. Certain laws and regulations, such as income tax laws, have a direct effect on the amounts and disclosures included in the financial statements. The auditors have a responsibility to design their audit to obtain reasonable assurance of detecting material violations of these laws and regulations.Many other laws and regulations, such as occupational safety and health laws, do not have a direct effect on the amounts included in the financial statements. An audit carried out in accordance with generally accepted auditing standards is not designed to detect client noncompliance with these other laws.Although an audit is not designed to provide reasonable assurance of detecting noncompliance with other laws, the CPAs should be aware of the possibility that they have occurred and investigate those identified. When they become aware of noncompliance with laws, the auditors should communicate the situation to the audit committee of the board of directors to remedy the situation and make appropriate modifications to the financial statements. If management fails to take appropriate action, the auditors should consider withdrawing from the engagement.

2-7 The first sentence of the quotation is correct. The completion of an audit of financial statements by a CPA following generally accepted auditing standards and satisfying the CPA provides the basis for expression of an unmodified opinion on the fairness of financial statements.The second sentence of the quotation is in error. Auditors never express an opinion (either qualified or unmodified) on the fairness of financial statements without first performing an audit. The audit provides the basis for the expression of an opinion. Such factors as audits made in prior years, confidence in management, and a "quick review" of the current year's financial statements are not an acceptable substitute for appropriate audit procedures.

2-8 The management of Pike Company is primarily responsible for the fairness of the company's financial statements. The retention of certified public accountants to perform an audit and express an opinion on the statements does not relieve management of its obligation to give an honest and complete accounting of its conduct of corporate affairs.

2-9

Independent Auditor’s Report

To the Audit Committee of ABC Company

We have audited the accompanying consolidated balance sheets of ABC Company and its subsidiaries, as of December 31, 20X1 and 20X0, and the related consolidated statements of income, retained earnings, and cash flows for the years then ended.

Management's Responsibility for the Financial Statements Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of consolidated financial statements that are free from material misstatement, whether due to fraud or error.

Auditor's Responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United

Solutions Manual, Chapter 2, Page 3 of 14

Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement.

An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditor's judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity's preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity's internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements.

We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.

Opinion In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of ABC Company and its subsidiaries as of December 31, 20X1 and 20X0, and the results of their operations and their cash flows for the years then ended in accordance with accounting principles generally accepted in the United States of America.

Williams & Co. LLP Phoenix, Arizona February 5, 20X2

2-10 Among the more common situations which prevent the issuance of an unmodified opinion upon

completion of an audit are the following:

(1) Certain necessary auditing procedures were omitted at the request of the client, or for reasons beyond the control of the client or the auditors.(2) The statements contained misstatements (or omissions) and the client refuses to change them.

2-11 In the opinion paragraph of the auditor's standard report the auditors make representations as to the

following:

(1) The fairness of the financial statements, in all material respects.(2) Application of generally accepted accounting principles.(3) By implication consistent application of generally accepted accounting principles.(4) By implication adequate disclosure.

2-12 The issuance of a standard audit report tells us that the audit was performed in accordance with generally accepted auditing standards and, accordingly, it was planned and performed to obtain reasonable assurance about whether the financial statements are free of material misstatement due to error or fraud. The audit included performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. These procedures were determined based on the auditors’ judgment, including their assessment of the risks of material misstatements of the financial statements.The auditors also evaluated the appropriateness of accounting policies used by the client, the reasonableness of significant accounting estimates, and the overall presentation of the financial statements.

Solutions Manual, Chapter 2, Page 4 of 14

Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

2-13 The auditors' report expresses an opinion on the client's financial statements, not on the accounting records. A major purpose of the audit is to give outsiders assurance that the financial statements are reliable. The client's accounting records are important to the public accounting firm only because they constitute evidence supporting the financial statements. The CPAs also gather evidence from outside the company and from internal sources other than the accounting records.

2-14 The public accounting firm must observe generally accepted auditing standards (or, if applicable, PCAOB Standards) in order to merit confidence in its opinion. The result of following these procedures is an audit report that includes a reasonable, but not absolute, assurance that the financial statements do not contain material misstatements due to errors or fraud. Reasonable assurance implies that there is a low level of risk remaining that the auditor expresses an opinion that the financial statements are properly stated when they are not. Reasonable and not absolute assurance is necessary due to (1) the nature of financial reporting (e.g., the necessary use of judgment), (2) the nature of audit procedures (e.g., they often do not provide absolutely conclusive evidence) and (3) the need to conduct an audit within a reasonable period of time at a reasonable cost. Accordingly, the auditor expresses an opinion on the financial statements, not a statement of fact.

2-15 Regardless of how careful and professional an audit of financial statements the public accounting firm has made, it cannot guarantee their correctness. The statements themselves include a variety of estimates; for example, the estimate of the allowance for uncollectible accounts and the choice of depreciation rates. Also, the auditors rely on a program of tests rather than on verifying every transaction. Some errors, therefore, may go undetected. The audit gives the auditors a firm basis for expressing an informed opinion on the financial statements, but no more than that.

2-16 A material amount is an amount that is sufficiently important to influence decisions made by reasonable users of financial statements. The amount may differ by account based on specific account characteristics. For example, a $100,000 shortage of cash may be extremely material to a small company, and a shortage of that amount might lead to bankruptcy. But, a $100,000 valuation overstatement of equipment may be of less significance if the company continues to produce its products and operate as in the past. Materiality is discussed further in Chapter 6.

2-17 If the guidance for a transaction or event is not specified within the authoritative GAAP (the FASB Codification), the auditor should first consider whether accounting principles for similar transactions or events exist within GAAP; if that is the case, those principles are followed to the extent considered appropriate. If not, nonauthoritative accounting guidance is consulted. Sources of nonauthoritative accounting guidance and literature include  Practices that are widely recognized and prevalent either generally or in the industry. FASB Concepts Statements. AICPA Issues Papers  International Financial Reporting Standards. Pronouncements of professional associations or regulatory agencies. Technical Information Service Inquiries and Replies included in AICPA  Technical Practice Aids. Accounting textbooks, handbooks, and articles.

The appropriateness of the above nonauthoritative accounting guidance and literature depends on its relevance to particular circumstances, how specific it is, the general recognition of the issuer or author as a authority, and the extent of its use in practice.