Chapter 1 ACCT 4400

An Introduction to Assurance and Financial Statement Auditing
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Terms in this set (...)

Difference between auditing and other courses
Other courses deal with rules and computations to prepare and analyze financial information and auditing uses analytical and logical skills and is much more conceptual in nature.
What is the role of the principal?
Provide capital and hire agent to manager resources
What is the role of the agent?
Hires auditor to report on the fairnessof agent's financial reports.
Agent pays auditor to do what?
Reduce principal's information risk.
What is the role of the auditor?
To gather evidence to evaluate fairness of agent's financial reports.
What does the auditor issue?
Audit opinion
What does the audit opinion do?
Adds credibility to the reports reducing principal's information risk.
How is the agent accountable to principal?
By providing financial reports
________ is the absentee owner.
Principal
________ is the manager
Agent
What leads to information risk for the principal?
Information assymetry and conflicts of interest
A systematic process of objectively obtaining and evaluating evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between those assertions and established criteria and communicating the results to interested users.
Auditing
Occurs when a practitioner is engaged to issue ... a report on subject matter, or an assertion about subject matter, that is the responsibility of another party.
Attest
Independent professional services that improve the quality of information, or its context, for decision makers.
Assurance Services
3 Fundamental Concepts in Conducting Financial Statement Audit
1. Audit Risk
2. Materiality
3. Evidence
Who Implements internal controls?
Management
Who conducts transactions?
Management
Who accumulates transactions into account balances?
Management
Who prepares financial statements?
Management
Who issues financial statements to users?
Management
Who obtains evidence?
Auditor
Who tests management assertions against criteria? (GAAP)
Auditor
Who determines overall fairness of financial statements?
Auditor
Who issues audit report to accompany financial statements?
Auditor
When an auditor issues an audit report to accompany financial statements, what part of the financial statement audit process is this?
Communication
When a manager prepares financial statements, what part of the financial statement audit process is this?
Assertions
When management implements internal controls, conducts transactions, and accumulates transactions into account balances, what part of the financial statement audit process is this?
Evidence
The magnitude of an omission or misstatement of accounting information that, in light of surrounding circumstances, makes it probable that the judgement of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement
Materiality
The risk that the auditor may knowingly fail to appropriately modify his or her opinion on financial statements that are materially misstated.
Audit risk
Report that states that the audit provides only reasonable assurance that the financial statements do not contain material misstatements.
Auditor's Standard Report
Implies some risk that a material misstatement could be present in the financial statements and the auditor would fail to detect it.
Reasonable assurance
Evidence that assists the auditor in evaluating management's financial statement assertions consists of what?
Underlying accounting data and any additional information available to the auditor, whether originating from the client or externality.
Is the information related to the specific assertion being tested?
Relevance
Can the information be relied upon to signal the true state of the specific assertion being tested?
Reliability
Inference based on limited observations
Sampling
Auditors use what 2 things to examine transactions?
1. Their knowledge about the transactions and/or
2. A sampling approach to examine the transactions
Why don't auditors examine every transaction?
Too costly
7 major phases of the audit
1. Client acceptance/continuance
2. Preliminary engagement activities
3. Plan the audit
4. Consider and audit internal control
5. Audit business processes and related account (ex: revenue generation)
6. Complete the audit
7. Evaluate results and issue audit report
3 opinions the auditor may issue
1. Unqualified
2. Qualified
3. Adverse
The title line of the audit report includes the word, "_________" and usually, the report is addressed to ___________.
Independent; Stockholders of the company
6 Things in every audit report
1. Introductory Paragraph
2. Scope Paragraph
3. Opinion Paragraph
4. Explanatory Paragraph
5. Name of the auditor or audit firm
6. Date of the audit report
The main product or output of the audit
Auditor's report (audit opinion)
The standard _________ (clean) audit report is the most common type of report issued.
Unqualified
Unqualified means what?
Because the financial statements are free of material misstatements, the auditor does not find it necessary to qualify his or her opinion about the fairness of the financial statements.
If a client's financial statements contain a misstatement that the auditor considers material and the client refuses to correct the misstatement, the auditor will likely ________ the report.
Qualify
What kind of opinion should be issued when financial statements are fairly stated except for the misstatement identified by the auditor?
Qualified
If a client's financial statements contain a misstatement that the auditor considers so material that it pervasively affects the interpretation of the financial statements, what kind of opinion should be issued?
Adverse
What kind of opinion should be issued if the financial statements are not fairly stated and should not be relied upon?
Adverse
What has given rise to an explosion in the demand for assurance provided by auditors?
The development of the corporate form of business and the expanding world economy over the last 200 years.
A company that sells its stock or bonds to the public, giving the public a valid interest in the proper use, or stewardship over the company's resources.
Public company
Managers are _______.
Agents
Stockholders are _______.
Principals
Independent auditing can best be described as:

A) A branch of accounting.
B) A discipline that provides assurance regarding the results of accounting and other functional operations and data.
C) A professional activity that measures and communicates financial and business data.
D) A regulatory function that prevents the issuance of improper financial information.
B) A discipline that provides assurance regarding the results of accounting and other functional operations and data.
Information asymmetry

A) Refers to an imbalance of information among stockholders in a company.
B) Refers to an imbalance of information between the auditor and the management of the company.
C) Refers to an imbalance of information between stockholders and the management of the company.
D) Refers to an imbalance of information between the auditor and the stockholders of the company.
C) Refers to an imbalance of information between stockholders and the management of the company.
Which of the following best describes the primary reason an independent auditor reports on financial statements?

A) To give stockholders some assurance that any fraudulent activities will be detected.
B) To identify a poorly designed internal control structure that may produce unreliable financial statements.
C) To provide expertise to clients, which may not be totally knowledgeable of prevailing GAAP.
D) To add credibility, where appropriate, since the client may not be perceived as objective with respect to its own financial statements.
D) To add credibility, where appropriate, since the client may not be perceived as objective with respect to its own financial statements.
Financial statement users' demand for assurance is similar to that of a potential home buyer who hires a home inspector in that

A) The buyer [or user] pays directly for this assurance in both situations.
B) There are often information asymmetry and conflicts of interest.
C) The cost of obtaining information is not relevant.
D) Independence is not relevant in either situation.
B) There are often information asymmetry and conflicts of interest.
Assurance services differ from auditing services in that

A) Assurance services are more narrow in scope than audit services.
B) Assurance services may include a report about the relevance and timeliness, not just the reliability, of the information.
C) Assurance services are limited to economic events or actions, and audit services are not similarly limited.
D) Audit services do not improve the quality of information as do assurance services.
B) Assurance services may include a report about the relevance and timeliness, not just the reliability, of the information.
Which of the following best describes the relationship between attestation services and audit services?

A) Attestation is a subset of auditing that improves the quality of information for decision makers.
B) Auditing is a subset of attestation and focuses on providing clients with advisory services and decision support.
C) Auditing is a subset of attestation that involves the issuance of an opinion regarding the fairness of financial statements.
D) Attestation is a subset of auditing that provides more assurance than does an audit engagement.
C) Auditing is a subset of attestation that involves the issuance of an opinion regarding the fairness of financial statements.
The fact that errors and/or omissions in certain relatively insignificant account balances would not affect an auditor's decision when reporting on the financial statements as a whole relates most closely to which major audit concept?

A) Materiality.
B) Audit risk.
C) Management assertions.
D) Reasonable assurance.
A) Materiality.
Audit evidence
A) May only be gathered from parties external to the client to be reliable.
B) May only be gathered from the client to be reliable since the client is the most knowledgeable source of information.
C) May only be gathered from computerized sources to avoid human error.
D) Can be gathered from many sources and is not limited to the underlying accounting data.
D) Can be gathered from many sources and is not limited to the underlying accounting data.
Audit risk

A) Can be completely eliminated through appropriate sampling of transactions.
B) Is the risk that a "clean" opinion will be issued when, in reality, the financial statements are materially misstated.
C) Is what creates the demand for an audit.
D) Is the risk that a company may hire an incompetent auditor.
B) Is the risk that a "clean" opinion will be issued when, in reality, the financial statements are materially misstated.
The examination of all of a client's transactions would make an audit very costly. Thus, auditors rely heavily on sampling as a way to obtain evidence. Which of the following would result in a smaller sample?

A) A decrease in the materiality level.
B) A decrease in the desired level of assurance.
C) An assessment that the account being audited is high risk.
D) An increase in the desired level of assurance.
B) A decrease in the desired level of assurance.
Which of the following audit phases would generally be conducted before all of the others listed below?

A) Auditing business processes and related accounts.
B) Evaluation of audit evidence.
C) Gaining an understanding of the client's industry.
D) Consideration of internal control systems.
C) Gaining an understanding of the client's industry.
An auditor's evaluation of the reasonableness of a client's loan loss reserve would normally be made during which phase of the audit?

A) Gaining an understanding of the client's industry.
B) Client acceptance.
C) Consideration of internal control systems.
D) Auditing business processes and related accounts.
D) Auditing business processes and related accounts.
Gaining an understanding of the client and its environment includes all of the following areas except

A) Regulatory issues unique to the industry.
B) The entity's application of accounting policies.
C) The audit fee and timeline for completion of the work.
D) The entity's business risks.
C) The audit fee and timeline for completion of the work.
The most favorable type of audit report opinion for the client to receive is

A) Qualified.
B) Unqualified.
C) Full assurance.
D) Exceptional.
B) Unqualified.
The study and practice of auditing is unlike other areas in accounting because it

A) Requires the memorization of formulas and patterns.
B) Requires the knowledge of GAAP.
C) Requires common sense and some creativity.
D) Is required by law for all companies in the United States.
C) Requires common sense and some creativity.