Chapter 1

Question 1

Financial accounting

Answer 1

given specific transactions or events –> determine how they should be recorded and appear in the F/S

• quantitative
• concrete “right” answer
• rules

Question 2

Auditing (as opposed to financial accounting)

Answer 2

given a set of F/S –> check for conformity with GAAP

• ask “how should we test in order to figure that out?
• less quantitative, more conceptual
• focus on analytical and logical skills
• backing into things after the fact

Question 3

agency problem

Answer 3

Public companies, owned by thousands of shareholders, hire managers to serve as agents for the owners and manage the co’s assets.

• conflict of interest? Manager may not always act in the best interest of owner
• info. asymmetry and info. risk
• users depend on accurate/reliable information to make decisions
• management needs to be monitored

Question 4

auditing origins

Answer 4

occurred during the industrial revolution, when companies became larger and needed to raise capital to finance expansion. A capital market was formed, allowing public companies to sell ownership/borrow to raise funds.

Question 5

information asymmetry

Answer 5

seller has more information than the buyer (leads to information risk)

Question 6

information risk

Answer 6

risk that information circulated by management will be false of misleading

Question 7

House inspector analogy

Answer 7

Similar to audit context - people want to make sure a house is safe before they buy it just as investors want to know they have accurate information about a company before the invest

Major difference from audit context - house inspector is paid for by the buyer. In audit context, the co. selects and pays the auditor

Question 8

management responsibilities

Answer 8

• maintaining internal controls
• preparing F/S
• management asserts that the F/S are “right” (fairly stated in accordance with GAAP)

Question 9

auditor responsibilities

Answer 9

• testing assertions of management and determining whether they are true
• rendering an opinion on the F/S

Question 10

desired characteristics of auditor

Answer 10

competitence, objective, honest, skeptical, responisble

Question 11

desirable traits of audit service

Answer 11

timely, reasonably priced, complete, effective, systematic, informative

Question 12

____ + _____ = information risk

Answer 12

information asymmetry and conflict of interest

Question 13

assurance services

Answer 13

independent (third party) professional services that improve the quality of information , or its context, for decision makers (they provide info to buyers to help them make decisions

-attest and audit are special types of assurance services

Question 14

audit

Answer 14

systematic process that objectively searches for and evaluates the relevance and validity of evidence and communicate results to interested users

Question 15

skepticism

Answer 15

questioning (the client); don’t accept everything at face value

-especially important for new hires because new hires think others are more experienced and they’re afraid they might look stupid for asking questions

Question 16

materiality

Answer 16

mistakes big enough to matter to interested users

Question 17

audit risk

Answer 17

auditors don’t look at 100% of the evidence for the sake of time so there is risk that something they missed is wrong

Question 18

sampling

Answer 18

take a sample and project findings out to represent the whole population of information

Question 19

evidence

Answer 19

data and documents used to form opinions about the sample (ie ledgers)

Question 20

management assertions

Answer 20

management asserts that the F/S are “correct” (conform with GAAP)

• auditor’s job to test that assertion
• “correct” = general concept because there are multiple ways F/S can end up not “correct” (5 typical ways/5 things to test)

Question 21

Ways the F/S could fail “to be correct”

Answer 21

1. omit something that should be included
2. include something that does not belong (fictitious or not legitimate) (ex: adding inventory that isn’t actually there)
3. include items that belong to someone else (ex: goods on consignment)
4. items are not adequately presented/disclosed according to gaap (ex: cost flow of inventory does not conform with gaap)
5. include items in the wrong period, at the wrong dollar amount or using the wrong valuation (fob shipping point error, inconsistencies of fifo vs lifo)

Question 22

Ways the F/S fail “to be correct” terminology

Answer 22

1. Existence assertion
2. Rights and Obligation assertion
3. Presentation and Disclosure assertion
4. Completeness assertion
5. Valuation allocation assertion

Question 23

PCAOB for management assertions

Answer 23

AS No. 1105

Question 24

valuation or allocation assertion consists of (subcomponents)

Answer 24

accuracy - includes math, positing and tie-in, authorization

cut-off - refers to timing (will always have completeness problem too)

classification - often mean presentation issues too

valuation/realizable value - amount amount you actually expect to receive/collect

Question 25

Audit report components

Answer 25

Standard unqualified audit report for public company

• Title: “Report of Independent Registered Public Accounting Form” (independent = unbiased; registered with PCAOB)
• Addressee (typically stockholders or board of directors or audit committee; NOT to management)
• content of the main body of report
  
  • info that was audited: 2 yrs of B/S, 3 yrs of I/S, CFs, SE
  • lays out responsibilities (management = F/S, auditor = opinion)
  • Identifies standards for conducting audit (PCAOB)
  • Describe what an audit entails
• F/S “present fairly, in all material respects”
• Identifies criteria for which F/S were prepared (GAAP)

Question 26

What does an audit entail? (described in audit reports)

Answer 26

• obtain “reasonable assurance”
• “free of material misstatement”
• “test basis”, “evidence”, “reasonable basis for our opinion”