Chapter 1

Question 1

Studying accounting

Answer 1

The rules, techniques, and computations required to prepare and analyze financial information.

Question 2

Studying auditing

Answer 2

Learning the analytical and logical skills necessary to evaluate the relevance and reliability of financial information as well as of the systems and processes responsible for recording and summarizing that information.

Question 3

Reliable information is important for managers, investors, creditors, and regulatory agencies to make…

Answer 3

Informed decisions.

Question 4

Auditing helps ensure that…

Answer 4

Information is reliable, credible, and relevant. In fact, the assurance provided by auditing is vital to the proper functioning of our economic system.

Question 5

Information symmetry (conflicts of interest)

Answer 5

The concept that the manager generally has more information about the true financial position and results of operations of the entity than the absentee owner.

Question 6

Management makes assertions (claims) about:

Answer 6

A. transactions
B. Account balances
C. Disclosures

Question 7

Auditing is demanded, because it plays a valuable role in monitoring…

Answer 7

The contractual relationships between the entity and its stockholders, managers, employees, and debt holders. CPAs have been charged with providing audit services because of their traditional reputation of competence, independence, objectivity, and concern for the public interest. As a result, they are able to add credibility to information produced and reported by management to outside parties.

Question 8

Assurance services

Answer 8

Independent professional services that improve the quality of information for decision makers.

Question 9

Attest services

Answer 9

Reporting on subject matter that is the responsibility of another party.

Question 10

Auditing is a systematic process of:

Answer 10

1) Objectively obtaining and evaluating evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between those assertions and established criteria.
2) Communicating the results to interested users.

Question 11

A financial statement audit is “built on” 3 fundamental concepts:

Answer 11

1) Materiality
2) Audit risk
3) Evidence

Question 12

Materiality

Answer 12

The amount by which a set of fundamental statements could be misstated without affecting the judgement of reasonable people.

Question 13

FASB definition for materiality

Answer 13

Information is material if omitting it or misstating it could influence decisions that users make on the basis of the financial information of a specific reporting entity.

Question 14

If materiality is set at a LOW level…

Answer 14

MORE evidence will need to be collected. (Inverse relationship)

Question 15

A common rule of thumb for determining materiality is that…

Answer 15

Total (aggregated) misstatements of more than about 3-5% of income before tax would cause the financial statements to be materially misstated.

Question 16

Audit risk

Answer 16

The risk that the auditor mistakenly expresses a clean audit opinion when the financial statements are materially misstated.

Question 17

The auditor’s standard report states that the audit provides “reasonable assurance” that the financial statements do not contain material misstatements. The phrase “reasonable assurance” implies that…

Answer 17

Even when the auditor does a good job, there is some risk that a material misstatement could be present in the financial statements and the auditor will fail to detect it.

Question 18

Audit evidence

Answer 18

Consists of the underlying accounting data and any additional information available to the auditor, whether originating from the client or externally.

Question 19

What are the 2 key descriptors of audit evidence?

Answer 19

Sufficient and appropriate.

Question 20

Auditors cannot examine all evidence due to ____ and ____ constraints.

Answer 20

Cost & time

Question 21

The size of the subset of items the auditor examines is primarily a function of…

Answer 21

Materiality and the desired level of assurance for the account or assertion being examined.

Question 22

There is a(n) ______ relationship between sample size and materiality, and a(n) _____ relationship between sample size and desired level of assurance.

Answer 22

Inverse; direct

Question 23

Major phases of an Audit

Answer 23

A. Client acceptance
B. Preliminary engagement activities
C. Plan the audit
D. Consider and audit internal control
E. AUDIT business processes (collect evidence) F. Complete the audit
G. Evaluate the evidence and issue a report

Question 24

The end product of an auditor’s work is an opinion indicating whether or not the client’s financial statements are free of material misstatement. What might an auditor do to obtain the information needed to develop and support that opinion?

Answer 24

The auditor must first obtain a thorough understanding of the client, its business and industry, and its information system. The auditor must understand the risks the client faces, how it deals with those risks, and what remaining risks are most likely to result in a material misstatement in the financial statements.

Question 25

The auditor can collect evidence in each of three different stages in a client’s accounting system to help determine whether the financial statements are fairly stated:

Answer 25

(1) the internal control put in place by the client to ensure proper handling of transactions (evaluate and test the controls).
(2) the transactions that affect each account balance (examine a sample of the transactions that happened during the period).
(3) the ending account balances themselves (examine a sample of the items that make up an ending account balance at year-end).

Question 26

Unqualified report requires:

Answer 26

A. Audit performed in accordance with standards
B. Auditor gathered sufficient and appropriate evidence
C. Auditor believes financial statements conform to GAAP in all material respects

Question 27

Other types of Opinions

Answer 27

A. Qualified – EXCEPT FOR opinion
B. Disclaimer – Cannot express as opinion
C. Adverse – Financial statements are NOT fairly stated and should not be relied upon.