Fundamental concepts (Audit)

Question 1

Statutory audit

Answer 1

required by law (for public companies)

Question 2

Voluntary audit

Answer 2

not required by law (NPO, government)

Question 3

Information gap between company and shareholders

Answer 3

Management is to prepare FS to fill the information gap between company and shareholders and the auditor is to confirm completeness/correctness

Question 4

Agency risk

Answer 4

the risk that managers are not acting in the best interest of shareholders
(model agency risk of scamming models)
- shareholders can mitigate agency risk by hiring external auditors

Question 5

Agency costs

Answer 5

costs of techniques used to reduce agency risk
- costs of audit, costs incurred in aligning manager and shareholder interests (bonus based on share prices, pay structures)

Question 6

Information risk

Answer 6

risk that FS are not reliable
- conducting an audit provides assurance to FS users

Question 7

Expectation gap

Answer 7

different expectations that the public has about the auditor role and what the auditor actually does

Question 8

Auditor responsibilities

Answer 8

• provide reasonable assurance of FS, NOT confirm 100% correct
• Understand the internal controls, NOT responsible for IC of the company
• Auditors are responsible for identifying MM based on fraud, NOT responsible for detection of all fraud
• does NOT prepare FS
• Identify MM based on breaches of law, NOT check for compliance with law
• No advice provided to management unless otherwise outlined in separate EL

Question 9

Reduce expectation risk by…

Answer 9

• Engagement Letter (before audit)
• Auditor report (after audit)
• both cover the scope and responsibilities of auditor