Set 1 - AU Chapter 2 - Fundamental Concepts

Question 1

Are statutory audits voluntary?

Answer 1

No. They are required by law, such as a securities commission requiring them for publicly listed companies.

Question 2

Define agency risk. How does this affect the financial statements?

Answer 2

The risk that management are not acting in the best interests of the shareholders.
There is a risk that management may manipulate financial statements for their own benefit.

Question 3

Define agency cost.

Answer 3

Costs of techniques to reduce agency risk due to potentially conflicting interests of shareholders and management. These include the prices of the audit.

Question 4

Define information risk.

Answer 4

Risk that the financial information provided by management and used for decision making is unreliable.

Question 5

What is the purpose of an audit?

Answer 5

To present an independent opinion on the financial statements - that they are free of material mis-statement whether caused by fraud or error and they are presented in accordance with a regulatory framework (ASPE/IFRS). They provide reasonable (not absolute) assurance.

Question 6

What is the expectation gap? What two things help to bridge this gap?

Answer 6

The expectation from the public about an auditor's role, and the actual role. For instance, public may expect auditors to find 100% of material errors, but audits are always on a sampling basis so not all errors may be found. 
#1 - Engagement letter - specifies terms of engagement and clarifies auditor and management responsibilities. Will also outline that there is still a risk of material misstatements despite auditors best efforts. 
#2 -  Auditor's report - explains auditors duties, and description of audit scope.