Audit Answer

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Solutions for Chapter 1

Auditing: Integral to the Economy

Review Questions:

1-1.The special function performed by the public accounting profession is the attestation to the fairness of the financial statements of clients. The special function ensures the reliability and integrity of the financial reporting system. Judge Burger described the special function as "certifying the public reports that collectively depict a corporation's financial status," which involves "a public responsibility transcending any employment relationship with the client."

The auditing profession exists to serve the users of an organization's financial statements. These include lenders, investors, management, government, and (indirectly) all individuals who are ultimately affected by the integrity of the financial reporting process. Auditors need to remember that they are serving the public interest and not the interests of client management.

1-2.The audit opinion formulation process is a systematic approach by which the auditor evaluates the risk of being associated with a client, through the process of gathering and evaluating audit evidence, to determining the type of audit opinion that should be rendered. The stages and outcome of each stage are as follows:

• Assessing Client Acceptance and Retention: The outcome is determining whether or not a firm should serve a potential client. The decision will depend on the risk to the auditor of being associated with a particular client. • Understanding the Client: The outcome is a business understanding of the client, its major processes, the risks inherent in its business, and the impact of current economic and competitive issues on the client and its financial statements. • Obtaining Evidence About Controls: The outcome is an understanding of the client’s internal control over financial reporting and whether the controls are sufficient to mitigate the risk of material misstatements in a company’s financial statements. • Obtaining Substantive Evidence about Account Balances: The outcome is the audit evidence that is gathered, evaluated, and synthesized to determine if the auditor has sufficient competent evidence to render an audit opinion. • Wrapping Up the Engagement: A final review of evidence, as well as a review of the audit process by someone outside of the audit to determine whether all procedures have been performed and that audit risks have been evaluated. The final outcome is the decision on which audit opinion to render.

1-3. Some of the factors leading up to the change include: (a) the failure of one of the largest public accounting firms in the world (Arthur Andersen & Co.); (b) four of the largest bankruptcies in history—and each of the bankruptcies occurred in companies where financial statement misrepresentation had taken place; (c) billions of dollars in investment and retirement fund losses; (d) a sense that auditors were not independent of management and (e) a question as to whether the public accounting profession could sufficiently govern itself to ensure that it would always act in the public interest. In response to these failures, Congress passed the Sarbanes-Oxley Act of 2002. The public accounting profession has been impacted by this Act in a number of ways including:

• The U.S. audit standards for public company audits are now set by a regulatory agency – the PCAOB. • The audit committee is to take the role of the client and has the responsibility to hire/fire the auditor. • Auditor independence requirements have been strengthened. • Audits of internal controls are now required for larger public companies.

While the environment has changed, the expectations of users have stayed essentially the same. They expect (a) auditors to detect and report on fraud, and (b) certify financial statements that are both in accordance with GAAP and are transparent regarding economic...
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