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CHAPTER 1
AN I NTRODUCTION TO ASSURANCE AND FI NANCI AL STATEMENT AUDI TI NG Answers to Review Questi ons
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The study of auditing is more conceptual in nature compared to other acc ounting cours es. Rather than foc using on learning the rules, techniques, and computations required to prepare financial statements, auditing emphasizes learning a framework of analytical and logical skills to evaluate the relevance and reliability of the systems and proc esses responsible for financial information, as well as the information its elf. To be successful, students must learn the framework and then learn to use logic and c ommon sens e in applying auditing conc epts to various circumst ances and situations.

Understanding auditing can improv e the decision making ability of cons ultants, business managers, and accountants by providing a framework for ev aluating the us efulness and reliability of information.

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There is a demand for auditing in a free-mark et economy bec aus e the agency relations hip bet ween an absentee owner and a manager produces a natural conflict of interest due to the information asy mmetry that exists bet ween the owner and manager. As a result, the agent agrees to be monitored as part of his/her employ ment contract. Auditing appears to be a cost-effective form of monit oring.

The empiric al evidence suggests auditing was demanded prior to government regulation such as statutory audit requirements. Additionally , many priv ate companies and other entities not subject to gov ernment auditing regulations als o demand auditing. 1-3

The agency relationship bet ween an owner and manager produces a natural conflict of interest because of differences in the t wo parties’ goals and bec aus e of information asy mmetry that exists bet ween them. That is, the manager generally has more information about the ‘true’ financial position and res ults of operations of the entity than the abs entee owner does. If both parties seek to max imize their own...