AUDITING AND ASSURANCE SERVICES
REVIEW QUESTIONS
1-1 (OBJECTIVE 1-1) What are the information and established criteria for the audit of Jones Company’s tax return by an internal revenue agent? What are they for the audit of Jones Company’s financial statements by a CPA firm?
1-2 (OBJECTIVE 1-2) In the conduct of audits of financial statements, it would be a serious breach of responsibility if the auditor did not thoroughly understand accounting. However, many competent accountants do not have an understanding of the auditing process. What causes this difference?
1-3 (OBJECTIVE 1-3) Discuss changes in accounting and business operations over the last decade that have increased the need for independent audits.
1-4 (OBJECTIVE 1-3) Distinguish among the following three factors impacting a loan interest rate: risk-free interest rate, business risk, and information risk. Which one or ones does the auditor reduce by performing an audit?
1-5 (OBJECTIVE 1-4) Identify the three main ways information risk can be reduced. What are the advantages and disadvantages of each?
1-6 (OBJECTIVE 1-4) Explain how the increased use of fair value accounting might increase information risk.
1-7 (OBJECTIVE 1-5) Explain audit services, attestation services, and assurance services, and give examples of each.
1-8 (OBJECTIVE 1-5) Why might an organization seek the assurance of a CPA about information presented in the organization’s corporate sustainability report?
1-9 (OBJECTIVES 1-1, 1-7) Describe the nature of the evidence the internal revenue agent will use in the audit of Jones Company’s tax return.
1-10 (OBJECTIVES 1-6, 1-7) List five examples of specific operational audits that can be conducted by an internal auditor in a manufacturing company.
1-11 (OBJECTIVES 1-5, 1-6) What knowledge does the auditor need about the client’s business in an audit of historical financial statements? Explain how this knowledge may be useful in performing other assurance or consulting services for the client.
1-12 (OBJECTIVE 1-8) Identify the four parts of the Uniform CPA Examination.
MULTIPLE CHOICE QUESTIONS FROM CPA EXAMINATIONS
1-13 (OBJECTIVES 1-1, 1-3, 1-5) The following questions deal with audits by CPA firms. Choose the best response.
a. Which of the following best describes why an independent auditor is asked to express an opinion on the fair presentation of financial statements?
(1) The opinion of an independent party is needed because a company may not be objective with respect to its own financial statements.
(2) It is management’s responsibility to seek available independent aid in the appraisal of the financial information shown in its financial statements.
(3) It is difficult to prepare financial statements that fairly present a company’s financial position, operations, and cash flows without the expertise of an independent auditor.
(4) It is a customary courtesy that all stockholders of a company receive an independent report on management’s stewardship of the affairs of the business.
19Chapter 1 / THE DEMAND FOR AUDIT AND OTHER ASSURANCE SERVICES
b. Which of the following professional services is an attestation engagement?
(1) A consulting service engagement to provide computer-processing advice to a client
(2) The preparation of financial statements from a client’s financial records
(3) An income tax engagement to prepare federal and state tax returns
(4) An engagement to report on compliance with statutory requirements
c. Which of the following attributes is likely to be unique to the audit work of CPAs as compared to the work performed by practitioners of other professions?
(1) Independence
(2) Competence
(3) Due professional care
(4) Complex body of knowledge
1-14 (OBJECTIVES 1-6, 1-7) The following questions deal with types of audits and auditors. Choose the best response.
a. Operational audits generally have been conducted by internal auditors and governmental audit agencies but may be performed by certified public accountants. A primary purpose of an operational audit is to provide
(1) a means of assurance that internal accounting controls are functioning as planned.
(2) the results of internal examinations of financial and accounting matters to a company’s top-level management.
(3) a measure of management performance in meeting organizational goals.
(4) aid to the independent auditor who is conducting the audit of the financial statements.
b. Which of the following best describes the operational audit?
(1) It requires the constant review by internal auditors of the administrative controls as they relate to the operations of the company.
(2) It concentrates on implementing financial and accounting control in a newly organized company.
(3) It focuses on verifying the fair presentation of a company’s results of operations.
(4) It concentrates on seeking aspects of operations in which waste could be reduced by the introduction of controls.
c. Compliance auditing often extends beyond audits leading to the expression of opinions on the fairness of financial presentation and includes audits of efficiency, economy, effectiveness, and
(1) adherence to specific rules or procedures.
(2) accuracy.
(3) evaluation.
(4) internal control.
MULTIPLE CHOICE QUESTIONS FROM BECKER CPA EXAM REVIEW
1-15 (OBJECTIVES 1-5, 1-6) The following questions deal with assurance services and types of audits. Choose the best response.
a. Which of the following is considered an assurance engagement?
(1) Bookkeeping
(2) Preparation
(3) Compilation
(4) Audit
b. Which of the following engagements is most likely to be considered an operational audit?
(1) The auditor determines whether the organization is following provisions of laws and regulations.
(2) The auditor examines information presented in an entity’s financial statements to determine whether the financial statements are presented fairly in accordance with the applicable financial reporting framework.
(3) The auditor evaluates the organization’s efficiency in processing payments.
(4) The auditor assists the client in preparation of financial statements.
c. In a financial statement audit, the auditor obtains a reasonable level of assurance about whether the financial statements are free of material misstatement in order to express an opinion. In order to obtain reasonable assurance, the auditor must
(1) have prior experience in the industry in which the audit client operates.
(2) examine all documents available that support the financial statements.
(3) obtain sufficient audit evidence.
(4) test controls around significant transaction cycles.
DISCUSSION QUESTIONS AND PROBLEMS
1-16 (OBJECTIVE 1-5) The list below indicates various audit, attestation, and other engagements involving auditors. 1. A report on the effectiveness of internal control over financial reporting as required by Section 404 of the Sarbanes–Oxley Act.
2. An examination report on whether a company’s statement of greenhouse gas emissions is presented in conformity with standards issued by the World Business Council for Sustainable Development and the World Resources Institute.
3. An auditor’s report on whether the financial statements are fairly presented in accordance with International Financial Reporting Standards.
4. An engagement to help a company structure a merger transaction to minimize the taxes of the combined entities.
5. A report stating whether the company has complied with restrictive covenants related to officer compensation and payment of dividends contained in a bank loan agreement.
6. A report on the effectiveness of internal controls at a company that provides payroll processing for other companies.
7. A review report that provides limited assurance about whether financial statements are fairly stated in accordance with U.S. GAAP.
8. An evaluation of the voting process and certification of the outcome for Rolling Stone Magazine’s “Greatest Singer of All Time” poll.
9. A report indicating whether a governmental entity has complied with certain government regulations.
10. A report about management’s assertion on the effectiveness of controls over the availability, reliability, integrity, and maintainability of its accounting information system.
11. An evaluation of the effectiveness of key measures used to assess an entity’s success in achieving specific targets linked to an entity’s strategic plan and vision.
a. Explain the relationships among audit services, attestation services, and other assurance and nonassurance services provided by CPAs.
b. For each of the services listed above, indicate the type of service from the list that follows.
(1) An audit of historical financial statements
(2) An attestation service other than an audit service
(3) An assurance or nonassurance service that is not an attestation service
1-17 (OBJECTIVE 1-3) Monterrey Corporation has an existing loan in the amount of $7 million with an annual interest rate of 6.5%. The company provides an internal company-prepared financial statement to the bank under the loan agreement. Two competing banks have offered to replace Monterrey Corporation’s existing loan agreement Required
21Chapter 1 / THE DEMAND FOR AUDIT AND OTHER ASSURANCE SERVICES
with a new one. Southwest National Bank has offered to loan Monterrey $7 million at a rate of 5.5% but requires Monterrey to provide financial statements that have been reviewed by a CPA firm. First City Bank has offered to loan Monterrey $7 million at a rate of 4.5% but requires Monterrey to provide financial statements that have been audited by a CPA firm. Monterrey Corporation’s controller approached a CPA firm and was given an estimated cost of $45,000 to perform a review and $80,000 to perform an audit.
a. Explain why the interest rate for the loan that requires a review report is lower than that for the loan that does not require a review. Explain why the interest rate for the loan that requires an audit report is lower than the interest rate for the other two loans.
b. Calculate Monterrey Corporation’s annual costs under each loan agreement, including interest and costs for the CPA firm’s services. Indicate whether Monterrey should keep its existing loan, accept the offer from Southwest National Bank, or accept the offer from First City Bank.
c. Assume that Southwest National Bank has offered the loan at a rate of 5.5% with a review, and the cost of the audit has increased to $125,000 due to new auditing standards requirements. Indicate whether Monterrey should keep its existing loan, accept the offer from Southwest National Bank, or accept the offer from First City Bank.
d. Discuss why Monterrey may desire to have an audit, ignoring the potential reduction in interest costs.
e. Explain how a strategic understanding of the client’s business may increase the value of the audit service.
1-18 (OBJECTIVES 1-3, 1-4, 1-5) Consumers Union is a nonprofit organization that p rovides information and counsel on consumer goods and services. A major part of its function is the testing of different brands of consumer products that are purchased on the open market and then the reporting of the results of the tests in Consumer Reports, a monthly publication. Examples of the types of products it tests are mid-sized automobiles, residential dehumidifiers, flat-screen TVs, and blue jeans.
a. In what ways are the services provided by Consumers Union similar to assurance services provided by CPA firms?
b. Compare the concept of information risk introduced in this chapter with the information risk problem faced by a buyer of an automobile.
c. Compare the four causes of information risk faced by users of financial statements as discussed in this chapter with those faced by a buyer of an automobile.
d. Compare the three ways users of financial statements can reduce information risk with those available to a buyer of an automobile.
1-19 (OBJECTIVE 1-1) James Burrow is the loan officer for the National Bank of Dallas. National has a loan of $325,000 outstanding to Regional Delivery Service, a company specializing in delivering products of all types on behalf of smaller companies. National’s collateral on the loan consists of 25 small delivery trucks with an average original cost of $24,000. Burrow is concerned about the collectibility of the outstanding loan and whether the trucks still exist. He therefore engages Samantha Altman, CPA, to count the trucks, using registration information held by Burrow. She was engaged because she spends most of her time auditing used automobile and truck dealerships and has extensive specialized knowledge about used trucks. Burrow requests that Altman issue a report stating the following:
1. Which of the 25 trucks is parked in Regional’s parking lot on the night of June 30, 2019.
2. Whether all of the trucks are owned by Regional Delivery Service.
3. The condition of each truck, using the guidelines of poor, good, and excellent.
4. The fair market value of each truck, using the current “blue book” for trucks, which states the approximate wholesale prices of all used truck models, and also using the poor, good, and excellent condition guidelines.
Required
Required
In-class Discussion
In-class Discussion
22 Part 1 / THE AUDITING PROFESSION
a. For each of the following parts of the definition of auditing, state which part of the preceding narrative fits the definition:
(1) Information
(2) Established criteria
(3) Accumulating and evaluating evidence
(4) Competent, independent person
(5) Reporting results
b. Identify the greatest difficulties Altman is likely to have doing this audit.
1-20 (OBJECTIVE 1-7) Five college seniors with majors in accounting are discussing alternative career plans. The first senior plans to become an internal revenue agent because his primary interest is income taxes. He believes the background in tax auditing will provide him with better exposure to income taxes than will any other available career choice. The second senior has decided to go to work for a CPA firm for at least 5 years, possibly as a permanent career. She believes the variety of experience in auditing and related fields offers a better alternative than any other available choice. The third senior has decided on a career in internal auditing with a large industrial company because of the many different aspects of the organization with which internal auditors become involved. The fourth senior plans to become an auditor for the GAO because she believes that this career will provide excellent experience in computer risk assessment techniques. The fifth senior would like to ultimately become a certified fraud examiner but is not sure where the best place is to begin his career so that he can achieve this long-term goal.
a. What are the major advantages and disadvantages of each of the four types of auditing careers?
b. What do you think is the best early career choice for the senior interested in ultimately becoming a certified fraud examiner?
c. What other types of auditing careers are available to those who are qualified?
1-21 (OBJECTIVES 1-6, 1-7) In the normal course of performing their responsibilities, auditors often conduct audits or reviews of the following:
1. The computer operations of a large corporation to evaluate whether the internal controls are likely to prevent misstatements in accounting and operating data.
2. Financial statements for use by stockholders when there is an internal audit staff.
3. A bond indenture agreement to make sure a company is following all requirements of the contract.
4. Internal controls at a casino to ensure the casino is in compliance with federal and state regulations.
5. Computer operations of a corporation to evaluate whether the computer center is being operated as efficiently as possible.
6. Annual statements for the use of management.
7. Operations of the IRS to determine whether the internal revenue agents are using their time efficiently in conducting audits.
8. Statements for bankers and other creditors when the client is too small to have an audit staff.
9. Financial statements of a branch of the federal government to make sure that the statements present fairly the actual disbursements made during a period of time.
10. Disbursements of a branch of the federal government for a special research project to determine whether the expenditures were consistent with the legislative bill that authorized the project.
11. Federal income tax returns of an officer of a private corporation to determine whether he or she has included all taxable income in his or her return.
12. Federal income tax returns of a corporation to determine whether the tax laws have been followed.
a. For these 12 examples, state the most likely type of auditor (CPA, GAO, IRS, or internal) to perform each.
b. In each example, state the type of audit (financial statement audit, operational audit, or compliance audit).
Required
Required
Required
23Chapter 1 / THE DEMAND FOR AUDIT AND OTHER ASSURANCE SERVICES
1-22 (OBJECTIVES 1-3, 1-5) Dave Czarnecki is the managing partner of Czarnecki and Hogan, a medium-sized local CPA firm located outside of Chicago. Over lunch, he is surprised when his friend Juarez Foley asks him, “Doesn’t it bother you that your clients don’t look forward to seeing their auditors each year?” Dave responds, “Well, auditing is only one of several services we provide. Most of our work for clients does not involve financial statement audits, and our audit clients seem to like interacting with us.”
a. Identify ways in which a financial statement audit adds value for clients.
b. List services other than audits that Czarnecki and Hogan likely provides.
c. Assume Czarnecki and Hogan has hired you as a consultant to identify ways in which they can expand their practice. Identify at least one additional service that you believe the firm should provide and explain why you believe this represents a growth opportunity for CPA firms.
1-23 (OBJECTIVE 1-5) There are many types of information that require assurance. Individually or in groups, identify the following types of assurance services.
a. Identify three or more assurance services that are likely to be provided only by public accounting firms.
b. Identify three or more assurance services that are likely to be provided by assurance providers other than public accounting firms.
c. Identify three or more assurance services that may be provided by public accounting firms or other assurance providers.
1-24 (OBJECTIVE 1-5) As discussed in the chapter opening vignette and on page 9, companies are increasingly issuing reports on corporate social responsibility. Visit the Global Reporting Initiative website (www.globalreporting.org) and answer the following questions.
a. What is the vision and mission of the Global Reporting Initiative?
b. What is a sustainability report? Explain the use of sustainability reports in integrated reporting.
c. Explain the two “in accordance” GRI guideline reporting options. What is the GRI guidance on assurance for “in accordance” reports?
1-25 (OBJECTIVE 1-8) Individuals are licensed as CPAs by individual states. Information on the requirements for each state can be found through links to websites of each state board of accountancy that are provided on the NASBA website (www.nasba.org). The Uniform CPA Examination is administered by the AICPA, and information on CPA examination requirements can be found on the AICPA website (www.aicpa.org).
a. Identify the education requirements to be eligible to sit for the CPA exam in your state. Include any specific educational content requirements.
b. List the work experience requirements in your state. Is experience in industry as an accountant or an internal auditor sufficient to be eligible to become a CPA?
c. List any frequently asked questions (FAQ), if there are any, related to experience and education requirements for your state, along with a summary of the responses.
d. What are the Elijah Watts Sells awards?
e. What was the passing rate for each exam section in the most recent quarter
