1Chapter 6 Audit Responsibilities and Objectives

Review Questions

6-1 The objective of the audit of financial statements by the independent auditor is the expression of an opinion on the fairness with which the financial statements present financial position, results of operations, and cash flows in conformity with generally accepted accounting principles. The auditor meets that objective by accumulating sufficient appropriate evidence to determine whether the financial statements are fairly stated. 6-2 It is management's responsibility to adopt sound accounting policies, maintain adequate internal control and ma e fair representations in the financial statements. The auditor's responsibility is to conduct an audit of the financial statements in accordance with auditing standards and report the findings of the audit in the auditor's report. 6-3 !n error is an unintentional misstatement of the financial statements. "raud represents intentional misstatements. The auditor is responsible for obtaining reasonable assurance that material misstatements in the financial statements are detected, whether those misstatements are due to errors or fraud . !n audit must be designed to provide reasonable assurance of detecting material misstatements in the financial statements. "urther, the audit must be planned and performed with an attitude of professional skepticism in all aspects of the engagement. #ecause there is an attempt at concealment of fraud, material misstatements due to fraud are usually more difficult to uncover than errors. The auditor$s best defense when material misstatements %either errors or fraud& are not uncovered in the audit is that the audit was conducted in accordance with auditing standards. 6-4 'isappropriation of assets represents the theft of assets by employees. "raudulent financial reporting is the intentional misstatement of financial information by management or a theft of assets by management, which is covered up by misstating financial statements. 'isappropriation of assets ordinarily occurs either because of inadequate internal controls or a violation of existing controls. The best way to prevent theft of assets is through adequate internal controls that function effectively. 'any times theft of assets is relatively small in dollar amounts and will have no effect on the fair presentation of financial statements. There are also the cases of large theft of assets that result in ban ruptcy to the company. "raudulent financial reporting is inherently difficult to uncover because it is possible for one or more members of management to override internal controls. In many cases the amounts are extremely large and may affect the fair presentation of financial statements. ()1

6-5 True, the auditor must rely on management for certain information in the conduct of his or her audit. *owever, the auditor must not accept management's representations blindly. The auditor must, whenever possible, obtain appropriate evidence to support the representations of management. !s an example, if management represents that certain inventory is not obsolete, the auditor should be able to examine purchase orders from customers that prove part of the inventory is being sold at a price that is higher than the company's cost plus selling expenses. If management represents an account receivable as being fully collectible, the auditor should be able to examine subsequent payments by the customer or correspondence from the customer that indicates a willingness and ability to pay. 6-6
C ARAC!"R#$!#C 1. 'anagement$s characteristics and influence over the control environment. A%&#! $!"'$
Investigate the past history of the

firm and its management.

+iscuss the possibility of fraudulent

financial reporting with previous auditor and company legal counsel after obtaining permission to do so from management. ,. Industry conditions.
-esearch current status of industry

and compare industry financial ratios to the company$s ratios. Investigate any unusual differences. -ead !I./!$s Industry Audit Risk Alert for the company$s industry, if available. .onsider the impact of specific ris s that are identified on the conduct of the audit. 0. 1perating characteristics and financial stability.
/erform analytical procedures to

evaluate the possibility of business failure. Investigate whether material transactions occur close to year) end.

6-( The cycle approach is a method of dividing the audit such that closely related types of transactions and account balances are included in the same cycle. "or example, sales, sales returns, and cash receipts transactions and the accounts receivable balance are all a part of the sales and collection cycle. The advantages of dividing the audit into different cycles are to divide the audit into more manageable parts, to assign tas s to different members of the audit team, and to eep closely related parts of the audit together.

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6-)
*"+"RA, ,"&*"R ACCO%+! 2ales !ccounts /ayable -etained 3arnings !ccounts -eceivable Inventory -epairs 4 'aintenance C-C," 2ales 4 .ollection !cquisition 4 /ayment .apital !cquisition 4 -epayment 2ales 4 .ollection Inventory 4 5arehousing !cquisition 4 /ayment

6-. There is a close relationship between each of these accounts. 2ales, sales returns and allowances, and cash discounts all affect accounts receivable. !llowance for uncollectible accounts is closely tied to accounts receivable and should not be separated. #ad debt expense is closely related to the allowance for uncollectible accounts. To separate these accounts from each other implies that they are not closely related. Including them in the same cycle helps the auditor eep their relationships in mind. 6-1/ 'anagement assertions are implied or expressed representations by management about classes of transactions and the related accounts and disclosures in the financial statements. These assertions are part of the criteria management uses to record and disclose accounting information in financial statements. !6 0,( classifies assertions into three categories7 1. !ssertions about classes of transactions and events for the period under audit ,. !ssertions about account balances at period end 0. !ssertions about presentation and disclosure 6-11 8eneral audit objectives follow from and are closely related to management assertions. 8eneral audit objectives, however, are intended to provide a framewor to help the auditor accumulate sufficient appropriate evidence required by the third standard of field wor . !udit objectives are more useful to auditors than assertions because they are more detailed and more closely related to helping the auditor accumulate sufficient appropriate evidence. 6-12
!RA+$AC!#O+-R",A!"& A%&#! O12"C!#3" 3#O,A!"& Timing .lassification

R"COR&#+* 0#$$!A!"0"+! "ixed asset repair is recorded on the wrong date. -epair is capitali9ed as a fixed asset instead of an expense.

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6-13 The existence objective deals with whether amounts included in the financial statements should actually be included. .ompleteness is the opposite of existence. The completeness objective deals with whether all amounts that should be included have actually been included. In the audit of accounts receivable, a nonexistent account receivable will lead to overstatement of the accounts receivable balance. "ailure to include a customer's account receivable balance, which is a violation of completeness, will lead to understatement of the accounts receivable balance. 6-14 2pecific audit objectives are the application of the general audit objectives to a given class of transactions, account balance, or presentation and disclosure. There must be at least one specific audit objective for each general audit objective and in many cases there should be more. 2pecific audit objectives for a class of transactions, account balance, or presentation and disclosure should be designed such that, once they have been satisfied, the related general audit objective should also have been satisfied for that class of transactions, account, or presentation and disclosure. 6-15 "or the specific balance)related audit objective, all recorded fixed assets exist at the balance sheet date, the management assertion and the general balance)related audit objective are both :existence.: 6-16 'anagement assertions and general balance)related audit objectives are consistent for all asset accounts for every audit. They were developed by the !uditing 2tandards #oard, practitioners, and academics over a period of time. 1ne or more specific balance)related audit objectives are developed for each general balance)related audit objective in an audit area such as accounts receivable. "or any given account, a ./! firm may decide on a consistent set of specific balance)related audit objectives for accounts receivable, or it may decide to use different objectives for different audits. 6-1( "or the specific presentation and disclosure)related audit objective, read the fixed asset footnote disclosure to determine that the types of fixed assets, depreciation methods and useful lives are clearly disclosed, the management assertion and the general presentation and disclosure)related audit objective are both :classification and understandability.: 6-1) The four phases of the audit are7 1. ,. 0. ;. /lan and design an audit approach. /erform tests of controls and substantive tests of transactions. /erform analytical procedures and tests of details of balances. .omplete the audit and issue an audit report.

The auditor uses these four phases to meet the overall objective of the audit, which is to express an opinion on the fairness with which the financial statements present fairly, in all material respects, the financial position, results of operations and cash flows in conformity with 8!!/. #y accumulating sufficient appropriate evidence for each audit objective, the overall objective is met. The accumulation of evidence is accomplished by performing the four phases of the audit. ();

0ultiple Choice Questions 4ro5 C'A "6a5inations %,& %1& b. b. %,& %,& c. c. %1& %1&

6-1. a. 6-2/ a.

&iscussion Questions And 'roble5s The purpose of the first part of the report of management is for management to state its responsibilities for internal control over financial reporting. The second part of the report states management$s responsibility for the fair presentation of the financial statements. b. The auditor$s responsibility is to express an opinion on the fairness of the presentation of the financial statements and an opinion on the effectiveness of internal control over financial reporting. a. 1. The function of the auditor in the audit of financial statements is to provide users of the statements with an informed opinion based on reasonable assurance obtained as to the fairness with which the statements portray financial position, results of operations, and cash flows in accordance with generally accepted accounting principles applied on a basis consistent with that of the preceding year. The responsibility of the independent auditor is to express an opinion on the financial statements he or she has audited. Inasmuch as the financial statements are the representation of management, responsibility rests with management for the proper recording of transactions in boo s of account, for the safeguarding of assets, and for the substantial accuracy and adequacy of the financial statements. In developing the basis for his or her opinion, the auditor is responsible for conducting an audit that conforms to auditing standards. These standards constitute the measure of the adequacy of the audit. Those standards require the auditor to obtain sufficient, appropriate evidence about material management assertions in the financial statements. The informed judgment of a qualified professional accountant is required of an independent auditor. The auditor must exercise this judgment in selecting the procedures he or she uses in the audit and in arriving at an opinion. In presenting himself or herself to the public as an independent auditor, he or she ma es himself or herself responsible for having the abilities expected of a qualified person in that profession. 2uch qualifications do not include those of an appraiser, valuer, expert in materials, expert in styles, insurer, or lawyer. The auditor is entitled to rely upon the judgment of experts in these other areas of nowledge ()<

6-21 a.

6-22

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and s ill. 6-22 7continued8 b. !uditors are responsible for obtaining reasonable assurance that material misstatements included in the financial statements are detected, whether those misstatements are due to error or fraud. /rofessional standards ac nowledge that it is often more difficult to detect fraud than errors because management or employees perpetrating the fraud attempt to conceal the fraud. That difficulty, however, does not change the auditor$s responsibility to properly plan and perform the audit. !uditors are required to specifically assess the ris of material misstatement due to fraud and should consider that assessment in designing the audit procedures to be performed. In recent years there has been increased emphasis on auditors$ responsibility to evaluate factors that may indicate an increased li elihood that fraud may be occurring. "or example, assume that management is dominated by a president who ma es most of the major operating and business decisions himself. *e has a reputation in the business community for ma ing optimistic projections about future earnings and then putting considerable pressure on operating and accounting staff to ma e sure those projections are met. *e has also been associated with other companies in the past that have gone ban rupt. These factors, considered together, may cause the auditor to conclude that the li elihood of fraud is fairly high. In such a circumstance, the auditor should put increased emphasis on searching for material misstatements due to fraud. The auditor may also uncover circumstances during the audit that may cause suspicions of fraudulent financial reporting. "or example, the auditor may find that management has lied about the age of certain inventory items. 5hen such circumstances are uncovered, the auditor must evaluate their implications and consider the need to modify audit evidence. !dequate internal control should be the principal means of thwarting and detecting misappropriation of assets. To rely entirely on an independent audit for the detection of misappropriation of assets would require expanding the auditor's wor to the extent that the cost might be prohibitive. The auditor normally assesses the li elihood of material misappropriation of assets as a part of understanding the entity$s internal control and assessing control ris . !udit evidence should be expanded when the auditor finds an absence of adequate controls or failure to follow prescribed procedures, if he or she believes a material fraud could result. The independent auditor is not an insurer or guarantor. The auditor$s implicit obligation in an engagement is that the audit be

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6-22 7continued8 made with due professional s ill and care in accordance with auditing standards. ! subsequent discovery of fraud, existent during the period covered by the independent audit, does not of itself indicate negligence on the auditor$s part. If an independent auditor uncovers circumstances arousing suspicion as to the existence of fraud, he or she should weigh the effect of the circumstances on the opinion on the financial statements. 5hen the auditor believes that the amount of the possible fraud is material, the matter must be investigated before an opinion can be given. The auditor should consider the implications for other aspects of the audit and discuss the matter with an appropriate level of management that is at least one level above those involved and with senior management. !dditionally, the auditor should obtain additional evidential matter to determine whether material fraud has occurred or is li ely to have occurred. The auditor may suggest that the client consult with legal counsel. 5henever the auditor has determined that there is evidence that fraud may exist, that matter should be brought to the attention of the audit committee %or equivalent&, unless the matter is clearly inconsequential.

c.

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6-23
a9 4#+A+C#A, $!A!"0"+! 1A,A+C" /urchase returns 4 allowances -ent revenue #ad debts b9 !#!," O4 2O%R+A, !cquisitions ?ournal -evenue ?ournal !djustments ?ournal !cquisitions ?ournal !djustments ?ournal !djustments ?ournal !djustments ?ournal /ayroll ?ournal c9 !RA+$AC!#O+ C-C," !cquisition 4 /ayment 2ales 4 .ollection 2ales 4 .ollection !cquisition 4 /ayment 2ales 4 .ollection 2ales 4 .ollection /ayroll 4 /ersonnel /ayroll 4 /ersonnel !cquisition 4 /ayment 2ales 4 .ollection

C,A$$ O4 !RA+$AC!#O+$ /6-.*!23 -3T6->2 -3>T!@ -3A3>63 .*!-83)1"" 1" 6>.1@@3.TI#@3 !..16>T2 !.B6I2ITI1> 1" 811+2 !>+ 23-AI.32 -3>T!@ !@@15!>.32 !+?62TI>8 3>T-I32 %"1/!C-1@@&

-epair and maintenance -ental allowances -ental allowances !ccrued payroll 2ales salaries

/!C-1@@ 23-AI.3 4 /!C'3>T2 .!2* +I2#6-23'3>T2 .!2* -3.3I/T2

!ccounts payable !ccounts receivable

.ash +isburse) ments ?ournal .ash -eceipts ?ournal

d. -ental revenue is li ely to be recorded in the cash receipts journal at the time the cash is received from renters. It is therefore li ely to be recorded as a debit to cash receipts and a credit to rental revenue. The journal will be summari9ed monthly and posted to the general ledger. There will be required adjusting entries for unearned rent and for rent receivable. ! record will be ept of each renter and a determination made whether rent is unpaid or unearned at the end of each accounting period. The entries that are li ely to be made in the adjustments journal are posted to the general ledger. Then the financial statements are prepared from the adjusted general ledger. -eversing entries may be used to eliminate the adjusting entries.

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6-24 a.
#+CO0" $!A!"0"+! ACCO%+!$ 2ales #ad debt expense Interest income

C-C," 2!@32 !>+ .1@@3.TI1>

1A,A+C" $ ""! ACCO%+!$ !ccounts receivable .ash >otes receivableEtrade !llowance for doubtful accounts Interest receivable Income tax payable !ccounts payable 6nexpired insurance "urniture and equipment .ash !ccumulated depreciation of furniture and equipment Inventory /roperty tax payable

!.B6I2ITI1> !>+ /!C'3>T

Income tax expense !dvertising expense Travel expense /urchases /roperty tax expense +epreciation expenseE furniture and equipment Telephone and fax expense Insurance expense -ent expense 2ales salaries expense 2alaries, office and general /urchases Interest expense

/!C-1@@ !>+ /3-21>>3@ I>A3>T1-C !>+ 5!-3*162I>8 .!/IT!@ !.B6I2ITI1> !>+ -3/!C'3>T

.ash !ccrued sales salaries Inventory #onds payable .ommon stoc .ash >otes payable -etained earnings /repaid interest expense

b. The general ledger accounts are not li ely to differ much between a retail and a wholesale company unless there are departments for which there are various categories. There would be large differences for a hospital or governmental unit. ! governmental unit would use the fund accounting system and would have entirely different titles. *ospitals are li ely to have several different inds of revenue accounts, rather than sales. They are also li ely to have such things as drug expense, laboratory supplies, etc. !t the same time, even a governmental unit or a hospital will have certain accounts such as cash, insurance expense, interest income, rent expense, and so forth.

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6-25 a.

'anagement assertions about transactions relate to transactions and other events that are reflected in the accounting records. In contrast, assertions about account balances relate to the ending account balances that are included in the financial statements, and assertions about presentation and disclosure relate to how those balances are reflected and disclosed in the financial statements.
b9 CA!"*OR- O4 0A+A*"0"+! A$$"R!#O+ .lasses of transactions /resentation and disclosure c9 +A0" O4 A$$"R!#O+ .ompleteness .lassification and understandability

0A+A*"0"+! A$$"R!#O+ a. !ll sales transactions have been recorded. b. -eceivables are appropriately classified as to trade and other receivables in the financial statements and are clearly described. c. !ccounts receivable are recorded at the correct amounts. d. 2ales transactions have been recorded in the proper period. e. 2ales transactions have been recorded in the appropriate accounts. f. !ll required disclosures about sales and receivables have been made. g. !ll accounts receivable have been recorded. h. There are no liens or other restrictions on accounts receivable. i. +isclosures related to accounts receivable are at the correct amounts. -ecorded sales transactions have occurred. . -ecorded accounts receivable exist. l. 2ales transactions have been recorded at the correct amounts.

!ccount balances .lasses of transactions .lasses of transactions /resentation and disclosure !ccount balances !ccount balances

Aaluation and allocation .utoff .lassification

.ompleteness

.ompleteness -ights and obligations

/resentation and disclosure .lasses of transactions !ccount balances .lasses of transactions /resentation and disclosure

!ccuracy and valuation 1ccurrence 3xistence !ccuracy 1ccurrence and rights and obligations

j.

f. +isclosures related to sales and receivables relate to the entity.

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6-26
$'"C#4#C 1A,A+C"R",A!"& A%&#! O12"C!#3" a. There are no unrecorded receivables. -eceivables have not been sold or discounted. 6ncollectible accounts have been provided for.

0A+A*"0"+! A$$"R!#O+ ,. .ompleteness

CO00"+!$ 6nrecorded transactions or amounts deal with the completeness objective. -eceivables not being sold or discounted concerns the rights and obligations objective and assertion. /roviding for uncollectible accounts concerns whether the allowance for uncollectible accounts is adequate. It is part of the reali9able value objective and the valuation or allocation assertion. This is part of the reali9able value objective and the valuation or allocation assertion. There may also be some argument that this is part of the existence objective and assertion. !ccounts that are uncollectible are no longer valid assets. !ccounts that are not expected to be collected within a year should be classified as long)term receivables. It is therefore being included as part of the classification objective and consequently under the valuation or allocation assertion. This is part of the detail tie)in objective and is part of the valuation or allocation assertion.

b.

;. -ights and obligations

c.

0. Aaluation or allocation

d.

-eceivables that have become uncollectible have been written off.

0. Aaluation or allocation

e.

!ll accounts on the list are expected to be collected within one year.

0. Aaluation or allocation

f.

The total of the amounts on the accounts receivable listing agrees with the general ledger balance for accounts receivable.

0. Aaluation or allocation

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6-26 7continued8
$'"C#4#C 1A,A+C"R",A!"& A%&#! O12"C!#3" g. !ll accounts on the list arose from the normal course of business and are not due from related parties.

0A+A*"0"+! A$$"R!#O+ 0. Aaluation or allocation

CO00"+!$ .oncerns the classification of accounts receivable and is therefore a part of the classification objective and the valuation or allocation assertion. 2ome people believe that li e item e., it is a part of presentation and disclosure. .utoff is a part of the cutoff objective and therefore part of the valuation or allocation assertion.

h.

2ales cutoff at year) end is proper.

0. Aaluation or allocation

6-2( a.

'anagement assertions are implied or expressed representations by management about the classes of transactions and related accounts in the financial statements. !6 0,( identifies five assertions about classes of transactions which are stated in the problem. These assertions are the same for every transaction cycle and account. 8eneral transaction)related audit objectives are essentially the same as management assertions, but they are expanded somewhat to help the auditor decide which audit evidence is necessary to satisfy the management assertions. !ccuracy and posting and summari9ation are a subset of the accuracy assertion. 2pecific transaction)related audit objectives are determined by the auditor for each general transaction)related audit objective. These are done for each transaction cycle to help the auditor determine the specific amount of evidence needed for that cycle to satisfy the general transaction)related audit objectives.

b. and c. The easiest way to do this problem is to first identify the general transaction)related audit objectives for each specific transaction) related audit objective. It is then easy to determine the management assertion using Table ()0 %p. 1<D in text& as a guide.

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6-2( 7continued8
b9 $'"C#4#C !RA+$AC!#O+R",A!"& A%&#! O12"C!#3" a. -ecorded cash disbursement transactions are for the amount of goods or services received and are correctly recorded. b. .ash disbursement transactions are properly included in the accounts payable master file and are correctly summari9ed. c. -ecorded cash disbursements are for goods and services actually received. d. .ash disbursement transactions are properly classified. e. 3xisting cash disbursement transactions are recorded. f. .ash disbursement transactions are recorded on the correct dates. 0A+A*"0"+! A$$"R!#O+ 0. !ccuracy c9 *"+"RA, !RA+$AC!#O+R",A!"& A%&#! O12"C!#3" D. !ccuracy

0. !ccuracy

F. /osting and summari9ation

1. 1ccurrence

(. 1ccurrence

;. .lassification ,. .ompleteness <. .utoff

1G. .lassification =. .ompleteness 11. Timing

6-2)
$'"C#4#C 'R"$"+!A!#O+ A+& &#$C,O$%R"-R",A!"& A%&#! O12"C!#3" a. !ll required disclosures about fixed assets have been made. b. "ootnote disclosures related to fixed assets are clear and understandable. c. 'ethods and useful lives disclosed for each category of fixed assets are accurate. d. +isclosed fixed asset dispositions have occurred. 0A+A*"0"+! A$$"R!#O+ ,. .ompleteness ;. .lassification and understandability 0. !ccuracy and valuation ;. 1ccurrence and rights and obligations

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6-2. a.

The first objective concerns amounts that should not be included on the list of accounts payable because there are no amounts due to such vendors. This objective concerns only the overstatement of accounts payable. The second objective concerns the possibility of accounts payable that should be included but that have not been included. This objective concerns only the possibility of understated accounts payable. b. The first objective deals with existence and the second deals with completeness. c. "or accounts payable, the auditor is usually most concerned about understatements. !n understatement of accounts payable is usually considered more important than overstatements because of potential legal liability. The completeness objective is therefore normally more important in the audit of accounts payable. The auditor is also concerned about overstatements of accounts payable. The existence objective is also therefore important in accounts payable, but usually less so than the completeness objective.

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6-3/ 1A,A+C"R",A!"& A%&#! O12"C!#3" !RA+$AC!#O+ R",A!"& A%&#! O12"C!#3"

%F& 1ccurrence %(& +etail Tie)In %1;& /osting and summari9ation

A%&#! 'ROC"&%R"
a. 3xamine a sample of duplicate sales invoices to determine whether each one has a shipping document attached. b. !dd all customer balances in the accounts receivable trial balance and agree the amount to the general ledger. c. "or a sample of sales transactions selected from the sales journal, verify that the amount of the transaction has been recorded in the correct customer account in the accounts receivable subledger. d. Inquire of the client whether any accounts receivable balances have been pledged as collateral on long)term debt and determine whether all required information is included in the footnote description for long)term debt. e. "or a sample of shipping documents selected from shipping records, trace each shipping document to a transaction recorded in the sales journal. f. +iscuss with credit department personnel the li elihood of collection of all accounts as of +ecember 01, ,GGF with a balance greater than H1GG,GGG and greater than FG days old as of year)end.

'R"$"+!A!#O+ A+& &#$C,O$%R" A%&#! O12"C!#3"

%1<& 1ccurrence and rights

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%1G& .ompleteness

%=& -eali9able value

g. 3xamine sales invoices for the last five sales transactions recorded in the sales journal in ,GGF and examine shipping documents to determine they are recorded in the correct period. h. "or a sample of customer accounts receivable balances for +ecember 01, ,GGF, examine subsequent cash receipts in ?anuary ,G1G to determine whether the customer paid the balance due.

%<& .utoff

%1& 3xistence %=& -eali9able value

Case ! review provides limited assurance about the fair presentation of financial statements in accordance with generally accepted accounting principles but far less assurance than an audit. /resumably, the ban decided that the assurances provided by a review were needed before a loan could be approved, but an audit was not necessary. ! review includes a ./! firm performing analytical procedures, ma ing inquiries about the fair presentation of the statements, and examining the information for reasonableness. #ecause of a ./! firm$s expertise in accounting, the accountant from the ./! firm can often identify incorrect presentations in the financial statements that have been overloo ed by the accountant for the company. -eviews are common for smaller privately)held companies with relatively small amounts of debt. The ban probably did not require an audit because the additional cost of an audit was greater than the benefit the ban perceived. In many cases, the decision as to whether to have a review or an audit is negotiated between the company see ing a loan and the ban loan officer. #oth the company and the ban have options in negotiating such things as the amount of the loan, the rate of interest, and whether to require an audit or a review. The ban can reject the loan request and the company can go to other ban s that want to ma e loans. "requently, ban s have a list of ./! firms in which they have considerable confidence due to their reputation in the community or past wor they have done for other ban customers. #ecause the amount of the loans from the ban to -itter increased, the ban probably wanted additional assurance about the reliability of the financial statements. It is also li ely that -ene -itter negotiated the one percent reduction of the interest rate by offering to have an audit instead of a review. ! one percent reduction in the interest rate saves -itter H;G,GGG annually compared to the H1<,GGG additional fee for an audit. -ene referred to the ./! firm as partners in a professional sense, not a business sense. The ./! firm had provided many consulting and tax services, as well as providing review and audit services over the entire business life of the company. -ene recogni9ed that these professional services had contributed to the success of the business and she chose to ac nowledge those contributions during her retirement comment. !ssuming that the ./! firm retained an attitude of independence throughout all audits and reviews, no violation of professional independence standards occurred. 'ost well run ./! firms provide selected consulting, tax, and assurance service for their privately held clients without violating independence requirements. !s the external auditor, the firm of 8on9ale9 4 "ineberg provides the stoc holders, creditors, and management an independent opinion

6-31 a.

b.

c.

d.

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6-31 7continued8 as to the fair presentation of the financial statements. 8iven the potential biases present when management prepares the financial statements, the stoc holders and creditors must consider the potential for information ris that might be present. The independent audit conducted by 8on9ale9 4 "ineberg helps stoc holders and creditors reduce their information ris . 'anagement also benefits by having the external auditors independently assess the financial statements even though those statements are prepared by management. +ue to the complexities involved in preparing financial statements in accordance with generally accepted accounting principles, the potential for misstatement on the part of management increases the need for an objective examination of those financial statements by a qualified independent party. The auditor is responsible for obtaining reasonable assurance that material misstatements are detected, whether those misstatements are due to errors or fraud. To obtain reasonable assurance, the auditor is required to gather sufficient, appropriate evidence. !uditors$ chief responsibility to stoc holders, creditors, and management is to conduct the audit in accordance with auditing standards in order to fulfill their responsibilities of the engagement.

e.

#nternet 'roble5 $olution: #nternational and 'CAO1 Audit Objectives

6-1 The objectives of an audit under 6.2. 8!!2 and international auditing standards are defined by !6 11G and I2! ,GG, respectively. 2imilarly, /.!1# !uditing 2tandard < defines the objective of an audit of internal control over financial reporting. 1. .ompare the objective of an audit under !6 11G and I2! ,GG %hint7 see paragraph 11&. !re there substantive differences in the objective of an audit as defined by these two standardsI Answer: /aragraph .G1 of !6 11G states that JKTLhe objective of the ordinary audit of financial statements by the independent auditor is the expression of an opinion on the fairness with which they present, in all material respects, financial position, results of operations, and its cash flows in conformity with generally accepted accounting principles.M 6.2. 8!!2 require the auditor to express an opinion on whether the financial statements are presented in conformity with generally accepted accounting principles and to identify those circumstances in which such principles have not been consistently observed in the preparation of financial statements. /aragraph .11 of I2! ,GG states that JIn conducting an audit of financial statements, the overall objectives of the auditor are %a& to obtain reasonable assurance about whether the financial

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#nternet 'roble5 6-1 7continued8 as a whole are free from material misstatement, whether due to fraud or error, thereby enabling the auditor to express an opinion on whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framewor and %b& to report on the financial statements, and communicate as required by the I2!s, in accordance with the auditor$s findings. 5hile there are differences in the wording about the objective of an audit of financial statements, the overall objectives stated in 6.2. 8!!2 and the I2!s are the same. #oth 6.2. 8!!2 and the I2!s note that the objective of the audit of financial statements is the expression of an opinion of whether the financial statements comply, in all material respects, with accounting standards. ,. 5hat is the objective of an audit of internal control over financial reportingI Answer: /aragraph .G0 of /.!1# !uditing 2tandard < states that JThe auditor$s objective in an audit of internal control over financial reporting is to express an opinion on the effectiveness of the company$s internal control over financial reporting.M That standard notes that to form a basis for an opinion, the auditor must plan and perform the audit to obtain competent evidence that is sufficient to obtain reasonable assurance about whether material wea nesses exist as of the date specified in management$s assessment. 0. 5hat defines whether financial statements are fairly stated, and what defines whether internal control is considered effectiveI !re they relatedI Answer: #oth 6.2. 8!!2 and international auditing standards define financial statements as being fairly stated when they are free of material misstatements. /.!1# !uditing 2tandard < defines internal control as effective when no material wea nesses exist. These definitions are related. The presence of a material misstatement generally suggests the presence of a material wea ness, since management$s internal controls over financial reporting failed to detect the material misstatement. 5hile the presence of a material wea ness in internal control does not automatically mean the financial statements contain a material misstatement, there is a high li elihood that a material misstatement could occur.
%+ote7 Internet problems address current issues using Internet sources. #ecause Internet sites are subject to change, Internet problems and solutions may change. .urrent information on Internet problems is available at www.pearsonhighered.comNarens&.

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