Solutions for Chapter 1
True/False Questions
1-1 T
1-2 T
1-3 F
1-4 F
1-5 F
1-6 F
1-7 T
1-8 T
1-9 T
1-10 F
1-11 T
1-12 T
1-13 T
1-14 T
Multiple Choice Questions
1-15 B
1-16 B
1-17 E
1-18 E
,1-19 D
1-20 D
1-21 C
1-22 A
1-23 A
1-24 B
1-25 D
1-26 C
1-27 B
1-28 D
Review and Short Case Questions
1-29
The objective of external auditing is to provide opinions on the reliability of the financial
statements and, as part of an integrated audit, provide opinions on internal control effectiveness.
The value of the external auditing profession is affirmed when the public has confidence in its
objectivity and the accuracy of its opinions. The capital markets depend on accurate, reliable, and
objective (neutral) data that portray the economic nature of an entity’s business and in turn
provide a base to judge current progress toward long-term objectives. If the market does not
receive reliable data, investors lose confidence in the system, make poor decisions, and may lose a
great deal of money; ultimately, the system may fail. By providing an independent audit opinion, the
capital markets can be assured that the financial data that they are basing their decisions upon are
accurate.
1-30
The special function performed by the external auditing profession is the attestation to the fairness
of the financial statements of clients. The special function helps ensure the reliability and integrity
of the financial reporting system. 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 necessarily
the interests of client management.
1-31
Audit services are demanded because there is a:
• Potential bias in providing information.
• Remoteness between a user and the organization or trading partner.
• Complexity in the transaction, information, or processing systems such that it is difficult to
determine their proper presentation without a review by an independent expert.
• Need to limit negative consequences that arise from relying on inaccurate information.
1-32
The audit enhances the quality of financial statements because the user has the assurance that an
independent, qualified professional has examined the financial statements and has rendered an
opinion on their fairness. The independence and expertise of the auditor serve as a quality control
function to overcome the potential bias of management in presenting the financial statements in a
manner that most flatters an assessment of their performance. The audit is designed to add
credibility to the financial statements.
An audit does not necessarily guarantee a fair presentation of a company's financial statements,
although it does dramatically increase the likelihood that there are no material misstatements in
the company's financial statements. The audit provides reasonable, but not absolute, assurance
about the accuracy of the financial statements. The caveats about fairness exist for two reasons:
• Fairness is judged within the applicable financial reporting framework. Some question whether
GAAP or IFRS results in the fairest possible presentations in all situations.
, • Although designed to detect material fraud, it might be possible that a well-executed audit may
still fail to detect fraud.
1-33
Independence means objectivity and freedom from bias. The auditor can favor neither the client
nor the third party in evaluating the fairness of the financial statements. The auditor must be
independent in fact and in appearance. Independence in fact means the auditor is unbiased and
objective. An auditor could be independent in fact if he or she owned a few shares of common stock
in an audit client, but might not appear independent to a third party. Independence in appearance
means that a third party with knowledge of the auditor’s relationship with the client would
consider the auditor to be independent. If users don’t perceive auditors to be independent then the
value of the audit is lacking.
1-34
a. An organization’s financial statements should reflect a true and fair view of the
organization’s financial results. The statements should not favor one user over another. However,
the interests of the various users can conflict. By having rules that encourage auditor independence
(e.g., not owning stock in the client company, not performing consulting services for a publicly
traded audit client), the profession encourages auditor independence.
b.
Management Review performance, make operational decisions, report results to
capital markets
Stockholders Buy or sell stock
Bondholders Buy or sell bonds
Financial Institutions Evaluate loan decisions, considering interest rates, terms, and risk
Taxing Authorities Determine taxable income and tax due
True/False Questions
1-1 T
1-2 T
1-3 F
1-4 F
1-5 F
1-6 F
1-7 T
1-8 T
1-9 T
1-10 F
1-11 T
1-12 T
1-13 T
1-14 T
Multiple Choice Questions
1-15 B
1-16 B
1-17 E
1-18 E
,1-19 D
1-20 D
1-21 C
1-22 A
1-23 A
1-24 B
1-25 D
1-26 C
1-27 B
1-28 D
Review and Short Case Questions
1-29
The objective of external auditing is to provide opinions on the reliability of the financial
statements and, as part of an integrated audit, provide opinions on internal control effectiveness.
The value of the external auditing profession is affirmed when the public has confidence in its
objectivity and the accuracy of its opinions. The capital markets depend on accurate, reliable, and
objective (neutral) data that portray the economic nature of an entity’s business and in turn
provide a base to judge current progress toward long-term objectives. If the market does not
receive reliable data, investors lose confidence in the system, make poor decisions, and may lose a
great deal of money; ultimately, the system may fail. By providing an independent audit opinion, the
capital markets can be assured that the financial data that they are basing their decisions upon are
accurate.
1-30
The special function performed by the external auditing profession is the attestation to the fairness
of the financial statements of clients. The special function helps ensure the reliability and integrity
of the financial reporting system. 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 necessarily
the interests of client management.
1-31
Audit services are demanded because there is a:
• Potential bias in providing information.
• Remoteness between a user and the organization or trading partner.
• Complexity in the transaction, information, or processing systems such that it is difficult to
determine their proper presentation without a review by an independent expert.
• Need to limit negative consequences that arise from relying on inaccurate information.
1-32
The audit enhances the quality of financial statements because the user has the assurance that an
independent, qualified professional has examined the financial statements and has rendered an
opinion on their fairness. The independence and expertise of the auditor serve as a quality control
function to overcome the potential bias of management in presenting the financial statements in a
manner that most flatters an assessment of their performance. The audit is designed to add
credibility to the financial statements.
An audit does not necessarily guarantee a fair presentation of a company's financial statements,
although it does dramatically increase the likelihood that there are no material misstatements in
the company's financial statements. The audit provides reasonable, but not absolute, assurance
about the accuracy of the financial statements. The caveats about fairness exist for two reasons:
• Fairness is judged within the applicable financial reporting framework. Some question whether
GAAP or IFRS results in the fairest possible presentations in all situations.
, • Although designed to detect material fraud, it might be possible that a well-executed audit may
still fail to detect fraud.
1-33
Independence means objectivity and freedom from bias. The auditor can favor neither the client
nor the third party in evaluating the fairness of the financial statements. The auditor must be
independent in fact and in appearance. Independence in fact means the auditor is unbiased and
objective. An auditor could be independent in fact if he or she owned a few shares of common stock
in an audit client, but might not appear independent to a third party. Independence in appearance
means that a third party with knowledge of the auditor’s relationship with the client would
consider the auditor to be independent. If users don’t perceive auditors to be independent then the
value of the audit is lacking.
1-34
a. An organization’s financial statements should reflect a true and fair view of the
organization’s financial results. The statements should not favor one user over another. However,
the interests of the various users can conflict. By having rules that encourage auditor independence
(e.g., not owning stock in the client company, not performing consulting services for a publicly
traded audit client), the profession encourages auditor independence.
b.
Management Review performance, make operational decisions, report results to
capital markets
Stockholders Buy or sell stock
Bondholders Buy or sell bonds
Financial Institutions Evaluate loan decisions, considering interest rates, terms, and risk
Taxing Authorities Determine taxable income and tax due
