,Solution manual For Auditing, A Practical
Approach with Data Analytics 2e Johnson
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, CHAPTER 1
Introduction and Overview of Audit and Assurance
Learning Objectives
1. Differentiate among assurance, attestation, and auditing services.
2. Describe the different types of assurance services.
3. Explain the demand for audit and assurance services.
4. Discuss the different roles of the financial statement preparer and the auditor.
5. Identify the roles of different regulators and organizations that affect the audit profession.
6. Explain the concepts of reasonable assurance, materiality, and the nature of an unquali-
fied/unmodified report on the audit of financial statements.
7. Explain the concept of reasonable assurance and the nature of an unqualified report on in-
ternal controls over financial reporting.
8. Discuss the audit expectation gap.
ANSWERS TO MULTIPLE-CHOICE QUESTIONS
1. C
LO 1, BT: C, Difficulty: Easy, TOT: 2 min., AACSB: None, AICPA AC: Risk Assessment, Analysis and Management, Section:
Assurance, Attestation, and Audit Services
2. A
LO 2, BT: C, Difficulty: Easy, TOT: 2 min., AACSB: None, AICPA AC: Risk Assessment, Analysis and Management, Section:
Different Assurance Services
3. B
LO 2, BT: C, Difficulty: Easy, TOT: 2 min., AACSB: None, AICPA AC: Risk Assessment, Analysis and Management, Section:
Different Assurance Services
4. C
LO 2, BT: C, Difficulty: Medium, TOT: 2 min., AACSB: None, AICPA AC: Risk Assessment, Analysis and Management,
Section: Different Assurance Services
5. C
LO 3, BT: C, Difficulty: Medium, TOT: 2 min., AACSB: None, AICPA AC: Risk Assessment, Analysis and Management,
Section: Demand for Audit and Assurance Services
6. B
1 | © 2022 John Wiley and Sons, Inc. For Instructor Use Only
,LO 4, BT: C, Difficulty: Easy, TOT: 2 min., AACSB: None, AICPA AC: Risk Assessment, Analysis and Management, Section:
Preparers and Auditors
7. A
LO 5, BT: C, Difficulty: Easy, TOT: 2 min., AACSB: None, AICPA AC: Reporting, Section: The Role of Regulators and Reg-
ulations
8. D
LO 5, BT: C, Difficulty: Easy, TOT: 2 min., AACSB: None, AICPA BC: Governance Perspective, Section: The Role of Regu-
lators and Regulations
9. D
LO 6, BT: C, Difficulty: Easy, TOT: 2 min., AACSB: None, AICPA AC: Risk Assessment, Analysis and Management, Section:
Audit Report on Financial Statements
10. C
LO 6, BT: C, Difficulty: Easy, TOT: 2 min., AACSB: None, AICPA AC: Reporting, Section: Audit Report on the Financial
Statements
11. B
LO 7, BT: C, Difficulty: Easy, TOT: 2 min., AACSB: None, AICPA AC: Reporting, Section: Audit Report on Internal Controls
over Financial Reporting
12. B
LO 8, BT: C, Difficulty: Medium, TOT: 2 min., AACSB: None, AICPA PC: Professional Behavior, Section: The Audit Expec-
tation Gap
2 | © 2022 John Wiley and Sons, Inc. For Instructor Use Only
, ANSWERS TO REVIEW QUESTIONS
R1.1 An assurance service is any service provided by an independent practitioner that improves
the quality of information, or its context, for decision makers. An independent practitioner can
verify that the information meets relevant criteria, which provides assurance to users who intend
to use the information for decision making. An assurance engagement has three parties: the as-
surance provider (auditor/practitioner), the party responsible for providing the information (cli-
ent), and the intended users of the information (investors/lenders/others who rely on the infor-
mation).
LO 1, BT: C, Difficulty: Easy, TOT: 5 min., AACSB: None, AICPA AC: Risk Assessment, Analysis and Management, Section:
Assurance, Attestation, and Audit Services
R1.2 The criterion used in a financial statement audit to measure and evaluate subject matter is
the applicable financial reporting framework used by the client. The most common framework
used in the U.S. is Generally Accepted Accounting Principles (GAAP).
LO 1, BT: C, Difficulty: Easy, TOT: 5 min., AACSB: None, AICPA AC: Measurement Analysis and Interpretation, Section:
Assurance, Attestation, and Audit Services
R1.3 Financial statements are not guaranteed to be free from error or fraud due to several limi-
tations. These limitations include the nature of financial reporting, the nature of audit proce-
dures and the need for the audit to be conducted within a reasonable period of time and within
a reasonable budget. The nature of financial reporting causes limitations because it includes
management’s judgment when applying accounting standards and estimates. The nature of the
audit procedures is a limitation because the auditors have to rely on management to provide all
the necessary documentation needed for the audit. The auditor may arrive at an inappropriate
conclusion if information is tampered with or excluded. The last limitation refers to the limited
resources of time and money for an audit engagement. It would be impractical for auditors to
examine every transaction. Therefore, auditors rely on sampling measures to provide an accurate
representation of the population, and sampling cannot provide absolute assurance.
LO 2, BT: C, Difficulty: Medium, TOT: 15 min., AACSB: None, AICPA AC: Risk Assessment, Analysis and Management,
Section: Different Assurance Services
R1.4 Management and those charged with governance can request an operational audit to help
improve the efficiency and effectiveness of a company’s operations. An organization’s internal
audit department typically conducts operational audits.
LO 2, BT: C, Difficulty: Easy, TOT: 5 min., AACSB: None, AICPA BC: Governance Perspective, Section: Different Assurance
Services
3 | © 2022 John Wiley and Sons, Inc. For Instructor Use Only
,R1.5 Investors are interested in the information that financial statements can provide about their
investment. This includes, but is not limited to, information regarding the profitability of the
company, return on investment, going concern/continuity of operations, and dividend distribu-
tions. An independent audit helps to ensure that the information in the financial statements is
credible and of high quality.
LO 3, BT: C, Difficulty: Easy, TOT: 10 min., AACSB: None, AICPA BC: Governance Perspective, Section: Demand for Audit
and Assurance Services
R1.6 Both the preparer and the auditor have responsibilities regarding the company’s financial
statements. Management (the preparer) is in charge of preparing the financial statements. This
includes ensuring the information is presented fairly and in compliance with GAAP, or other ap-
plicable financial reporting framework. Management is responsible for designing, implementing,
and maintaining internal control over financial reporting, as well as providing auditors with all
the necessary documentation and personnel needed to complete the audit. Auditors are respon-
sible for providing an opinion on whether the financial statements are presented fairly and in ac-
cordance with the applicable financial reporting framework. The three responsibilities of auditors
are to conduct the audit in accordance with the appropriate audit standards, plan and perform
the audit with professional skepticism, and exercise professional judgment.
LO 4, BT: C, Difficulty: Medium, TOT: 15 min., AACSB: None, AICPA AC: Reporting, Section: Preparers and Auditors
R1.7 The SOX Act of 2002, which emphasized a need for better governance over financial re-
porting, created the Public Company Accounting Oversight Board (PCAOB). The PCAOB is a
non-profit corporation established to oversee the audits of public companies. The U.S. Securities
and Exchange Commission (SEC) is a federal government agency whose role is to enforce and
interpret securities laws. The SEC approves each new auditing standard established by the
PCAOB before it can be implemented. The SEC and PCAOB work closely together to ensure
standards are in place for both public companies and auditors to safeguard investors.
LO 5, BT: C, Difficulty: Medium, TOT: 10 min., AACSB: None, AICPA AC: Reporting, Section: The Role of Regulators and
Regulations
R1.8 Some functions of the state boards of accountancy include issuing Certified Public Ac-
countant (CPA) licenses, adopting and enforcing professional conduct rules for CPAs, enforcing
continuing professional education requirements, and administering disciplinary actions. The Na-
tional Association of State Boards of Accountancy (NASBA) is a professional organization that
works to unite the interests of the 55 jurisdictions of state boards with regulative and legislative
bodies.
LO 5, BT: AP, Difficulty: Easy, TOT: 10 min., AACSB: Analytic, AICPA PC: Professional Behavior, Section: The Role of Reg-
ulators and Regulations
4 | © 2022 John Wiley and Sons, Inc. For Instructor Use Only
,R1.9 The principles of Generally Accepted Audit Standards (GAAS) start with the purpose of an
audit, which is to provide an opinion on whether a company’s financial statements are presented
fairly and in accordance with GAAP. The next principle describes the premise upon which an au-
dit is conducted. This outlines management’s responsibility to prepare the financial statements
in accordance with the applicable framework, manage and maintain internal controls over finan-
cial reporting, and provide the auditor with access to all documentation relevant to conduct the
audit. The next principle outlines the responsibilities of the auditor, which explicitly states audi-
tors have to be competent, comply with auditing standards, maintain professional skepticism
and exercise professional judgment during an audit. While performing an audit, an auditor must
obtain reasonable assurance that the financial statements are free from material misstatement,
but also recognize it is not an absolute assurance due to several limitations. The last principle
states that auditors must report the results of the audit in a formalized written report.
LO 5, BT: C, Difficulty: Easy, TOT: 10 min., AACSB: None, AICPA AC: Reporting, Section: The Role of Regulators and
Regulations
R1.10 Audit reports for private and public companies are very similar in content. Both reports
contain the essential components: a title with the word “independent,” an address to the share-
holders/owners and board, identification of which financial statements were audited, an opinion
on the outcome, a description of the responsibilities of the parties involved, a description of the
conduct of an audit, a signature with the firm’s name and a date indicating the end of fieldwork.
However, there are a few differences between the two. The title for an audit report of a public
company includes the term “registered” indicating the firm is registered with the PCAOB. Audit
reports for public companies state the auditor is required to be independent from the company
in accordance with U.S. federal securities laws and with regulations of the SEC and PCAOB. The
report for a public company includes a paragraph referencing the audit of the firm’s internal
controls over financial reporting. Public companies are required to have two audits, one for fi-
nancial statements and the other for Internal Control over Financial Reporting (ICFR); whereas
private companies are not required to have an audit of ICFR. A report of a public company will
indicate the audit was performed in accordance with the standards of the PCAOB, whereas a pri-
vate company report will indicate the audit was conducted in accordance with GAAS (issued by
the AICPA). Finally, auditors must provide a statement about auditor tenure at the bottom of the
audit report for public companies and must also include a section for the discussion of critical
audit matters (CAM). Neither of these features is required for an audit report for a private com-
pany client.
LO 6, BT: AN, Difficulty: Medium, TOT: 15 min., AACSB: Analytic, AICPA AC: Reporting, Section: Audit Report on Finan-
cial Statements
5 | © 2022 John Wiley and Sons, Inc. For Instructor Use Only
,R1.11 The components of an auditor’s report on internal controls over financial reporting in-
clude the title, address, opinion, reference to the financial statement audit, basis for opinion par-
agraph, scope paragraph, definition and limitations paragraph, signature and date. The title
must include two important terms—“independent” and “registered”—signifying the auditor’s in-
dependence and that the firm is registered with the PCAOB. The report is addressed to the
board and shareholders of the company. The opinion paragraph states that an audit of the com-
pany’s internal controls was conducted using the COSO Internal Control-Integrated Framework
as the criteria, and then states whether or not the company maintained effective internal control.
The next paragraph references the audit of the company’s financial statements since public
companies require two audits. The basis for opinion paragraph briefly describes the responsibili-
ties of management and the auditor and mentions that auditors are required to be independent
from the company. The scope paragraph briefly describes how an audit of ICFR is conducted.
The definition and inherent limitations paragraph defines ICFR for users unfamiliar with the ter-
minology and emphasizes that internal controls will not be able to prevent or detect all mis-
statements or errors. The report is signed by the firm and dated to represent the end of the
fieldwork.
LO 7, BT: C, Difficulty: Medium, TOT: 15 min., AACSB: None, AICPA AC: Reporting, Section: Audit Report on Internal
Controls over Financial Reporting
R1.12 The audit expectation gap occurs when the auditor’s professional responsibilities do not
align with the financial statement users’ beliefs. This gap is created when the user has unrealistic
expectations for the audit. Some examples of unrealistic expectations are as follows:
• the user may believe the auditor is providing absolute assurance instead of reasonable
assurance,
• the user may believe the auditor is guaranteeing future viability of the company,
• the user may believe a favorable audit conclusion indicates complete accuracy instead of
no material misstatements,
• the user may believe the auditor will find any and all fraud when that is simply impossi-
ble, and
• the user may believe the auditor has tested every transaction instead of a sample.
It is impossible for professional auditing standards to give users what they want because of in-
herent limitations with the conduct of an audit, such as the cost of an audit and completing the
audit in a reasonable time frame.
Auditors sometimes do not meet professional standards because of time constraints in com-
pleting the audit (possibly being short staffed), not exercising enough professional skepticism,
and not maintaining professional competence through continuing professional education.
LO 8, BT: AN, Difficulty: Medium, TOT: 10 min., AACSB: Analytic, AICPA AC: Risk Assessment, Analysis and Manage-
ment, Section: The Audit Expectation Gap
6 | © 2022 John Wiley and Sons, Inc. For Instructor Use Only
, SOLUTIONS TO ANALYSIS PROBLEMS
AP1.1 Although internal and external audit are different professional fields, they share some
similar responsibilities. Both fields follow rules and regulations made by their respective profes-
sional organizations, the Institute of Internal Auditors (IIA) and the American Institute of Certi-
fied Public Accountants (AICPA). Additionally, external auditors of public companies must ad-
here to regulations set forth by the PCAOB and SEC. Internal auditors are typically employees of
the organization and therefore cannot have the same level of independence from the organiza-
tion as an external auditor can. Nevertheless, internal auditors are required to maintain inde-
pendence from management to ensure objectivity and an unbiased attitude. External auditors
cannot be employees of the audit client, and they must adhere to strict independence guide-
lines to ensure there are no conflicts of interest in performing the audit engagement.
The most common role for internal auditors is to monitor internal controls and improve
the effectiveness of controls, governance, and risk management strategies. Internal auditors re-
port their results to those charged with governance and typically do not report findings to the
public. The role of the external auditors is to express an opinion on the fair presentation of the
client’s financial statements in accordance with the applicable financial reporting framework. For
certain public company clients, external auditors also provide an opinion on the effectiveness of
the client’s internal controls over financial reporting. The external auditors report their opinion(s)
to those charged with governance, and for public company clients, to interested users outside of
the client.
LO 1, 2 BT: AN, Difficulty: Easy, TOT: 15 min., AACSB: Analytic, Technology, AICPA AC: Research, Section: Assurance,
Attestation, and Audit Services, Different Assurance Services
AP1.2 Users demand audited financial statements for various reasons. If the accounting firm
performing the audit is perceived as incompetent, not independent, or unethical, then the value
of the audit service is lost. Users will not be confident that the information management pre-
sents in the financial statements is unbiased and reliable. If users think the financial statements
are unreliable, then they may not invest in the company, do business with the company, or lend
money to the company. Therefore, a company does not want to be associated with an account-
ing firm that has a poor reputation or that is in violation of professional standards. That is why
clients dropped Arthur Andersen after charges were brought against the firm.
LO 3, BT: AP, Difficulty: Hard, TOT: 15 min., AACSB: Analytic, AICPA PC: Professional Behavior, Section: Demand for Au-
dit and Assurance Services
7 | © 2022 John Wiley and Sons, Inc. For Instructor Use Only
, AP1.3 The solution will depend on the accounting firm chosen and the date of the analysis. How-
ever, the answers should show for the Big 4: greater geographic coverage, larger numbers of staff
and broader range of skills offered, greater claims to specialization and industry coverage, more
publications available (particularly from the international offices), more consistent and sophisti-
cated marketing.
LO 3,4, BT: AN, Difficulty: Medium, TOT: 20 min., AACSB: Analytic, Technology, AICPA AC: Research, Section: Demand
for Audit and Assurance Services, Preparers and Auditors
AP1.4
a. Financial statement audits are mandatory for public companies, so overall demand is largely
fixed or determined by economic conditions affecting the number of companies. However, for
organizations that are not required by legislation to have an audit, there are two opposing pres-
sures in times of economic recession. First, cost-cutting would result in fewer audits. Second, or-
ganizations with less credible financial statements will face the most difficulty in borrowing during
a credit squeeze. This suggests that demand for auditing will increase in difficult times, because
an audit will increase the credibility of the financial statements and thus increase access to external
financing.
b. Shifting from a mid-tier auditor to a Big 4 auditor would increase both costs and financial
statement credibility for a company. Therefore, it can be argued that companies with greater need
to reduce costs will shift “down” from Big 4 auditors to mid-tier auditors, but companies with
greater need for credibility (and financial advice) will shift “up” from mid-tier auditors to Big 4
auditors.
LO 3, 4 BT: AP, Difficulty: Hard, TOT: 15 min., AACSB: Analytic, AICPA BC: Customer Perspective, Section: Demand for
Audit and Assurance Services, Preparers and Auditors
AP1.5 The solution will vary based on the states selected by the student to research. In general,
most states require a bachelor’s degree and relevant accounting and business courses. Some
states, such as Texas and Colorado, require an ethics course. Some states allow candidates to sit
for the CPA exam after completing a bachelor’s degree with the relevant accounting courses, but
a total of 150 hours of college credits are required to be licensed as a CPA. In addition to passing
the CPA exam and meeting the education requirements, most states require 1-2 years of work
experience in public accounting to be licensed.
LO 5, BT: AN, Difficulty: Basic, TOT: 20 min., AACSB: Technology, AICPA AC: Research, Section: The Role of Regulators
and Regulations
AP1.6 To be registered with the PCAOB, a firm must complete a 27-page application (Form 1)
and pay the required fees. The purpose of Form 1 is to capture information about the firm in-
cluding contact information, number of employees, types of clients serviced by the firm, any on-
going or pending criminal or civil actions against the firm, quality control procedures, and
names of issuers that the firm expects to provide audit services to in the current year. Form 1 is
signed by a partner or authorized officer of the firm. The application fee is $500 for a firm that
audits less than 50 issuers, $3,000 for a firm that audits 50-100 issuers, $29,000 for a firm that
audits 101-1000 issuers, and $390,000 for a firm that audits 1001 or more issuers.
Once a firm is registered, annual fees are $100,000 for firms with more than 500 issuer
8 | © 2022 John Wiley and Sons, Inc. For Instructor Use Only
Approach with Data Analytics 2e Johnson
Hello all ,
We have all what you need with best price
Our email :
Our website :
testbanks-store.com
, CHAPTER 1
Introduction and Overview of Audit and Assurance
Learning Objectives
1. Differentiate among assurance, attestation, and auditing services.
2. Describe the different types of assurance services.
3. Explain the demand for audit and assurance services.
4. Discuss the different roles of the financial statement preparer and the auditor.
5. Identify the roles of different regulators and organizations that affect the audit profession.
6. Explain the concepts of reasonable assurance, materiality, and the nature of an unquali-
fied/unmodified report on the audit of financial statements.
7. Explain the concept of reasonable assurance and the nature of an unqualified report on in-
ternal controls over financial reporting.
8. Discuss the audit expectation gap.
ANSWERS TO MULTIPLE-CHOICE QUESTIONS
1. C
LO 1, BT: C, Difficulty: Easy, TOT: 2 min., AACSB: None, AICPA AC: Risk Assessment, Analysis and Management, Section:
Assurance, Attestation, and Audit Services
2. A
LO 2, BT: C, Difficulty: Easy, TOT: 2 min., AACSB: None, AICPA AC: Risk Assessment, Analysis and Management, Section:
Different Assurance Services
3. B
LO 2, BT: C, Difficulty: Easy, TOT: 2 min., AACSB: None, AICPA AC: Risk Assessment, Analysis and Management, Section:
Different Assurance Services
4. C
LO 2, BT: C, Difficulty: Medium, TOT: 2 min., AACSB: None, AICPA AC: Risk Assessment, Analysis and Management,
Section: Different Assurance Services
5. C
LO 3, BT: C, Difficulty: Medium, TOT: 2 min., AACSB: None, AICPA AC: Risk Assessment, Analysis and Management,
Section: Demand for Audit and Assurance Services
6. B
1 | © 2022 John Wiley and Sons, Inc. For Instructor Use Only
,LO 4, BT: C, Difficulty: Easy, TOT: 2 min., AACSB: None, AICPA AC: Risk Assessment, Analysis and Management, Section:
Preparers and Auditors
7. A
LO 5, BT: C, Difficulty: Easy, TOT: 2 min., AACSB: None, AICPA AC: Reporting, Section: The Role of Regulators and Reg-
ulations
8. D
LO 5, BT: C, Difficulty: Easy, TOT: 2 min., AACSB: None, AICPA BC: Governance Perspective, Section: The Role of Regu-
lators and Regulations
9. D
LO 6, BT: C, Difficulty: Easy, TOT: 2 min., AACSB: None, AICPA AC: Risk Assessment, Analysis and Management, Section:
Audit Report on Financial Statements
10. C
LO 6, BT: C, Difficulty: Easy, TOT: 2 min., AACSB: None, AICPA AC: Reporting, Section: Audit Report on the Financial
Statements
11. B
LO 7, BT: C, Difficulty: Easy, TOT: 2 min., AACSB: None, AICPA AC: Reporting, Section: Audit Report on Internal Controls
over Financial Reporting
12. B
LO 8, BT: C, Difficulty: Medium, TOT: 2 min., AACSB: None, AICPA PC: Professional Behavior, Section: The Audit Expec-
tation Gap
2 | © 2022 John Wiley and Sons, Inc. For Instructor Use Only
, ANSWERS TO REVIEW QUESTIONS
R1.1 An assurance service is any service provided by an independent practitioner that improves
the quality of information, or its context, for decision makers. An independent practitioner can
verify that the information meets relevant criteria, which provides assurance to users who intend
to use the information for decision making. An assurance engagement has three parties: the as-
surance provider (auditor/practitioner), the party responsible for providing the information (cli-
ent), and the intended users of the information (investors/lenders/others who rely on the infor-
mation).
LO 1, BT: C, Difficulty: Easy, TOT: 5 min., AACSB: None, AICPA AC: Risk Assessment, Analysis and Management, Section:
Assurance, Attestation, and Audit Services
R1.2 The criterion used in a financial statement audit to measure and evaluate subject matter is
the applicable financial reporting framework used by the client. The most common framework
used in the U.S. is Generally Accepted Accounting Principles (GAAP).
LO 1, BT: C, Difficulty: Easy, TOT: 5 min., AACSB: None, AICPA AC: Measurement Analysis and Interpretation, Section:
Assurance, Attestation, and Audit Services
R1.3 Financial statements are not guaranteed to be free from error or fraud due to several limi-
tations. These limitations include the nature of financial reporting, the nature of audit proce-
dures and the need for the audit to be conducted within a reasonable period of time and within
a reasonable budget. The nature of financial reporting causes limitations because it includes
management’s judgment when applying accounting standards and estimates. The nature of the
audit procedures is a limitation because the auditors have to rely on management to provide all
the necessary documentation needed for the audit. The auditor may arrive at an inappropriate
conclusion if information is tampered with or excluded. The last limitation refers to the limited
resources of time and money for an audit engagement. It would be impractical for auditors to
examine every transaction. Therefore, auditors rely on sampling measures to provide an accurate
representation of the population, and sampling cannot provide absolute assurance.
LO 2, BT: C, Difficulty: Medium, TOT: 15 min., AACSB: None, AICPA AC: Risk Assessment, Analysis and Management,
Section: Different Assurance Services
R1.4 Management and those charged with governance can request an operational audit to help
improve the efficiency and effectiveness of a company’s operations. An organization’s internal
audit department typically conducts operational audits.
LO 2, BT: C, Difficulty: Easy, TOT: 5 min., AACSB: None, AICPA BC: Governance Perspective, Section: Different Assurance
Services
3 | © 2022 John Wiley and Sons, Inc. For Instructor Use Only
,R1.5 Investors are interested in the information that financial statements can provide about their
investment. This includes, but is not limited to, information regarding the profitability of the
company, return on investment, going concern/continuity of operations, and dividend distribu-
tions. An independent audit helps to ensure that the information in the financial statements is
credible and of high quality.
LO 3, BT: C, Difficulty: Easy, TOT: 10 min., AACSB: None, AICPA BC: Governance Perspective, Section: Demand for Audit
and Assurance Services
R1.6 Both the preparer and the auditor have responsibilities regarding the company’s financial
statements. Management (the preparer) is in charge of preparing the financial statements. This
includes ensuring the information is presented fairly and in compliance with GAAP, or other ap-
plicable financial reporting framework. Management is responsible for designing, implementing,
and maintaining internal control over financial reporting, as well as providing auditors with all
the necessary documentation and personnel needed to complete the audit. Auditors are respon-
sible for providing an opinion on whether the financial statements are presented fairly and in ac-
cordance with the applicable financial reporting framework. The three responsibilities of auditors
are to conduct the audit in accordance with the appropriate audit standards, plan and perform
the audit with professional skepticism, and exercise professional judgment.
LO 4, BT: C, Difficulty: Medium, TOT: 15 min., AACSB: None, AICPA AC: Reporting, Section: Preparers and Auditors
R1.7 The SOX Act of 2002, which emphasized a need for better governance over financial re-
porting, created the Public Company Accounting Oversight Board (PCAOB). The PCAOB is a
non-profit corporation established to oversee the audits of public companies. The U.S. Securities
and Exchange Commission (SEC) is a federal government agency whose role is to enforce and
interpret securities laws. The SEC approves each new auditing standard established by the
PCAOB before it can be implemented. The SEC and PCAOB work closely together to ensure
standards are in place for both public companies and auditors to safeguard investors.
LO 5, BT: C, Difficulty: Medium, TOT: 10 min., AACSB: None, AICPA AC: Reporting, Section: The Role of Regulators and
Regulations
R1.8 Some functions of the state boards of accountancy include issuing Certified Public Ac-
countant (CPA) licenses, adopting and enforcing professional conduct rules for CPAs, enforcing
continuing professional education requirements, and administering disciplinary actions. The Na-
tional Association of State Boards of Accountancy (NASBA) is a professional organization that
works to unite the interests of the 55 jurisdictions of state boards with regulative and legislative
bodies.
LO 5, BT: AP, Difficulty: Easy, TOT: 10 min., AACSB: Analytic, AICPA PC: Professional Behavior, Section: The Role of Reg-
ulators and Regulations
4 | © 2022 John Wiley and Sons, Inc. For Instructor Use Only
,R1.9 The principles of Generally Accepted Audit Standards (GAAS) start with the purpose of an
audit, which is to provide an opinion on whether a company’s financial statements are presented
fairly and in accordance with GAAP. The next principle describes the premise upon which an au-
dit is conducted. This outlines management’s responsibility to prepare the financial statements
in accordance with the applicable framework, manage and maintain internal controls over finan-
cial reporting, and provide the auditor with access to all documentation relevant to conduct the
audit. The next principle outlines the responsibilities of the auditor, which explicitly states audi-
tors have to be competent, comply with auditing standards, maintain professional skepticism
and exercise professional judgment during an audit. While performing an audit, an auditor must
obtain reasonable assurance that the financial statements are free from material misstatement,
but also recognize it is not an absolute assurance due to several limitations. The last principle
states that auditors must report the results of the audit in a formalized written report.
LO 5, BT: C, Difficulty: Easy, TOT: 10 min., AACSB: None, AICPA AC: Reporting, Section: The Role of Regulators and
Regulations
R1.10 Audit reports for private and public companies are very similar in content. Both reports
contain the essential components: a title with the word “independent,” an address to the share-
holders/owners and board, identification of which financial statements were audited, an opinion
on the outcome, a description of the responsibilities of the parties involved, a description of the
conduct of an audit, a signature with the firm’s name and a date indicating the end of fieldwork.
However, there are a few differences between the two. The title for an audit report of a public
company includes the term “registered” indicating the firm is registered with the PCAOB. Audit
reports for public companies state the auditor is required to be independent from the company
in accordance with U.S. federal securities laws and with regulations of the SEC and PCAOB. The
report for a public company includes a paragraph referencing the audit of the firm’s internal
controls over financial reporting. Public companies are required to have two audits, one for fi-
nancial statements and the other for Internal Control over Financial Reporting (ICFR); whereas
private companies are not required to have an audit of ICFR. A report of a public company will
indicate the audit was performed in accordance with the standards of the PCAOB, whereas a pri-
vate company report will indicate the audit was conducted in accordance with GAAS (issued by
the AICPA). Finally, auditors must provide a statement about auditor tenure at the bottom of the
audit report for public companies and must also include a section for the discussion of critical
audit matters (CAM). Neither of these features is required for an audit report for a private com-
pany client.
LO 6, BT: AN, Difficulty: Medium, TOT: 15 min., AACSB: Analytic, AICPA AC: Reporting, Section: Audit Report on Finan-
cial Statements
5 | © 2022 John Wiley and Sons, Inc. For Instructor Use Only
,R1.11 The components of an auditor’s report on internal controls over financial reporting in-
clude the title, address, opinion, reference to the financial statement audit, basis for opinion par-
agraph, scope paragraph, definition and limitations paragraph, signature and date. The title
must include two important terms—“independent” and “registered”—signifying the auditor’s in-
dependence and that the firm is registered with the PCAOB. The report is addressed to the
board and shareholders of the company. The opinion paragraph states that an audit of the com-
pany’s internal controls was conducted using the COSO Internal Control-Integrated Framework
as the criteria, and then states whether or not the company maintained effective internal control.
The next paragraph references the audit of the company’s financial statements since public
companies require two audits. The basis for opinion paragraph briefly describes the responsibili-
ties of management and the auditor and mentions that auditors are required to be independent
from the company. The scope paragraph briefly describes how an audit of ICFR is conducted.
The definition and inherent limitations paragraph defines ICFR for users unfamiliar with the ter-
minology and emphasizes that internal controls will not be able to prevent or detect all mis-
statements or errors. The report is signed by the firm and dated to represent the end of the
fieldwork.
LO 7, BT: C, Difficulty: Medium, TOT: 15 min., AACSB: None, AICPA AC: Reporting, Section: Audit Report on Internal
Controls over Financial Reporting
R1.12 The audit expectation gap occurs when the auditor’s professional responsibilities do not
align with the financial statement users’ beliefs. This gap is created when the user has unrealistic
expectations for the audit. Some examples of unrealistic expectations are as follows:
• the user may believe the auditor is providing absolute assurance instead of reasonable
assurance,
• the user may believe the auditor is guaranteeing future viability of the company,
• the user may believe a favorable audit conclusion indicates complete accuracy instead of
no material misstatements,
• the user may believe the auditor will find any and all fraud when that is simply impossi-
ble, and
• the user may believe the auditor has tested every transaction instead of a sample.
It is impossible for professional auditing standards to give users what they want because of in-
herent limitations with the conduct of an audit, such as the cost of an audit and completing the
audit in a reasonable time frame.
Auditors sometimes do not meet professional standards because of time constraints in com-
pleting the audit (possibly being short staffed), not exercising enough professional skepticism,
and not maintaining professional competence through continuing professional education.
LO 8, BT: AN, Difficulty: Medium, TOT: 10 min., AACSB: Analytic, AICPA AC: Risk Assessment, Analysis and Manage-
ment, Section: The Audit Expectation Gap
6 | © 2022 John Wiley and Sons, Inc. For Instructor Use Only
, SOLUTIONS TO ANALYSIS PROBLEMS
AP1.1 Although internal and external audit are different professional fields, they share some
similar responsibilities. Both fields follow rules and regulations made by their respective profes-
sional organizations, the Institute of Internal Auditors (IIA) and the American Institute of Certi-
fied Public Accountants (AICPA). Additionally, external auditors of public companies must ad-
here to regulations set forth by the PCAOB and SEC. Internal auditors are typically employees of
the organization and therefore cannot have the same level of independence from the organiza-
tion as an external auditor can. Nevertheless, internal auditors are required to maintain inde-
pendence from management to ensure objectivity and an unbiased attitude. External auditors
cannot be employees of the audit client, and they must adhere to strict independence guide-
lines to ensure there are no conflicts of interest in performing the audit engagement.
The most common role for internal auditors is to monitor internal controls and improve
the effectiveness of controls, governance, and risk management strategies. Internal auditors re-
port their results to those charged with governance and typically do not report findings to the
public. The role of the external auditors is to express an opinion on the fair presentation of the
client’s financial statements in accordance with the applicable financial reporting framework. For
certain public company clients, external auditors also provide an opinion on the effectiveness of
the client’s internal controls over financial reporting. The external auditors report their opinion(s)
to those charged with governance, and for public company clients, to interested users outside of
the client.
LO 1, 2 BT: AN, Difficulty: Easy, TOT: 15 min., AACSB: Analytic, Technology, AICPA AC: Research, Section: Assurance,
Attestation, and Audit Services, Different Assurance Services
AP1.2 Users demand audited financial statements for various reasons. If the accounting firm
performing the audit is perceived as incompetent, not independent, or unethical, then the value
of the audit service is lost. Users will not be confident that the information management pre-
sents in the financial statements is unbiased and reliable. If users think the financial statements
are unreliable, then they may not invest in the company, do business with the company, or lend
money to the company. Therefore, a company does not want to be associated with an account-
ing firm that has a poor reputation or that is in violation of professional standards. That is why
clients dropped Arthur Andersen after charges were brought against the firm.
LO 3, BT: AP, Difficulty: Hard, TOT: 15 min., AACSB: Analytic, AICPA PC: Professional Behavior, Section: Demand for Au-
dit and Assurance Services
7 | © 2022 John Wiley and Sons, Inc. For Instructor Use Only
, AP1.3 The solution will depend on the accounting firm chosen and the date of the analysis. How-
ever, the answers should show for the Big 4: greater geographic coverage, larger numbers of staff
and broader range of skills offered, greater claims to specialization and industry coverage, more
publications available (particularly from the international offices), more consistent and sophisti-
cated marketing.
LO 3,4, BT: AN, Difficulty: Medium, TOT: 20 min., AACSB: Analytic, Technology, AICPA AC: Research, Section: Demand
for Audit and Assurance Services, Preparers and Auditors
AP1.4
a. Financial statement audits are mandatory for public companies, so overall demand is largely
fixed or determined by economic conditions affecting the number of companies. However, for
organizations that are not required by legislation to have an audit, there are two opposing pres-
sures in times of economic recession. First, cost-cutting would result in fewer audits. Second, or-
ganizations with less credible financial statements will face the most difficulty in borrowing during
a credit squeeze. This suggests that demand for auditing will increase in difficult times, because
an audit will increase the credibility of the financial statements and thus increase access to external
financing.
b. Shifting from a mid-tier auditor to a Big 4 auditor would increase both costs and financial
statement credibility for a company. Therefore, it can be argued that companies with greater need
to reduce costs will shift “down” from Big 4 auditors to mid-tier auditors, but companies with
greater need for credibility (and financial advice) will shift “up” from mid-tier auditors to Big 4
auditors.
LO 3, 4 BT: AP, Difficulty: Hard, TOT: 15 min., AACSB: Analytic, AICPA BC: Customer Perspective, Section: Demand for
Audit and Assurance Services, Preparers and Auditors
AP1.5 The solution will vary based on the states selected by the student to research. In general,
most states require a bachelor’s degree and relevant accounting and business courses. Some
states, such as Texas and Colorado, require an ethics course. Some states allow candidates to sit
for the CPA exam after completing a bachelor’s degree with the relevant accounting courses, but
a total of 150 hours of college credits are required to be licensed as a CPA. In addition to passing
the CPA exam and meeting the education requirements, most states require 1-2 years of work
experience in public accounting to be licensed.
LO 5, BT: AN, Difficulty: Basic, TOT: 20 min., AACSB: Technology, AICPA AC: Research, Section: The Role of Regulators
and Regulations
AP1.6 To be registered with the PCAOB, a firm must complete a 27-page application (Form 1)
and pay the required fees. The purpose of Form 1 is to capture information about the firm in-
cluding contact information, number of employees, types of clients serviced by the firm, any on-
going or pending criminal or civil actions against the firm, quality control procedures, and
names of issuers that the firm expects to provide audit services to in the current year. Form 1 is
signed by a partner or authorized officer of the firm. The application fee is $500 for a firm that
audits less than 50 issuers, $3,000 for a firm that audits 50-100 issuers, $29,000 for a firm that
audits 101-1000 issuers, and $390,000 for a firm that audits 1001 or more issuers.
Once a firm is registered, annual fees are $100,000 for firms with more than 500 issuer
8 | © 2022 John Wiley and Sons, Inc. For Instructor Use Only
