VE
Chapter 1
R
IF
The Demand for Audit and Other Assurance Services
IE
Concept Checks
D
P. 7
BR
1. To do an audit, there must be information in a verifiable form and some
standards (criteria) by which the auditor can evaluate the information.
AI
Determining the degree of correspondence between information and
established criteria is determining whether a given set of information is in
N
accordance with the established criteria. For an audit of a company’s
BO
financial statements the criteria are U.S. generally accepted accounting
principles or International Financial Reporting Standards.
O
2. The four primary causes of information risk are remoteness of information,
biases and motives of the provider, voluminous data, and the existence of
ST
complex exchange transactions.
The three main ways to reduce information risk are:
ER
1. User verifies the information.
2. User shares the information risk with management.
3. Audited financial statements are provided.
P. 16
1. The three main types of audits are operational audits, compliance audits, and
financial statement audits. The table below summarizes the purposes and
nature of each type of audit.
AUDITS OF
OPERATIONAL COMPLIANCE FINANCIAL
AUDITS AUDITS STATEMENTS
PURPOSE To evaluate To determine To determine
whether whether the client is whether the
operating following specific overall financial
procedures are procedures set by a statements are
efficient and higher authority presented in
effective accordance with
specified criteria
(usually GAAP)
1-1
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Concept Check, P. 16 (continued)
R
IF
AUDITS OF
OPERATIONAL COMPLIANCE FINANCIAL
IE
AUDITS AUDITS STATEMENTS
D
USERS OF Management of Authority that Different groups
AUDIT organization established rules, for different
BR
REPORT regulations, and purposes — many
procedures, either outside entities
internal or external to
AI
auditee
N
NATURE Highly Not standardized, Highly
nonstandard; but specific and standardized
BO
often subjective usually objective
PERFORMED
O
BY: Almost
CPAs Frequently Occasionally universally
ST
GAO
AUDITORS Frequently Frequently Occasionally
ER
IRS
AUDITORS Never Universally Never
INTERNAL
AUDITORS Frequently Frequently Frequently*
* Internal auditors may assist CPAs in the audit of financial statements. Internal
auditors may also audit internal financial statements for use by management.
2. The major differences in the scope of audit responsibilities for CPAs, GAO
auditors, IRS agents, and internal auditors are:
CPAs perform audits of financial statements prepared using U.S.
GAAP or IFRS in accordance with auditing standards.
GAO auditors perform compliance or operational audits in order to
assure the Congress of the expenditure of public funds in accordance
with its directives and the law.
IRS agents perform compliance audits to enforce the federal tax laws
as defined by Congress, interpreted by the courts, and regulated by the
IRS.
Internal auditors perform compliance or operational audits in order to
assure management or the board of directors that controls and policies
are properly and consistently developed, applied, and evaluated.
1-2
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, VE
Review Questions
R
1-1 To do an audit, there must be information in a verifiable form and some
IF
standards (criteria) by which the auditor can evaluate the information. The
IE
information for Jones Company's tax return is the federal tax returns filed by the
company. The established criteria are found in the Internal Revenue Code
D
and all interpretations. For the audit of Jones Company's financial
statements the information is the financial statements being audited and the
BR
established criteria are U.S. GAAP or IFRS.
1-2 This apparent paradox arises from the distinction between the function of
AI
auditing and the function of accounting. The accounting function is the recording,
classifying, and summarizing of economic events to provide relevant information
N
to decision makers. The rules of accounting are the criteria used by the auditor
BO
for evaluating the presentation of economic events for financial statements and
they must therefore have an understanding of accounting standards, as well as
auditing standards. The accountant need not, and frequently does not,
O
understand what auditors do, unless they are involved in doing audits, or have
been trained as an auditor.
ST
1-3 An independent audit is a means of satisfying the need for reliable
ER
information on the part of decision makers. Recent changes in accounting and
business operations include:
1. Increased global activities of many businesses
a. Multiple product lines and transaction locations
b. Foreign exchange affects transactions
2. Complex accounting and exchange transactions
a. Increasing use of derivatives and hedging activities
b. Increasingly complex accounting standards in areas such as
revenue recognition
3. More complex information systems
a. Possibly millions of transactions processed daily through on-
line and traditional sales channels
b. Voluminous data requires interpretation
1-4 1. Risk-free interest rate This is approximately the rate the bank could
earn by investing in U.S. treasury notes for the same length of time
as the business loan.
2. Business risk for the customer This risk reflects the possibility that
the business will not be able to repay its loan because of economic
or business conditions such as a recession, poor management
decisions, or unexpected competition in the industry.
3. Information risk This risk reflects the possibility that the information
upon which the business risk decision was made was inaccurate. A
likely cause of the information risk is the possibility of inaccurate
financial statements.
1-3
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1-4 (continued)
R
Auditing has no effect on either the risk-free interest rate or business risk.
IF
However, auditing can significantly reduce information risk.
IE
1-5 The three main ways to reduce information risk are:
D
1. User verifies the information.
BR
2. User shares the information risk with management.
3. Audited financial statements are provided.
The advantages and disadvantages of each are as follows:
AI
N
ADVANTAGES DISADVANTAGES
BO
USER VERIFIES 1. User obtains information 1. High cost of obtaining
INFORMATION desired. information.
2. User can be more confident 2. Inconvenience to the
O
of the qualifications and person providing the
activities of the person information because
ST
getting the information. large number of users
would require access
ER
to information.
USER SHARES 1. No audit costs incurred. 1. User may not be able
INFORMATION to collect on losses.
RISK WITH
MANAGEMENT
AUDITED 1. Multiple users obtain the 1. May not meet needs
FINANCIAL information. of certain users.
STATEMENTS 2. Information risk can usually 2. Cost may be higher
ARE PROVIDED be reduced sufficiently to than the benefits in
satisfy users at reasonable some situations, such
cost. as for a small
3. Minimal inconvenience to company.
management by having
only one auditor.
1-6 Information risk is the risk that information upon which a business decision is
made is inaccurate. Fair value accounting is often based on estimates and requires
judgment. Fair value can be estimated using multiple methods with some estimates
being more subjective than others. Fair value estimates are made at a point in time,
but can also change rapidly, depending on market conditions. All of these factors
increase information risk.
1-7 An assurance service is an independent professional service to improve the
quality of information for decision makers. An attestation service is a form of
assurance service in which the CPA firm issues a report about the reliability of an
assertion that is the responsibility of another party.
1-4
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VERIFIEDBRAINBOOSTER
, VE
1-7 (continued)
R
The most common form of audit service is an audit of historical financial
IF
statements, in which the auditor expresses a conclusion as to whether the
IE
financial statements are presented in accordance with an applicable financial
reporting framework such as U.S. GAAP or IFRS. An example of an attestation
D
service is a report on the effectiveness of an entity’s internal control over financial
reporting. There are many possible forms of assurance services, including services
BR
related to business performance measurement, health care performance, and
information system reliability.
AI
1-8 Some organizations issue sustainability reports to highlight the work they
are doing related to the environment, social issues, and governance (often
N
referred to as ESG). These reports include different types of data that reflect the
BO
organization’s overall performance related to their sustainability efforts. For
example, some organizations provide data related to carbon emissions, resource
usage, and waste generation to highlight their impact on the environment. Others
O
report demographic data about the types of individuals they hire as employees or
serve as customers. Investors and other users of these sustainability reports may
ST
desire assurance from CPAs about the accuracy and reliability of these data
items.
ER
1-9 The primary evidence the internal revenue agent will use in the audit of
the Jones Company's tax return include all available documentation and other
information available in Jones’ office or from other sources. For example, when
the internal revenue agent audits taxable income, a major source of information
will be bank statements, the cash receipts journal and deposit slips. The internal
revenue agent is likely to emphasize unrecorded receipts and revenues. For
expenses, major sources of evidence are likely to be cancelled checks and
electronic funds transfers, vendors' invoices, and other supporting
documentation.
1-10 Five examples of specific operational audits that could be conducted by an
internal auditor in a manufacturing company are:
1. Examine employee time records and personnel records to determine
if sufficient information is available to maximize the effective use of
personnel.
2. Review the processing of sales invoices to determine if it could be
done more efficiently.
3. Review the acquisitions of goods, including costs, to determine if
they are being purchased at the lowest possible cost considering
the quality needed.
4. Review and evaluate the efficiency of the manufacturing process.
5. Review the processing of cash receipts to determine if they are
deposited as quickly as possible.
1-5
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VERIFIEDBRAINBOOSTER
, VE
1-11 When auditing historical financial statements, an auditor must have a
R
thorough understanding of the client and its environment, including knowledge
about the client’s regulatory and operating environment, business strategies and
IF
processes, and measurement indicators. This strategic understanding is also
IE
useful in other assurance or consulting engagements. For example, an auditor
performing an assurance service on information technology would need to
D
understand the client’s business strategies and processes related to information
technology, including such things as purchases and sales via the Internet.
BR
Similarly, a practitioner performing a consulting engagement to evaluate the
efficiency and effectiveness of a client’s manufacturing process would likely start
with an analysis of various measurement indicators, including ratio analysis and
AI
benchmarking against key competitors.
N
1-12 Prior to January 2024, the four parts of the Uniform CPA Examination are:
BO
Auditing and Attestation, Financial Accounting and Reporting, Regulation, and
Business Environment and Concepts. Effective January 2024, every individual
taking the CPA exam will take three “Core” sections (Accounting, Audit and
O
Attestation, and Tax) and will choose one discipline area (Business Analysis and
Reporting, Information Systems and Controls, or Tax Compliance and Planning)
ST
that will cover a deeper dive of relevant content.
ER
Multiple Choice Questions From CPA Examinations
1-13 a. (1) b. (4) c. (1)
1-14 a. (3) b. (4) c. (1)
Multiple Choice Questions From Becker CPA Exam Review
1-15 a. (4) b. (3) c. (3)
Discussion Questions And Problems
1-16 a. Audit services are a form of attestation service, and attestation
services are a form of assurance service. In a diagram, audit
services are located within the attestation service area, and
attestation services are located within the assurance service area.
b. 1. (2) An attestation service other than an audit service
2. (2) An attestation service other than an audit service
3. (1) An audit of historical financial statements
4. (3) An assurance or nonassurance service that is not an
attestation service
5. (2) An attestation service other than an audit service
6. (2) An attestation service other than an audit service
1-6
Copyright © 2024 Pearson Education, Inc.
VERIFIEDBRAINBOOSTER
Chapter 1
R
IF
The Demand for Audit and Other Assurance Services
IE
Concept Checks
D
P. 7
BR
1. To do an audit, there must be information in a verifiable form and some
standards (criteria) by which the auditor can evaluate the information.
AI
Determining the degree of correspondence between information and
established criteria is determining whether a given set of information is in
N
accordance with the established criteria. For an audit of a company’s
BO
financial statements the criteria are U.S. generally accepted accounting
principles or International Financial Reporting Standards.
O
2. The four primary causes of information risk are remoteness of information,
biases and motives of the provider, voluminous data, and the existence of
ST
complex exchange transactions.
The three main ways to reduce information risk are:
ER
1. User verifies the information.
2. User shares the information risk with management.
3. Audited financial statements are provided.
P. 16
1. The three main types of audits are operational audits, compliance audits, and
financial statement audits. The table below summarizes the purposes and
nature of each type of audit.
AUDITS OF
OPERATIONAL COMPLIANCE FINANCIAL
AUDITS AUDITS STATEMENTS
PURPOSE To evaluate To determine To determine
whether whether the client is whether the
operating following specific overall financial
procedures are procedures set by a statements are
efficient and higher authority presented in
effective accordance with
specified criteria
(usually GAAP)
1-1
Copyright © 2024 Pearson Education, Inc.
VERIFIEDBRAINBOOSTER
, VE
Concept Check, P. 16 (continued)
R
IF
AUDITS OF
OPERATIONAL COMPLIANCE FINANCIAL
IE
AUDITS AUDITS STATEMENTS
D
USERS OF Management of Authority that Different groups
AUDIT organization established rules, for different
BR
REPORT regulations, and purposes — many
procedures, either outside entities
internal or external to
AI
auditee
N
NATURE Highly Not standardized, Highly
nonstandard; but specific and standardized
BO
often subjective usually objective
PERFORMED
O
BY: Almost
CPAs Frequently Occasionally universally
ST
GAO
AUDITORS Frequently Frequently Occasionally
ER
IRS
AUDITORS Never Universally Never
INTERNAL
AUDITORS Frequently Frequently Frequently*
* Internal auditors may assist CPAs in the audit of financial statements. Internal
auditors may also audit internal financial statements for use by management.
2. The major differences in the scope of audit responsibilities for CPAs, GAO
auditors, IRS agents, and internal auditors are:
CPAs perform audits of financial statements prepared using U.S.
GAAP or IFRS in accordance with auditing standards.
GAO auditors perform compliance or operational audits in order to
assure the Congress of the expenditure of public funds in accordance
with its directives and the law.
IRS agents perform compliance audits to enforce the federal tax laws
as defined by Congress, interpreted by the courts, and regulated by the
IRS.
Internal auditors perform compliance or operational audits in order to
assure management or the board of directors that controls and policies
are properly and consistently developed, applied, and evaluated.
1-2
Copyright © 2024 Pearson Education, Inc.
VERIFIEDBRAINBOOSTER
, VE
Review Questions
R
1-1 To do an audit, there must be information in a verifiable form and some
IF
standards (criteria) by which the auditor can evaluate the information. The
IE
information for Jones Company's tax return is the federal tax returns filed by the
company. The established criteria are found in the Internal Revenue Code
D
and all interpretations. For the audit of Jones Company's financial
statements the information is the financial statements being audited and the
BR
established criteria are U.S. GAAP or IFRS.
1-2 This apparent paradox arises from the distinction between the function of
AI
auditing and the function of accounting. The accounting function is the recording,
classifying, and summarizing of economic events to provide relevant information
N
to decision makers. The rules of accounting are the criteria used by the auditor
BO
for evaluating the presentation of economic events for financial statements and
they must therefore have an understanding of accounting standards, as well as
auditing standards. The accountant need not, and frequently does not,
O
understand what auditors do, unless they are involved in doing audits, or have
been trained as an auditor.
ST
1-3 An independent audit is a means of satisfying the need for reliable
ER
information on the part of decision makers. Recent changes in accounting and
business operations include:
1. Increased global activities of many businesses
a. Multiple product lines and transaction locations
b. Foreign exchange affects transactions
2. Complex accounting and exchange transactions
a. Increasing use of derivatives and hedging activities
b. Increasingly complex accounting standards in areas such as
revenue recognition
3. More complex information systems
a. Possibly millions of transactions processed daily through on-
line and traditional sales channels
b. Voluminous data requires interpretation
1-4 1. Risk-free interest rate This is approximately the rate the bank could
earn by investing in U.S. treasury notes for the same length of time
as the business loan.
2. Business risk for the customer This risk reflects the possibility that
the business will not be able to repay its loan because of economic
or business conditions such as a recession, poor management
decisions, or unexpected competition in the industry.
3. Information risk This risk reflects the possibility that the information
upon which the business risk decision was made was inaccurate. A
likely cause of the information risk is the possibility of inaccurate
financial statements.
1-3
Copyright © 2024 Pearson Education, Inc.
VERIFIEDBRAINBOOSTER
, VE
1-4 (continued)
R
Auditing has no effect on either the risk-free interest rate or business risk.
IF
However, auditing can significantly reduce information risk.
IE
1-5 The three main ways to reduce information risk are:
D
1. User verifies the information.
BR
2. User shares the information risk with management.
3. Audited financial statements are provided.
The advantages and disadvantages of each are as follows:
AI
N
ADVANTAGES DISADVANTAGES
BO
USER VERIFIES 1. User obtains information 1. High cost of obtaining
INFORMATION desired. information.
2. User can be more confident 2. Inconvenience to the
O
of the qualifications and person providing the
activities of the person information because
ST
getting the information. large number of users
would require access
ER
to information.
USER SHARES 1. No audit costs incurred. 1. User may not be able
INFORMATION to collect on losses.
RISK WITH
MANAGEMENT
AUDITED 1. Multiple users obtain the 1. May not meet needs
FINANCIAL information. of certain users.
STATEMENTS 2. Information risk can usually 2. Cost may be higher
ARE PROVIDED be reduced sufficiently to than the benefits in
satisfy users at reasonable some situations, such
cost. as for a small
3. Minimal inconvenience to company.
management by having
only one auditor.
1-6 Information risk is the risk that information upon which a business decision is
made is inaccurate. Fair value accounting is often based on estimates and requires
judgment. Fair value can be estimated using multiple methods with some estimates
being more subjective than others. Fair value estimates are made at a point in time,
but can also change rapidly, depending on market conditions. All of these factors
increase information risk.
1-7 An assurance service is an independent professional service to improve the
quality of information for decision makers. An attestation service is a form of
assurance service in which the CPA firm issues a report about the reliability of an
assertion that is the responsibility of another party.
1-4
Copyright © 2024 Pearson Education, Inc.
VERIFIEDBRAINBOOSTER
, VE
1-7 (continued)
R
The most common form of audit service is an audit of historical financial
IF
statements, in which the auditor expresses a conclusion as to whether the
IE
financial statements are presented in accordance with an applicable financial
reporting framework such as U.S. GAAP or IFRS. An example of an attestation
D
service is a report on the effectiveness of an entity’s internal control over financial
reporting. There are many possible forms of assurance services, including services
BR
related to business performance measurement, health care performance, and
information system reliability.
AI
1-8 Some organizations issue sustainability reports to highlight the work they
are doing related to the environment, social issues, and governance (often
N
referred to as ESG). These reports include different types of data that reflect the
BO
organization’s overall performance related to their sustainability efforts. For
example, some organizations provide data related to carbon emissions, resource
usage, and waste generation to highlight their impact on the environment. Others
O
report demographic data about the types of individuals they hire as employees or
serve as customers. Investors and other users of these sustainability reports may
ST
desire assurance from CPAs about the accuracy and reliability of these data
items.
ER
1-9 The primary evidence the internal revenue agent will use in the audit of
the Jones Company's tax return include all available documentation and other
information available in Jones’ office or from other sources. For example, when
the internal revenue agent audits taxable income, a major source of information
will be bank statements, the cash receipts journal and deposit slips. The internal
revenue agent is likely to emphasize unrecorded receipts and revenues. For
expenses, major sources of evidence are likely to be cancelled checks and
electronic funds transfers, vendors' invoices, and other supporting
documentation.
1-10 Five examples of specific operational audits that could be conducted by an
internal auditor in a manufacturing company are:
1. Examine employee time records and personnel records to determine
if sufficient information is available to maximize the effective use of
personnel.
2. Review the processing of sales invoices to determine if it could be
done more efficiently.
3. Review the acquisitions of goods, including costs, to determine if
they are being purchased at the lowest possible cost considering
the quality needed.
4. Review and evaluate the efficiency of the manufacturing process.
5. Review the processing of cash receipts to determine if they are
deposited as quickly as possible.
1-5
Copyright © 2024 Pearson Education, Inc.
VERIFIEDBRAINBOOSTER
, VE
1-11 When auditing historical financial statements, an auditor must have a
R
thorough understanding of the client and its environment, including knowledge
about the client’s regulatory and operating environment, business strategies and
IF
processes, and measurement indicators. This strategic understanding is also
IE
useful in other assurance or consulting engagements. For example, an auditor
performing an assurance service on information technology would need to
D
understand the client’s business strategies and processes related to information
technology, including such things as purchases and sales via the Internet.
BR
Similarly, a practitioner performing a consulting engagement to evaluate the
efficiency and effectiveness of a client’s manufacturing process would likely start
with an analysis of various measurement indicators, including ratio analysis and
AI
benchmarking against key competitors.
N
1-12 Prior to January 2024, the four parts of the Uniform CPA Examination are:
BO
Auditing and Attestation, Financial Accounting and Reporting, Regulation, and
Business Environment and Concepts. Effective January 2024, every individual
taking the CPA exam will take three “Core” sections (Accounting, Audit and
O
Attestation, and Tax) and will choose one discipline area (Business Analysis and
Reporting, Information Systems and Controls, or Tax Compliance and Planning)
ST
that will cover a deeper dive of relevant content.
ER
Multiple Choice Questions From CPA Examinations
1-13 a. (1) b. (4) c. (1)
1-14 a. (3) b. (4) c. (1)
Multiple Choice Questions From Becker CPA Exam Review
1-15 a. (4) b. (3) c. (3)
Discussion Questions And Problems
1-16 a. Audit services are a form of attestation service, and attestation
services are a form of assurance service. In a diagram, audit
services are located within the attestation service area, and
attestation services are located within the assurance service area.
b. 1. (2) An attestation service other than an audit service
2. (2) An attestation service other than an audit service
3. (1) An audit of historical financial statements
4. (3) An assurance or nonassurance service that is not an
attestation service
5. (2) An attestation service other than an audit service
6. (2) An attestation service other than an audit service
1-6
Copyright © 2024 Pearson Education, Inc.
VERIFIEDBRAINBOOSTER
