Solution Manual for
Principles of Auditing and Other Assurance Services
22nd Edition by Ray Whittington, Kurt Pany,
All Chapters 1 - 21
,
,CHAPTER 1
The Role of the Public
Accountant in the
American Economy
Review Questions
1-1 The ―crisis of credibility‖ largely arose from the number of companies that restated their previously issued financial statements as a
result of accounting irregularities and fraud. Especially responsible werethe very visible Enron and WorldCom fraud cases. Both
companies filed for bankruptcy and constituted the largest companies in American history to do so. The extent of the accounting
irregularities and fraud being investigated and disclosed brought into question the effectiveness of financial statement audits. In
addition, the criminal conviction of Arthur Andersen, LLP, one of the then Big 5 accounting firms, on charges of destroying documents
related to the Enron case brought into question the ethics standards of the profession.
1-2 Assurance services are professional services that enhance the quality of information, or its context, for decision-making. The two
types are: (a) those that increase the reliability of information and (b) those that involve putting information in a form or context that
facilitates decision-making.
1-3 A financial statement audit is, by far, the most common type of attest engagement. The overall assertion,made by management, most
frequently is that the financial statements follow generally accepted accounting principles.
1-4 A large corporation with securities listed on a stock exchange is required by the rules of the stock exchange and by the rules of the
Securities and Exchange Commission to provide an audit report with theannual financial statements furnished to its stockholders. It also
is required to engage the auditors to provide an opinion on its internal control. Apart from legal requirements, however, a large listed
corporation recognizes that it must maintain investor confidence in the reliability of its financial statements and internal control over
financial reporting if it is to continue to be able to secure capital from the public. The report by a firm of certified public accountants
adds credibility to the financial statements prepared by the corporation. When a small family-owned enterprise elects to have an audit,
the purpose usually is to use the auditors' report to support an application for a bank loan.
Solutions Manual, Chapter 6, Page 1 of 357
, 1-5 A report by an independent public accountant concerning the fairness of a company's financial statementsis commonly required in the
following situations:
(1) Application for a bank loan.
(2) Establishing credit for purchase of merchandise, equipment, or other assets.
(3) Reporting operating results, financial position, and cash flows to absentee owners (stockholdersor partners).
(4) Issuance of securities by a corporation.
(5) Annual financial statements by a corporation with securities listed on a stock exchange or tradedover the counter.
(6) Sale of an ongoing business.
(7) Termination of a partnership.
1-6 To add credibility to financial statements is to increase the likelihood that they have been prepared following the appropriate criteria,
usually generally accepted accounting principles. As such, an increasein credibility results in financial statements that can be believed
and relied upon by third parties.
1-7 Business risk is the risk that the investment will be impaired because a company invested in is unable tomeet its financial obligations
due to economic conditions or poor management decisions. Information risk is the risk that the information used to assess business
risk is not accurate. Auditors can directly reduce information risk, but have only limited effect on business risk.
1-8 At the beginning of the century, the principal objective of auditing was the prevention and detection of fraud. Audit work centered on the
balance sheet, because the income statement was regarded as highly confidential and not for public disclosure. Today, the principal
objective of auditing is to form an opinion on the fairness of financial statements and their conformity with generally accepted
accounting principles. But the professional standards also require that an audit be designed to provide reasonable assurance of detecting
material misstatements, due to errors or fraud. Particular emphasis is placed on the income statement which is of great importance to
investors. Auditing today also has the objectives ofmeeting the requirements of the Securities and Exchange Commission (SEC) and the
Public Company Accounting Oversight Board for public companies.
1-9 The statement is incorrect. The increasing integrated databases of today, along with available auditprocedures make audited
entire populations a possibility in many situations.
1-10 An operational audit attempts to measure the effectiveness and efficiency of a specific unit of an organization. It involves more
subjective judgments than a compliance audit or an audit of financial statements because the criteria of effectiveness and efficiency
of departmental performance are not asclearly established as are many laws and regulations or generally accepted accounting
principles.
The report prepared after completion of an operational audit is usually directed to managementof the organization in which
the audit work was done.
1-11 A compliance audit is an audit to determine whether financial reports or other assertions are in compliance with established criteria.
The necessary ingredients are verifiable data and the existence of standards established by an authoritative body. An operational audit,
on the other hand, is a review of adepartment or other unit of a business or governmental organization to measure the effectiveness
and efficiency of operations. Internal auditors often perform operational audits as do auditors employed by the Government
Accountability Office (GAO) of the federal government.
1-12 Internal auditors must be independent of the department heads and other line executives whose work theyreview. However, internal
auditors are not independent in the same sense as a public accounting firm.
Solutions Manual, Chapter 6, Page 2 of 357
