AUDIT Chapter 2 Review Questions

(2-9) What kind of organization is the PCAOB, why was it formed, and what does it do?

Public Company Accounting Oversight Board (PCAOB) is a nonprofit and quasi-government organization established by Congress under the Sarbanes-Oxley Act to oversee the audits of public companies in order to protect the interests of investors. The public accounting firms who provide audits services to public trade companies must register with the PCAOB and follow its auditing standards.

(2-11) Identify three of the documents required by the Security Exchange Act of 1934 that are commonly encountered by auditors. Briefly describe the purpose of each of these documents.

1) 10K are annual reports. 2) 10Q are quarterly reports. 3) 8K are documents filed when a "material corporate event" occurs, such as a change of auditors.

(2-10) What role does the SEC play in the establishment of accounting and auditing standards for public companies?

- The SEC has congressional authority from the original Securities Acts of 1933 and 1934 to establish accounting and auditing standards for publicly traded companies; however, in the past the SEC has largely delegated this authority to other bodies, including the FASB and the AICPA's Auditing Standards Board. - The Sarbanes-Oxley Act of 2002 gave the SEC the mandate to actively regulate the public accounting profession by establishing and overseeing the PCAOB and its standard-setting process relating to the audits of public companies. - The SEC has authority to implement and oversee standards relating to all aspects of the audits of public companies, including standards relating to auditor independence (such as the requirement for audit firms to rotate audit partners off audit engagements every five years).

(2-1) List the various type of auditors and describe their respective role in a sentence or two each.

1) External auditors who provide independent audit and other assurance services to public and nonpublic trade companies. 2) Internal auditors are employees of individual companies, government agencies, and other entities, and they often conduct service within their own organization. 3) Government auditors are employed by government agencies and audit public organizations that receive fund from government, such as school. 4) Forensic auditors are auditors who specially trained in detecting, investigating, and detecting fraud. Corporations, government agencies, and public accounting firms could hire forensic auditors if they suspect fraud in the process of providing services.

(2-8) The AICPA performs a number of functions that directly bear on independent auditors of nonpublic entities, including promulgation of rules and standards. List four types of rules or standards issued by the AICPA.

1) The Code of Professional Conduct. 2) Quality control and peer review standard. 3) Attestation standards. 4) Compilation and review standards.

(2-2) Give one example each of compliance, operational, and forensic audits.

A compliance audit of a bank determines if loan offices follow a policy of granting loans to borrowers. An operational audit could evaluate how efficient of a manufacturing product line. A corporation could hire an independent auditor to conduct a forensic audit if it suspects a division manager embezzlement.

(2-13) Discuss why auditing standards are important for evaluating whether an auditor has done an adequate audit, especially when the auditor fails to detect a material misstatement in the financial statement.

Auditors can provide "reasonable assurance" for financial report in free of material misstatement. However, with audit risk, auditor could possible fail to detect material misstatement. In such case, auditors must proof they have done an adequate audit with due care in accordance with the level of auditing standards' requirement.

(2-3) Briefly discuss the key events that led up to the Sarbanes-Oxley Act of 2002 and the creation of the PCAOB.

During the late 1990s and early 2000s, public accounting firms began to provide lubricate nonaudit service such as consulting. This service derived from their core audit practice. Since nonaudit generated a massive amount of revenue for CPA firms, auditors refused to challenge managements' actions that resulted in conflict between professional ethics and prosperous. Successive financial scandals caused investors to doubt the integrity of the financial reporting and audit system. Under pressures to restore investors' confidence, Congress passed the Sox of 2002 and created PCAOB in 2002.

(2-6) Why might understanding the characteristics of an entity's business model be important for a financial statement auditor?

Even thought different industries have strikingly different characteristics, most businesses have some fundamental conceptual in common. These commonalities facilitate auditors to organize and plan their audit procedure regardless of the type of entity they are auditing.

(2-14) Why is independence such an important standard for auditors? How does auditor independence relate to the agency relationship between owners and managers discussed in Chapter 1?

Independence is an important requirement for auditors because the level of owners' confidence in the auditors' work are directly related to the level of independence. If there are ties between the managers and external auditors, owners will not believe that the audit reports can reduce information risk.

(2-5) Compare and contrast management's responsibility for the entity's financial statement with the auditor's responsibilities for detecting errors and fraud in the financial statements.

Management is responsible for presenting fair financial statements in conformity with GAAP, and audits are confined to express their opinion on the information provided. Auditors are responsible to evaluate if management is conforming with GAAP without materiality error.

(2-12) List and briefly describe the four categories of Principles Underlying an Audit Conducted in Accordance with GAAS.

The four categories of Principles Underlying an Audit Conducted in Accordance with GAAS are: 1) Purpose and premise of audit: Purpose of audit is to provide an opinion on whether the F/S prepared in accordance with applicable financial reporting framework, while premise is the management's responsibilities to prepare F/S in accordance with applicable financial reporting framework and to provide necessary information and access to audit evidence for auditors. 2) Personal responsibilities of an auditor: Auditors must have appropriate competence, ethics, professional skepticism, and judgment. 3) Auditor actions in performing the audit: ????? 4) Reporting: based on evaluation of audit evidence obtained, express an opinion.

(2-7) What roles do information systems and systems of internal control play in the high-level model of business discussed in the chapter, and why might it be important for an auditor to understand these roles?

The information systems must maintain a record of all business transactions, be able to produce accurate and summarized financial report for the entity. Meanwhile, effective internal control is required to ensure that a proper environment is established for the entity and the entity's information systems. Auditing standards require that the auditor obtain an understanding of its client's environment, including its internal control, in planning the nature, timing, and extent of testing.