Auditing: An International Approach Seventh Canadian Edition Solution Manual
Auditing: An International Approach Seventh Canadian Edition Solution Manual is the ultimate guide for understanding and solving textbook problems.
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Smieliauskas & Bewley, Auditing: An International Approach, 7th Edition Page 1-1
Solutions Manual
CHAPTER 1
Introduction to Auditing
SOLUTIONS FOR REVIEW CHECKPOINTS
ESSENTIALS
1-1. In this example of a three-party accountability structure, the owner is the 'third party', the hired manager is the
'first party' and the auditor is the 'second party'. The owner is looking out for his/her own longer-term economic
interests, but has to rely on the actions and information provided by the hired manager, who may have shorter
term concerns (like his/her own compensation and job prospects) and thus act self-interestedly.
The owner is accountable for financing the business and treating the manager fairly, particularly in terms of
compensating his/her efforts and successes appropriately. The manager is accountable for giving reliable and fair
reports of the business profit performance to the owner. Give the potential conflicts between the interests of the
first and third parties, there is information risk - the risk that the financial statement information will not be a full
and fair representation of the transactions and events that really occurred, and will not be reliable for economic
decisions that the owner may base upon it. The auditor is accountable for objectively verifying the fairness and
reliability of the information and providing an independent opinion on how well the information reflects the
underlying realities of the entity's operations. The auditor's opinion can benefit both the first and third parties -
the owner directly by lowering information risk, and the manager indirectly because if the owner has more basis to
trust the manager not to act against the owner's interests the owner will be more willing to share the profits with
the manager (this is referred to as lowering "agency costs," which are charged by the owner/principal and incurred
by the manager/agent if the owner does not trust the manager). For the auditor's opinion to have value in giving
the owner some comfort (i.e., "assurance") that the manager's information can be relied on, the auditor must have
no personal interest in either side and be able remain objective.
1-2. The concept of reasonable assurance describes a mental attitude that the auditor gains from the conclusions
drawn from audit examination findings. Based on the examination, if the auditor comes to believe the financial
statements are reliable and fair to the interests of third party users, this belief forms the basis of the opinion the
auditor will communicate to financial statement users in the Auditor's Report. An 'audit opinion' provides a high
level of assurance to the user that the auditor believes that the information risk is low, and has evidence to
support that belief.
TEXT
1-3 Auditors add credibility to financial information provided by the accountable party such as management (i.e.
auditors make the financial or other information more likely to be true or representationally faithful). Other
common ways of characterizing this property of audited numbers is that the numbers are more accurate, have
higher assurance, or are more reliable. These relate to different dimension of truthfulness, as we discuss later in
the text.
1-4 By obtaining more accurate or reliable information about the company, Aunt Zhang can obtain a more accurate
valuation of the company. This more accurate valuation gives Aunt Zhang more confidence that she will get her
money’s worth in the investment. The preceding assumes Aunt Zhang is risk averse—a common assumption about
economic behavior.
1-5 Auditing is the verification of numbers provided by others. To attest means to lend credibility or to vouch for the
truth or accuracy of the statements that one party makes to another. The attest function is a term often applied to
Solutions Manual
CHAPTER 1
Introduction to Auditing
SOLUTIONS FOR REVIEW CHECKPOINTS
ESSENTIALS
1-1. In this example of a three-party accountability structure, the owner is the 'third party', the hired manager is the
'first party' and the auditor is the 'second party'. The owner is looking out for his/her own longer-term economic
interests, but has to rely on the actions and information provided by the hired manager, who may have shorter
term concerns (like his/her own compensation and job prospects) and thus act self-interestedly.
The owner is accountable for financing the business and treating the manager fairly, particularly in terms of
compensating his/her efforts and successes appropriately. The manager is accountable for giving reliable and fair
reports of the business profit performance to the owner. Give the potential conflicts between the interests of the
first and third parties, there is information risk - the risk that the financial statement information will not be a full
and fair representation of the transactions and events that really occurred, and will not be reliable for economic
decisions that the owner may base upon it. The auditor is accountable for objectively verifying the fairness and
reliability of the information and providing an independent opinion on how well the information reflects the
underlying realities of the entity's operations. The auditor's opinion can benefit both the first and third parties -
the owner directly by lowering information risk, and the manager indirectly because if the owner has more basis to
trust the manager not to act against the owner's interests the owner will be more willing to share the profits with
the manager (this is referred to as lowering "agency costs," which are charged by the owner/principal and incurred
by the manager/agent if the owner does not trust the manager). For the auditor's opinion to have value in giving
the owner some comfort (i.e., "assurance") that the manager's information can be relied on, the auditor must have
no personal interest in either side and be able remain objective.
1-2. The concept of reasonable assurance describes a mental attitude that the auditor gains from the conclusions
drawn from audit examination findings. Based on the examination, if the auditor comes to believe the financial
statements are reliable and fair to the interests of third party users, this belief forms the basis of the opinion the
auditor will communicate to financial statement users in the Auditor's Report. An 'audit opinion' provides a high
level of assurance to the user that the auditor believes that the information risk is low, and has evidence to
support that belief.
TEXT
1-3 Auditors add credibility to financial information provided by the accountable party such as management (i.e.
auditors make the financial or other information more likely to be true or representationally faithful). Other
common ways of characterizing this property of audited numbers is that the numbers are more accurate, have
higher assurance, or are more reliable. These relate to different dimension of truthfulness, as we discuss later in
the text.
1-4 By obtaining more accurate or reliable information about the company, Aunt Zhang can obtain a more accurate
valuation of the company. This more accurate valuation gives Aunt Zhang more confidence that she will get her
money’s worth in the investment. The preceding assumes Aunt Zhang is risk averse—a common assumption about
economic behavior.
1-5 Auditing is the verification of numbers provided by others. To attest means to lend credibility or to vouch for the
truth or accuracy of the statements that one party makes to another. The attest function is a term often applied to
Smieliauskas & Bewley, Auditing: An International Approach, 7th Edition Page 1-1
Solutions Manual
CHAPTER 1
Introduction to Auditing
SOLUTIONS FOR REVIEW CHECKPOINTS
ESSENTIALS
1-1. In this example of a three-party accountability structure, the owner is the 'third party', the hired manager is the
'first party' and the auditor is the 'second party'. The owner is looking out for his/her own longer-term economic
interests, but has to rely on the actions and information provided by the hired manager, who may have shorter
term concerns (like his/her own compensation and job prospects) and thus act self-interestedly.
The owner is accountable for financing the business and treating the manager fairly, particularly in terms of
compensating his/her efforts and successes appropriately. The manager is accountable for giving reliable and fair
reports of the business profit performance to the owner. Give the potential conflicts between the interests of the
first and third parties, there is information risk - the risk that the financial statement information will not be a full
and fair representation of the transactions and events that really occurred, and will not be reliable for economic
decisions that the owner may base upon it. The auditor is accountable for objectively verifying the fairness and
reliability of the information and providing an independent opinion on how well the information reflects the
underlying realities of the entity's operations. The auditor's opinion can benefit both the first and third parties -
the owner directly by lowering information risk, and the manager indirectly because if the owner has more basis to
trust the manager not to act against the owner's interests the owner will be more willing to share the profits with
the manager (this is referred to as lowering "agency costs," which are charged by the owner/principal and incurred
by the manager/agent if the owner does not trust the manager). For the auditor's opinion to have value in giving
the owner some comfort (i.e., "assurance") that the manager's information can be relied on, the auditor must have
no personal interest in either side and be able remain objective.
1-2. The concept of reasonable assurance describes a mental attitude that the auditor gains from the conclusions
drawn from audit examination findings. Based on the examination, if the auditor comes to believe the financial
statements are reliable and fair to the interests of third party users, this belief forms the basis of the opinion the
auditor will communicate to financial statement users in the Auditor's Report. An 'audit opinion' provides a high
level of assurance to the user that the auditor believes that the information risk is low, and has evidence to
support that belief.
TEXT
1-3 Auditors add credibility to financial information provided by the accountable party such as management (i.e.
auditors make the financial or other information more likely to be true or representationally faithful). Other
common ways of characterizing this property of audited numbers is that the numbers are more accurate, have
higher assurance, or are more reliable. These relate to different dimension of truthfulness, as we discuss later in
the text.
1-4 By obtaining more accurate or reliable information about the company, Aunt Zhang can obtain a more accurate
valuation of the company. This more accurate valuation gives Aunt Zhang more confidence that she will get her
money’s worth in the investment. The preceding assumes Aunt Zhang is risk averse—a common assumption about
economic behavior.
1-5 Auditing is the verification of numbers provided by others. To attest means to lend credibility or to vouch for the
truth or accuracy of the statements that one party makes to another. The attest function is a term often applied to
Solutions Manual
CHAPTER 1
Introduction to Auditing
SOLUTIONS FOR REVIEW CHECKPOINTS
ESSENTIALS
1-1. In this example of a three-party accountability structure, the owner is the 'third party', the hired manager is the
'first party' and the auditor is the 'second party'. The owner is looking out for his/her own longer-term economic
interests, but has to rely on the actions and information provided by the hired manager, who may have shorter
term concerns (like his/her own compensation and job prospects) and thus act self-interestedly.
The owner is accountable for financing the business and treating the manager fairly, particularly in terms of
compensating his/her efforts and successes appropriately. The manager is accountable for giving reliable and fair
reports of the business profit performance to the owner. Give the potential conflicts between the interests of the
first and third parties, there is information risk - the risk that the financial statement information will not be a full
and fair representation of the transactions and events that really occurred, and will not be reliable for economic
decisions that the owner may base upon it. The auditor is accountable for objectively verifying the fairness and
reliability of the information and providing an independent opinion on how well the information reflects the
underlying realities of the entity's operations. The auditor's opinion can benefit both the first and third parties -
the owner directly by lowering information risk, and the manager indirectly because if the owner has more basis to
trust the manager not to act against the owner's interests the owner will be more willing to share the profits with
the manager (this is referred to as lowering "agency costs," which are charged by the owner/principal and incurred
by the manager/agent if the owner does not trust the manager). For the auditor's opinion to have value in giving
the owner some comfort (i.e., "assurance") that the manager's information can be relied on, the auditor must have
no personal interest in either side and be able remain objective.
1-2. The concept of reasonable assurance describes a mental attitude that the auditor gains from the conclusions
drawn from audit examination findings. Based on the examination, if the auditor comes to believe the financial
statements are reliable and fair to the interests of third party users, this belief forms the basis of the opinion the
auditor will communicate to financial statement users in the Auditor's Report. An 'audit opinion' provides a high
level of assurance to the user that the auditor believes that the information risk is low, and has evidence to
support that belief.
TEXT
1-3 Auditors add credibility to financial information provided by the accountable party such as management (i.e.
auditors make the financial or other information more likely to be true or representationally faithful). Other
common ways of characterizing this property of audited numbers is that the numbers are more accurate, have
higher assurance, or are more reliable. These relate to different dimension of truthfulness, as we discuss later in
the text.
1-4 By obtaining more accurate or reliable information about the company, Aunt Zhang can obtain a more accurate
valuation of the company. This more accurate valuation gives Aunt Zhang more confidence that she will get her
money’s worth in the investment. The preceding assumes Aunt Zhang is risk averse—a common assumption about
economic behavior.
1-5 Auditing is the verification of numbers provided by others. To attest means to lend credibility or to vouch for the
truth or accuracy of the statements that one party makes to another. The attest function is a term often applied to
Smieliauskas & Bewley, Auditing: An International Approach, 7th Edition Page 1-2
Solutions Manual
the activities of independent PAs when acting as auditors of financial statements.
Since financial statements are prepared by managers of an entity who have authority and responsibility for
financial success or failure, an outsider may be skeptical that the statements are objective, free from bias, fully
informative, and free from material error--intentional or inadvertent. The audit opinion of an independent-PA
auditor helps resolve those doubts because the auditor's success depends upon his independent, objective, and
competent assessment of the conformity of the financial statements with GAAP. The auditor's role is to lend
credibility to the statements, hence the outsider will likely seek his independent audit opinion.
1-6 Client: the company, board of directors, agency, or some other person or group who retains (hires) the
auditor. Usually the party who pays the fee.
Auditee: the entity (e.g., business firm, hospital, city government) whose financial information is under
audit.
Auditors: report to the client on the auditee's financial or control information.
Three party accountability consists of the auditor, the accountable party of the auditee such as management of the
auditee, and the users. Users include the client as defined above. Traditionally management hired the auditor so
that there was some confusion as to who was the true client. New corporate governance concepts in part attempt
to clarify this three party accountability.
1-7 Auditors gather evidence related to the assertions management makes in financial statements and render a report.
Accountants record, classify, and summarize (report) a company's assets, liabilities, capital, revenue, and expense
in financial statements. Accountants produce the financial statements, auditors audit them.
1-8 The conditions of complexity, remoteness and consequences produce demands by outside users for financial
reports. They cannot produce the reports for themselves because of these conditions. Company managers and
accountant produce them.
1-9 Students can refer to the AAA and CAS 200 (CPA Canada) definitions in Chapter 1. Some instructors may want to
extend the consideration of definitions to include the internal and governmental definitions.
In response to "what do auditors do," students can refer to Exhibit 1-2 and respond in terms of: (1) obtain and
evaluate evidence about assertions management makes about economic actions and events, (2) ascertains the
degree of correspondence between the assertions and GAAP, and (3) gives an audit report (opinion).
Students can also respond more generally in terms of "lending credibility" to financial statements presented by
management (attestation).
1-10 The essence of the risk reduction theory is that audits of financial statements reduce the information risk
(probability of materially misleading statements) to users to a socially acceptable level.
These various users cannot take it upon themselves to determine whether financial reports are reliable, therefore
low in the information risk scale. They do not have the expertise, resources, or time to enter thousands of
companies
1-11 Forensic accounting is the broader term that includes fraud auditing. Forensic accounting is the use of accounting
for legal or investigative purposes. Fraud auditing is the use of forensic accounting in criminal investigations
involving allegations of fraud. Frauds that PAs are most interested in are misappropriation of assets and fraudulent
financial reporting (misreporting).
1-12 Fraud is intentional deception resulting in a loss to the deceived party. Frauds that PAs are most interested in are
Solutions Manual
the activities of independent PAs when acting as auditors of financial statements.
Since financial statements are prepared by managers of an entity who have authority and responsibility for
financial success or failure, an outsider may be skeptical that the statements are objective, free from bias, fully
informative, and free from material error--intentional or inadvertent. The audit opinion of an independent-PA
auditor helps resolve those doubts because the auditor's success depends upon his independent, objective, and
competent assessment of the conformity of the financial statements with GAAP. The auditor's role is to lend
credibility to the statements, hence the outsider will likely seek his independent audit opinion.
1-6 Client: the company, board of directors, agency, or some other person or group who retains (hires) the
auditor. Usually the party who pays the fee.
Auditee: the entity (e.g., business firm, hospital, city government) whose financial information is under
audit.
Auditors: report to the client on the auditee's financial or control information.
Three party accountability consists of the auditor, the accountable party of the auditee such as management of the
auditee, and the users. Users include the client as defined above. Traditionally management hired the auditor so
that there was some confusion as to who was the true client. New corporate governance concepts in part attempt
to clarify this three party accountability.
1-7 Auditors gather evidence related to the assertions management makes in financial statements and render a report.
Accountants record, classify, and summarize (report) a company's assets, liabilities, capital, revenue, and expense
in financial statements. Accountants produce the financial statements, auditors audit them.
1-8 The conditions of complexity, remoteness and consequences produce demands by outside users for financial
reports. They cannot produce the reports for themselves because of these conditions. Company managers and
accountant produce them.
1-9 Students can refer to the AAA and CAS 200 (CPA Canada) definitions in Chapter 1. Some instructors may want to
extend the consideration of definitions to include the internal and governmental definitions.
In response to "what do auditors do," students can refer to Exhibit 1-2 and respond in terms of: (1) obtain and
evaluate evidence about assertions management makes about economic actions and events, (2) ascertains the
degree of correspondence between the assertions and GAAP, and (3) gives an audit report (opinion).
Students can also respond more generally in terms of "lending credibility" to financial statements presented by
management (attestation).
1-10 The essence of the risk reduction theory is that audits of financial statements reduce the information risk
(probability of materially misleading statements) to users to a socially acceptable level.
These various users cannot take it upon themselves to determine whether financial reports are reliable, therefore
low in the information risk scale. They do not have the expertise, resources, or time to enter thousands of
companies
1-11 Forensic accounting is the broader term that includes fraud auditing. Forensic accounting is the use of accounting
for legal or investigative purposes. Fraud auditing is the use of forensic accounting in criminal investigations
involving allegations of fraud. Frauds that PAs are most interested in are misappropriation of assets and fraudulent
financial reporting (misreporting).
1-12 Fraud is intentional deception resulting in a loss to the deceived party. Frauds that PAs are most interested in are
Smieliauskas & Bewley, Auditing: An International Approach, 7th Edition Page 1-2
Solutions Manual
the activities of independent PAs when acting as auditors of financial statements.
Since financial statements are prepared by managers of an entity who have authority and responsibility for
financial success or failure, an outsider may be skeptical that the statements are objective, free from bias, fully
informative, and free from material error--intentional or inadvertent. The audit opinion of an independent-PA
auditor helps resolve those doubts because the auditor's success depends upon his independent, objective, and
competent assessment of the conformity of the financial statements with GAAP. The auditor's role is to lend
credibility to the statements, hence the outsider will likely seek his independent audit opinion.
1-6 Client: the company, board of directors, agency, or some other person or group who retains (hires) the
auditor. Usually the party who pays the fee.
Auditee: the entity (e.g., business firm, hospital, city government) whose financial information is under
audit.
Auditors: report to the client on the auditee's financial or control information.
Three party accountability consists of the auditor, the accountable party of the auditee such as management of the
auditee, and the users. Users include the client as defined above. Traditionally management hired the auditor so
that there was some confusion as to who was the true client. New corporate governance concepts in part attempt
to clarify this three party accountability.
1-7 Auditors gather evidence related to the assertions management makes in financial statements and render a report.
Accountants record, classify, and summarize (report) a company's assets, liabilities, capital, revenue, and expense
in financial statements. Accountants produce the financial statements, auditors audit them.
1-8 The conditions of complexity, remoteness and consequences produce demands by outside users for financial
reports. They cannot produce the reports for themselves because of these conditions. Company managers and
accountant produce them.
1-9 Students can refer to the AAA and CAS 200 (CPA Canada) definitions in Chapter 1. Some instructors may want to
extend the consideration of definitions to include the internal and governmental definitions.
In response to "what do auditors do," students can refer to Exhibit 1-2 and respond in terms of: (1) obtain and
evaluate evidence about assertions management makes about economic actions and events, (2) ascertains the
degree of correspondence between the assertions and GAAP, and (3) gives an audit report (opinion).
Students can also respond more generally in terms of "lending credibility" to financial statements presented by
management (attestation).
1-10 The essence of the risk reduction theory is that audits of financial statements reduce the information risk
(probability of materially misleading statements) to users to a socially acceptable level.
These various users cannot take it upon themselves to determine whether financial reports are reliable, therefore
low in the information risk scale. They do not have the expertise, resources, or time to enter thousands of
companies
1-11 Forensic accounting is the broader term that includes fraud auditing. Forensic accounting is the use of accounting
for legal or investigative purposes. Fraud auditing is the use of forensic accounting in criminal investigations
involving allegations of fraud. Frauds that PAs are most interested in are misappropriation of assets and fraudulent
financial reporting (misreporting).
1-12 Fraud is intentional deception resulting in a loss to the deceived party. Frauds that PAs are most interested in are
Solutions Manual
the activities of independent PAs when acting as auditors of financial statements.
Since financial statements are prepared by managers of an entity who have authority and responsibility for
financial success or failure, an outsider may be skeptical that the statements are objective, free from bias, fully
informative, and free from material error--intentional or inadvertent. The audit opinion of an independent-PA
auditor helps resolve those doubts because the auditor's success depends upon his independent, objective, and
competent assessment of the conformity of the financial statements with GAAP. The auditor's role is to lend
credibility to the statements, hence the outsider will likely seek his independent audit opinion.
1-6 Client: the company, board of directors, agency, or some other person or group who retains (hires) the
auditor. Usually the party who pays the fee.
Auditee: the entity (e.g., business firm, hospital, city government) whose financial information is under
audit.
Auditors: report to the client on the auditee's financial or control information.
Three party accountability consists of the auditor, the accountable party of the auditee such as management of the
auditee, and the users. Users include the client as defined above. Traditionally management hired the auditor so
that there was some confusion as to who was the true client. New corporate governance concepts in part attempt
to clarify this three party accountability.
1-7 Auditors gather evidence related to the assertions management makes in financial statements and render a report.
Accountants record, classify, and summarize (report) a company's assets, liabilities, capital, revenue, and expense
in financial statements. Accountants produce the financial statements, auditors audit them.
1-8 The conditions of complexity, remoteness and consequences produce demands by outside users for financial
reports. They cannot produce the reports for themselves because of these conditions. Company managers and
accountant produce them.
1-9 Students can refer to the AAA and CAS 200 (CPA Canada) definitions in Chapter 1. Some instructors may want to
extend the consideration of definitions to include the internal and governmental definitions.
In response to "what do auditors do," students can refer to Exhibit 1-2 and respond in terms of: (1) obtain and
evaluate evidence about assertions management makes about economic actions and events, (2) ascertains the
degree of correspondence between the assertions and GAAP, and (3) gives an audit report (opinion).
Students can also respond more generally in terms of "lending credibility" to financial statements presented by
management (attestation).
1-10 The essence of the risk reduction theory is that audits of financial statements reduce the information risk
(probability of materially misleading statements) to users to a socially acceptable level.
These various users cannot take it upon themselves to determine whether financial reports are reliable, therefore
low in the information risk scale. They do not have the expertise, resources, or time to enter thousands of
companies
1-11 Forensic accounting is the broader term that includes fraud auditing. Forensic accounting is the use of accounting
for legal or investigative purposes. Fraud auditing is the use of forensic accounting in criminal investigations
involving allegations of fraud. Frauds that PAs are most interested in are misappropriation of assets and fraudulent
financial reporting (misreporting).
1-12 Fraud is intentional deception resulting in a loss to the deceived party. Frauds that PAs are most interested in are
Smieliauskas & Bewley, Auditing: An International Approach, 7th Edition Page 1-3
Solutions Manual
misappropriation of assets and fraudulent financial reporting (misreporting).
1-13 Operational auditing is the study of business operations for the purpose of making recommendations about the
economic and efficient use of resources, effective achievement of business objectives, and compliance with
company policies.
CPA Canada views operational auditing as a type of management advisory service offered by public accounting
firms.
1-14 The elements of comprehensive auditing include: (1) financial and compliance audits, (2) economy and efficiency
audits, and (3) program results or effectiveness audits. Public sector is the part of the economy represented by all
levels of government. Public companies are companies whose shares are traded on the stock markets.
1-15 A compliance audit involves a study of an organization's policies, procedures, and performance in following laws,
rules, and regulations. An example is a company’s compliance with environmental laws.
1-16 Other kinds of auditors: Revenue Canada agents/auditors, provincial and federal bank examiners, provincial
insurance commissioner auditors.
1-17 Yes, to a reasonable degree. Financial statement audits are intended to provide assurance there are no significant
intentional or unintentional misstatements.
1-19 IAASB stands for International Auditing and Assurance Standards Board. Its ISAs are the basis for Canada’s CASs
used throughout this text. The IFAC site is at www.ifac.org and click on “standards and guidance.”
SOLUTIONS FOR MULTIPLE CHOICE QUESTIONS
MC 1-1 LO1 When people speak of the assurance function, they are referring to the work of auditors in
a. lending credibility to a client’s financial statements.
b. detecting fraud and embezzlement in a company.
c. lending credibility to an auditee’s financial statements.
d. performing a program results audit in a government agency.
MC 1-2 LO1 Company A hired Sampson & Delila, CPAs, to audit the financial statements of Company B and deliver the
audit report to Megabank. Which is the client?
a. Megabank
b. Sampson & Delila
c. Company A
d. Company B
MC 1-3 LO1 According to the CPA Canada, the objective of an audit of -financial statements is
a. an expression of opinion on the fairness with which they present financial position, results of operations, and
cash flows in conformity with generally accepted accounting principles.
b. an expression of opinion on the fairness with which they present financial position, results of operations, and cash
flows in conformity with accounting standards promulgated by the Financial Accounting Standards Board.
c. an expression of opinion on the fairness with which they present financial position, results of operations, and cash
flows in conformity with accounting standards promulgated by the CPA Canada Accounting Standards Committee.
d. to obtain systematic and objective evidence about -financial assertions and report the results to interested users.
MC 1-4 LO4 Bankers who are processing loan applications from companies seeking large loans will probably ask for
financial statements audited by an independent PA because
a. financial statements are too complex for them to analyze themselves.
Solutions Manual
misappropriation of assets and fraudulent financial reporting (misreporting).
1-13 Operational auditing is the study of business operations for the purpose of making recommendations about the
economic and efficient use of resources, effective achievement of business objectives, and compliance with
company policies.
CPA Canada views operational auditing as a type of management advisory service offered by public accounting
firms.
1-14 The elements of comprehensive auditing include: (1) financial and compliance audits, (2) economy and efficiency
audits, and (3) program results or effectiveness audits. Public sector is the part of the economy represented by all
levels of government. Public companies are companies whose shares are traded on the stock markets.
1-15 A compliance audit involves a study of an organization's policies, procedures, and performance in following laws,
rules, and regulations. An example is a company’s compliance with environmental laws.
1-16 Other kinds of auditors: Revenue Canada agents/auditors, provincial and federal bank examiners, provincial
insurance commissioner auditors.
1-17 Yes, to a reasonable degree. Financial statement audits are intended to provide assurance there are no significant
intentional or unintentional misstatements.
1-19 IAASB stands for International Auditing and Assurance Standards Board. Its ISAs are the basis for Canada’s CASs
used throughout this text. The IFAC site is at www.ifac.org and click on “standards and guidance.”
SOLUTIONS FOR MULTIPLE CHOICE QUESTIONS
MC 1-1 LO1 When people speak of the assurance function, they are referring to the work of auditors in
a. lending credibility to a client’s financial statements.
b. detecting fraud and embezzlement in a company.
c. lending credibility to an auditee’s financial statements.
d. performing a program results audit in a government agency.
MC 1-2 LO1 Company A hired Sampson & Delila, CPAs, to audit the financial statements of Company B and deliver the
audit report to Megabank. Which is the client?
a. Megabank
b. Sampson & Delila
c. Company A
d. Company B
MC 1-3 LO1 According to the CPA Canada, the objective of an audit of -financial statements is
a. an expression of opinion on the fairness with which they present financial position, results of operations, and
cash flows in conformity with generally accepted accounting principles.
b. an expression of opinion on the fairness with which they present financial position, results of operations, and cash
flows in conformity with accounting standards promulgated by the Financial Accounting Standards Board.
c. an expression of opinion on the fairness with which they present financial position, results of operations, and cash
flows in conformity with accounting standards promulgated by the CPA Canada Accounting Standards Committee.
d. to obtain systematic and objective evidence about -financial assertions and report the results to interested users.
MC 1-4 LO4 Bankers who are processing loan applications from companies seeking large loans will probably ask for
financial statements audited by an independent PA because
a. financial statements are too complex for them to analyze themselves.
Smieliauskas & Bewley, Auditing: An International Approach, 7th Edition Page 1-4
Solutions Manual
b. they are too far away from company headquarters to perform accounting and auditing themselves.
c. the consequences of making a bad loan are very undesirable.
d. they generally see a potential conflict of interest between company managers who want to get loans and their
needs for reliable financial statements.
MC 1-5 LO4 Operational audits of a company’s efficiency and economy of managing projects and of the results of
programs are conducted by whom?
a. Financial statement auditors
b. The company’s internal auditors
c. Tax auditors employed by the federal government
d. Fraud auditors
MC 1-6 LO3 Independent auditors of financial statements perform audits that reduce and control
a. the business risks faced by investors.
b. the information risk faced by investors.
c. the complexity of financial statements.
d. quality reviews performed by other PA firms.
MC 1-7 LO4 The primary objective of compliance auditing is to
a. give an opinion on financial statements.
b. develop a basis for a report on internal control.
c. perform a study of effective and efficient use of resources.
d. determine whether auditee personnel are following laws, rules, regulations, and policies.
SOLUTIONS FOR EXERCISES AND PROBLEMS
EP1-1 When the PA is hired by Hughes Corporation, he can no longer be considered independent with respect to the
annual audit. The annual audit may then be unnecessary in a short-run view and unnecessary to the extent of
services exclusive of the attest opinion. It is true that the in-house PA can perform all the procedural analyses that
would be required of an independent audit; however, it is extremely unlikely that he could inspire the confidence
of users of financial statements outside the company. He cannot modify the perception of potential conflict of
interest that creates demand for the independent audit. As a matter of ethics rules, this PA would be prohibited
from signing the standard unqualified attest opinion.
EP1-2 You should point out that you will be unable to replace the independent audit with your own communication
output as controller. Make the point that you can conduct an effective internal audit function and be of
considerable service to management and can even assist the independent auditors with preparation of schedules
and general cooperation (thus facilitating the independent audit).
Nevertheless, as a member of management, it would be impossible to be truly objective and unbiased about the
financial results of management's decisions, hence the directors could not satisfy their obligations to the
shareholders' interests. Neither could you issue an opinion to be used by outsiders.
Lacking an opinion on the financial statements, the company could find itself in noncompliance with audit
requirements of a stock exchange, a Provincial Securities Commission, or the U.S. Securities and Exchange
Commission.
EP1-3 a. risk of litigation needs offsetting lower information risk (for example, litigation due to share practice decline
or failure to meet a bond covenant).
b. strength of internal controls (e.g., controls over financial instruments, controls over cash).
c. financial health of client (industry factors, economic factors).
d. management compensation system (management highly motivated to beat earnings targets, compensation
Solutions Manual
b. they are too far away from company headquarters to perform accounting and auditing themselves.
c. the consequences of making a bad loan are very undesirable.
d. they generally see a potential conflict of interest between company managers who want to get loans and their
needs for reliable financial statements.
MC 1-5 LO4 Operational audits of a company’s efficiency and economy of managing projects and of the results of
programs are conducted by whom?
a. Financial statement auditors
b. The company’s internal auditors
c. Tax auditors employed by the federal government
d. Fraud auditors
MC 1-6 LO3 Independent auditors of financial statements perform audits that reduce and control
a. the business risks faced by investors.
b. the information risk faced by investors.
c. the complexity of financial statements.
d. quality reviews performed by other PA firms.
MC 1-7 LO4 The primary objective of compliance auditing is to
a. give an opinion on financial statements.
b. develop a basis for a report on internal control.
c. perform a study of effective and efficient use of resources.
d. determine whether auditee personnel are following laws, rules, regulations, and policies.
SOLUTIONS FOR EXERCISES AND PROBLEMS
EP1-1 When the PA is hired by Hughes Corporation, he can no longer be considered independent with respect to the
annual audit. The annual audit may then be unnecessary in a short-run view and unnecessary to the extent of
services exclusive of the attest opinion. It is true that the in-house PA can perform all the procedural analyses that
would be required of an independent audit; however, it is extremely unlikely that he could inspire the confidence
of users of financial statements outside the company. He cannot modify the perception of potential conflict of
interest that creates demand for the independent audit. As a matter of ethics rules, this PA would be prohibited
from signing the standard unqualified attest opinion.
EP1-2 You should point out that you will be unable to replace the independent audit with your own communication
output as controller. Make the point that you can conduct an effective internal audit function and be of
considerable service to management and can even assist the independent auditors with preparation of schedules
and general cooperation (thus facilitating the independent audit).
Nevertheless, as a member of management, it would be impossible to be truly objective and unbiased about the
financial results of management's decisions, hence the directors could not satisfy their obligations to the
shareholders' interests. Neither could you issue an opinion to be used by outsiders.
Lacking an opinion on the financial statements, the company could find itself in noncompliance with audit
requirements of a stock exchange, a Provincial Securities Commission, or the U.S. Securities and Exchange
Commission.
EP1-3 a. risk of litigation needs offsetting lower information risk (for example, litigation due to share practice decline
or failure to meet a bond covenant).
b. strength of internal controls (e.g., controls over financial instruments, controls over cash).
c. financial health of client (industry factors, economic factors).
d. management compensation system (management highly motivated to beat earnings targets, compensation
Smieliauskas & Bewley, Auditing: An International Approach, 7th Edition Page 1-5
Solutions Manual
tied to factors over which management has little control may motivate management to “manage
earnings”).
e. private vs. public company (publicly held company owners are more reliant on financial statements for
information about their investment).
EP1-4 Financial statements are prepared on basis of GAAP. Knowledge of GAAP is thus indispensable for determining if
the financial statements are in conformity with GAAP. For example lease accounting used to consist of some very
specific rules (bright line rules) that the auditor effectively tested compliance with. Unfortunately such detailed
rule based accounting leads to what some refer to as a checklist mentality where the form is more important than
the substance. Enron’s special purpose entity accounting also comes to mind.
EP1-5 Operational Auditing
Bigdeal cannot hire the OAG. This government agency does not perform operational audits for private industry.
One possibility is the management advisory services department of a large PA firm. The major advantage may be
total objectivity. The PA firm has no stake in making a report reflect favorably or unfavorably on Smalltek (provided
there are no prior relations of the PA firm with Bigdeal managers that may suggest a bias or with Smalltek). The
possible disadvantage is that the PA firm may not possess the required expertise in Smalltek' type of business.
Another possibility is the Bigdeal internal audit department. The major advantage may be a thorough appreciation
of Bigdeal's managerial effectiveness and efficiency standards and a longstanding familiarity with Bigdeal's
business. The possible disadvantage could be that the internal auditors may not be independent enough from
internal management pressures for making or breaking the deal for reasons other than Smalltek's efficiency and
effectiveness.
Another possibility is a nonPA management consulting firm. The major advantage of objectivity would be similar to
the PA firm, and such firms often have experts in manufacturing, sales, and research and development
management. The major disadvantage could be a lack of appreciation and familiarity with Bigdeal's management
standards (as possessed by the Bigdeal internal auditors).
EP1-6 The neighbor appears to be uninformed on the following points:
1. According to auditors' dogma, Price Waterhouse did
not prepare the Dodge Corporation financial
statements, and no auditor prepares a
company's statements.
Inform your neighbor that Dodge management is
primarily responsible for preparing the financial
statements and deciding upon the appropriate
accounting principles.
2. An unqualified opinion does not mean an investment
is safe.
Tell your neighbor that the financial statements
are history. The value of his investment depends
on future events, including the many factors that
affect market prices. Tell him the opinion only
means that the statements conform to GAAP
(and you can add that the auditor knows of no
material fraud or error).
EP1-7 Identification of Audits and Auditors
The responses to this matching type of question are ambiguous. The engagement examples are real examples of
external, internal and governmental audit situations. You might point out to students that the distinctions among
Solutions Manual
tied to factors over which management has little control may motivate management to “manage
earnings”).
e. private vs. public company (publicly held company owners are more reliant on financial statements for
information about their investment).
EP1-4 Financial statements are prepared on basis of GAAP. Knowledge of GAAP is thus indispensable for determining if
the financial statements are in conformity with GAAP. For example lease accounting used to consist of some very
specific rules (bright line rules) that the auditor effectively tested compliance with. Unfortunately such detailed
rule based accounting leads to what some refer to as a checklist mentality where the form is more important than
the substance. Enron’s special purpose entity accounting also comes to mind.
EP1-5 Operational Auditing
Bigdeal cannot hire the OAG. This government agency does not perform operational audits for private industry.
One possibility is the management advisory services department of a large PA firm. The major advantage may be
total objectivity. The PA firm has no stake in making a report reflect favorably or unfavorably on Smalltek (provided
there are no prior relations of the PA firm with Bigdeal managers that may suggest a bias or with Smalltek). The
possible disadvantage is that the PA firm may not possess the required expertise in Smalltek' type of business.
Another possibility is the Bigdeal internal audit department. The major advantage may be a thorough appreciation
of Bigdeal's managerial effectiveness and efficiency standards and a longstanding familiarity with Bigdeal's
business. The possible disadvantage could be that the internal auditors may not be independent enough from
internal management pressures for making or breaking the deal for reasons other than Smalltek's efficiency and
effectiveness.
Another possibility is a nonPA management consulting firm. The major advantage of objectivity would be similar to
the PA firm, and such firms often have experts in manufacturing, sales, and research and development
management. The major disadvantage could be a lack of appreciation and familiarity with Bigdeal's management
standards (as possessed by the Bigdeal internal auditors).
EP1-6 The neighbor appears to be uninformed on the following points:
1. According to auditors' dogma, Price Waterhouse did
not prepare the Dodge Corporation financial
statements, and no auditor prepares a
company's statements.
Inform your neighbor that Dodge management is
primarily responsible for preparing the financial
statements and deciding upon the appropriate
accounting principles.
2. An unqualified opinion does not mean an investment
is safe.
Tell your neighbor that the financial statements
are history. The value of his investment depends
on future events, including the many factors that
affect market prices. Tell him the opinion only
means that the statements conform to GAAP
(and you can add that the auditor knows of no
material fraud or error).
EP1-7 Identification of Audits and Auditors
The responses to this matching type of question are ambiguous. The engagement examples are real examples of
external, internal and governmental audit situations. You might point out to students that the distinctions among
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Solutions Manual
compliance, economy and efficiency and program results audits are not always clear. The "solution" is shown
below in matrix form, showing some engagement numbers in two or three cells. The required schedule follows.
Type of Audit
Financial Economy, Program
Kind of Auditor Statement Compliance Efficiency Results
Independent PA 2, 10
Internal Auditor 6, 8 4, 8
Governmental (auditors) 3 1, 3, 9 1, 3
CRA Auditor X 5 X X
Bank Examiner X 7 X X
1. FHA loan interest equity Economy and Efficiency or
Program Results
Governmental (AGC)
2. Advertising agency financial
statements
Financial statement Independent PAs
3. Dept. of Interior policies Compliance or Economy and
Efficiency or Program Results
Governmental (AGC)
4. Municipal services Economy and Efficiency Internal auditors
5. Tax shelters Compliance CRA auditors
6. Test pilot reporting Compliance Internal auditors
7. Bank solvency Compliance Bank examiners
8. Materials inspection by
manufacturer
Compliance or Economy and
Efficiency
Internal auditors
9. Drug enforcement vehicle
seizures
Economy and Efficiency Governmental (AGC)
10. Sports complex forecast Financial statement Independent PAs
EP1-8 Analysis and Judgment
This problem is one of Robert Ashton's cases on judgment and decision making (Accounting Review, January, 1984,
pp. 78-97.) Ashton gives credit to Joyce and Biddle, "Anchoring and Adjustment in Probabilistic Inference in
Auditing." Journal of Accounting Research, Spring, 1981, pp. 1
The case is set up to illustrate a person's tendency to anchor an estimate on some known information and adjust
from that point in the course of performing analysis. This particular case set-up is intended to illustrate conjunctive
and disjunctive events. Ashton's "answer key" explains in this manner:
Ashton's Answer Key (abridged)
This exercise focuses on probability estimates for two types of complex events called "conjunctive" and
"disjunctive." The occurrence of a conjunctive event depends on the joint occurrence of all of a number of sub-
events, each with a given probability of occurrence.
An example is getting three 3's in a row when rolling a die. This is a conjunctive event with probability of 1/6 raised
to the third power (1/6 x 1/6 x 1/6), or about 0.005.
An example of a disjunctive event is getting at least one of a number of sub-events, such as one 3 in three rolls of
the die. The probability of this disjunctive event is about 0.42
Solutions Manual
compliance, economy and efficiency and program results audits are not always clear. The "solution" is shown
below in matrix form, showing some engagement numbers in two or three cells. The required schedule follows.
Type of Audit
Financial Economy, Program
Kind of Auditor Statement Compliance Efficiency Results
Independent PA 2, 10
Internal Auditor 6, 8 4, 8
Governmental (auditors) 3 1, 3, 9 1, 3
CRA Auditor X 5 X X
Bank Examiner X 7 X X
1. FHA loan interest equity Economy and Efficiency or
Program Results
Governmental (AGC)
2. Advertising agency financial
statements
Financial statement Independent PAs
3. Dept. of Interior policies Compliance or Economy and
Efficiency or Program Results
Governmental (AGC)
4. Municipal services Economy and Efficiency Internal auditors
5. Tax shelters Compliance CRA auditors
6. Test pilot reporting Compliance Internal auditors
7. Bank solvency Compliance Bank examiners
8. Materials inspection by
manufacturer
Compliance or Economy and
Efficiency
Internal auditors
9. Drug enforcement vehicle
seizures
Economy and Efficiency Governmental (AGC)
10. Sports complex forecast Financial statement Independent PAs
EP1-8 Analysis and Judgment
This problem is one of Robert Ashton's cases on judgment and decision making (Accounting Review, January, 1984,
pp. 78-97.) Ashton gives credit to Joyce and Biddle, "Anchoring and Adjustment in Probabilistic Inference in
Auditing." Journal of Accounting Research, Spring, 1981, pp. 1
The case is set up to illustrate a person's tendency to anchor an estimate on some known information and adjust
from that point in the course of performing analysis. This particular case set-up is intended to illustrate conjunctive
and disjunctive events. Ashton's "answer key" explains in this manner:
Ashton's Answer Key (abridged)
This exercise focuses on probability estimates for two types of complex events called "conjunctive" and
"disjunctive." The occurrence of a conjunctive event depends on the joint occurrence of all of a number of sub-
events, each with a given probability of occurrence.
An example is getting three 3's in a row when rolling a die. This is a conjunctive event with probability of 1/6 raised
to the third power (1/6 x 1/6 x 1/6), or about 0.005.
An example of a disjunctive event is getting at least one of a number of sub-events, such as one 3 in three rolls of
the die. The probability of this disjunctive event is about 0.42
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Solutions Manual
If you are asked to estimate the probabilities of the conjunctive and disjunctive events of rolling the die, a natural
starting place (anchor) would be to know that the probability of getting one three in one roll is 1/6, or 0.167. Then
to estimate the harder conjunctive event (three 3's in a row), a downward adjustment would be required.
Conversely, for the disjunctive event (one 3 in three rolls), an upward adjustment would be needed. However,
since adjustments from an anchor are usually insufficient, the estimated probability of the conjunctive event will
likely be too large, and that of the disjunctive event too small.
Form A of the problem (the one in the textbook chapter) is a conjunctive statement of the problem, and it asks for
an estimate of the probability of successful product introduction. With the five sub-events considered independent
of each other, the best answer is 0.554 (.80 x .90 x .95 x .90 x .90). Students may anchor on the probabilities of the
elementary sub-events and fail to adjust sufficiently downward, and their probability estimates will be higher than
0.554.
Form B of the problem (reproduced below, not in the textbook) is a disjunctive statement of the same problem,
and the best answer is still 0. 554. Form B, however, is stated in terms of failure in the chain of events. (Student
responses must be subtracted from 1.000 to make them comparable to Form A.) If students anchor on the
probabilities of the elementary disjunctive sub-events in Form B, their probability estimates (subtracted from
1.000) will probably be too low.
As part of your regular year-end audit of a publicly-held client, you must make an estimate of the probability of
success of its proposed new product line. The client has experienced financial difficulty during the last few years
and--in your judgment--a successful introduction of the new product line is necessary for the client to remain a
going concern.
Any one of the following occurrences will prevent successful introduction of the new product line: (1) unsuccessful
labor negotiations between the construction firms contracted to build the necessary addition to the present plant
and the building trades unions; (2) unsuccessful defense of patent rights; (3) failure to obtain product approval by
the FDA; (4) failure to successfully negotiate a long-term raw materials contract with a foreign supplier; and (5)
failure to successfully conclude distribution contract talks with a large national retail distributor.
In view of the circumstances, you contact experts who have provided your audit firm with reliable estimates in the
past. The labor relations expert estimates that there is a 20 percent chance that labor negotiations will not be
successfully resolved before the strike deadline. Legal counsel advises that there is a 10 percent chance that the
patent rights defense will not be successful. The expert on FDA product approvals estimates the probability of
failing to obtain approval at five percent. The experts in the two remaining areas estimate the probabilities of
failing to resolve (a) the raw materials contract and (b) the distribution contract talks to be 10 percent in each case.
Assume these estimates are reliable.
Required:
What is your assessment of the probability that the product introduction will fail? (Hint: You can assume the five
steps are independent of each other.)
NOTE TO INSTRUCTORS: You may want to reproduce Form B and give both the textbook problem (conjunctive) and
the Form B alternative (disjunctive) to different groups of students to illustrate the anchoring and adjustment
behavioral phenomenon.
You may also want to give students a response scale to make your classroom discussion easier. Ask them to circle
one:
Solutions Manual
If you are asked to estimate the probabilities of the conjunctive and disjunctive events of rolling the die, a natural
starting place (anchor) would be to know that the probability of getting one three in one roll is 1/6, or 0.167. Then
to estimate the harder conjunctive event (three 3's in a row), a downward adjustment would be required.
Conversely, for the disjunctive event (one 3 in three rolls), an upward adjustment would be needed. However,
since adjustments from an anchor are usually insufficient, the estimated probability of the conjunctive event will
likely be too large, and that of the disjunctive event too small.
Form A of the problem (the one in the textbook chapter) is a conjunctive statement of the problem, and it asks for
an estimate of the probability of successful product introduction. With the five sub-events considered independent
of each other, the best answer is 0.554 (.80 x .90 x .95 x .90 x .90). Students may anchor on the probabilities of the
elementary sub-events and fail to adjust sufficiently downward, and their probability estimates will be higher than
0.554.
Form B of the problem (reproduced below, not in the textbook) is a disjunctive statement of the same problem,
and the best answer is still 0. 554. Form B, however, is stated in terms of failure in the chain of events. (Student
responses must be subtracted from 1.000 to make them comparable to Form A.) If students anchor on the
probabilities of the elementary disjunctive sub-events in Form B, their probability estimates (subtracted from
1.000) will probably be too low.
As part of your regular year-end audit of a publicly-held client, you must make an estimate of the probability of
success of its proposed new product line. The client has experienced financial difficulty during the last few years
and--in your judgment--a successful introduction of the new product line is necessary for the client to remain a
going concern.
Any one of the following occurrences will prevent successful introduction of the new product line: (1) unsuccessful
labor negotiations between the construction firms contracted to build the necessary addition to the present plant
and the building trades unions; (2) unsuccessful defense of patent rights; (3) failure to obtain product approval by
the FDA; (4) failure to successfully negotiate a long-term raw materials contract with a foreign supplier; and (5)
failure to successfully conclude distribution contract talks with a large national retail distributor.
In view of the circumstances, you contact experts who have provided your audit firm with reliable estimates in the
past. The labor relations expert estimates that there is a 20 percent chance that labor negotiations will not be
successfully resolved before the strike deadline. Legal counsel advises that there is a 10 percent chance that the
patent rights defense will not be successful. The expert on FDA product approvals estimates the probability of
failing to obtain approval at five percent. The experts in the two remaining areas estimate the probabilities of
failing to resolve (a) the raw materials contract and (b) the distribution contract talks to be 10 percent in each case.
Assume these estimates are reliable.
Required:
What is your assessment of the probability that the product introduction will fail? (Hint: You can assume the five
steps are independent of each other.)
NOTE TO INSTRUCTORS: You may want to reproduce Form B and give both the textbook problem (conjunctive) and
the Form B alternative (disjunctive) to different groups of students to illustrate the anchoring and adjustment
behavioral phenomenon.
You may also want to give students a response scale to make your classroom discussion easier. Ask them to circle
one:
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Solutions Manual
.00 .10 .20 .30 .40 .50 .60 .70 .80 .90 1.00
EP1-9 Information Risk Questions.
Examples of misstatements that create audit risk: the balance sheet does not balance, cash is understated,
inventory is overstated, and unrecorded payables. Examples of misstatements that create accounting risk: a
company that will fail in the next 3 months records all assets and liabilities assuming that the going concern
assumption is true, impaired goodwill is not written down, the allowance for doubtful accounts has not been
adjusted for changed economic circumstances, and the fair value assets have not been updated for changes in
future cash flows. Accounting misstatements relate to future events whereas audit misstatements relate to facts
about the present or past events.
EP1-10 The audit society.
An example from the Auditor General of Ontario is given in the text. There was extensive coverage in Globe and
Mail, Toronto Star, and local TV news coverage.
EP1-11 The audit society
A recent controversy is the Canadian government’s proposed acquisition of a fleet of 65 single engine F35 fighter jets for
$46 billion. See
http://www.thestar.com/news/canada/2012/04/03/auditor_general_slams_canadas_plan_to_buy_f35_jets.html
Solutions Manual
.00 .10 .20 .30 .40 .50 .60 .70 .80 .90 1.00
EP1-9 Information Risk Questions.
Examples of misstatements that create audit risk: the balance sheet does not balance, cash is understated,
inventory is overstated, and unrecorded payables. Examples of misstatements that create accounting risk: a
company that will fail in the next 3 months records all assets and liabilities assuming that the going concern
assumption is true, impaired goodwill is not written down, the allowance for doubtful accounts has not been
adjusted for changed economic circumstances, and the fair value assets have not been updated for changes in
future cash flows. Accounting misstatements relate to future events whereas audit misstatements relate to facts
about the present or past events.
EP1-10 The audit society.
An example from the Auditor General of Ontario is given in the text. There was extensive coverage in Globe and
Mail, Toronto Star, and local TV news coverage.
EP1-11 The audit society
A recent controversy is the Canadian government’s proposed acquisition of a fleet of 65 single engine F35 fighter jets for
$46 billion. See
http://www.thestar.com/news/canada/2012/04/03/auditor_general_slams_canadas_plan_to_buy_f35_jets.html
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Smieliauskas & Bewley, Auditing: An International Approach, 7th Edition Page 2-1
Solutions Manual © 2016, McGraw-Hill Education. All Rights Reserved.
CHAPTER 2
Auditors’ Professional Roles and Responsibilities
SOLUTIONS FOR REVIEW CHECKPOINTS
ESSENTIALS
2-1. Since auditing is a critical function in the economy, it is extensively regulated to ensure it remains effective. In
Canada, the regulation of professional accountants and auditors is a provincial responsibility, and varies somewhat
depending on the legislation in different provinces. The profession also has a national umbrella organization that
all provincial organizations are associated with. At the time of writing, the profession is being streamlined at both
the national and provincial levels by uniting three formerly separate accounting designations (CA, CGA, CMA) into a
single designation for Canadian professional accountants, the “CPA” (Chartered Professional Accountant). The
national umbrella organization is CPA-Canada, and there are counterpart CPA associations in each province (e.g.,
CPA-Saskatchewan) and territory.
2-2. When an accountant provides auditing and assurance services for use by the general public, this is referred to as
‘public accounting’. Public accounting is distinct from many other types of accounting-related work that do not
produce information that the general public will use and possibly rely on, such as bookkeeping and financial
statement and tax preparation for individuals or private companies. Since a person from the general public may
not be able to assess whether an accountant is properly qualified and regulated to act in their best interest, to
practice public accounting a person will meet higher standards than are required to do other types of non-public
accounting work. Generally, a public accountant in Canada must have a CPA designation, and in many (most)
provinces of Canada must obtain further qualification and licensing (e.g., in Ontario, from the Public Accountants’
Council of Ontario). In the case of public accounting that involves auditing publicly-traded companies' financial
statements, securities laws require the public accounting firm to be registered with the Canadian Public
Accountability Board (CPAB). CPAB will inspect their financial statement audit work on public companies annually
to provide the highest level of public protection, since these companies can sell their securities directly to the
public.
2-3. Members of a CPA association are required to comply with the professional ethics code of their provincial
association. Every ethics code has five similar components, requiring the member: to act with integrity; to remain
objective; to maintain the professional competencies their work requires and to do their work with appropriate
‘due’ care; to keep confidential all information they acquire through their professional work, and; to behave
professionally in a way that befits a well-respected profession.
2-4. In public accounting engagements, CPAs must demonstrate they can be objective by remaining independent of any
potentially conflicting interests, which includes being independent in fact and also independent as it would appear
to an outsider.
2-5. Independence in fact means the auditor maintains an objective perspective in doing his or her work - this frame of
mind is essential to performing an assurance role effectively, however it is not visible (or provable) to outsiders.
The auditor's independence must also be apparent to outsiders for them to believe the auditor's opinion is in fact
independent. Outsiders must see evidence that the CPA has no financial or other interest that would cause them
to act in a biased way, rather than in the outside user’s best interest.
2-6. The professional ethics codes for accountants identify five situations that can arise in a three-party accountability
relationship and, if they exist, can threaten an auditor’s independence: self-review, self-interest, advocacy,
familiarity and intimidation. An important theme here is that even in their public interest role, an auditor is still
just a human being, and vulnerable to the usual human weaknesses and failings. The independence guidance
Solutions Manual © 2016, McGraw-Hill Education. All Rights Reserved.
CHAPTER 2
Auditors’ Professional Roles and Responsibilities
SOLUTIONS FOR REVIEW CHECKPOINTS
ESSENTIALS
2-1. Since auditing is a critical function in the economy, it is extensively regulated to ensure it remains effective. In
Canada, the regulation of professional accountants and auditors is a provincial responsibility, and varies somewhat
depending on the legislation in different provinces. The profession also has a national umbrella organization that
all provincial organizations are associated with. At the time of writing, the profession is being streamlined at both
the national and provincial levels by uniting three formerly separate accounting designations (CA, CGA, CMA) into a
single designation for Canadian professional accountants, the “CPA” (Chartered Professional Accountant). The
national umbrella organization is CPA-Canada, and there are counterpart CPA associations in each province (e.g.,
CPA-Saskatchewan) and territory.
2-2. When an accountant provides auditing and assurance services for use by the general public, this is referred to as
‘public accounting’. Public accounting is distinct from many other types of accounting-related work that do not
produce information that the general public will use and possibly rely on, such as bookkeeping and financial
statement and tax preparation for individuals or private companies. Since a person from the general public may
not be able to assess whether an accountant is properly qualified and regulated to act in their best interest, to
practice public accounting a person will meet higher standards than are required to do other types of non-public
accounting work. Generally, a public accountant in Canada must have a CPA designation, and in many (most)
provinces of Canada must obtain further qualification and licensing (e.g., in Ontario, from the Public Accountants’
Council of Ontario). In the case of public accounting that involves auditing publicly-traded companies' financial
statements, securities laws require the public accounting firm to be registered with the Canadian Public
Accountability Board (CPAB). CPAB will inspect their financial statement audit work on public companies annually
to provide the highest level of public protection, since these companies can sell their securities directly to the
public.
2-3. Members of a CPA association are required to comply with the professional ethics code of their provincial
association. Every ethics code has five similar components, requiring the member: to act with integrity; to remain
objective; to maintain the professional competencies their work requires and to do their work with appropriate
‘due’ care; to keep confidential all information they acquire through their professional work, and; to behave
professionally in a way that befits a well-respected profession.
2-4. In public accounting engagements, CPAs must demonstrate they can be objective by remaining independent of any
potentially conflicting interests, which includes being independent in fact and also independent as it would appear
to an outsider.
2-5. Independence in fact means the auditor maintains an objective perspective in doing his or her work - this frame of
mind is essential to performing an assurance role effectively, however it is not visible (or provable) to outsiders.
The auditor's independence must also be apparent to outsiders for them to believe the auditor's opinion is in fact
independent. Outsiders must see evidence that the CPA has no financial or other interest that would cause them
to act in a biased way, rather than in the outside user’s best interest.
2-6. The professional ethics codes for accountants identify five situations that can arise in a three-party accountability
relationship and, if they exist, can threaten an auditor’s independence: self-review, self-interest, advocacy,
familiarity and intimidation. An important theme here is that even in their public interest role, an auditor is still
just a human being, and vulnerable to the usual human weaknesses and failings. The independence guidance
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attempts to bring these potential weaknesses to light, so auditors will have a better chance of seeing when they
might be failing to remain impartial. A self-review threat means the auditor is checking his/her own work; in this
case s/he cannot provide the critical, independent perspective that a user (third party) would expect. With a self-
interest threat, the auditor has something personal to gain and so is not free to do what is in the user's best
interest - in that case his/her opinion will not meet the user's needs. With an advocacy threat, the auditor has
taken a personal stand in support of the first party's positions, so they are invested in that and will have a hard
time seeing objectively whether the position they publicly supported is wrong - again the auditor is not free to act
in the user's best interest. With a familiarity threat, the auditor is too friendly and close to the first party and that
makes it more difficult for the auditor to suspect or believe that this well-known person would do anything wrong,
or act against the best interests of the third party. In the case of an intimidation threat, the auditor is facing
personal risk and naturally must put their own critical interests first, before they can meet their professional
responsibilities. In an intimidation threat situation, an auditor would need to seek legal advice on how best to
protect him/herself without violating their professional duties.
2-7. Financial statement audits are required in various laws. Corporation laws require companies to produce audited
annual financial statements (though private and smaller companies sometimes can waive this requirement), and
securities laws require public companies to file audited financial statements within 90 days of their year end.
2-8. The professional ethics codes incorporate professional accounting and auditing standards, making compliance with
these standards the bottom-line professional responsibility of professional accountants. CPA members meet the
ethical requirements of professional competency and due care in performance their work by complying with
requirements of the CPA-Canada standards for accounting (generally accepted accounting principles, GAAP, e.g.,
ASPE or IFRS) and auditing (generally accepted auditing standards, GAAS: CAS).
2-9. The overall objectives of a financial statement audit are stated in Canadian Auditing Standards (CAS) in the CPA-
Canada Assurance Handbook, in CAS 200, “Overall Objective of the Independent Auditor, and the Conduct of the
Audit in Accordance with Canadian Auditing Standards” CAS states a financial statement auditor's overall
objectives are: (a) To obtain reasonable assurance about whether the financial statements as a whole are free
from material misstatement, whether due to fraud or error, thereby enabling the auditor to express an opinion on
whether the financial statements are prepared, in all material respects, in accordance with an applicable financial
reporting framework; and (b) To report on the financial statements, and communicate as required by the ISAs, in
accordance with the auditor’s findings. CAS 200 also sets out principles and fundamental concepts that underlie
the auditing function.
2-10. Self-regulation refers to the powers a professional group has in regulating its affairs without intervention by a
government or a government established external regulator. These affairs include setting of standards, codes of
conduct, education requirements, certification, and disciplining of members.
Since the failure of Enron in 2001, there has been increased involvement by outside agencies in the monitoring of
the audit function. Auditing is increasingly viewed as a key pillar in capital markets, along with regulators and good
governance practices. As a result external regulation of the profession has been increasing. In Canada, this has
taken the form of increased monitoring of auditors of public companies via CPAB. CPAB however does not have
the power to create audit and ethics standards as does the PCAOB in the U.S. Nevertheless, both CPAB and PCAOB
are increasingly assertive monitoring the quality of audit practice and sanctioning auditors who do not meet their
expectations. A major focus of inspections by CPAB and PCAOB is the quality of the audit. Quality generally refers
to degree of conformity with standards and nature of procedures performed and their documentation.
"Procedures" relate to acts to be performed. "Standards" deal with measures of the quality of performance of
those acts and the objectives to be attained by the use of procedures. The standards are less subject to change.
The standards provide the criteria for rejecting, accepting, or modifying a procedure in a given circumstance. An
example of the relative stability of standards and procedures is found in the change from non-EDP to EDP systems.
New procedures were required to audit EDP systems, but auditing standards remained unchanged and were the
criteria for determining the adequacy of the new procedures.
Solutions Manual © 2016, McGraw-Hill Education. All Rights Reserved.
attempts to bring these potential weaknesses to light, so auditors will have a better chance of seeing when they
might be failing to remain impartial. A self-review threat means the auditor is checking his/her own work; in this
case s/he cannot provide the critical, independent perspective that a user (third party) would expect. With a self-
interest threat, the auditor has something personal to gain and so is not free to do what is in the user's best
interest - in that case his/her opinion will not meet the user's needs. With an advocacy threat, the auditor has
taken a personal stand in support of the first party's positions, so they are invested in that and will have a hard
time seeing objectively whether the position they publicly supported is wrong - again the auditor is not free to act
in the user's best interest. With a familiarity threat, the auditor is too friendly and close to the first party and that
makes it more difficult for the auditor to suspect or believe that this well-known person would do anything wrong,
or act against the best interests of the third party. In the case of an intimidation threat, the auditor is facing
personal risk and naturally must put their own critical interests first, before they can meet their professional
responsibilities. In an intimidation threat situation, an auditor would need to seek legal advice on how best to
protect him/herself without violating their professional duties.
2-7. Financial statement audits are required in various laws. Corporation laws require companies to produce audited
annual financial statements (though private and smaller companies sometimes can waive this requirement), and
securities laws require public companies to file audited financial statements within 90 days of their year end.
2-8. The professional ethics codes incorporate professional accounting and auditing standards, making compliance with
these standards the bottom-line professional responsibility of professional accountants. CPA members meet the
ethical requirements of professional competency and due care in performance their work by complying with
requirements of the CPA-Canada standards for accounting (generally accepted accounting principles, GAAP, e.g.,
ASPE or IFRS) and auditing (generally accepted auditing standards, GAAS: CAS).
2-9. The overall objectives of a financial statement audit are stated in Canadian Auditing Standards (CAS) in the CPA-
Canada Assurance Handbook, in CAS 200, “Overall Objective of the Independent Auditor, and the Conduct of the
Audit in Accordance with Canadian Auditing Standards” CAS states a financial statement auditor's overall
objectives are: (a) To obtain reasonable assurance about whether the financial statements as a whole are free
from material misstatement, whether due to fraud or error, thereby enabling the auditor to express an opinion on
whether the financial statements are prepared, in all material respects, in accordance with an applicable financial
reporting framework; and (b) To report on the financial statements, and communicate as required by the ISAs, in
accordance with the auditor’s findings. CAS 200 also sets out principles and fundamental concepts that underlie
the auditing function.
2-10. Self-regulation refers to the powers a professional group has in regulating its affairs without intervention by a
government or a government established external regulator. These affairs include setting of standards, codes of
conduct, education requirements, certification, and disciplining of members.
Since the failure of Enron in 2001, there has been increased involvement by outside agencies in the monitoring of
the audit function. Auditing is increasingly viewed as a key pillar in capital markets, along with regulators and good
governance practices. As a result external regulation of the profession has been increasing. In Canada, this has
taken the form of increased monitoring of auditors of public companies via CPAB. CPAB however does not have
the power to create audit and ethics standards as does the PCAOB in the U.S. Nevertheless, both CPAB and PCAOB
are increasingly assertive monitoring the quality of audit practice and sanctioning auditors who do not meet their
expectations. A major focus of inspections by CPAB and PCAOB is the quality of the audit. Quality generally refers
to degree of conformity with standards and nature of procedures performed and their documentation.
"Procedures" relate to acts to be performed. "Standards" deal with measures of the quality of performance of
those acts and the objectives to be attained by the use of procedures. The standards are less subject to change.
The standards provide the criteria for rejecting, accepting, or modifying a procedure in a given circumstance. An
example of the relative stability of standards and procedures is found in the change from non-EDP to EDP systems.
New procedures were required to audit EDP systems, but auditing standards remained unchanged and were the
criteria for determining the adequacy of the new procedures.
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The word "procedure" is used in SAS 46 (AU 390)--"Consideration of Omitted Procedures After the Report Date"--
to refer to (1) an act to be performed and (2) sufficient competent evidence. SAS 46 speaks of omitted procedures
and the relative seriousness of their omission. The importance of any "omitted procedure," however, is the
evidence the auditors failed to obtain. Merely omitting technical procedures is only a superficial analysis of an
audit problem; the substance is the evidence not obtained.
The standard for due audit care is the care which would be exercised by the prudent auditor. The prudent auditor
is one who exercises reasonable judgment, who is not expected to be omniscient, who is presumed to have
knowledge special to his profession, who is expected to be aware of his own ignorance, who is expected to possess
the skills of his profession whether he is a beginner or a veteran.
2-11. The Canadian board (CPAB) is more self-regulatory in that the profession has more influence through having a
higher percentage of board membership, the monitoring process is less public and more designed to help firms
improve their practices. The CICA continues to set audit standards. The PCAOB, on the other hand, not only sets
standards but also has a more confrontational and public approach in its monitoring process.
The most important difference is that PCAOB actually sets auditing and professional ethics standards for public
company audits in the U.S. In Canada, audit standards are set by the CPA Canada while professional ethics
standards are set by the provincial institutes/societies of CGAs, CMAs, and CAs. PCAOB reports are much more
detailed disclosing the results of each inspection by firm, whereas CPAB reports are more generic providing an
overall evaluation of the state of public company audits in Canada. Students generally find the PCAOB reports
more interesting because they learn about problems identified for the firms they have accepted positions in. The
CPAB report issued on April 3, 2012 on 2011 inspections was disappointed with the state of audits in Canada,
particularly the implementation of audits in higher risk areas. “The Big 4 firms, which audit 94% of reporting issuers
by market capitalization, had a GAAS deficiency rate of 20-26% on files inspected by CPAB.” Other audit firms had a
47% GAAS deficiency rate. CPAB found these results consistent with other regulators. This is not just a Canadian
problem.
2-12. CA’s, CGA’s, and CMA’s are the old terms. They are all now CPAs and belong to CPA Canada and related provincial
associations such as CPA Ontario.
2-13. Examples of other assurance services rendered on representations other than financial statements are on issues
such as the effectiveness of internal controls, vote counts at the Academy Awards, forecasts of financial
information, efficiency of public sector activities.
• Vote counts (Academy Awards)
• Amount of prizes claimed to have been given in sweepstakes advertisements
• Investment performance statistics
• Characteristics claimed for computer software programs
• Also see the list of value for money audit engagements in chapter 1.
2-14. The three major areas of public accounting services:
Accounting and auditing
Taxation
Management advisory services (consulting)
2-15. The SEC site is more comprehensive but covers only the Canadian companies cross listed on U.S. exchanges.
2-16. "Procedures" relate to acts to be performed. "Standards" deal with measures of the quality of performance of
those acts and the objectives to be attained by the use of procedures. The standards are less subject to change.
The standards provide the criteria for rejecting, accepting, or modifying a procedure in a given circumstance. An
example of the relative stability of standards and procedures is found in the change from non-EDP to EDP systems.
New procedures were required to audit EDP systems, but auditing standards remained unchanged and were the
Solutions Manual © 2016, McGraw-Hill Education. All Rights Reserved.
The word "procedure" is used in SAS 46 (AU 390)--"Consideration of Omitted Procedures After the Report Date"--
to refer to (1) an act to be performed and (2) sufficient competent evidence. SAS 46 speaks of omitted procedures
and the relative seriousness of their omission. The importance of any "omitted procedure," however, is the
evidence the auditors failed to obtain. Merely omitting technical procedures is only a superficial analysis of an
audit problem; the substance is the evidence not obtained.
The standard for due audit care is the care which would be exercised by the prudent auditor. The prudent auditor
is one who exercises reasonable judgment, who is not expected to be omniscient, who is presumed to have
knowledge special to his profession, who is expected to be aware of his own ignorance, who is expected to possess
the skills of his profession whether he is a beginner or a veteran.
2-11. The Canadian board (CPAB) is more self-regulatory in that the profession has more influence through having a
higher percentage of board membership, the monitoring process is less public and more designed to help firms
improve their practices. The CICA continues to set audit standards. The PCAOB, on the other hand, not only sets
standards but also has a more confrontational and public approach in its monitoring process.
The most important difference is that PCAOB actually sets auditing and professional ethics standards for public
company audits in the U.S. In Canada, audit standards are set by the CPA Canada while professional ethics
standards are set by the provincial institutes/societies of CGAs, CMAs, and CAs. PCAOB reports are much more
detailed disclosing the results of each inspection by firm, whereas CPAB reports are more generic providing an
overall evaluation of the state of public company audits in Canada. Students generally find the PCAOB reports
more interesting because they learn about problems identified for the firms they have accepted positions in. The
CPAB report issued on April 3, 2012 on 2011 inspections was disappointed with the state of audits in Canada,
particularly the implementation of audits in higher risk areas. “The Big 4 firms, which audit 94% of reporting issuers
by market capitalization, had a GAAS deficiency rate of 20-26% on files inspected by CPAB.” Other audit firms had a
47% GAAS deficiency rate. CPAB found these results consistent with other regulators. This is not just a Canadian
problem.
2-12. CA’s, CGA’s, and CMA’s are the old terms. They are all now CPAs and belong to CPA Canada and related provincial
associations such as CPA Ontario.
2-13. Examples of other assurance services rendered on representations other than financial statements are on issues
such as the effectiveness of internal controls, vote counts at the Academy Awards, forecasts of financial
information, efficiency of public sector activities.
• Vote counts (Academy Awards)
• Amount of prizes claimed to have been given in sweepstakes advertisements
• Investment performance statistics
• Characteristics claimed for computer software programs
• Also see the list of value for money audit engagements in chapter 1.
2-14. The three major areas of public accounting services:
Accounting and auditing
Taxation
Management advisory services (consulting)
2-15. The SEC site is more comprehensive but covers only the Canadian companies cross listed on U.S. exchanges.
2-16. "Procedures" relate to acts to be performed. "Standards" deal with measures of the quality of performance of
those acts and the objectives to be attained by the use of procedures. The standards are less subject to change.
The standards provide the criteria for rejecting, accepting, or modifying a procedure in a given circumstance. An
example of the relative stability of standards and procedures is found in the change from non-EDP to EDP systems.
New procedures were required to audit EDP systems, but auditing standards remained unchanged and were the
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Solutions Manual © 2016, McGraw-Hill Education. All Rights Reserved.
criteria for determining the adequacy of the new procedures.
The word "procedure" is used in SAS 46 (AU 390)--"Consideration of Omitted Procedures After the Report Date"--
to refer to (1) an act to be performed and (2) sufficient competent evidence. SAS 46 speaks of omitted procedures
and the relative seriousness of their omission. The importance of any "omitted procedure," however, is the
evidence the auditors failed to obtain. Merely omitting technical procedures is only a superficial analysis of an
audit problem; the substance is the evidence not obtained.
2-17. The standard for due audit care is the care which would be exercised by the prudent auditor. The prudent auditor
is one who exercises reasonable judgment, who is not expected to be omniscient, who is presumed to have
knowledge special to his profession, who is expected to be aware of his own ignorance, who is expected to possess
the skills of his profession whether he is a beginner or a veteran.
2-18. Three elements of planning and supervision considered essential in audit practice are:
1. A written audit program.
2. An understanding of the client's (auditee's) business.
PA firm procedures to allow an audit team member to document disagreements with accounting or
auditing conclusions and disassociate himself or herself from the matter.
3. Ensuring that staff have appropriate training and competence to perform the audit.
2-19. The timing of the auditor's appointment matters because the auditor needs time to plan the audit properly and
perform the work without undue pressure from too-short deadlines.
2-20. An auditor obtains an understanding of a client's internal control system as a part of the control risk assessment
process primarily in order to plan the nature, timing and extent of subsequent substantive audit procedures.
Understanding of internal control allows an auditor to gain a measure of comfort as to how much to rely on the
information generated by the auditee’s accounting system. A secondary purpose (not covered in Chapter 2) is to
obtain information about reportable conditions (control deficiencies) to report to the client.
2-21. CAS 500.5(c) defines audit evidence as “Information used by the auditor in arriving at conclusions on which the
auditor’s opinion is based. Audit evidence includes both information contained in the accounting records
underlying the financial statements and other information.” Audit evidence is (and includes) all the influences on
the mind of an auditor which affect decisions about the fair presentation of propositions (financial or otherwise)
submitted for audit. Evidence may be quantified or qualified; it may be objective to a greater or lesser degree; it
may be absolutely compelling or only mildly persuasive to a decision.
2-22. The ten important elements of the standard unmodified audit report.
1. Title. The title should contain the word independent, as in independent auditor or independent accountant.
2- Address. The report shall be addressed to the client, which occasionally may be different from the auditee.
3. Notice of Audit. A sentence should identify the financial statements and declare that they were audited.
This appears in the introduction paragraph.
4. Responsibilities. The report should state management's responsibility for the financial statements and the
auditor's responsibility for the audit report. These statements are also in the last paragraph.
5. Description of the Audit. The auditor responsibilities and basis for opinion paragraphs (scope paragraphs
should declare that the audit was conducted in accordance with generally accepted auditing standards and
describe the principal characteristics of an audit, including a statement of belief that the audit provided a
reasonable basis for the opinion.
6. Opinion. The report shall contain an opinion (opinion paragraph) regarding conformity with generally
accepted accounting principles.
7. Signature. The auditor shall sign the report, manually or otherwise.
8. Date. The report shall be dated with the date when all significant field work was completed.
Solutions Manual © 2016, McGraw-Hill Education. All Rights Reserved.
criteria for determining the adequacy of the new procedures.
The word "procedure" is used in SAS 46 (AU 390)--"Consideration of Omitted Procedures After the Report Date"--
to refer to (1) an act to be performed and (2) sufficient competent evidence. SAS 46 speaks of omitted procedures
and the relative seriousness of their omission. The importance of any "omitted procedure," however, is the
evidence the auditors failed to obtain. Merely omitting technical procedures is only a superficial analysis of an
audit problem; the substance is the evidence not obtained.
2-17. The standard for due audit care is the care which would be exercised by the prudent auditor. The prudent auditor
is one who exercises reasonable judgment, who is not expected to be omniscient, who is presumed to have
knowledge special to his profession, who is expected to be aware of his own ignorance, who is expected to possess
the skills of his profession whether he is a beginner or a veteran.
2-18. Three elements of planning and supervision considered essential in audit practice are:
1. A written audit program.
2. An understanding of the client's (auditee's) business.
PA firm procedures to allow an audit team member to document disagreements with accounting or
auditing conclusions and disassociate himself or herself from the matter.
3. Ensuring that staff have appropriate training and competence to perform the audit.
2-19. The timing of the auditor's appointment matters because the auditor needs time to plan the audit properly and
perform the work without undue pressure from too-short deadlines.
2-20. An auditor obtains an understanding of a client's internal control system as a part of the control risk assessment
process primarily in order to plan the nature, timing and extent of subsequent substantive audit procedures.
Understanding of internal control allows an auditor to gain a measure of comfort as to how much to rely on the
information generated by the auditee’s accounting system. A secondary purpose (not covered in Chapter 2) is to
obtain information about reportable conditions (control deficiencies) to report to the client.
2-21. CAS 500.5(c) defines audit evidence as “Information used by the auditor in arriving at conclusions on which the
auditor’s opinion is based. Audit evidence includes both information contained in the accounting records
underlying the financial statements and other information.” Audit evidence is (and includes) all the influences on
the mind of an auditor which affect decisions about the fair presentation of propositions (financial or otherwise)
submitted for audit. Evidence may be quantified or qualified; it may be objective to a greater or lesser degree; it
may be absolutely compelling or only mildly persuasive to a decision.
2-22. The ten important elements of the standard unmodified audit report.
1. Title. The title should contain the word independent, as in independent auditor or independent accountant.
2- Address. The report shall be addressed to the client, which occasionally may be different from the auditee.
3. Notice of Audit. A sentence should identify the financial statements and declare that they were audited.
This appears in the introduction paragraph.
4. Responsibilities. The report should state management's responsibility for the financial statements and the
auditor's responsibility for the audit report. These statements are also in the last paragraph.
5. Description of the Audit. The auditor responsibilities and basis for opinion paragraphs (scope paragraphs
should declare that the audit was conducted in accordance with generally accepted auditing standards and
describe the principal characteristics of an audit, including a statement of belief that the audit provided a
reasonable basis for the opinion.
6. Opinion. The report shall contain an opinion (opinion paragraph) regarding conformity with generally
accepted accounting principles.
7. Signature. The auditor shall sign the report, manually or otherwise.
8. Date. The report shall be dated with the date when all significant field work was completed.
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Solutions Manual © 2016, McGraw-Hill Education. All Rights Reserved.
9. Key audit matters paragraph indicate significant judgments or uncertainties in the audit
10. Address
2-23. CPA Canada Handbook Recommendations are the highest level of authoritative support for GAAP. Textbooks and
journal articles are the lowest level. In between are regulatory requirements emerging issues task force guides,
Handbook Guidelines and the Conceptual Framework. Some would argue that an appropriate conceptual
framework should be the highest set of principles.
2-24. Yes.
The unmodified opinion sentence contains in the audit report implies, among other things, that the accounting
principles used by the company are appropriate in the circumstances.
2-25. Four types of opinions and their messages:
Type Message
Unmodified opinion Financial statements are presented in conformity with GAAP.
Adverse opinion Financial statements are not presented in conformity with GAAP.
Qualified opinion Financial statements are presented in conformity with GAAP, except
for one or more departures.
Disclaimer of opinion Auditor's declaration that no opinion is given.
2-26. Two messages are usually implicit in a standard audit report by their absence: (1) disclosures are adequate, and (2)
the accounting principles have been consistently applied.
2-27. The major differences between assurance standards and generally accepted auditing standards (GAAS) lie in the
areas of practitioner competence, internal control, reporting, and suitability criteria.
GAAS presume knowledge of accounting and require training and proficiency as an auditor (meaning an auditor of
financial statements. The assurance standards are more general, requiring training and proficiency in the
"assurance function" and knowledge of the "subject matter of the assertions."
The assurance standards have no requirement regarding an understanding of the internal control structure for an
information system. Considerations of internal control are implicit in the task of obtaining sufficient evidence.
Anyway, some kinds of attested information may not have an underlying information control system in the same
sense as a financial accounting and reporting system.
Reporting is different because assurance on nonfinancial information do not depend upon generally accepted
accounting principles. The assurance standards speak of "evaluation suitable criteria," and "conformity with
established or stated criteria" and leave the door open for assurance on a wide variety of informational assertions.
2-28 An assurance engagement is: An engagement in which a practitioner is engaged to issue or does issue a written
communication that expresses a conclusion concerning a subject matter for which the accountable party in an
accountability relationship is responsible.
2-29 The theoretical essence of an assurance engagement is an person's ability to recognize the information being
asserted, determine the evidence relevant to the assertions, and make decisions about the correspondence of the
information asserted with suitable criteria.
2-30 The assertion is that amateur golfers can drive Wilson golf balls farther than competing brands. The Wilson
company is the asserter (2nd party), the PA firm is the assurer (1st party), and the amateur golfer is the 3rd party
owed accountability. The criterion is the average drive by the average amateur golfer. This criterion allows
objective verification with sufficient numbers of representative amateurs at high (audit) level of assurance. Critical
Solutions Manual © 2016, McGraw-Hill Education. All Rights Reserved.
9. Key audit matters paragraph indicate significant judgments or uncertainties in the audit
10. Address
2-23. CPA Canada Handbook Recommendations are the highest level of authoritative support for GAAP. Textbooks and
journal articles are the lowest level. In between are regulatory requirements emerging issues task force guides,
Handbook Guidelines and the Conceptual Framework. Some would argue that an appropriate conceptual
framework should be the highest set of principles.
2-24. Yes.
The unmodified opinion sentence contains in the audit report implies, among other things, that the accounting
principles used by the company are appropriate in the circumstances.
2-25. Four types of opinions and their messages:
Type Message
Unmodified opinion Financial statements are presented in conformity with GAAP.
Adverse opinion Financial statements are not presented in conformity with GAAP.
Qualified opinion Financial statements are presented in conformity with GAAP, except
for one or more departures.
Disclaimer of opinion Auditor's declaration that no opinion is given.
2-26. Two messages are usually implicit in a standard audit report by their absence: (1) disclosures are adequate, and (2)
the accounting principles have been consistently applied.
2-27. The major differences between assurance standards and generally accepted auditing standards (GAAS) lie in the
areas of practitioner competence, internal control, reporting, and suitability criteria.
GAAS presume knowledge of accounting and require training and proficiency as an auditor (meaning an auditor of
financial statements. The assurance standards are more general, requiring training and proficiency in the
"assurance function" and knowledge of the "subject matter of the assertions."
The assurance standards have no requirement regarding an understanding of the internal control structure for an
information system. Considerations of internal control are implicit in the task of obtaining sufficient evidence.
Anyway, some kinds of attested information may not have an underlying information control system in the same
sense as a financial accounting and reporting system.
Reporting is different because assurance on nonfinancial information do not depend upon generally accepted
accounting principles. The assurance standards speak of "evaluation suitable criteria," and "conformity with
established or stated criteria" and leave the door open for assurance on a wide variety of informational assertions.
2-28 An assurance engagement is: An engagement in which a practitioner is engaged to issue or does issue a written
communication that expresses a conclusion concerning a subject matter for which the accountable party in an
accountability relationship is responsible.
2-29 The theoretical essence of an assurance engagement is an person's ability to recognize the information being
asserted, determine the evidence relevant to the assertions, and make decisions about the correspondence of the
information asserted with suitable criteria.
2-30 The assertion is that amateur golfers can drive Wilson golf balls farther than competing brands. The Wilson
company is the asserter (2nd party), the PA firm is the assurer (1st party), and the amateur golfer is the 3rd party
owed accountability. The criterion is the average drive by the average amateur golfer. This criterion allows
objective verification with sufficient numbers of representative amateurs at high (audit) level of assurance. Critical
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Solutions Manual © 2016, McGraw-Hill Education. All Rights Reserved.
issues: how to define amateur golfer and the population it represents? How to obtain a representative sample of
amateur golfers? What are representative golfing conditions? What is a sufficient sample size to determine the
average drive with audit level assurance so that the auditor does not commit the logical fallacy of “hasty
generalization”?
SOLUTIONS TO MULTIPLE-CHOICE QUESTIONS
MC 2-1 LO3 It is always a good idea for auditors to begin an audit with professional skepticism characterized by the
assumption that
a. a potential conflict of interest always exists between the auditor and the management of the enterprise under
audit.
b. in audits of financial statements, the auditor acts exclusively in the capacity of an auditor.
c. the professional status of the independent auditor imposes commensurate professional obligations.
d. financial statements and financial data are verifiable.
MC 2-2 LO3 When Auditee Company prohibits auditors from visiting selected branch offices of the business, this is an
example of interference with
a. reporting independence.
b. investigative independence.
c. auditors’ training and proficiency.
d. audit planning and supervision.
MC 2-3 LO4 After the auditors learned of Auditee Company’s failure to record an expense for obsolete inventory, they
agreed to a small adjustment to the financial statements because the Auditee president told them the company
would violate its debt agreements if the full amount were recorded. This is an example of a lack of
a. auditors’ training and proficiency.
b. planning and supervision.
c. audit investigative independence.
d. audit reporting independence.
MC 2-4 LO3 The primary purpose for obtaining an understanding of the company’s internal controls in a financial
statement audit is to
a. determine the nature, timing, and extent of auditing procedures to be performed.
b. make consulting suggestions to the management.
c. obtain direct, sufficient, and appropriate evidential matter to afford a reasonable basis for an opinion on the
financial statements.
d. determine whether the company has changed any accounting principles.
MC 2-5 LO4 Which of these generally accepted auditing standards are not affected by the auditee’s utilization of a
computerized accounting system?
a. The audit report shall state whether the financial statements are presented in accordance with GAAP.
b. The work is to be adequately planned and assistants, if any, are to be properly supervised.
c. Sufficient appropriate evidential matter is to be obtained ... to afford a reasonable basis for an opinion regarding
the financial statements under audit.
d. The audit is to be performed by a person or persons having adequate technical training and proficiency as an
auditor.
MC 2-6 LO2 Which of the following is not found in the standard unqualified audit report on financial statements?
a. An identification of the financial statements that were audited
b. A general description of an audit
c. An opinion that the financial statements present financial position in conformity with GAAP
d. An emphasis paragraph commenting on the effect of economic conditions on the company
MC 2-7 LO4 Assurance standards do not contain a requirement that auditors obtain
a. adequate knowledge in the subject matter of the assertions being examined.
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issues: how to define amateur golfer and the population it represents? How to obtain a representative sample of
amateur golfers? What are representative golfing conditions? What is a sufficient sample size to determine the
average drive with audit level assurance so that the auditor does not commit the logical fallacy of “hasty
generalization”?
SOLUTIONS TO MULTIPLE-CHOICE QUESTIONS
MC 2-1 LO3 It is always a good idea for auditors to begin an audit with professional skepticism characterized by the
assumption that
a. a potential conflict of interest always exists between the auditor and the management of the enterprise under
audit.
b. in audits of financial statements, the auditor acts exclusively in the capacity of an auditor.
c. the professional status of the independent auditor imposes commensurate professional obligations.
d. financial statements and financial data are verifiable.
MC 2-2 LO3 When Auditee Company prohibits auditors from visiting selected branch offices of the business, this is an
example of interference with
a. reporting independence.
b. investigative independence.
c. auditors’ training and proficiency.
d. audit planning and supervision.
MC 2-3 LO4 After the auditors learned of Auditee Company’s failure to record an expense for obsolete inventory, they
agreed to a small adjustment to the financial statements because the Auditee president told them the company
would violate its debt agreements if the full amount were recorded. This is an example of a lack of
a. auditors’ training and proficiency.
b. planning and supervision.
c. audit investigative independence.
d. audit reporting independence.
MC 2-4 LO3 The primary purpose for obtaining an understanding of the company’s internal controls in a financial
statement audit is to
a. determine the nature, timing, and extent of auditing procedures to be performed.
b. make consulting suggestions to the management.
c. obtain direct, sufficient, and appropriate evidential matter to afford a reasonable basis for an opinion on the
financial statements.
d. determine whether the company has changed any accounting principles.
MC 2-5 LO4 Which of these generally accepted auditing standards are not affected by the auditee’s utilization of a
computerized accounting system?
a. The audit report shall state whether the financial statements are presented in accordance with GAAP.
b. The work is to be adequately planned and assistants, if any, are to be properly supervised.
c. Sufficient appropriate evidential matter is to be obtained ... to afford a reasonable basis for an opinion regarding
the financial statements under audit.
d. The audit is to be performed by a person or persons having adequate technical training and proficiency as an
auditor.
MC 2-6 LO2 Which of the following is not found in the standard unqualified audit report on financial statements?
a. An identification of the financial statements that were audited
b. A general description of an audit
c. An opinion that the financial statements present financial position in conformity with GAAP
d. An emphasis paragraph commenting on the effect of economic conditions on the company
MC 2-7 LO4 Assurance standards do not contain a requirement that auditors obtain
a. adequate knowledge in the subject matter of the assertions being examined.
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b. an understanding of the auditee’s internal control structure.
c. sufficient evidence for the conclusions expressed in an attestation report.
d. independence in mental attitude.
MC 2-8 LO3 Auditor Jones is studying a company’s accounting treatment of a series of complicated transactions in
exotic financial instruments. She should look for the highest level of authoritative support for proper accounting in
a. provincial securities commissions’ staff position statements.
b. CPA Canada industry audit and accounting guides.
c. CPA Canada recommendations in the Handbook.
d. Emerging Issues Committee consensus statements.
MC 2-9 LO5 Which of the following is not an example of a quality control procedure likely to be used by a public
accounting firm to meet its professional responsibilities to auditees?
a. Completion of independence questionnaires by all partners and employees
b. Review and approval of audit plan by the partner in charge of the engagement just prior to signing the auditor’s
report
c. Evaluating professional staff after the conclusion of each engagement
d. Evaluating the integrity of management for each new audit client
MC 2-10 LO3 Which of the following concepts is not included in the wording of the auditor’s standard report?
a. Management’s responsibility for the financial statements
b. Auditor’s responsibility to assess significant estimates made by management
c. Extent of auditor’s reliance on the auditee’s internal controls
d. Examination of evidence on a test basis
MC 2-11 LO3 Which of the following is not mandatory when performing an audit in accordance with GAAS?
a. Proper supervision of assistants
b. Efficient performance of audit procedures
c. Understanding the auditee’s system of internal controls
d. Adequate planning of work to be performed
SOLUTIONS FOR EXERCISES AND PROBLEMS
EP2-1 a. PAs should not follow clients' suggestions about the conduct of an audit unless the suggestions clearly do
not conflict with his professional competence, judgment, honesty, independence, or ethical standards.
Where there is no disagreement about the results to be accomplished and the client's suggestion
represents a good idea a PA can accept it. Within professional bounds, mutual agreement with the client is
all right. The PA must never agree to any arrangement which violates generally accepted auditing standards
or the Code of Professional Conduct.
b. The reasons against dividing the assignment of audit work solely according to assets, liabilities and income
and expenses include the following:
1. Work should be assigned to staff members by considering the degree of difficulty in relation to the
technical competence and experience of individual staff members.
2. Sequence of work performed on an examination should be in accordance with an overall audit plan.
3. It is impossible to segregate work areas by major captions because often a close relationship exists
among a number of accounts in more than one category, as for example where income is based on
assets or expense is based on liabilities.
4. Often a single audit work paper is desirable to substantiate balances in accounts of various types,
such as an insurance analysis supporting premium disbursements, the expense portion and the
prepaid balance.
5. Duplication of staff effort would be more likely to occur if assignments were made on such a basis.
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b. an understanding of the auditee’s internal control structure.
c. sufficient evidence for the conclusions expressed in an attestation report.
d. independence in mental attitude.
MC 2-8 LO3 Auditor Jones is studying a company’s accounting treatment of a series of complicated transactions in
exotic financial instruments. She should look for the highest level of authoritative support for proper accounting in
a. provincial securities commissions’ staff position statements.
b. CPA Canada industry audit and accounting guides.
c. CPA Canada recommendations in the Handbook.
d. Emerging Issues Committee consensus statements.
MC 2-9 LO5 Which of the following is not an example of a quality control procedure likely to be used by a public
accounting firm to meet its professional responsibilities to auditees?
a. Completion of independence questionnaires by all partners and employees
b. Review and approval of audit plan by the partner in charge of the engagement just prior to signing the auditor’s
report
c. Evaluating professional staff after the conclusion of each engagement
d. Evaluating the integrity of management for each new audit client
MC 2-10 LO3 Which of the following concepts is not included in the wording of the auditor’s standard report?
a. Management’s responsibility for the financial statements
b. Auditor’s responsibility to assess significant estimates made by management
c. Extent of auditor’s reliance on the auditee’s internal controls
d. Examination of evidence on a test basis
MC 2-11 LO3 Which of the following is not mandatory when performing an audit in accordance with GAAS?
a. Proper supervision of assistants
b. Efficient performance of audit procedures
c. Understanding the auditee’s system of internal controls
d. Adequate planning of work to be performed
SOLUTIONS FOR EXERCISES AND PROBLEMS
EP2-1 a. PAs should not follow clients' suggestions about the conduct of an audit unless the suggestions clearly do
not conflict with his professional competence, judgment, honesty, independence, or ethical standards.
Where there is no disagreement about the results to be accomplished and the client's suggestion
represents a good idea a PA can accept it. Within professional bounds, mutual agreement with the client is
all right. The PA must never agree to any arrangement which violates generally accepted auditing standards
or the Code of Professional Conduct.
b. The reasons against dividing the assignment of audit work solely according to assets, liabilities and income
and expenses include the following:
1. Work should be assigned to staff members by considering the degree of difficulty in relation to the
technical competence and experience of individual staff members.
2. Sequence of work performed on an examination should be in accordance with an overall audit plan.
3. It is impossible to segregate work areas by major captions because often a close relationship exists
among a number of accounts in more than one category, as for example where income is based on
assets or expense is based on liabilities.
4. Often a single audit work paper is desirable to substantiate balances in accounts of various types,
such as an insurance analysis supporting premium disbursements, the expense portion and the
prepaid balance.
5. Duplication of staff effort would be more likely to occur if assignments were made on such a basis.
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6. Frequently, the scope of work regarding a single account requires simultaneous participation by the
staff, such as in the observation of inventories.
7. Many audit operations are not susceptible to division by category, as for example investigating
internal control, testing transactions and writing the report.
c. The staff member whose uncle owns the advertising agency should not be assigned to examine the
advertising account, even if this is the staff member that has the most detailed, in-depth knowledge of this
account. The firm is responsible for avoiding any relationships which might even suggest a conflict of
interest. Even if this staff member could show independence and not be biased, it still could seem as if
there's a conflict of interest to outsiders. So to play it safe, it would be better to avoid this type of situation.
If an issue came up down the road, it could potentially jeopardize the firm's position; therefore, any
situation where a bias might exist, that situation should be avoided.
EP2-2 From a theoretical viewpoint (and, in fact, from a practical viewpoint as well) such short notice of a request for an
audit causes difficulties with planning the audit work, with staffing, and with reviewing the work--all of these
features being elements of the exercise of due audit care. The December 26-January 20 period is a serious time
constraint for a first audit. The greatest difficulties involve the third general standard (due audit care) and the
three field standards. In view of the short notice and the time constraint, there may be some question as to
whether a sufficient first audit could be completed by January 20.
EP2-3 You must determine whether an unqualified opinion satisfies the GAAS reporting standard, in particular:
a. Determine whether the financial statements are presented in conformity with GAAP.
1. Read the footnote description of accounting policies.
2. Use a GAAP checklist.
3. Review the working papers for any indication of accounting policies not described in the footnote or
ones apparently not in conformity with GAAP.
4. Refer to GAAP criteria concerning the "meaning of present fairly" such as
(i) The accounting principles are generally acceptable, having authoritative support.
(ii) The accounting principles are appropriate in the circumstances.
(iii) The financial statements are informative.
(iv) The information is reasonably summarized.
(v) Material adjustments have not been waived without good reasons.
b. Determine whether any accounting changes have been made and whether accounting principles have been
applied consistently.
c. Determine whether the footnote disclosures are adequate to inform users of any material information
evident in the working papers.
EP2-4 GAAS in a Computer Environment
In an audit of a computer-based system, adequate training and experience must be directly related to EDP. In
particular, the auditor should be knowledgeable of what computer systems do, how to test the operations of an
EDP system, and how to use EDP-unique documentation.
The training and proficiency standard contributes to satisfaction of the independence standard by enabling the
auditor to make his own decisions and judgments. Otherwise, he might tend to subordinate his judgment to other
persons, possibly to client personnel. When the auditor lacks training and proficiency, it is virtually impossible to
maintain an operational independence over audit decisions. An independence of mental attitude is futile if actual
decisions are subordinated to others.
The exercise of due audit care requires a critical review at every level of audit supervision of the work done and
the decisions made by auditors Lacking the requisite skills and lacking independent decisions, the due care
expected of an auditor at operational, supervisor, and review levels cannot be delivered.
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6. Frequently, the scope of work regarding a single account requires simultaneous participation by the
staff, such as in the observation of inventories.
7. Many audit operations are not susceptible to division by category, as for example investigating
internal control, testing transactions and writing the report.
c. The staff member whose uncle owns the advertising agency should not be assigned to examine the
advertising account, even if this is the staff member that has the most detailed, in-depth knowledge of this
account. The firm is responsible for avoiding any relationships which might even suggest a conflict of
interest. Even if this staff member could show independence and not be biased, it still could seem as if
there's a conflict of interest to outsiders. So to play it safe, it would be better to avoid this type of situation.
If an issue came up down the road, it could potentially jeopardize the firm's position; therefore, any
situation where a bias might exist, that situation should be avoided.
EP2-2 From a theoretical viewpoint (and, in fact, from a practical viewpoint as well) such short notice of a request for an
audit causes difficulties with planning the audit work, with staffing, and with reviewing the work--all of these
features being elements of the exercise of due audit care. The December 26-January 20 period is a serious time
constraint for a first audit. The greatest difficulties involve the third general standard (due audit care) and the
three field standards. In view of the short notice and the time constraint, there may be some question as to
whether a sufficient first audit could be completed by January 20.
EP2-3 You must determine whether an unqualified opinion satisfies the GAAS reporting standard, in particular:
a. Determine whether the financial statements are presented in conformity with GAAP.
1. Read the footnote description of accounting policies.
2. Use a GAAP checklist.
3. Review the working papers for any indication of accounting policies not described in the footnote or
ones apparently not in conformity with GAAP.
4. Refer to GAAP criteria concerning the "meaning of present fairly" such as
(i) The accounting principles are generally acceptable, having authoritative support.
(ii) The accounting principles are appropriate in the circumstances.
(iii) The financial statements are informative.
(iv) The information is reasonably summarized.
(v) Material adjustments have not been waived without good reasons.
b. Determine whether any accounting changes have been made and whether accounting principles have been
applied consistently.
c. Determine whether the footnote disclosures are adequate to inform users of any material information
evident in the working papers.
EP2-4 GAAS in a Computer Environment
In an audit of a computer-based system, adequate training and experience must be directly related to EDP. In
particular, the auditor should be knowledgeable of what computer systems do, how to test the operations of an
EDP system, and how to use EDP-unique documentation.
The training and proficiency standard contributes to satisfaction of the independence standard by enabling the
auditor to make his own decisions and judgments. Otherwise, he might tend to subordinate his judgment to other
persons, possibly to client personnel. When the auditor lacks training and proficiency, it is virtually impossible to
maintain an operational independence over audit decisions. An independence of mental attitude is futile if actual
decisions are subordinated to others.
The exercise of due audit care requires a critical review at every level of audit supervision of the work done and
the decisions made by auditors Lacking the requisite skills and lacking independent decisions, the due care
expected of an auditor at operational, supervisor, and review levels cannot be delivered.
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The first field work standard requires adequate planning and supervision of assistants. Training and proficiency in
computer systems auditing is necessary in order to plan access to computerized records, programs, and to obtain
machine time for conducting audit procedures. The planning should provide for an early examination of the
computer system so that further procedures involving non-computer control and accounting features may be
planned should they depend upon computer control procedures.
Training and proficiency are very important for being able to obtain an understanding of the internal control
structure in a computer system. Client personnel will expect audit personnel to be capable of working with a
computer system.
The third standard of field work requires the auditor to obtain sufficient competent evidential matter to provide a
basis for an opinion on financial statements. Documentary evidence relating to a computer system includes
program flow charts, logic diagrams, and decision tables that are not normally used in non-computer systems.
Since these types of documentation are a part of the evidence, they must be understood by the auditor, and
understanding of them comes through training and proficiency in their use.
EP2-5 Audit Report Language
a. The auditor is reporting to the body that has engaged the auditing services. While the report may be read
and used by others who are indirect beneficiaries of the audit, current custom is not to address the report
to the unknown class of users.
b. The scope paragraph should specifically identify the audited statements by name so that there can be no
mistake about the subject of the report. The alternative language is not as precise.
c. The standard language effectively bases the audit on an extensive body of written auditing standards that
are known to others and can be cited in case of controversy. The alternative language, on the other hand,
seems to break loose from profession-wide quality norms and make the audit quality depend more on "the
circumstances," which introduces an element of mystery and lack of definition into the report.
d. The alternative wording is similar to the typical British audit report, and they seem to be able to live with it,
but Canadian auditors believe that "opinion" connotes belief or judgment stronger than impression but less
strong than positive knowledge. Canadian auditors do not wish to appear to have full, positive knowledge
about the statements on the grounds that it's not feasible to know all there is to know about the financial
statements. Also, the standard language leans heavily on GAAP as the criteria for fair presentation whereas
the alternative language contains no reference to authoritative accounting criteria.
EP2-6 The question requires one to review and discuss the current regulatory development in the audit profession. Some
points that can be discussed include:
The public accountability boards are intended to provide an additional level of independence for the public
accounting function. Public concerns arose that public accountants and auditors lack independence because they
are hired by and paid by the Company managers whom they are supposed to be monitoring.
Since Company managers are effectively providing their own report cards when they issue their financial
statements, the audit role has value because it provides an independent assessment of the validity of the claims
managers are making in their financial statements. This independent audit assessment is important to outsiders
using the financial statements because it enhances the reliability of that information. Since outsiders may suspect
that managers will issue biased information if left to their own devices, they demand an independent assessment
of the manager’s claims as this should detect any bias and require the manager to correct it. An effective
independent audit function should also act as a deterrent against managers issuing biased reports in the first
place. This function is referred to as monitoring. If outsiders question the independence of the auditor it cannot
Solutions Manual © 2016, McGraw-Hill Education. All Rights Reserved.
The first field work standard requires adequate planning and supervision of assistants. Training and proficiency in
computer systems auditing is necessary in order to plan access to computerized records, programs, and to obtain
machine time for conducting audit procedures. The planning should provide for an early examination of the
computer system so that further procedures involving non-computer control and accounting features may be
planned should they depend upon computer control procedures.
Training and proficiency are very important for being able to obtain an understanding of the internal control
structure in a computer system. Client personnel will expect audit personnel to be capable of working with a
computer system.
The third standard of field work requires the auditor to obtain sufficient competent evidential matter to provide a
basis for an opinion on financial statements. Documentary evidence relating to a computer system includes
program flow charts, logic diagrams, and decision tables that are not normally used in non-computer systems.
Since these types of documentation are a part of the evidence, they must be understood by the auditor, and
understanding of them comes through training and proficiency in their use.
EP2-5 Audit Report Language
a. The auditor is reporting to the body that has engaged the auditing services. While the report may be read
and used by others who are indirect beneficiaries of the audit, current custom is not to address the report
to the unknown class of users.
b. The scope paragraph should specifically identify the audited statements by name so that there can be no
mistake about the subject of the report. The alternative language is not as precise.
c. The standard language effectively bases the audit on an extensive body of written auditing standards that
are known to others and can be cited in case of controversy. The alternative language, on the other hand,
seems to break loose from profession-wide quality norms and make the audit quality depend more on "the
circumstances," which introduces an element of mystery and lack of definition into the report.
d. The alternative wording is similar to the typical British audit report, and they seem to be able to live with it,
but Canadian auditors believe that "opinion" connotes belief or judgment stronger than impression but less
strong than positive knowledge. Canadian auditors do not wish to appear to have full, positive knowledge
about the statements on the grounds that it's not feasible to know all there is to know about the financial
statements. Also, the standard language leans heavily on GAAP as the criteria for fair presentation whereas
the alternative language contains no reference to authoritative accounting criteria.
EP2-6 The question requires one to review and discuss the current regulatory development in the audit profession. Some
points that can be discussed include:
The public accountability boards are intended to provide an additional level of independence for the public
accounting function. Public concerns arose that public accountants and auditors lack independence because they
are hired by and paid by the Company managers whom they are supposed to be monitoring.
Since Company managers are effectively providing their own report cards when they issue their financial
statements, the audit role has value because it provides an independent assessment of the validity of the claims
managers are making in their financial statements. This independent audit assessment is important to outsiders
using the financial statements because it enhances the reliability of that information. Since outsiders may suspect
that managers will issue biased information if left to their own devices, they demand an independent assessment
of the manager’s claims as this should detect any bias and require the manager to correct it. An effective
independent audit function should also act as a deterrent against managers issuing biased reports in the first
place. This function is referred to as monitoring. If outsiders question the independence of the auditor it cannot
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provide this monitoring value.
A concern raised by some is that, if auditors lack independence, they themselves require some monitoring. It is
this" monitoring the monitor" function that the public accountability boards were established to perform.
At this time, the procedures these boards will follow to monitor public accountants and auditors are still evolving.
The boards may also become involved in establishing generally accepted auditing standards, quality control review
standards, peer review requirements and other specific procedures that public accountants and auditors will be
required to adhere to.
EP2-7 The case involves identifying a situation in which the audit scope is limited.
In situation a) the auditor has been unable to determine the impact of a contract that the client company has
entered into. One means by which an auditor might determine the potential financial impact of contract would be
to make inquiries of the Company's lawyer and obtain assertions from the lawyer that could be relied on.
If this is not possible, the auditor is not in a position to assess whether the contracts would have a material impact
on the Company that should be included in the Company's financial statements. Here the auditor has a scope
limitation that prevents providing an opinion on whether the financial statements are fairly stated as there is the
possibility that the statements exclude a material liability that should either be accrued or disclosed. In this
situation, the auditor has a responsibility to ensure that users are aware of the existence of the contract and the
auditor's inability to assess the potential impact of contract or to obtain evidence from the Company or its lawyer
regarding the potential impact. Users' decisions based on the financial statements may well be affected if they are
aware that Company management is bound by a contract yet cannot provide a reasonable explanation of its
impact.
In situation b) the Company is subject to regulations that can have a financial impact if violated. Determining if a
violation has occurred requires scientific information. In this situation, the auditor would be required to try to
determine whether any violations had occurred. Appropriate evidence would require obtaining representations
from people with scientific qualifications because experts must be qualified in order for auditors to rely on their
representations as evidence. In this situation, it is possible that the auditor could obtain reasonable evidence from
scientific experts so no scope limitation would arise. However, similar to situation a) if the auditor it is unable to
obtain evidence that can confirm whether the financial impact of complying with the environmental regulation has
been properly measured and reported, then the scope limitation exists and this should be noted in the audit
report. Similar to situation a), users’ decisions may be affected by the fact that the company is not able to provide
evidence to the auditor about whether or not it is violating governmental regulations.
EP2-8 ITR's statements does not appear to be an assurance engagement, after considering the components of assurance
engagements.
The parties involved are ITR and Knovel.
• These parties could be involved in an assurance engagement, with Knovel making in assertions regarding a
subject matter and ITR providing assurance to third parties regarding that assertion.
The subject matter is how long it takes to recover, or "payback", the investment in Knovel's new software product.
• If the objective of the engagement is to provide assurance that this payback is three months, the assurance
provider needs to obtain management's acknowledgment of responsibility for the subject matter as it relates
to this objective. Since Knovel management cannot be responsible for how a purchaser of a software product
implements that product to achieve operational savings and recover the investment in that product over a
period such as three months, it would be difficult to identify generally accepted, appropriate criteria for
assessing the subject matter in this case. This leads to the conclusion that this is not a subject matter on which
an assurance can be provided in accordance with assurance standards set out by CPA Canada.
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provide this monitoring value.
A concern raised by some is that, if auditors lack independence, they themselves require some monitoring. It is
this" monitoring the monitor" function that the public accountability boards were established to perform.
At this time, the procedures these boards will follow to monitor public accountants and auditors are still evolving.
The boards may also become involved in establishing generally accepted auditing standards, quality control review
standards, peer review requirements and other specific procedures that public accountants and auditors will be
required to adhere to.
EP2-7 The case involves identifying a situation in which the audit scope is limited.
In situation a) the auditor has been unable to determine the impact of a contract that the client company has
entered into. One means by which an auditor might determine the potential financial impact of contract would be
to make inquiries of the Company's lawyer and obtain assertions from the lawyer that could be relied on.
If this is not possible, the auditor is not in a position to assess whether the contracts would have a material impact
on the Company that should be included in the Company's financial statements. Here the auditor has a scope
limitation that prevents providing an opinion on whether the financial statements are fairly stated as there is the
possibility that the statements exclude a material liability that should either be accrued or disclosed. In this
situation, the auditor has a responsibility to ensure that users are aware of the existence of the contract and the
auditor's inability to assess the potential impact of contract or to obtain evidence from the Company or its lawyer
regarding the potential impact. Users' decisions based on the financial statements may well be affected if they are
aware that Company management is bound by a contract yet cannot provide a reasonable explanation of its
impact.
In situation b) the Company is subject to regulations that can have a financial impact if violated. Determining if a
violation has occurred requires scientific information. In this situation, the auditor would be required to try to
determine whether any violations had occurred. Appropriate evidence would require obtaining representations
from people with scientific qualifications because experts must be qualified in order for auditors to rely on their
representations as evidence. In this situation, it is possible that the auditor could obtain reasonable evidence from
scientific experts so no scope limitation would arise. However, similar to situation a) if the auditor it is unable to
obtain evidence that can confirm whether the financial impact of complying with the environmental regulation has
been properly measured and reported, then the scope limitation exists and this should be noted in the audit
report. Similar to situation a), users’ decisions may be affected by the fact that the company is not able to provide
evidence to the auditor about whether or not it is violating governmental regulations.
EP2-8 ITR's statements does not appear to be an assurance engagement, after considering the components of assurance
engagements.
The parties involved are ITR and Knovel.
• These parties could be involved in an assurance engagement, with Knovel making in assertions regarding a
subject matter and ITR providing assurance to third parties regarding that assertion.
The subject matter is how long it takes to recover, or "payback", the investment in Knovel's new software product.
• If the objective of the engagement is to provide assurance that this payback is three months, the assurance
provider needs to obtain management's acknowledgment of responsibility for the subject matter as it relates
to this objective. Since Knovel management cannot be responsible for how a purchaser of a software product
implements that product to achieve operational savings and recover the investment in that product over a
period such as three months, it would be difficult to identify generally accepted, appropriate criteria for
assessing the subject matter in this case. This leads to the conclusion that this is not a subject matter on which
an assurance can be provided in accordance with assurance standards set out by CPA Canada.
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The accountability relationships would be between the Company and the assurance provider, and between each of
these parties and third parties. The third parties would be potential customers that could be making decisions
based on the assertion and on the assurance attached to that assertion. These accountability relationships could
result in an assurance engagement.
The nature of the report that could be issued, in accordance with CPA Canada assurance standards, would be as
follows:
• The report would need to identify to whom it is addressed, the objective of the assurance engagements, the
entity and the subject matter covered by the engagement, management's assertion, the responsibilities of
management and the assurance provider, the standards that were followed in conducting the engagement,
the criteria against which subject matter was evaluated, a conclusion indicating the level of assurance being
provided, the name of the assurance provider, the date and place where the assurance report was issued.
The president may have wanted the ad stopped because, effectively, the ad is providing assurance related to the
claim that the Knovel software will payback in three months. Since ITR has not performed an assurance
engagement, it has no basis for providing such assurance. Thus it is not appropriate to publicize this claim in a way
that implies ITR is providing assurance on it.
EP2-9 The question involves the relation between GAAP and providing an audit opinion. One approach to this issue is as
follows.
a) When an auditor needs to assess whether CPA Canada Handbook Recommendations have been followed
but the Handbook is silent on a particular issue, auditors usually go down a hierarchy to find the next
highest source of support for the client's accounting solution to a financial reporting problem. The
auditor can refer to the positions taken on accounting matters by provincial securities commissions, to
accounting pronouncements issued in other countries (for example, the US Financial Accounting
Standards Board or the International Accounting Standards Board), industry accounting guidelines and
practices followed in financial reports of other companies in the same industry, CPA Canada EIC consensus
positions, accounting research reports, textbooks, etc.
In using any of these supports, including the CPA Canada Handbook, to determine what is GAAP in a
particular situation, the exercise of good professional judgment by the auditor is critical. In applying
judgment, the auditor has to take into account the context of the situation, how the information will be
used, who the users are and what their level of sophistication and access to other information is, the
motives of the preparers of the accounting information, and any other relevant issues that in the auditor’s
experience may shed light on the reliability and appropriateness of the reported information.
Possible examples of accounting issues that may not be covered in CPA Canada Handbook
Recommendations (current at time of writing, but note that CPA Canada Handbook Recommendations are
updated frequently)
- revenue recognition for complex software sales that combine software and future services such as
maintenance
-capitalization or expensing of environmental control equipment expenditures
b) When the CPA Canada Handbook Recommendations allow for different choices of accounting methods,
the auditor needs to consider whether the client's choice is appropriate in the circumstances. Again, the
exercise of good professional judgment by the auditor is critical. In applying judgment, the auditor has to
take into account the context of the situation, how the information will be used, who the users are and
what their level of sophistication and access to other information is, the motives of the preparers of the
accounting information, and any other relevant issues that in the auditor’s experience may shed light on
the reliability and appropriateness of the reported information.
Examples of accounting choices set out in CPA Canada Handbook Recommendations (current at time of
writing, but note that CPA Canada Handbook Recommendations are updated frequently)
Solutions Manual © 2016, McGraw-Hill Education. All Rights Reserved.
The accountability relationships would be between the Company and the assurance provider, and between each of
these parties and third parties. The third parties would be potential customers that could be making decisions
based on the assertion and on the assurance attached to that assertion. These accountability relationships could
result in an assurance engagement.
The nature of the report that could be issued, in accordance with CPA Canada assurance standards, would be as
follows:
• The report would need to identify to whom it is addressed, the objective of the assurance engagements, the
entity and the subject matter covered by the engagement, management's assertion, the responsibilities of
management and the assurance provider, the standards that were followed in conducting the engagement,
the criteria against which subject matter was evaluated, a conclusion indicating the level of assurance being
provided, the name of the assurance provider, the date and place where the assurance report was issued.
The president may have wanted the ad stopped because, effectively, the ad is providing assurance related to the
claim that the Knovel software will payback in three months. Since ITR has not performed an assurance
engagement, it has no basis for providing such assurance. Thus it is not appropriate to publicize this claim in a way
that implies ITR is providing assurance on it.
EP2-9 The question involves the relation between GAAP and providing an audit opinion. One approach to this issue is as
follows.
a) When an auditor needs to assess whether CPA Canada Handbook Recommendations have been followed
but the Handbook is silent on a particular issue, auditors usually go down a hierarchy to find the next
highest source of support for the client's accounting solution to a financial reporting problem. The
auditor can refer to the positions taken on accounting matters by provincial securities commissions, to
accounting pronouncements issued in other countries (for example, the US Financial Accounting
Standards Board or the International Accounting Standards Board), industry accounting guidelines and
practices followed in financial reports of other companies in the same industry, CPA Canada EIC consensus
positions, accounting research reports, textbooks, etc.
In using any of these supports, including the CPA Canada Handbook, to determine what is GAAP in a
particular situation, the exercise of good professional judgment by the auditor is critical. In applying
judgment, the auditor has to take into account the context of the situation, how the information will be
used, who the users are and what their level of sophistication and access to other information is, the
motives of the preparers of the accounting information, and any other relevant issues that in the auditor’s
experience may shed light on the reliability and appropriateness of the reported information.
Possible examples of accounting issues that may not be covered in CPA Canada Handbook
Recommendations (current at time of writing, but note that CPA Canada Handbook Recommendations are
updated frequently)
- revenue recognition for complex software sales that combine software and future services such as
maintenance
-capitalization or expensing of environmental control equipment expenditures
b) When the CPA Canada Handbook Recommendations allow for different choices of accounting methods,
the auditor needs to consider whether the client's choice is appropriate in the circumstances. Again, the
exercise of good professional judgment by the auditor is critical. In applying judgment, the auditor has to
take into account the context of the situation, how the information will be used, who the users are and
what their level of sophistication and access to other information is, the motives of the preparers of the
accounting information, and any other relevant issues that in the auditor’s experience may shed light on
the reliability and appropriateness of the reported information.
Examples of accounting choices set out in CPA Canada Handbook Recommendations (current at time of
writing, but note that CPA Canada Handbook Recommendations are updated frequently)
Loading page 20...
Smieliauskas & Bewley, Auditing: An International Approach, 7th Edition Page 2-12
Solutions Manual © 2016, McGraw-Hill Education. All Rights Reserved.
- revenue recognition
- amortization method
- inventory costs flow method
EP2-10 (Some instructors may prefer to defer this question until after Chapter 14 is covered.)
The case presents a scenario where events occurring subsequent to the year-end potentially have an impact on the
information that should be reported in Bunting's year-end financial statements. One possible analysis follows.
One issue that is raised is the timeliness of financial reporting. By fixing a set date as of which financial statements
are prepared, financial statements can become out of date before they are even issued, especially when business
and economic conditions are undergoing rapid change, as is the situation in this case.
Another issue is the sensitivity of the Company's operations to information that might be reported in the financial
statements. In this case, information regarding the launch of a competing product can have a harmful impact on
sales contracts the company is in the process of negotiating. Here Company management is arguing that this is
proprietary information and that it has to be kept private. On the other hand, the auditor believes this information
has a material impact on the company’s financial position and therefore it must be reported to users. The auditor
might also argue that this information exists so it is very likely that potential customers are also aware of it already.
By not including the impact in financial statements that are currently being prepared, the company runs the risk of
giving the impression that is trying to mislead these potential customers. This can be very damaging to the
company's reputation, and have very significant negative impact on its future operations. This negative impression
would be aggravated by a qualified audit report which indicates that, not only was management aware of this new
development, but it also refused to disclose the information even though the company’s auditor was insisting on
disclosure.
A further issue is the reliability of estimating the potential impact of the new product on the Bunting's future
earnings. As management points out, since the product is untried in the marketplace it may well not operate as
advertise. So it is a conjecture to say that its impact on Bunting's operations can be known at this time. This is
difficult trade-off for the auditor to make: how should information that is highly relevant to users and their
decisions but very difficult to measure reliably the handled in audit engagement? This line of reasoning would
suggest that the auditor's may have gone too far in including estimated amounts and their impact on financial
statement items in their audit qualification. This may explain why Bunting's management refused to accept the
auditor's approach, resulting the qualified audit report.
Other valid issues based on the case facts can be identified, analyzed from different perspectives, and concluded
on.
EP2-11 (Some instructors may prefer to defer this question until after Chapter 4 is covered.)
The following are some of the points that can be discussed.
Professional skepticism is required to comply with the general standard of auditing and that requires the auditor to
conduct the audit with due care. Accepting management representations as being truthful without attempting to
verify them by gathering relevant appropriate audit evidence is not exercising the required level of care.
The need for the auditor to rely on management representations at some point creates a conflict. Some
representations are not amenable to verification using feasible audit procedures. A good example of this is the
completeness representation. Management represents that it has presented complete information concerning its
liabilities, its revenues, its commitments, etc. but to verify these claims is not feasible. For example, verifying
completeness of liabilities would require the auditor to inquire of every possible creditor - this is impossible.
In practice this conflict is resolved some extent through the requirements of generally accepted auditing
standards. In general, any management claim that can be verified by reasonable audit procedures will be verified,
subject to consideration of its materiality. Representations that cannot be verified by reasonable means are
Solutions Manual © 2016, McGraw-Hill Education. All Rights Reserved.
- revenue recognition
- amortization method
- inventory costs flow method
EP2-10 (Some instructors may prefer to defer this question until after Chapter 14 is covered.)
The case presents a scenario where events occurring subsequent to the year-end potentially have an impact on the
information that should be reported in Bunting's year-end financial statements. One possible analysis follows.
One issue that is raised is the timeliness of financial reporting. By fixing a set date as of which financial statements
are prepared, financial statements can become out of date before they are even issued, especially when business
and economic conditions are undergoing rapid change, as is the situation in this case.
Another issue is the sensitivity of the Company's operations to information that might be reported in the financial
statements. In this case, information regarding the launch of a competing product can have a harmful impact on
sales contracts the company is in the process of negotiating. Here Company management is arguing that this is
proprietary information and that it has to be kept private. On the other hand, the auditor believes this information
has a material impact on the company’s financial position and therefore it must be reported to users. The auditor
might also argue that this information exists so it is very likely that potential customers are also aware of it already.
By not including the impact in financial statements that are currently being prepared, the company runs the risk of
giving the impression that is trying to mislead these potential customers. This can be very damaging to the
company's reputation, and have very significant negative impact on its future operations. This negative impression
would be aggravated by a qualified audit report which indicates that, not only was management aware of this new
development, but it also refused to disclose the information even though the company’s auditor was insisting on
disclosure.
A further issue is the reliability of estimating the potential impact of the new product on the Bunting's future
earnings. As management points out, since the product is untried in the marketplace it may well not operate as
advertise. So it is a conjecture to say that its impact on Bunting's operations can be known at this time. This is
difficult trade-off for the auditor to make: how should information that is highly relevant to users and their
decisions but very difficult to measure reliably the handled in audit engagement? This line of reasoning would
suggest that the auditor's may have gone too far in including estimated amounts and their impact on financial
statement items in their audit qualification. This may explain why Bunting's management refused to accept the
auditor's approach, resulting the qualified audit report.
Other valid issues based on the case facts can be identified, analyzed from different perspectives, and concluded
on.
EP2-11 (Some instructors may prefer to defer this question until after Chapter 4 is covered.)
The following are some of the points that can be discussed.
Professional skepticism is required to comply with the general standard of auditing and that requires the auditor to
conduct the audit with due care. Accepting management representations as being truthful without attempting to
verify them by gathering relevant appropriate audit evidence is not exercising the required level of care.
The need for the auditor to rely on management representations at some point creates a conflict. Some
representations are not amenable to verification using feasible audit procedures. A good example of this is the
completeness representation. Management represents that it has presented complete information concerning its
liabilities, its revenues, its commitments, etc. but to verify these claims is not feasible. For example, verifying
completeness of liabilities would require the auditor to inquire of every possible creditor - this is impossible.
In practice this conflict is resolved some extent through the requirements of generally accepted auditing
standards. In general, any management claim that can be verified by reasonable audit procedures will be verified,
subject to consideration of its materiality. Representations that cannot be verified by reasonable means are
Loading page 21...
Smieliauskas & Bewley, Auditing: An International Approach, 7th Edition Page 2-13
Solutions Manual © 2016, McGraw-Hill Education. All Rights Reserved.
documented in management’s "Letter of Representation". Further, management's responsibility for the financial
statements is explained in the standard wording of the auditor's report. Also, many companies, especially public
companies, include with the financial statements a "Statement of Management's Responsibility" to communicate
to users management's role in preparing the financial statements and its responsibility for the assertions,
accounting choices and estimates contained in those financial statements.
To the extent that these conflicts cannot ever be completely resolved, this a limitation to the assurance that an
audit can provide. Audits can never provide 100% assurance, and knowledgeable users are expected to be aware
of the limitations of audits.
EP2-12 (Some instructors may prefer to defer this question until after Chapter 17 is covered.)
The question requires the application of basis assurance principles to a unique setting, United Nations weapons in
Iraq. One possible response is as follows.
The subject matter is the existence of chemical, biological and nuclear weapons in Iraq.
Using the analogy of auditing for missing liabilities in a company, the Iraqi government ("management") represents
that there are no hidden weapons ("unrecorded liabilities").
An approach for the assessing risks and probabilities of weapons existing.
Given the concerns of the UN about the harm that might arise from the Iraqi government possessing weapons of
mass destruction, the inspectors would want to reduce the risk of missing hidden weapons to very low level. To
parallel this to an audit of financial statements, this would be like setting the acceptable audit risk very low, which
the auditor will do when the consequences to the auditor of missing a misstatement in the financial statements
can be very costly (for example, an audit of a public company or a financial institution).
The probabilities of weapons existing is comparable to the assessment of inherent risk in a financial statement
audit. Based on their resources devoted to the weapons inspection exercise and a heightened attention focused
on the inspectors work and findings, it seems the UN assessed the inherent risk that weapons exist as being very
high. This may have been based on internal investigations, intelligence reports or other information available to
the inspectors but not public knowledge.
To implement the inspection, the inspectors would have to follow a systematic process similar to that followed by
financial statement auditors.
The inspectors would need to obtain a knowledge of the types of weapons and weapon manufacturing equipment
that may exist, where such weapons could be concealed, the process involved in creating such weapons and
transporting them. This could be paralleled to the "knowledge of business" that the financial statement auditor
requires in order to plan and execute the audit. This knowledge would inform the inspectors of the kinds of places
that they need to visit and the kinds of evidence that may exist to indicate that weapons have been created or
transported to a particular location. Any internal reports or other intelligence that exists concerning the use of
public buildings for storing concealed weapons would also be relevant to determining the probabilities that
weapons are concealed in particular locations.
A planning procedure would need to be followed to scope out the extent of the territory and existing structures
and facilities that will need to be inspected and the staff required. This will determine the number of inspectors
that need to be employed, the types of qualifications they require, the specific procedures they will have to
perform and to estimate the time required to complete the inspection.
EP2-13 According to some recent CPAB reports PA firms seem to have most problems with meeting the independence
requirements and the quality of documentation in their audit files. These problems have been ongoing for the first
10 years of the CPAB’s monitoring. In part this may be why the Handbook now has a special section dealing with
standards for quality control for PA firms. CPAB findings seem to increasingly influence the CPA Canada and it, in
Solutions Manual © 2016, McGraw-Hill Education. All Rights Reserved.
documented in management’s "Letter of Representation". Further, management's responsibility for the financial
statements is explained in the standard wording of the auditor's report. Also, many companies, especially public
companies, include with the financial statements a "Statement of Management's Responsibility" to communicate
to users management's role in preparing the financial statements and its responsibility for the assertions,
accounting choices and estimates contained in those financial statements.
To the extent that these conflicts cannot ever be completely resolved, this a limitation to the assurance that an
audit can provide. Audits can never provide 100% assurance, and knowledgeable users are expected to be aware
of the limitations of audits.
EP2-12 (Some instructors may prefer to defer this question until after Chapter 17 is covered.)
The question requires the application of basis assurance principles to a unique setting, United Nations weapons in
Iraq. One possible response is as follows.
The subject matter is the existence of chemical, biological and nuclear weapons in Iraq.
Using the analogy of auditing for missing liabilities in a company, the Iraqi government ("management") represents
that there are no hidden weapons ("unrecorded liabilities").
An approach for the assessing risks and probabilities of weapons existing.
Given the concerns of the UN about the harm that might arise from the Iraqi government possessing weapons of
mass destruction, the inspectors would want to reduce the risk of missing hidden weapons to very low level. To
parallel this to an audit of financial statements, this would be like setting the acceptable audit risk very low, which
the auditor will do when the consequences to the auditor of missing a misstatement in the financial statements
can be very costly (for example, an audit of a public company or a financial institution).
The probabilities of weapons existing is comparable to the assessment of inherent risk in a financial statement
audit. Based on their resources devoted to the weapons inspection exercise and a heightened attention focused
on the inspectors work and findings, it seems the UN assessed the inherent risk that weapons exist as being very
high. This may have been based on internal investigations, intelligence reports or other information available to
the inspectors but not public knowledge.
To implement the inspection, the inspectors would have to follow a systematic process similar to that followed by
financial statement auditors.
The inspectors would need to obtain a knowledge of the types of weapons and weapon manufacturing equipment
that may exist, where such weapons could be concealed, the process involved in creating such weapons and
transporting them. This could be paralleled to the "knowledge of business" that the financial statement auditor
requires in order to plan and execute the audit. This knowledge would inform the inspectors of the kinds of places
that they need to visit and the kinds of evidence that may exist to indicate that weapons have been created or
transported to a particular location. Any internal reports or other intelligence that exists concerning the use of
public buildings for storing concealed weapons would also be relevant to determining the probabilities that
weapons are concealed in particular locations.
A planning procedure would need to be followed to scope out the extent of the territory and existing structures
and facilities that will need to be inspected and the staff required. This will determine the number of inspectors
that need to be employed, the types of qualifications they require, the specific procedures they will have to
perform and to estimate the time required to complete the inspection.
EP2-13 According to some recent CPAB reports PA firms seem to have most problems with meeting the independence
requirements and the quality of documentation in their audit files. These problems have been ongoing for the first
10 years of the CPAB’s monitoring. In part this may be why the Handbook now has a special section dealing with
standards for quality control for PA firms. CPAB findings seem to increasingly influence the CPA Canada and it, in
Loading page 22...
Smieliauskas & Bewley, Auditing: An International Approach, 7th Edition Page 2-14
Solutions Manual © 2016, McGraw-Hill Education. All Rights Reserved.
turn, is influencing IFAC. For example, the CPA Canada at the urging of CPAB has recently created three
committees to look at research and professional literature related to 1. The audit report 2. Auditor independence,
including mandatory rotation of audit firms 3. The role of audit committees.
EP2-14 One major source of the expectations gap is the public’s expectations regarding auditor responsibilities to detect
fraud. Discuss in class. The profession’s response is discussed in chapter 7. This is a complex problem. Some
questions to consider in class. How much assurance can the auditor give that management (or anyone) is honest?
Should auditors provide the same assurance for detecting management fraud as for detecting lower level
employee fraud? Should the auditor have responsibility only for fraud affecting the financial statements or for any
fraud? Does fraud have to be a material amount, or is all fraud automatically material no matter how small the
amount? It is also important to keep in mind that accusing somebody of committing fraud (or any criminal act) can
lead to libel unless the accusation is proven in a court of law. In Canada’s legal system an individual is considered
innocent until a criminal act is proven in a court of law. These are just some of the complications in trying to close
the expectations gap. For now it is sufficient for the students to get a general idea of the complexities and this can
be done best through class discussion.
EP2-15 There definitely seems to be more of an expectations gap in the private sector. Chapter 1 illustrates that public
sector auditors have some of the best reputations in Canada. You cannot say the same about partners in the
private sector! Some might argue that is due to the fact public sector auditors arguably have more independence
than private sector auditors. See application case discussion for chapters1 and 2. For example, when an auditor
general decides which organization to audit and what type of audit (VFM? Compliance?) to perform, the auditee
cannot say no! Public sector auditors have been very successful in rooting out corruption and waste and this
appears to be closer to the public’s image about what all auditors should be doing. See discussion in EP15. Perhaps
all audits should be more like VFM audits in meeting the public’s expectations. Again, surveying class attitudes at
this point is a good way to get students thinking about what should be the role of auditors and comparing that to
what standards actually require.
EP2-16 Most students find that their non-accounting friends or relatives have only a vague understanding of what auditors
do. Having them read the audit report does not seem to have improved matters. See discussion of answer to EP 2-
15. Perhaps a more valid question is whether more sophisticated users have a better understanding.
Solutions Manual © 2016, McGraw-Hill Education. All Rights Reserved.
turn, is influencing IFAC. For example, the CPA Canada at the urging of CPAB has recently created three
committees to look at research and professional literature related to 1. The audit report 2. Auditor independence,
including mandatory rotation of audit firms 3. The role of audit committees.
EP2-14 One major source of the expectations gap is the public’s expectations regarding auditor responsibilities to detect
fraud. Discuss in class. The profession’s response is discussed in chapter 7. This is a complex problem. Some
questions to consider in class. How much assurance can the auditor give that management (or anyone) is honest?
Should auditors provide the same assurance for detecting management fraud as for detecting lower level
employee fraud? Should the auditor have responsibility only for fraud affecting the financial statements or for any
fraud? Does fraud have to be a material amount, or is all fraud automatically material no matter how small the
amount? It is also important to keep in mind that accusing somebody of committing fraud (or any criminal act) can
lead to libel unless the accusation is proven in a court of law. In Canada’s legal system an individual is considered
innocent until a criminal act is proven in a court of law. These are just some of the complications in trying to close
the expectations gap. For now it is sufficient for the students to get a general idea of the complexities and this can
be done best through class discussion.
EP2-15 There definitely seems to be more of an expectations gap in the private sector. Chapter 1 illustrates that public
sector auditors have some of the best reputations in Canada. You cannot say the same about partners in the
private sector! Some might argue that is due to the fact public sector auditors arguably have more independence
than private sector auditors. See application case discussion for chapters1 and 2. For example, when an auditor
general decides which organization to audit and what type of audit (VFM? Compliance?) to perform, the auditee
cannot say no! Public sector auditors have been very successful in rooting out corruption and waste and this
appears to be closer to the public’s image about what all auditors should be doing. See discussion in EP15. Perhaps
all audits should be more like VFM audits in meeting the public’s expectations. Again, surveying class attitudes at
this point is a good way to get students thinking about what should be the role of auditors and comparing that to
what standards actually require.
EP2-16 Most students find that their non-accounting friends or relatives have only a vague understanding of what auditors
do. Having them read the audit report does not seem to have improved matters. See discussion of answer to EP 2-
15. Perhaps a more valid question is whether more sophisticated users have a better understanding.
Loading page 23...
Smieliauskas & Bewley, Auditing: An International Approach, 7th Edition Page 3-1
Solutions Manual © 2016, McGraw-Hill Education. All Rights Reserved.
CHAPTER 3
AUDITORS’ ETHICAL AND LEGAL RESPONSIBILITIES
SOLUTIONS FOR REVIEW CHECKPOINTS
ESSENTIALS
3-1. The essential role and responsibility of an auditor is to establish and communicate assurance to users that the
financial statements are ‘fairly presented’, which implies that unethical reporting has not occurred. Unethical
reporting means the accountable party has prepared the financial statements in a biased way that either conceals
fraud or provides a deceptive and misleading impression of the financial performance and condition of a company.
Unethical reporting is an aspect of information risk. To reduce the information risk, the auditor must consider the
possibility, and address any suspicions, that the reporting has been done unethically.
3-2. To say financial statements are ‘fairly presented’ implies that unethical reporting has not occurred. It means the
financial statements meet the qualitative characteristics set out in the conceptual framework of accounting, the
most relevant of which is ‘representational faithfulness’. This quality means that information presented in an
entity’s financial statements closely corresponds to the actual underlying transactions and events affecting it,
conveying their economic substance rather than simply their legal form. Informally, fair presentation means that
outside users have a fair shot at making reasonable decisions based on the information in the financial statements.
3-3. An example of a potential conflict between a manager and shareholders of a company would be when
management decides to incur lavish travel expenses which are not directly leading to increased profits and hence
not in the long term interest of shareholders. A conflict between auditors and management can arise when
management want use an aggressive revenue recognition policy, or a valuation model that underestimates its bad
debt provision, and auditors contend these policies are not appropriate. A conflict could arise between the
auditors and the shareholders if the auditors gave a clean opinion and the company later had to restate its profits
to a much lower amount. The shareholders would probably think the auditors had done a poor job, or perhaps
they even were complicit with management and not acting in the shareholders’ best interest.
3-4. An example would be when an auditor has been auditing the same company for many years and becomes very
fond of some of the people in the accounting function there. This can happen through many shared experiences
working together on the challenges of completing the audit that build up good memories. In this case it requires
strong will on the part of the auditor to recognize and act appropriately, in an unbiased way, if a situation should
arise where the someone in the accounting staff is doing something that impairs the auditors ability to get the
evidence they need to comply with GAAS, or takes a decision that result in the financial statements not being fairly
presented.
3-5. Professional skepticism means that an auditor neither trusts nor distrusts claims made by management of the
enterprise being audited. The auditor always wants to question these claims and therefore seeks independent,
corroborating evidence. The auditor has a duty to corroborate management’s claims and assertions - this is what
the ethics code refers to as using ‘due care’. A practical approach to being skeptical is to always be thinking about
‘what could go wrong here?’
3-6. Critical thinking is a process of reasoning logically to assess whether evidence provides reliable reasons that
support a particular claim. Auditors must gather their own evidence on the financial statements and disclosures to
reach reasonable and supportable decision to provide assurance on the truthfulness of management’s financial
statements, and use critical thinking to reach their conclusions.
3-7. Professional judgment refers to an auditor applying relevant training, knowledge and experience, in the context
Solutions Manual © 2016, McGraw-Hill Education. All Rights Reserved.
CHAPTER 3
AUDITORS’ ETHICAL AND LEGAL RESPONSIBILITIES
SOLUTIONS FOR REVIEW CHECKPOINTS
ESSENTIALS
3-1. The essential role and responsibility of an auditor is to establish and communicate assurance to users that the
financial statements are ‘fairly presented’, which implies that unethical reporting has not occurred. Unethical
reporting means the accountable party has prepared the financial statements in a biased way that either conceals
fraud or provides a deceptive and misleading impression of the financial performance and condition of a company.
Unethical reporting is an aspect of information risk. To reduce the information risk, the auditor must consider the
possibility, and address any suspicions, that the reporting has been done unethically.
3-2. To say financial statements are ‘fairly presented’ implies that unethical reporting has not occurred. It means the
financial statements meet the qualitative characteristics set out in the conceptual framework of accounting, the
most relevant of which is ‘representational faithfulness’. This quality means that information presented in an
entity’s financial statements closely corresponds to the actual underlying transactions and events affecting it,
conveying their economic substance rather than simply their legal form. Informally, fair presentation means that
outside users have a fair shot at making reasonable decisions based on the information in the financial statements.
3-3. An example of a potential conflict between a manager and shareholders of a company would be when
management decides to incur lavish travel expenses which are not directly leading to increased profits and hence
not in the long term interest of shareholders. A conflict between auditors and management can arise when
management want use an aggressive revenue recognition policy, or a valuation model that underestimates its bad
debt provision, and auditors contend these policies are not appropriate. A conflict could arise between the
auditors and the shareholders if the auditors gave a clean opinion and the company later had to restate its profits
to a much lower amount. The shareholders would probably think the auditors had done a poor job, or perhaps
they even were complicit with management and not acting in the shareholders’ best interest.
3-4. An example would be when an auditor has been auditing the same company for many years and becomes very
fond of some of the people in the accounting function there. This can happen through many shared experiences
working together on the challenges of completing the audit that build up good memories. In this case it requires
strong will on the part of the auditor to recognize and act appropriately, in an unbiased way, if a situation should
arise where the someone in the accounting staff is doing something that impairs the auditors ability to get the
evidence they need to comply with GAAS, or takes a decision that result in the financial statements not being fairly
presented.
3-5. Professional skepticism means that an auditor neither trusts nor distrusts claims made by management of the
enterprise being audited. The auditor always wants to question these claims and therefore seeks independent,
corroborating evidence. The auditor has a duty to corroborate management’s claims and assertions - this is what
the ethics code refers to as using ‘due care’. A practical approach to being skeptical is to always be thinking about
‘what could go wrong here?’
3-6. Critical thinking is a process of reasoning logically to assess whether evidence provides reliable reasons that
support a particular claim. Auditors must gather their own evidence on the financial statements and disclosures to
reach reasonable and supportable decision to provide assurance on the truthfulness of management’s financial
statements, and use critical thinking to reach their conclusions.
3-7. Professional judgment refers to an auditor applying relevant training, knowledge and experience, in the context
Loading page 24...
Smieliauskas & Bewley, Auditing: An International Approach, 7th Edition Page 3-2
Solutions Manual © 2016, McGraw-Hill Education. All Rights Reserved.
provided by auditing, accounting and ethical standards, to make informed decisions about the most appropriate
action to take in the circumstances of an audit engagement. Professional judgment in auditing requires critical
thinking on accounting issues and the evidence related to them. A critical-thinking framework can be used for
deciding when an audit conclusion is sufficiently justified, giving consideration to possible conflicts of interest.
3-8. Good professional judgment in auditing involves applying relevant training, knowledge and experience, in the
context provided by auditing, accounting and ethical standards, to make informed decisions about the most
appropriate action to take in the circumstances of an audit engagement. Experience is required to develop good
judgment because most important lessons are learned by trying something new and making mistakes. To allow
professionals to develop good judgment, auditing work is typically organized so that more junior auditors work
under the supervision of more experienced ones.
3-9. A strong argument can be made that it can not. Being independent and objective, taking a skeptical attitude, and
thinking carefully and critically, are an individual responsibility. But people may also find it challenging to ‘think for
themselves’. It may seem difficult to go against the views of more experienced people, or the views of the
majority. But if an individual’s own critical reasoning leads to the conclusion that some action or decision is
unethical, it is still unethical even if more experienced people support it, or ‘everyone is doing it’.
3-10. ‘The expectation gap’ refers to a difference between what users of audit reports expect - that auditors will always
detect errors, fraud, theft, and illegal acts and report them publicly, and what auditors take responsibility for -
detecting material misstatements. This gap can lead to lawsuits, particularly if a business fails. That is because even
if auditors have performed well, the users may expect them to have done more to warn of the future business
failure. If an audit fails to detect unethical reporting, and the third party believes that auditors have not met their
professional responsibilities, auditors can face legal liability.
3-11. To establish auditor liability under common law, the plaintiff (the party who claims to have been wronged) must
prove four elements of negligence:
1. There was a legal duty of care to the plaintiff;
2. There was a breach of that duty;
3. There is proof that damages to the plaintiff resulted from the breach;
4. There is a reasonable connection between the breach and the damages.
The auditor's defense in a liability law suit is to show that any of the elements is not proven.
3-12. Statutory liability is written into law statutes which specify when auditors can be found liable and the ranges of
penalties auditors can be charged if they are liable. In common law, auditor liability principles and penalties are set
by judges, who refer to basic principles of fairness and to the past decisions of courts of law to support their
judgments. The development of statute-based regulation of auditors reflects that governments no longer rely on
the audit profession to self-regulate, as historically was the case.
TEXT
3-13 This arises from the three party accountability discussed in chapter 1. The auditor is hired because users expect
there may be such a conflict. If users completely trusted management there would be no need to have an auditor.
This is the only way to detect fraudulent or misleading reporting. The goal is to reduce this potential to an
acceptable level of risk. If the auditor assumed this risk was zero to start with the auditor would not need to
provide evidence that the possibility is low, and that contradicts the reason users demand an audit.
3-14 No, the auditor cannot detect deception without being skeptical. A non-skeptical auditor on finding evidence of
fraud may not treat it with the significance it deserves. The rule that suspicious transactions or evidence of
management deceit should automatically be considered material, even when the absolute amounts involved may
be very small or insignificant, is an example of skeptical logic in action. Since three party accountability implies
some degree of mistrust of management by users, the auditor must incorporate skepticism in his or her reasoning
process when management makes assertions about the financial statements it has prepared.
Solutions Manual © 2016, McGraw-Hill Education. All Rights Reserved.
provided by auditing, accounting and ethical standards, to make informed decisions about the most appropriate
action to take in the circumstances of an audit engagement. Professional judgment in auditing requires critical
thinking on accounting issues and the evidence related to them. A critical-thinking framework can be used for
deciding when an audit conclusion is sufficiently justified, giving consideration to possible conflicts of interest.
3-8. Good professional judgment in auditing involves applying relevant training, knowledge and experience, in the
context provided by auditing, accounting and ethical standards, to make informed decisions about the most
appropriate action to take in the circumstances of an audit engagement. Experience is required to develop good
judgment because most important lessons are learned by trying something new and making mistakes. To allow
professionals to develop good judgment, auditing work is typically organized so that more junior auditors work
under the supervision of more experienced ones.
3-9. A strong argument can be made that it can not. Being independent and objective, taking a skeptical attitude, and
thinking carefully and critically, are an individual responsibility. But people may also find it challenging to ‘think for
themselves’. It may seem difficult to go against the views of more experienced people, or the views of the
majority. But if an individual’s own critical reasoning leads to the conclusion that some action or decision is
unethical, it is still unethical even if more experienced people support it, or ‘everyone is doing it’.
3-10. ‘The expectation gap’ refers to a difference between what users of audit reports expect - that auditors will always
detect errors, fraud, theft, and illegal acts and report them publicly, and what auditors take responsibility for -
detecting material misstatements. This gap can lead to lawsuits, particularly if a business fails. That is because even
if auditors have performed well, the users may expect them to have done more to warn of the future business
failure. If an audit fails to detect unethical reporting, and the third party believes that auditors have not met their
professional responsibilities, auditors can face legal liability.
3-11. To establish auditor liability under common law, the plaintiff (the party who claims to have been wronged) must
prove four elements of negligence:
1. There was a legal duty of care to the plaintiff;
2. There was a breach of that duty;
3. There is proof that damages to the plaintiff resulted from the breach;
4. There is a reasonable connection between the breach and the damages.
The auditor's defense in a liability law suit is to show that any of the elements is not proven.
3-12. Statutory liability is written into law statutes which specify when auditors can be found liable and the ranges of
penalties auditors can be charged if they are liable. In common law, auditor liability principles and penalties are set
by judges, who refer to basic principles of fairness and to the past decisions of courts of law to support their
judgments. The development of statute-based regulation of auditors reflects that governments no longer rely on
the audit profession to self-regulate, as historically was the case.
TEXT
3-13 This arises from the three party accountability discussed in chapter 1. The auditor is hired because users expect
there may be such a conflict. If users completely trusted management there would be no need to have an auditor.
This is the only way to detect fraudulent or misleading reporting. The goal is to reduce this potential to an
acceptable level of risk. If the auditor assumed this risk was zero to start with the auditor would not need to
provide evidence that the possibility is low, and that contradicts the reason users demand an audit.
3-14 No, the auditor cannot detect deception without being skeptical. A non-skeptical auditor on finding evidence of
fraud may not treat it with the significance it deserves. The rule that suspicious transactions or evidence of
management deceit should automatically be considered material, even when the absolute amounts involved may
be very small or insignificant, is an example of skeptical logic in action. Since three party accountability implies
some degree of mistrust of management by users, the auditor must incorporate skepticism in his or her reasoning
process when management makes assertions about the financial statements it has prepared.
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Smieliauskas & Bewley, Auditing: An International Approach, 7th Edition Page 3-3
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3-15 A professional accountant must be prepared to be agent, spectator, advisor, instructor, judge, and critic.
3-16 In ethical philosophy, the word “conscience” is used to describe the “undefinable mental process that yields moral
decisions.” A close kin in the political science terms would be “anarchy.”
Conscience might not be a sufficient guide for personal ethics decisions because the individual’s undefinable
mental processes may be based on caprice, immaturity, ignorance, stubbornness, or misunderstanding.
Conscience may fail to show the consistency, clarity, practicability, impartiality, and adequacy preferred in ethical
standards and behavior. Exactly the same can be said about professional ethics decisions because a
nonhypocritical individual can no more split his behavior between personal life and professional life than he can
voluntarily split his own personality.
3-17 The rule “Failure to tell the whole truth is wrong” would (a) require that you not serve as a bank director when a
conflict of interest might arise, (b) tell the employer what you know about the forgeries. This rule may be called
imperative because it requires the truth regardless of what you might personally feel about the consequences.
Strict duty based or imperative theories (e.g., Kant) excuses the individual from undesirable consequences as long
as his decisions do not cause other people to be used as means.
3-18 Utilitarian ethics theory requires that a decision maker recognizes value attributes of the consequences of ethical
choice alternatives (good v. evil), somehow measure or weigh these, and then decide on the basis of the greater
good (or the lesser evil). Duty based ethics does not require that consequences be considered.
3-19 Monistic theories are based on idealizations or simplifications of the real world. The real world is “messy” with the
context of a situation, such as whether there is three party or two party accountability, having a major impact on
the proper role of an individual. Everyone has multiple social roles in life and it is the conflicts in these multiple
roles that seem to cause the most problems for monistic theories.
3-20 In the current audit environment, PAs are expected to better justify their decisions. This need for justification,
including the consideration of ethical issues, increases the importance of critical thinking.
3-21 Three specific aspects of on-the-job independence
1. Programming independence
2. Investigative independence
3- Reporting independence
3-22 In a class action lawsuit, a few aggrieved persons with small losses can bring suit on behalf of a large group of
similar persons, collectively having large losses (as in a securities offering). Large lawsuits often result in large
damage awards, and many lawyers are willing to take such plaintiffs on a contingency fee basis. Such fees are very
lucrative for lawyers, and probably less lucrative for their clients. Anyway, the losses loom large for PAs and their
insurance companies.
3-23 Some causes are as follows:
• Failure to report known departures from accounting principles, including misinterpretation of accounting
principles.
• Failure to conduct audits properly, including (a) misinterpretation of auditing standards, and (b) faulty
implementation of auditing procedures.
• Failure to detect management fraud, fraudulent financial reporting.
• Actual involvement in fraud.
• Also, business failure by clients after rendering an unqualified audit report.
3-24 Lawsuits related to tax practice, about 60 percent.
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3-15 A professional accountant must be prepared to be agent, spectator, advisor, instructor, judge, and critic.
3-16 In ethical philosophy, the word “conscience” is used to describe the “undefinable mental process that yields moral
decisions.” A close kin in the political science terms would be “anarchy.”
Conscience might not be a sufficient guide for personal ethics decisions because the individual’s undefinable
mental processes may be based on caprice, immaturity, ignorance, stubbornness, or misunderstanding.
Conscience may fail to show the consistency, clarity, practicability, impartiality, and adequacy preferred in ethical
standards and behavior. Exactly the same can be said about professional ethics decisions because a
nonhypocritical individual can no more split his behavior between personal life and professional life than he can
voluntarily split his own personality.
3-17 The rule “Failure to tell the whole truth is wrong” would (a) require that you not serve as a bank director when a
conflict of interest might arise, (b) tell the employer what you know about the forgeries. This rule may be called
imperative because it requires the truth regardless of what you might personally feel about the consequences.
Strict duty based or imperative theories (e.g., Kant) excuses the individual from undesirable consequences as long
as his decisions do not cause other people to be used as means.
3-18 Utilitarian ethics theory requires that a decision maker recognizes value attributes of the consequences of ethical
choice alternatives (good v. evil), somehow measure or weigh these, and then decide on the basis of the greater
good (or the lesser evil). Duty based ethics does not require that consequences be considered.
3-19 Monistic theories are based on idealizations or simplifications of the real world. The real world is “messy” with the
context of a situation, such as whether there is three party or two party accountability, having a major impact on
the proper role of an individual. Everyone has multiple social roles in life and it is the conflicts in these multiple
roles that seem to cause the most problems for monistic theories.
3-20 In the current audit environment, PAs are expected to better justify their decisions. This need for justification,
including the consideration of ethical issues, increases the importance of critical thinking.
3-21 Three specific aspects of on-the-job independence
1. Programming independence
2. Investigative independence
3- Reporting independence
3-22 In a class action lawsuit, a few aggrieved persons with small losses can bring suit on behalf of a large group of
similar persons, collectively having large losses (as in a securities offering). Large lawsuits often result in large
damage awards, and many lawyers are willing to take such plaintiffs on a contingency fee basis. Such fees are very
lucrative for lawyers, and probably less lucrative for their clients. Anyway, the losses loom large for PAs and their
insurance companies.
3-23 Some causes are as follows:
• Failure to report known departures from accounting principles, including misinterpretation of accounting
principles.
• Failure to conduct audits properly, including (a) misinterpretation of auditing standards, and (b) faulty
implementation of auditing procedures.
• Failure to detect management fraud, fraudulent financial reporting.
• Actual involvement in fraud.
• Also, business failure by clients after rendering an unqualified audit report.
3-24 Lawsuits related to tax practice, about 60 percent.
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SOLUTIONS FOR MULTIPLE CHOICE QUESTIONS
MC 3-1 LO5 Auditors are interested in having independence in appearance because
a. they want to impress the public with their independence in fact.
b. they want the public at large to have confidence in the profession.
c. they need to comply with the standards of field work of GAAS.
d. audits should be planned, and assistants, if any, need to be properly supervised.
MC 3-2 LO1 If a PA says she always follows the rule that requires adherence to CPA Canada pronouncements in order
to give a standard unqualified audit report, she is following a philosophy characterized by
a. the imperative principle in ethics.
b. the utilitarian principle in ethics.
c. the generalization principle in ethics.
d. reliance on one’s inner conscience.
MC 3-3 LO4 Which of the following “committees” have been authorized to discipline members in violation of the rules
of professional conduct?
a. CPA Canda Committee on Professional Ethics
b. Appeals Committee
c. Discipline Committee
d. Professional Conduct Committee
MC 3-4 LO4 Which of the following bodies does not have any power to punish individual members for violations of
the rules of professional conduct?
a. CPA Canada
b. Canada Revenue Agency
c. OSC
d. CPA Ontario
MC 3-5 LO4 Phil Greb has a thriving practice in which he assists lawyers in preparing litigation dealing with accounting
and auditing matters. Phil is “practicing public accounting” if he
a. uses his PA designation on his letterhead and business card.
b. is in partnership with another PA.
c. practices in a limited partnership with other PAs.
d. never lets his clients know that he is a PA.
MC 3-6 LO4 CPA Ontario should remove its general prohibition against PAs taking commissions and contingent fees
because
a. CPAs prefer more price competition to less.
b. commissions and contingent fees enhance audit independence.
c. the Charter of Rights will force the change anyway.
d. objectivity is not always necessary in accounting and auditing services.
MC 3-7 LO5 PA Smith is the auditor of Ajax Corporation. Her audit independence will not be considered impaired if
she
a. owns $1,000 worth of Ajax shares.
b. has a husband who owns $2,000 worth of Ajax shares.
c. has a sister who is the financial vice-president of Ajax.
d. owns $1,000 worth of the shares of Pericles Corporation, which is controlled by Ajax as a result of Ajax’s
ownership of 40 percent of Pericles’s shares, and Pericles contributes 3 percent of the total assets and income
in Ajax’s financial statements.
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SOLUTIONS FOR MULTIPLE CHOICE QUESTIONS
MC 3-1 LO5 Auditors are interested in having independence in appearance because
a. they want to impress the public with their independence in fact.
b. they want the public at large to have confidence in the profession.
c. they need to comply with the standards of field work of GAAS.
d. audits should be planned, and assistants, if any, need to be properly supervised.
MC 3-2 LO1 If a PA says she always follows the rule that requires adherence to CPA Canada pronouncements in order
to give a standard unqualified audit report, she is following a philosophy characterized by
a. the imperative principle in ethics.
b. the utilitarian principle in ethics.
c. the generalization principle in ethics.
d. reliance on one’s inner conscience.
MC 3-3 LO4 Which of the following “committees” have been authorized to discipline members in violation of the rules
of professional conduct?
a. CPA Canda Committee on Professional Ethics
b. Appeals Committee
c. Discipline Committee
d. Professional Conduct Committee
MC 3-4 LO4 Which of the following bodies does not have any power to punish individual members for violations of
the rules of professional conduct?
a. CPA Canada
b. Canada Revenue Agency
c. OSC
d. CPA Ontario
MC 3-5 LO4 Phil Greb has a thriving practice in which he assists lawyers in preparing litigation dealing with accounting
and auditing matters. Phil is “practicing public accounting” if he
a. uses his PA designation on his letterhead and business card.
b. is in partnership with another PA.
c. practices in a limited partnership with other PAs.
d. never lets his clients know that he is a PA.
MC 3-6 LO4 CPA Ontario should remove its general prohibition against PAs taking commissions and contingent fees
because
a. CPAs prefer more price competition to less.
b. commissions and contingent fees enhance audit independence.
c. the Charter of Rights will force the change anyway.
d. objectivity is not always necessary in accounting and auditing services.
MC 3-7 LO5 PA Smith is the auditor of Ajax Corporation. Her audit independence will not be considered impaired if
she
a. owns $1,000 worth of Ajax shares.
b. has a husband who owns $2,000 worth of Ajax shares.
c. has a sister who is the financial vice-president of Ajax.
d. owns $1,000 worth of the shares of Pericles Corporation, which is controlled by Ajax as a result of Ajax’s
ownership of 40 percent of Pericles’s shares, and Pericles contributes 3 percent of the total assets and income
in Ajax’s financial statements.
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Smieliauskas & Bewley, Auditing: An International Approach, 7th Edition Page 3-5
Solutions Manual © 2016, McGraw-Hill Education. All Rights Reserved.
MC 3-8 LO4 When a client’s financial statements contain a material departure from a CPA Canada Handbook
Accounting Recommendation and the PA believes that disclosure is necessary to make the statements not
misleading, the PA
a. must qualify the audit report for a departure from GAAP.
b. can explain why the departure is necessary, and then give an unqualified opinion paragraph in the audit
report.
c. must give an adverse audit report.
d. can give the standard unqualified audit report with an unqualified opinion paragraph.
MC 3-9 LO4 Which of the following would not be considered confidential information obtained in the course of an
engagement for which the client’s consent would be needed for disclosure?
a. Information about whether a consulting client has paid the PA’s fees on time
b. The actuarial assumptions used by a tax client in calculating pension expense
c. Management’s strategic plan for next year’s labour negotiations
d. Information about material contingent liabilities relevant for audited financial statements
MC 3-10 LO4 Which of the following would probably not be considered an “act discreditable to the profession”?
a. Numerous moving traffic violations
b. Failing to file the PA’s own tax return
c. Filing a fraudulent tax return for a client in a severe financial difficulty
d. Refusing to hire Asian Canadians in an accounting practice
MC 3-11 LO4 A group of investors sued Anderson, Olds & Watershed, PAs, for alleged damages suffered when the
company they held common shares in went bankrupt. In order to avoid liability under the common law, AOW must
prove which of the following?
a. The investors actually suffered a loss.
b. The investors relied on the financial statements audited by AOW.
c. The investors’ loss was a direct result of their reliance on the audited financial statements.
d. The audit was conducted in accordance with generally accepted auditing standards and with due professional
care.
MC 3-12 LO6 A PA’s legal licence to practice public accounting can be revoked by which organization?
a. the CPA Canada
b. provincial body of PAs
c. Auditing Standards Board
d. provincial securities commissions
MC 3-13 LO5 A PA’s independence would not be considered impaired if he had
a. owned common shares of the audit client but sold them before the company became a client.
b. sold short his common shares of an audit client while working on the audit engagement.
c. served as the company’s treasurer for six months during the year covered by the audit but resigned before the
company became a client.
d. performed the bookkeeping and financial statement preparation for the company, which had no accounting
personnel, and a president with no understanding of accounting principles.
MC 3-14 LO4 When a PA knows that a tax client has skimmed cash receipts and not reported the income on his federal
income tax return, but he signs the return as a PA who prepared the return, that PA has violated which rule of
professional conduct?
a. Confidential Client Information
b. Integrity and Objectivity
c. Independence
d. Accounting Principles
MC 3-15 LO6 Under the Foreign Corrupt Practices Act,
a. companies must refrain from bribing foreign politicians for commercial advantage.
b. independent auditors must audit all elements of a company’s internal control system.
c. independent auditors must establish control systems to keep books, records, and accounts properly.
Solutions Manual © 2016, McGraw-Hill Education. All Rights Reserved.
MC 3-8 LO4 When a client’s financial statements contain a material departure from a CPA Canada Handbook
Accounting Recommendation and the PA believes that disclosure is necessary to make the statements not
misleading, the PA
a. must qualify the audit report for a departure from GAAP.
b. can explain why the departure is necessary, and then give an unqualified opinion paragraph in the audit
report.
c. must give an adverse audit report.
d. can give the standard unqualified audit report with an unqualified opinion paragraph.
MC 3-9 LO4 Which of the following would not be considered confidential information obtained in the course of an
engagement for which the client’s consent would be needed for disclosure?
a. Information about whether a consulting client has paid the PA’s fees on time
b. The actuarial assumptions used by a tax client in calculating pension expense
c. Management’s strategic plan for next year’s labour negotiations
d. Information about material contingent liabilities relevant for audited financial statements
MC 3-10 LO4 Which of the following would probably not be considered an “act discreditable to the profession”?
a. Numerous moving traffic violations
b. Failing to file the PA’s own tax return
c. Filing a fraudulent tax return for a client in a severe financial difficulty
d. Refusing to hire Asian Canadians in an accounting practice
MC 3-11 LO4 A group of investors sued Anderson, Olds & Watershed, PAs, for alleged damages suffered when the
company they held common shares in went bankrupt. In order to avoid liability under the common law, AOW must
prove which of the following?
a. The investors actually suffered a loss.
b. The investors relied on the financial statements audited by AOW.
c. The investors’ loss was a direct result of their reliance on the audited financial statements.
d. The audit was conducted in accordance with generally accepted auditing standards and with due professional
care.
MC 3-12 LO6 A PA’s legal licence to practice public accounting can be revoked by which organization?
a. the CPA Canada
b. provincial body of PAs
c. Auditing Standards Board
d. provincial securities commissions
MC 3-13 LO5 A PA’s independence would not be considered impaired if he had
a. owned common shares of the audit client but sold them before the company became a client.
b. sold short his common shares of an audit client while working on the audit engagement.
c. served as the company’s treasurer for six months during the year covered by the audit but resigned before the
company became a client.
d. performed the bookkeeping and financial statement preparation for the company, which had no accounting
personnel, and a president with no understanding of accounting principles.
MC 3-14 LO4 When a PA knows that a tax client has skimmed cash receipts and not reported the income on his federal
income tax return, but he signs the return as a PA who prepared the return, that PA has violated which rule of
professional conduct?
a. Confidential Client Information
b. Integrity and Objectivity
c. Independence
d. Accounting Principles
MC 3-15 LO6 Under the Foreign Corrupt Practices Act,
a. companies must refrain from bribing foreign politicians for commercial advantage.
b. independent auditors must audit all elements of a company’s internal control system.
c. independent auditors must establish control systems to keep books, records, and accounts properly.
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Smieliauskas & Bewley, Auditing: An International Approach, 7th Edition Page 3-6
Solutions Manual © 2016, McGraw-Hill Education. All Rights Reserved.
d. independent auditors must establish control systems to keep books, records, and accounts properly.
MC 3-16 LO7 The management accountants employed by Robbins, Inc., wrongfully charged executives’ personal
expenses to the overhead on a government contract. Their activities can be characterized as
a. errors in the application of accounting principles.
b. irregularities of the type independent auditors should plan an audit to detect.
c. irregularities of the type independent auditors have no responsibility to plan an audit to detect.
d. illegal acts of a type independent auditors should be aware might occur in government contract business.
SOLUTIONS FOR EXERCISES AND PROBLEMS
EP3-1 Independence, Integrity, and Objectivity Cases
a. Interpretation--Honorary Directorships and Trusteeships. The PA will be considered independent
provided:
1. the position is in fact purely honorary, and
2. listings of directors show she is an honorary director and
3. she restricts participation strictly to the use of her name, and
4. she does not vote or participate in management functions.
b. Interpretation--Retired Partners and Firm Independence. Since the PA is still active with the firm as an ex-
officio member of the income tax advisory committee, meeting monthly, his situation would impair the
appearance of the firm’s independence. The CPA should either resign from the Palmer board or cease his
association with the accounting firm.
Another ethics issue arises over Wolfe’s ability to hear about tax problems of other clients, and his
directorship with Palmer would raise appearance questions about confidential information (Rule 208).
c. Interpretation--Accounting Services.
The PA must be careful to know whether outsiders would perceive relationships that would indicate
status as an employee, hence impairing the appearance of independence. In particular, the PA must.
1. Not have any business connection with Harper Corp. or with Marvin Harper that would in fact
impair independence, objectivity and integrity, and
2. Impress Marvin Harper (and the board of directors) that they must be able and willing to accept
primary responsibility for the financial statements as their own, and
3. Not take managerial responsibility for conducting operations of the Harper Corp. (although the
PA’s supervision of the bookkeeper seems to have this characteristic), and
4. Conduct the audit in conformity with GAAS and not fail to audit records simply because they
were processed under the PA’s supervision.
This case assumes Harper Corp. is not a reporting entity, in which case the PA’s audit independence would
certainly be impaired as a result of participating in the bookkeeping work.
d. Interpretation of--Effect of Family Relationships on Independence
The PA’s wife’s interest is attributed to him, and he would not be independent. The financial interest is
considered direct.
e. Interpretation
The PA is still not independent, so long as the daughter is a dependent child. The financial interest is
considered direct.
f. Interpretation
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d. independent auditors must establish control systems to keep books, records, and accounts properly.
MC 3-16 LO7 The management accountants employed by Robbins, Inc., wrongfully charged executives’ personal
expenses to the overhead on a government contract. Their activities can be characterized as
a. errors in the application of accounting principles.
b. irregularities of the type independent auditors should plan an audit to detect.
c. irregularities of the type independent auditors have no responsibility to plan an audit to detect.
d. illegal acts of a type independent auditors should be aware might occur in government contract business.
SOLUTIONS FOR EXERCISES AND PROBLEMS
EP3-1 Independence, Integrity, and Objectivity Cases
a. Interpretation--Honorary Directorships and Trusteeships. The PA will be considered independent
provided:
1. the position is in fact purely honorary, and
2. listings of directors show she is an honorary director and
3. she restricts participation strictly to the use of her name, and
4. she does not vote or participate in management functions.
b. Interpretation--Retired Partners and Firm Independence. Since the PA is still active with the firm as an ex-
officio member of the income tax advisory committee, meeting monthly, his situation would impair the
appearance of the firm’s independence. The CPA should either resign from the Palmer board or cease his
association with the accounting firm.
Another ethics issue arises over Wolfe’s ability to hear about tax problems of other clients, and his
directorship with Palmer would raise appearance questions about confidential information (Rule 208).
c. Interpretation--Accounting Services.
The PA must be careful to know whether outsiders would perceive relationships that would indicate
status as an employee, hence impairing the appearance of independence. In particular, the PA must.
1. Not have any business connection with Harper Corp. or with Marvin Harper that would in fact
impair independence, objectivity and integrity, and
2. Impress Marvin Harper (and the board of directors) that they must be able and willing to accept
primary responsibility for the financial statements as their own, and
3. Not take managerial responsibility for conducting operations of the Harper Corp. (although the
PA’s supervision of the bookkeeper seems to have this characteristic), and
4. Conduct the audit in conformity with GAAS and not fail to audit records simply because they
were processed under the PA’s supervision.
This case assumes Harper Corp. is not a reporting entity, in which case the PA’s audit independence would
certainly be impaired as a result of participating in the bookkeeping work.
d. Interpretation of--Effect of Family Relationships on Independence
The PA’s wife’s interest is attributed to him, and he would not be independent. The financial interest is
considered direct.
e. Interpretation
The PA is still not independent, so long as the daughter is a dependent child. The financial interest is
considered direct.
f. Interpretation
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Solutions Manual © 2016, McGraw-Hill Education. All Rights Reserved.
Still not enough. The grandfather (either the PA’s father or his father-in-law) is considered a
nondependent close relative, but the appearance of independence is impaired. The grandfather’s
investment is material (50 percent) in relation to his net financial resources.
g. Interpretation
The remote kin (uncle) who is geographically separated and in infrequent contact is far enough removed.
h. Interpretation--Meaning of Certain Independence Terminology
The firm’s independence is not impaired by the attributable managerial relationship so long as the PA is
not connected with the ATC audit.
i. The PA’s promotion changes the situation. When he becomes a partner, a stricter standard will apply and
his firm’s independence will be considered impaired even if he does not work on the ATC audit. Such
occurrences are not really too rare in practice, affecting family relationships other than husband and wife.
PA firms’ resolutions are that one must forgo partnership or the other must give up his or her job with a
client.
j. Interpretation
Such loans would impair independence.
EP3-2 Independence, Integrity, and Objectivity Cases
(a, b, c, d, e, f) Interpretation--Effect of Actual or Threatened Litigation on Independence.
In general, when the present management of a client company commences or expresses an intention to
commence legal actions against the auditor, the auditor and the client management may be placed in adversary
positions in which the management’s willingness to make complete disclosures and the auditor’s objectivity may
be affected by self-interest. Independence may be impaired whenever the auditor and his client company or its
management are in positions of material adverse interest by reason of actual or threatened litigation. Various
situations are hard to generalize, and the responses offered below are guidelines expressed in AICPA Ethics
Interpretations 101-6 (Effect of Litigation). SEC Accounting Series Release No. 234 (December 1977) expresses
similar guidelines.
a. An expressed intention by the client company to begin litigation alleging deficiencies in audit work is
considered to impair independence if the auditor concluded that there is a strong possibility that such a
claim will actually be filed.
b. The commencement of litigation alleging deficiencies in audit work would be considered to impair
independence.
c. The commencement of litigation by the auditor alleging management fraud or deceit would be considered
to impair independence.
d. The claim under subrogation by the insurance company would not “normally” affect the auditor’s
independence. In this case, the client company and members of management are not the nominal
plaintiffs. However, the idea of “normally” needs to be evaluated. If members of Contrary management
are going to testify on behalf of the insurance company’s interest and thus act in an adversary relation to
the auditor, independence would seem to be impaired. The substance of the situation is essentially the
same as if Contrary Corporation was the named plaintiff.
e. Litigation not related to the audit work, whether threatened or actual, for an amount that is not material
to the audit firm or to the financial statements of the client company would not usually be considered to
affect the PA-client relationship in such a way as to impair independence. According to the SEC, this
situation might impair independence.
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Still not enough. The grandfather (either the PA’s father or his father-in-law) is considered a
nondependent close relative, but the appearance of independence is impaired. The grandfather’s
investment is material (50 percent) in relation to his net financial resources.
g. Interpretation
The remote kin (uncle) who is geographically separated and in infrequent contact is far enough removed.
h. Interpretation--Meaning of Certain Independence Terminology
The firm’s independence is not impaired by the attributable managerial relationship so long as the PA is
not connected with the ATC audit.
i. The PA’s promotion changes the situation. When he becomes a partner, a stricter standard will apply and
his firm’s independence will be considered impaired even if he does not work on the ATC audit. Such
occurrences are not really too rare in practice, affecting family relationships other than husband and wife.
PA firms’ resolutions are that one must forgo partnership or the other must give up his or her job with a
client.
j. Interpretation
Such loans would impair independence.
EP3-2 Independence, Integrity, and Objectivity Cases
(a, b, c, d, e, f) Interpretation--Effect of Actual or Threatened Litigation on Independence.
In general, when the present management of a client company commences or expresses an intention to
commence legal actions against the auditor, the auditor and the client management may be placed in adversary
positions in which the management’s willingness to make complete disclosures and the auditor’s objectivity may
be affected by self-interest. Independence may be impaired whenever the auditor and his client company or its
management are in positions of material adverse interest by reason of actual or threatened litigation. Various
situations are hard to generalize, and the responses offered below are guidelines expressed in AICPA Ethics
Interpretations 101-6 (Effect of Litigation). SEC Accounting Series Release No. 234 (December 1977) expresses
similar guidelines.
a. An expressed intention by the client company to begin litigation alleging deficiencies in audit work is
considered to impair independence if the auditor concluded that there is a strong possibility that such a
claim will actually be filed.
b. The commencement of litigation alleging deficiencies in audit work would be considered to impair
independence.
c. The commencement of litigation by the auditor alleging management fraud or deceit would be considered
to impair independence.
d. The claim under subrogation by the insurance company would not “normally” affect the auditor’s
independence. In this case, the client company and members of management are not the nominal
plaintiffs. However, the idea of “normally” needs to be evaluated. If members of Contrary management
are going to testify on behalf of the insurance company’s interest and thus act in an adversary relation to
the auditor, independence would seem to be impaired. The substance of the situation is essentially the
same as if Contrary Corporation was the named plaintiff.
e. Litigation not related to the audit work, whether threatened or actual, for an amount that is not material
to the audit firm or to the financial statements of the client company would not usually be considered to
affect the PA-client relationship in such a way as to impair independence. According to the SEC, this
situation might impair independence.
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Smieliauskas & Bewley, Auditing: An International Approach, 7th Edition Page 3-8
Solutions Manual © 2016, McGraw-Hill Education. All Rights Reserved.
f. The class action lawsuit against both auditor and company in itself would not alter fundamental
relationships between the company management and directors and the auditor and therefore would not
be considered to have an adverse impact on the auditor’s independence. These situations, however,
should be examined carefully.
Actions to be taken
When independence is considered impaired, the auditor should (a) withdraw from the audit engagement
in order to avoid the appearance that his self-interest would affect his objectivity or (b) issue an opinion
denial because of lack of independence.
g. Interpretation--Effect on Independence of Financial Interests in Non-clients Having Investor or Investee
Relationships with a Member’s Client
The PA’s financial interest in Dove Corp. (investor) is sufficiently large to allow him to influence the
actions of Dove, and the PA’s (and the PA firm’s) independence would be considered impaired. The PA’s
ability to influence Dove Corp. could permit him to exercise a degree of control over Tale Company (the
investee, a client) that would place the PA in a capacity equivalent to that of a member of management.
h.i. Interpretation
Assuming that the North Country is a profit-seeking enterprise, the independence of the auditors is not
impaired by the association of the two individuals who served both as members of the auditing firm and
as directors for the client during the period examined as long as they have ended all ties with the bank
and are not involved in the audit.
j. The auditor’s services may consist of advice and technical services, but he must not make management
decisions or take positions which might impair his objectivity. The independence of the auditing firm
would be compromised by any partner making a decision on loan approvals and the minimum balance
checking account policy, but normally not by his performing a computer feasibility study.
If the former controller’s participation in the feasibility study was objective and advisory, and his advice
was subject to effective client review and decision, the firm’s independence has not been compromised. It
is desirable, however, that the former controller not participate in the audit of the North Country’s
financial statements. (AICPA Adapted)
k. The acceptance by the PA of the unsecured interest-bearing notes in payment of unpaid fees would not
be construed as discrediting the PA’s independence in his relations with his client because the notes are
merely a substitution for an open account payable. The rule of professional conduct that prohibits a PA
from having any financial interest in a client does not extend to the liability for the PA’s fee. If liability for
the PA’s fee was considered to be financial interest in a client, the present form of the PA-client
relationship would not be permitted to continue because often (frequently in engagements for continuing
audits) the client’s statements being audited include a liability for the CPA’s services.
Under SEC rules, however, a definite arrangement for paying the notes must be stated by the client.
However, the acceptance of two shares of common stock (or prior commitment to accept stock) would be
a violation of Rule 204. Any direct financial interest such as common stock holdings are construed as
discrediting the PA’s independence. (AICPA adapted)
l. Interpretation 204 -- Acceptance of a Gift.
The rules apply to Johnny if he’s a student member of the provincial body. The ruling applies to the
independence of a firm if an employee accepts a gift that is more than token. Independence is impaired
because a member cannot permit his employees to break rules he himself is obligated to observe.
m. Member as Bank Stockholder.
Solutions Manual © 2016, McGraw-Hill Education. All Rights Reserved.
f. The class action lawsuit against both auditor and company in itself would not alter fundamental
relationships between the company management and directors and the auditor and therefore would not
be considered to have an adverse impact on the auditor’s independence. These situations, however,
should be examined carefully.
Actions to be taken
When independence is considered impaired, the auditor should (a) withdraw from the audit engagement
in order to avoid the appearance that his self-interest would affect his objectivity or (b) issue an opinion
denial because of lack of independence.
g. Interpretation--Effect on Independence of Financial Interests in Non-clients Having Investor or Investee
Relationships with a Member’s Client
The PA’s financial interest in Dove Corp. (investor) is sufficiently large to allow him to influence the
actions of Dove, and the PA’s (and the PA firm’s) independence would be considered impaired. The PA’s
ability to influence Dove Corp. could permit him to exercise a degree of control over Tale Company (the
investee, a client) that would place the PA in a capacity equivalent to that of a member of management.
h.i. Interpretation
Assuming that the North Country is a profit-seeking enterprise, the independence of the auditors is not
impaired by the association of the two individuals who served both as members of the auditing firm and
as directors for the client during the period examined as long as they have ended all ties with the bank
and are not involved in the audit.
j. The auditor’s services may consist of advice and technical services, but he must not make management
decisions or take positions which might impair his objectivity. The independence of the auditing firm
would be compromised by any partner making a decision on loan approvals and the minimum balance
checking account policy, but normally not by his performing a computer feasibility study.
If the former controller’s participation in the feasibility study was objective and advisory, and his advice
was subject to effective client review and decision, the firm’s independence has not been compromised. It
is desirable, however, that the former controller not participate in the audit of the North Country’s
financial statements. (AICPA Adapted)
k. The acceptance by the PA of the unsecured interest-bearing notes in payment of unpaid fees would not
be construed as discrediting the PA’s independence in his relations with his client because the notes are
merely a substitution for an open account payable. The rule of professional conduct that prohibits a PA
from having any financial interest in a client does not extend to the liability for the PA’s fee. If liability for
the PA’s fee was considered to be financial interest in a client, the present form of the PA-client
relationship would not be permitted to continue because often (frequently in engagements for continuing
audits) the client’s statements being audited include a liability for the CPA’s services.
Under SEC rules, however, a definite arrangement for paying the notes must be stated by the client.
However, the acceptance of two shares of common stock (or prior commitment to accept stock) would be
a violation of Rule 204. Any direct financial interest such as common stock holdings are construed as
discrediting the PA’s independence. (AICPA adapted)
l. Interpretation 204 -- Acceptance of a Gift.
The rules apply to Johnny if he’s a student member of the provincial body. The ruling applies to the
independence of a firm if an employee accepts a gift that is more than token. Independence is impaired
because a member cannot permit his employees to break rules he himself is obligated to observe.
m. Member as Bank Stockholder.
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