Solution Manual for Auditing and Assurance Services, 16th Edition

Name: Solution Manual for Auditing and Assurance Services, 16th Edition
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1-1
Chapter 1
The Demand for Audit and Other Assurance Services
 Concept Checks
P. 8
1. To do an audit, there must be information in a verifiable form and some
standards (criteria) by which the auditor can evaluate the information.
Determining the degree of correspondence between information and
established criteria is determining whether a given set of information is in
accordance with the established criteria. For an audit of a company’s
financial statements the criteria are U.S. generally accepted accounting
principles or International Financial Reporting Standards.
2. The four primary causes of information risk are remoteness of information,
biases and motives of the provider, voluminous data, and the existence of
complex exchange transactions.
The three main ways to reduce information risk are:
1. User verifies the information.
2. User shares the information risk with management.
3. Audited financial statements are provided.
P. 17
1. The three main types of audits are operational audits, compliance audits, and
financial statement audits. The table below summarizes the purposes and
nature of each type of audit.
OPERATIONAL
AUDITS
COMPLIANCE
AUDITS
AUDITS OF
FINANCIAL
STATEMENTS
PURPOSE To evaluate
whether
operating
procedures are
efficient and
effective
To determine
whether the client is
following specific
procedures set by a
higher authority
To determine
whether the
overall financial
statements are
presented in
accordance with
specified criteria
(usually GAAP)

1-2
Concept Checks (continued)
OPERATIONAL
AUDITS
COMPLIANCE
AUDITS
AUDITS OF
FINANCIAL
STATEMENTS
USERS OF
AUDIT
REPORT
Management of
organization
Authority setting
down procedures,
internal or external
Different groups
for different
purposes — many
outside entities
NATURE Highly
nonstandard;
often subjective
Not standardized,
but specific and
usually objective
Highly
standardized
PERFORMED
BY:
CPAs Frequently Occasionally
Almost
universally
GAO
AUDITORS Frequently Frequently Occasionally
IRS
AUDITORS Never Universally Never
INTERNAL
AUDITORS Frequently Frequently Frequently*
* Internal auditors may assist CPAs in the audit of financial statements. Internal
auditors may also audit internal financial statements for use by management.
2. The major differences in the scope of audit responsibilities for CPAs, GAO
auditors, IRS agents, and internal auditors are:
• CPAs perform audits of financial statements prepared using U.S.
GAAP or IFRS in accordance with auditing standards.
• GAO auditors perform compliance or operational audits in order to
assure the Congress of the expenditure of public funds in accordance
with its directives and the law.
• IRS agents perform compliance audits to enforce the federal tax laws
as defined by Congress, interpreted by the courts, and regulated by the
IRS.
• Internal auditors perform compliance or operational audits in order to
assure management or the board of directors that controls and policies
are properly and consistently developed, applied, and evaluated.

1-3
 Review Questions
1-1 To do an audit, there must be information in a verifiable form and some
standards (criteria) by which the auditor can evaluate the information. The
information for Jones Company's tax return is the federal tax returns filed by the
company. The established criteria are found in the Internal Revenue Code
and all interpretations. For the audit of Jones Company's financial
statements the information is the financial statements being audited and the
established criteria are U.S. GAAP or IFRS.
1-2 This apparent paradox arises from the distinction between the function of
auditing and the function of accounting. The accounting function is the recording,
classifying, and summarizing of economic events to provide relevant information
to decision makers. The rules of accounting are the criteria used by the auditor
for evaluating the presentation of economic events for financial statements and
he or she must therefore have an understanding of accounting standards, as well
as auditing standards. The accountant need not, and frequently does not,
understand what auditors do, unless he or she is involved in doing audits, or has
been trained as an auditor.1-3 An independent audit is a means of satisfying
the need for reliable information on the part of decision makers. Recent changes
in accounting and business operations include:
1. Increased global activities of many businesses
a. Multiple product lines and transaction locations
b. Foreign exchange affects transactions
2. Complex accounting and exchange transactions
a. Increasing use of derivatives and hedging activities
b. Increasingly complex accounting standards in areas such as
revenue recognition
3. More complex information systems
a. Possibly millions of transactions processed daily through on-
line and traditional sales channels
b. Voluminous data requires interpretation
1-4 1. Risk-free interest rate This is approximately the rate the bank could
earn by investing in U.S. treasury notes for the same length of time
as the business loan.
2. Business risk for the customer This risk reflects the possibility that
the business will not be able to repay its loan because of economic
or business conditions such as a recession, poor management
decisions, or unexpected competition in the industry.
3. Information risk This risk reflects the possibility that the information
upon which the business risk decision was made was inaccurate. A
likely cause of the information risk is the possibility of inaccurate
financial statements.
Auditing has no effect on either the risk-free interest rate or business risk.
However, auditing can significantly reduce information risk.

1-4
1-5 The three main ways to reduce information risk are:
1. User verifies the information.
2. User shares the information risk with management.
3. Audited financial statements are provided.
The advantages and disadvantages of each are as follows:
ADVANTAGES DISADVANTAGES
USER VERIFIES
INFORMATION
1. User obtains information
desired.
2. User can be more confident
of the qualifications and
activities of the person
getting the information.
1. High cost of obtaining
information.
2. Inconvenience to the
person providing the
information because
large number of users
would be on premises.
USER SHARES
INFORMATION
RISK WITH
MANAGEMENT
1. No audit costs incurred. 1. User may not be able
to collect on losses.
AUDITED
FINANCIAL
STATEMENTS
ARE PROVIDED
1. Multiple users obtain the
information.
2. Information risk can usually
be reduced sufficiently to
satisfy users at reasonable
cost.
3. Minimal inconvenience to
management by having
only one auditor.
1. May not meet needs
of certain users.
2. Cost may be higher
than the benefits in
some situations, such
as for a small
company.
1-6 Information risk is the risk that information upon which a business decision is
made is inaccurate. Fair value accounting is often based on estimates and requires
judgment. Fair value can be estimated using multiple methods with some estimates
being more subjective than others. Fair value estimates are made at a point in time,
but can also change rapidly, depending on market conditions. All of these factors
increase information risk.
1-7 An assurance service is an independent professional service to improve the
quality of information for decision makers. An attestation service is a form of
assurance service in which the CPA firm issues a report about the reliability of an
assertion that is the responsibility of another party. Audit services are a form of
attestation service in which the auditor expresses a written conclusion about
the degree of correspondence between information and established criteria.

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