Solution Manual for Auditing and Assurance Services: A Systematic Approach, 11th Edition

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Chapter01-AnIntroduction toAssurance andFinancial Statement Auditing1-1CHAPTER 1AN INTRODUCTION TO ASSURANCE AND FINANCIALSTATEMENT AUDITINGAnswers to Review Questions1-1The study of auditing is more conceptual in natureascompared to other accounting courses.Rather than focusing onlearning the rules, techniques, and computations required to preparefinancial statements, auditing emphasizes learning a framework of analytical and logicalskills. This framework enables auditorsto evaluate the relevance and reliability of thesystems and processes responsible for financial information as well as the information itself.To be successful, students must learn the framework and then learn to use logic and commonsense in applying auditing concepts to various circumstances and situations.Understandingauditing can improve the decision-making ability of consultants, business managers, andaccountants by providing a framework for evaluating the usefulness and reliability ofinformation—an important task in many differentbusinesscontexts.1-2There is a demand for auditing in a free-market economy because the agency relationshipbetween an absentee owner and a manager produces a natural conflict of interest due to theinformation asymmetry that exists betweenthese two parties. As a result, the agent agreesto be monitored as part of his/her employment contract. Auditing appears to be a cost-effective form of monitoring.The empirical evidence suggeststhatauditing was demandedprior to government regulation. In 1926, before it was requiredby law, independent auditorsaudited 82 percent of the companies on the New York Stock Exchange. Additionally, manyprivate companies and municipalities not subject to government regulations, such as theSecurities Act of 1933 and Securities Exchange Actof 1934, also purchase various formsof auditing and assurance services.Many private companies seek out financial statementaudits in order to secure financing for their operations.Companiespreparing to go publicalso benefit from having an audit.1-3The agency relationship between an owner and manager produces a naturalconflict ofinterestbecause of differences in the two parties’ goals and because of theinformationasymmetrythat exists between them. That is, the managerlikely hasdifferent goals than theowner, and generally has more information about the "true" financial position and results ofoperations of the entity than the absentee owner does. If both parties seek to maximize theirown self-interest, the managermaynot act in the bestinterest of the owner and maymanipulate the information provided to the owner accordingly.1-4Independence is a bedrock principle for auditors. If an auditor is not independent of theclient, users may lose confidence in the auditor’s ability to report objectively and truthfullyon the financial statements, and the auditor’s work loses its value.From an agencyperspective, if the principal (owner) knows that the auditor is not independent, the ownerwill not trust the auditor’s work. Thus, the agent will not hire the auditor because theauditor’s report will not be effective in reducing information risk from the perspective ofthe owner.Auditor independenceis also a regulatory requirement.

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