Solution Manual for Auditing and Assurance Services 15th Edition by Arens

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Chapter 2

The CPA Profession

Review Questions

2-1        The four major services that CPAs provide are:

1.            Audit and assurance services Assurance services are independent professional services that improve the quality of information for decision makers. Assurance services include attestation services, which are any services in which the CPA firm issues a report that expresses a conclusion about the reliability of an assertion that is the responsibility of another party. The four categories of attestation services are audits of historical financial statements, attestation on the effectiveness of internal control over financial reporting, reviews of historical financial statements, and other attestation services.

2.            Accounting and bookkeeping services Accounting services involve preparing the client’s financial statements from the client’s records. Bookkeeping services include the preparation of the client’s journals and ledgers as well as financial statements.

3.            Tax services Tax services include preparation of corporate, individual, and estate returns as well as tax-planning assistance.

4.            Management consulting services These services range from suggestions to improve the client’s accounting system to computer installations.

2-2 The major characteristics of CPA firms that permit them to fulfill their social function competently and independently are:

1.            Organizational form A CPA firm exists as a separate entity to avoid an employer-employee relationship with its clients. The CPA firm employs a professional staff of sufficient size to prevent one client from constituting a significant portion of total income and thereby endangering the firm’s independence.

2.            Conduct A CPA firm employs a professional staff of sufficient size to provide a broad range of expertise, continuing education, and promotion of a professional independent attitude and competence.

3.            Peer review This practice evaluates the performance of CPA firms in an attempt to keep competence high.

2-3 The Public Company Accounting Oversight Board provides oversight for auditors of public companies, including establishing auditing and quality control standards for public company audits, and performing inspections of the quality controls at audit firms performing those audits.

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2-4 The purpose of the Securities and Exchange Commission is to assist in providing investors with reliable information upon which to make investment decisions. Since most reasonably large CPA firms have clients that must file reports with the SEC each year (all companies filing registration statements under the securities acts of 1933 and 1934 must file audited financial statements and other reports with the SEC at least once each year), the profession is highly involved with the SEC requirements.

The SEC has considerable influence in setting generally accepted accounting principles and disclosure requirements for financial statements because of its authority for specifying reporting requirements considered necessary for fair disclosure to investors. In addition, the SEC has power to establish rules for any CPA associated with audited financial statements submitted to the Commission.

2-5        The AICPA is the organization that sets professional requirements for

CPAs. The AICPA also conducts research and publishes materials on many different subjects related to accounting, auditing, management advisory services, and taxes. The organization also prepares and grades the CPA examinations, provides continuing education to its members, and develops specialty designations to help market and assure the quality of services in specialized practice areas.

2-6 Statements on Standards for Attestation Engagements provide a framework for attest engagements, including detailed standards for specific types of attestation engagements.

2-7 The PCAOB has responsibility for establishing auditing standards for U.S. public companies, while the Auditing Standards Board (ASB) of the AICPA establishes auditing standards for U.S. private companies. Prior to the creation of the PCAOB, the ASB had responsibility for establishing auditing standards for both public and private companies. Because existing auditing standards were adopted by the PCAOB as interim auditing standards for public company audits, there is considerable overlap in the two sets of auditing standards.

2-8 Auditing standards represent the combination of the four principles and all the Statements on Auditing Standards (SASs) that are codified in the AU-C sections. While the 10 GAAS standards highlighted in Table 2-3 are no longer referenced as general, fieldwork, and reporting standards, the underlying concepts contained in those continue to be relevant in U.S. auditing standards. Examples of auditing standards include any of the SASs (e.g., SAS No. 125).

Generally accepted accounting principles are specific rules for accounting for transactions occurring in a business enterprise. Examples may be any of the opinions of the FASB, such as accounting for leases, pensions, or fair value assets.

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2-9 Auditors develop their competency and capabilities for performing an audit through formal education in auditing and accounting, adequate practical experience, and continuing professional education. Auditors can demonstrate their proficiency by becoming licensed to practice as CPAs, which requires successful completion of the Uniform CPA Examination. The specific requirements for licensure vary from state to state.

2-10 For the most part, auditing standards, including SASs, are general rather than specific. Many practitioners along with critics of the profession believe the standards should provide more clearly defined guidelines as an aid in determining the extent of evidence to be accumulated. This would eliminate some of the difficult audit decisions and provide a source of defense if the CPA is charged with conducting an inadequate audit. On the other hand, highly specific requirements could turn auditing into mechanical evidence gathering, void of professional judgment. From the point of view of both the profession and the users of auditing services, there is probably a greater harm from defining authoritative guidelines too specifically than too broadly.

2-11 International Standards on Auditing (ISAs) are issued by the International Auditing and Assurance Standards Board (IAASB) of the International Federation of Accountants (IFAC) and are designed to improve the uniformity of auditing practices and related services throughout the world. The IAASB issues pronouncements on a variety of audit and attest functions and promotes their acceptance worldwide. As a result of efforts by the Auditing Standards Board to converge U.S. GAAS with international standards, AICPA auditing standards and International Standards on Auditing are similar in most respects.

2-12 Quality controls are the procedures used by a CPA firm that help it meet its professional responsibilities to clients. Quality controls are therefore established for the entire CPA firm as opposed to individual engagements.

2-13 The element of quality control is personnel management. The purpose of the requirement is to help assure CPA firms that all new personnel are qualified to perform their work competently. A CPA firm must have competent employees conducting the audits if quality audits are to occur.

2-14 A peer review is a review, by CPAs, of a CPA firm’s compliance with its quality control system. A mandatory peer review means that such a review is required periodically. AICPA member firms are required to have a peer review every three years. Registered firms with the PCAOB are subject to quality inspections. These are different than peer reviews because they are performed by independent inspection teams rather than another CPA firm.

Peer reviews can be beneficial to the profession and to individual firms. By helping firms meet quality control standards, the profession gains if reviews result in practitioners doing higher quality audits. A firm having a peer review can also gain if it improves the firm’s practices and thereby enhances its reputation and effectiveness, and reduces the likelihood of lawsuits. Of course, peer reviews are costly. There is always a trade-off between cost and benefits.

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The main objective of an audit of financial statements is 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 in a written report on whether the financial statements are presented fairly, in all material respects, in accordance with an applicable financial reporting framework.

Multiple Choice Questions From CPA Examinations

2-15	a.	(2)	b.	(1)
2-16	a.	(2)	b.	(3)	c.	(3)
2-17	a.	(1)	b.	(2)	c.	(3)

Discussion Questions And Problems

2-18     a.

b.            No. In an audit of the financial statements, the auditor performs audit procedures to obtain reasonable assurance about whether the financial statements contain material misstatements. While a high level of assurance, reasonable assurance is less than a guarantee― which implies absolute (100%) assurance. In an audit, the auditor issues an opinion on whether the financial statements are presented fairly, but the auditor is not guaranteeing that the financial statements are accurate with certainty.

c.            No. Fraud is a broad legal concept that describes any intentional deceit meant to deprive another person or party of their property or rights. The auditor does not take responsibility for detecting all types of fraud, given many types of fraud do not impact the financial statements. Instead, the auditor performs auditing procedures to obtain reasonable assurance that the financial statements do not contain material misstatements, whether due to fraud or error. Thus, the auditor is concerned with detecting fraud that leads to a material misstatement. The auditor is not responsible for detecting fraud that does not lead to a material misstatement.

d.            Each entity faces a number of risks unique to the nature of its business and industry. The types of operations, the extent of regulation, how the organization obtains capital to fund its business model, and the nature of accounts in the financial statements, among other factors, each trigger different types of risks that could lead to material misstatements. In addition, there are unique accounting standards for certain industries that impact how transactions, accounts, and disclosures are reported in financial statements. Thus, a thorough understanding of the client’s business is critical to assessing the risk of material misstatements in the financial statements when planning the audit.

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2-18 (continued)

e.            The auditor is responsible for obtaining sufficient appropriate audit evidence about whether the financial statements are free of material misstatements. In addition to understanding whether the amounts reported in the financial statements are mathematically accurate, the auditor obtains other types of information to determine that the amounts reported represent valid transactions and accounts and that all valid transactions and accounts are included in those statements. Evidence is also gathered to determine that the entity has the rights to assets and has the obligation to repay liabilities reflected in those financial statements and whether the correct disclosures are included in the financial statements as required by accounting standards.

2-19    a.            Engagement performance

b.            Monitoring

c.            Engagement performance

d.            Engagement performance

e.            Relevant ethical requirement

f.            Human resources

g.            Human resources

h.            Acceptance and continuation of clients and engagements

i.            Engagement performance

j.             Leadership responsibilities

2-20 a. The AICPA Auditing Standards Board (ASB) is responsible for issuing standards in the U.S. to be used by auditors when auditing the financial statements of all entities other than U.S. publicly traded companies. The Public Company Accounting Oversight Board

(PCAOB) is responsible for issuing standards to be used by auditors when auditing a U.S. public company.

b.            The International Auditing and Assurance Standards Board (IAASB) of the International Federation of Accountants (IFAC) is responsible for issuing International Standards on Auditing (ISAs). The ISAs do not override a specific country’s regulations governing the audit of financial statements.

c.            The ASB has revised most of its standards to converge them with the international standards. As a result, U.S. standards are mostly consistent with international standards, except for certain requirements that reflect unique characteristics of the U.S. environment.

d.            When developing a new SAS, the ASB uses the ISAs as the base standard and then modifies that base standard only when appropriate for the U.S. environment.

e.            The PCAOB develops and issues its standards. While the PCAOB considers existing international standards, it does not start with the ISA standard as the base.

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2-21

BRIEF DESCRIPTION	HOLMES’ ACTIONS RESULTING IN
OF PRINCIPLE	FAILURE TO COMPLY WITH PRINCIPLE
RESPONSIBILITIES
PRINCIPLES
The auditor must possess the	It was inappropriate for Holmes to hire the two
competency and capabilities	students to conduct the audit. The audit must
to perform the audit.	be conducted by persons with proper
	education and experience in the field of
	auditing. Although a junior assistant has not
	completed his formal education, he may help in
	the conduct of the audit as long as there is
	proper supervision and review.
The auditor must comply	To satisfy this principle, Holmes must be without
with ethical requirements, which	bias with respect to the client under audit.
include maintaining	Holmes has an obligation for fairness to the
independence in mental attitude	owners, management, and creditors who may
in all matters relating to the	rely on the report. Because of the financial
audit.	interest in whether the bank loan is granted to
	Ray, Holmes is independent in neither fact nor
	appearance with respect to the assignment
	undertaken.
The auditor must maintain	This principle requires Holmes to perform the
professional skepticism and	audit with due care, which imposes on Holmes
exercise professional judgment	and everyone in Holmes’ organization a
in the performance of the audit	responsibility to observe the principles of
and the preparation of the	performance and reporting. Maintaining
report.	professional skepticism and exercising
	professional judgment require critical review at
	every level of supervision of the work done and
	the judgments exercised by those assisting in
	the audit. Holmes did not review the work or
	the judgments of the assistants and clearly
	failed to adhere to this standard.

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2-21 (continued)

BRIEF DESCRIPTION	HOLMES’ ACTIONS RESULTING IN
OF PRINCIPLE	FAILURE TO COMPLY WITH PRINCIPLE
PERFORMANCE
PRINCIPLES
The auditor must adequately plan	This principle recognizes that early appointment
the work and must properly	of the auditor has advantages for the auditor
supervise any assistants.	and the client. Holmes accepted the
	engagement without considering the
	availability of competent staff. In addition,
	Holmes failed to supervise the assistants. The
	work performed was not adequately planned.
The auditor must identify and	Holmes did not obtain an understanding of the
assess the risks of material	entity or its internal control, nor did the
misstatement based on a	assistants obtain such an understanding.
sufficient understanding of the	There appears to have been no audit at all.
entity and its environment,	The work performed was more an accounting
including its internal control, to	service than it was an auditing service.
design the nature, timing, and
extent of further audit
procedures.
The auditor must obtain sufficient	Holmes acquired no evidence that would
appropriate audit evidence by	support the financial statements. Holmes
performing audit procedures to	merely checked the mathematical accuracy of
afford a reasonable basis for an	the records and summarized the accounts.
opinion regarding the financial	Standard audit procedures and techniques
statements under audit.	were not performed.

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2-21 (continued)

BRIEF DESCRIPTION	HOLMES’ ACTIONS RESULTING IN
OF PRINCIPLE	FAILURE TO COMPLY WITH PRINCIPLE
REPORTING
PRINCIPLES
The auditor must express an	Holmes’ report made no reference to generally
opinion in a written report about	accepted accounting principles. Because
whether the financial statements	Holmes did not conduct a proper audit, the
are presented in accordance	report should state that no opinion can be
with the applicable financial	expressed as to the fair presentation of the
reporting framework.	financial statements in accordance with
The auditor must either express	generally accepted accounting principles.
	Although Holmes’ report contains an expression
an opinion regarding the
financial statements, taken as a	of opinion, such opinion is not based on the
whole, or state that an opinion	results of a proper audit. Holmes should
cannot be expressed in the	disclaim an opinion because he failed to
auditor’s report. When the	conduct an audit in accordance with auditing
auditor cannot express an	standards.
overall opinion, the auditor
should state the reasons
therefor in the auditor’s report.
In all cases where an auditor’s
name is associated with
financial statements, the auditor
should clearly indicate the
character of the auditor’s work,
if any, and the degree of
responsibility the auditor is
taking, in the auditor’s report.
The auditor must assess whether	Holmes’ improper audit would not enable him to
the financial statements are	determine whether generally accepted
presented in accordance with	accounting principles were consistently
the financial reporting	applied. Holmes’ report should make no
framework.	reference to the consistent application of
	accounting principles.
	Management is primarily responsible for
	adequate disclosures in the financial
	statements, but when the statements do
	not contain adequate disclosures the auditor
	should make such disclosures in
	the auditor’s report. In this case both the
	statements and the auditor’s report lack
	adequate disclosures.

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2-22     a.            U.S. generally accepted auditing standards.

b.            International auditing standards.

c.            PCAOB auditing standards.

d.            PCAOB auditing standards (reporting in the U.K. will be under international auditing standards).

e.            U.S. generally accepted auditing standards.

f.            U.S. generally accepted auditing standards.

g.            International auditing standards.

h.            PCAOB auditing standards (due to the publicly traded debt).

Research Problem 2-1: International Auditing and Assurance Standards

Board

a.            The objective of the IAASB is to serve the public interest by setting high-quality auditing and assurance standards and by facilitating the convergence of international and national standards, thereby enhancing the quality and uniformity of practice throughout the world and strengthening public confidence in the global auditing and assurance profession. International Standards on Auditing

(ISA) are used by auditors in countries that have adopted ISAs as their auditing standards.

b.            The IAASB follows a due process in setting standards.

The standards-setting Public Interest Activity Committees (PIAC) identify new projects based on review of international developments and consultation with the Public Interest Oversight Board. PIAC meetings are open to the public and written materials are prepared in English.

The PIAC is responsible for consulting with the PIAC Consultative Advisory Group (CAG) on the identication and prioritization of projects to be undertaken by the PIAC.

The project may be assigned to a task force, which considers whether to hold a public forum or roundtable.

Draft pronouncements are exposed for a minimum of 90 days.

The task force considers all comments and whether re-exposure is needed.

When the Project Task Force is satisfied that it has a proposed final pronouncement ready for approval, it presents the revised content of the exposed standard to the PIAC for approval.

The PIAC votes on the approval or withdrawal of the pronouncement.

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Research Problem 2-1 (continued)

c.            The IAASB is committed to transparency. Where practicable, meetings are broadcast over the Internet or recorded. Meeting agendas and minutes are published on the International Federation of Accountants (IFAC) Web site. All exposure drafts are subject to public exposure for a minimum of 90 days. Meetings of the PIAC are open to the public.

(Note: Research problems address current issues, using Internet sources. Because Internet sites are subject to change, Research problems and solutions may change. Any revisions to Research problems will be posted on the book’s Web site at www.pearsonhighered.com/arens.)

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