Auditing Theory Cabrera Answer Key PDF

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CHAPTER 1PROFESSIONAL PRACTICE OF ACCOUNTANCYQuestions Generally, to be a CPA one must meet certain education requirements, and pass the CPA exam. The CPA examination is prepared and graded twice each year. It is generally recognized as an academic examination. It includes multiple-choice questions ...

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CHAPTER 1 PROFESSIONAL PRACTICE OF ACCOUNTANCY Questions 1.

Generally, to be a CPA one must meet certain education requirements, and pass the CPA exam. The CPA examination is prepared and graded twice each year. It is generally recognized as an academic examination. It includes multiple-choice questions in the following subjects namely, Theory of Accounts, Practical Accounting I, Practical Accounting II, Auditing Theory, Auditing Problems, Management Services, Business Law and Taxation.

2.

Refer to page 11 of the textbook.

3.

Refer to page 110 (Section 28 of the Philippine Accountancy Act of 2004) of the textbook.

4.

Competencies include both what individual auditors know and what individual auditors and audit teams do. Competencies are evidenced by auditors applying their skills in the delivery of services to clients or supporting the delivery of those services. These competencies categorized as “High Opportunity Competencies” and “Low Opportunity Competencies” are as follows: High Opportunity Competencies have a high likelihood of being building blocks for selling or delivering new assurance services. •

Analytical Skills

•

Business Advisory Skills

•

Business Knowledge

•

Capacity for Work

•

Comprehension of Client’s Business Processes

•

Communication Skills

•

Efficiency

•

Intellectual Capability

•

Learning and Rejuvenation

•

Marketing and Selling

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Solutions Manual – Public Accountancy Profession •

Model Building

•

People Development

•

Relationship Management

•

Responsiveness and Timeliness

•

Technology

•

Verification

Low Opportunity Competencies, while important to the delivery of current assurance services, are less likely to be exploited in the development of future services. •

Accounting and Auditing Standards

•

Administrative Capability

•

Managing Audit Risk

5.

Refer to page 4 of the textbook.

6.

The Philippine Accountancy Act of 2004 (R.A. 9298) Article I, Section 4, paragraphs (a) to (d) spell out the scope of the practice of accountancy as follows: •

Practice of Public Accountancy

•

Practice in Commerce and Industry

•

Practice in Education/Academe

•

Practice in the Government

7.

Refer to pages 8 to 10 of the textbook.

8.

Refer to page 11 of the textbook.

9.

Refer to pages 13 to 14 of the textbook.

10. Refer to pages 14 to 15 of the textbook. 11. Refer to pages 16 to 17 of the textbook.

Professional Practice of Accountancy

1-3

12. This is brought about by the nature of accounting standards and the demand for accounting-related information which have changed in several significant ways. These changes include: •

Global Harmonization of Accounting Standards

•

Expanded Accountability

•

More Detailed Reporting

•

Increased Risk Reporting

•

Global Audit Standards

13. (a) While university-level training is important, it is also necessary that professionals continue their education throughout their careers, as accounting and auditing standards will change. In this particular case, the staff member would need to stay abreast of current developments in order to meet the competence and capabilities element of the responsibilities principle. (b) Auditors need to be both independent in fact and independent in appearance. While a small financial investment might not impair the auditors’ actual state of mind (independence in fact), it is unlikely that financial statement users will perceive the auditor to be independent (independence in appearance). Professional standards would not consider the auditor independent in this case, as no direct financial interests in clients are permitted. Multiple Choice Questions 1. 2. 3. 4.

D C B B

CHAPTER 2 PRACTICE OF PUBLIC ACCOUNTANCY Questions 1.

Refer to page 29 of the textbook.

2.

Refer to pages 30 to 35 of the textbook.

3.

Refer to page 37 of the textbook.

4.

Refer to page 37 of the textbook.

5.

The following are the most sought - after services among accountants.

professional

A. Assurance Services. Examples are: 1.

Independent financial statement audit

2.

Reviews

3.

Other assurance services (e.g., CPA Web Trust, Business Performance Measurement Service)

B. Non-Assurance Services. Examples are:

6.

1.

Agreed-upon procedures

2.

Compilation

3.

Tax

4.

Management consultancy/advisory services

5.

Accounting and data processing

6.

Other non-assurance services (e.g., Information Technology System Services)

In an assurance engagement, a practitioner aims to provide a high or moderate level of assurance that an assertion being made by one party for use by another party can be relied upon while in a consulting engagement, the practitioner aims to provide professional advice on how the limited resources of an enterprise can be put into optimal use in order to attain the company’s objectives.

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Solutions Manual – Public Accountancy Profession 7.

Examples of assurance engagements on information technology are: a) b)

CPA Web Trust Service Information System Reliability Service

Refer to page 41 of the textbook for a brief discussion of these services. 8.

Refer to page 52 of the textbook.

9.

Refer to pages 44 to 52 of the textbook.

10. Refer to page 38 of the textbook. 11. Refer to page 47 of the textbook. 12. Refer to pages 52 to 54 of the textbook. 13. Refer to page 36 of the textbook. 14. Refer to pages 56 and 57 of the textbook.

Multiple Choice Questions 1. 2. 3. 4. 5.

C A D D D

6. 7. 8. 9. 10.

C D D D C

11. 12. 13. 14.

D C D C

Cases 1.

(a) The purpose of CPA reporting on internal control is to provide assurance about whether management’s assertion about internal control is fairly stated in all material respects, based on the control criteria being followed. Thus, for example, an examination provides the highest degree of assurance that information produced by the system will be reliable. (b) When involved in performing an examination on the effectiveness of internal control a practitioner should: • • • •

Plan the engagement. Obtain an understanding of internal control. Evaluate the design and operating effectiveness of internal control. Form an opinion about the fairness of management’s assertion on internal control.

Practice of Public Accountancy 2.

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(a) PSA 100, Assurance Engagements, provide guidance for an engagement such as one on customer satisfaction. They provide guidelines on audits and related services such as examinations and reviews. (b) Suitable criteria are those that are objective and permit reasonably consistent measurements. In addition, the criteria must be sufficiently complete such that no relevant factors are omitted that would affect a conclusion about the subject matter. Finally, the criteria must measure some characteristic of the subject matter that is relevant to a user’s decision. (c)

INDEPENDENT ACCOUNTANTS’ REPORT We have examined the accompanying Schedule of Customer Satisfaction Measures for the three years ended December 31, 2013. This schedule is the responsibility of Gonzales, Inc.’s management. Our responsibility is to express an opinion on this schedule based on our examination. Our examination was conducted in accordance with standards on assurance engagements adopted in the Philippines and, accordingly, included examining, on a test basis, evidence supporting the schedule and performing such other procedures as we considered necessary in the circumstances. We believe that our examination provides a reasonable basis for our opinion. In our opinion, the Schedule of Customer Satisfaction Measures referred to above presents fairly, in all material respects, the levels of customer satisfaction for the three years ended December 31, 2013, in conformity with the measurement and disclosure criteria set forth in Note 1.

Santos & Lopez, LLP March 1, 2014 NOTE TO INSTRUCTOR: If the CPAs believe that the criteria are not understandable by users other than management a paragraph must be added to the report restricting its use.

CHAPTER 3 OVERVIEW OF AUDITING Questions 1.

One definition of auditing is that it is a systematic process by which a competent, independent person objectively obtains and evaluates evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between those assertions and established criteria and communicating the results to interested users. The Philippine Standards on Auditing (PSA) 120 “Framework of Philippine Standards on Auditing” states the objective of an audit as follows: “The objective of an audit of financial statements is to enable the auditor to express an opinion whether the financial statements are prepared in all material respects, in accordance with an identified financial reporting framework.”

2.

This apparent paradox arises from the distinction between the auditing and the function of accounting.

function

of

The accounting function is the process of recording, classifying and summarizing 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 Philippine Financial Reporting Standards (PFRS), as well as Philippine Standards on Auditing (PSA). 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. Audits of Financial Statements Purpose

To determine whether the financial statements are presented in accordance with PFRS.

Compliance Audits To determine whether the client is following specific procedures set by higher authority.

Operational Audits To evaluate whether operating procedures are efficient and effective.

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Solutions Manual – Public Accountancy Profession Compliance Audits Authority setting down procedures, internal or external Not standardized, but very specific and usually objective

Operational Audits Management of organization

Nature

Audits of Financial Statements Different groups for different purposes – many outside entities. Highly standardized

Performed by: CPAs COA Auditors BIR Auditors Internal Auditors

Almost universally Occasionally Never Frequently

Occasionally Frequently Universally Frequently

Frequently Frequently Never Frequently

Users of Audit Report

4.

The major differences in the scope of audit responsibilities are: 1.

2.

3.

4.

5.

Highly nonstandard; often very subjective

CPAs perform audits in accordance with Philippine Standards on Auditing of published financial statements prepared in accordance with identified and applicable Statements of Financial Accounting Standards. COA 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. BIR agents perform compliance audits to enforce the tax laws as defined by Congress, interpreted by the courts, and regulated by the BIR law. 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.

An independent audit is a means of satisfying the need for reliable information on the part of decision makers. Factors of a complex society which contribute to this need are: 1.

remoteness of information a. owners (stockholders) divorced from management b. directors not involved in day-to-day operations or decisions c. dispersion of the business among numerous geographic locations and complex corporate structures

2.

bias and motives of provider a. information will be biased in favor of the provider when his goals are inconsistent with the decision maker.

3.

voluminous data a. possibly millions of transactions processed daily via sophisticated computerized systems

b. c. 4.

6.

multiple product lines multiple transaction locations

complex exchange transactions a. new and changing business relationships lead to innovative accounting and reporting problems b. potential impact of transactions not quantifiable, leading to increased disclosures

The four primary causes of information risk are remoteness of information, bias in motives of the provider, voluminous data, and existence of complex exchange transactions. The three main ways to reduce information risk are: 1. 2. 3.

User verifies the information itself. The users share the information risk with management. Have audited financial statements provided.

The advantages and disadvantages of each are as follows:

User verifies information

Users share information risk with management Audited financial statements are prepared

7.

Advantages Disadvantages 1. User obtains information desired. 1. High cost of obtaining 2. User can be more confident of information. the qualifications and activities 2. Inconvenience to the person of the person getting the providing the information information. because large number of users would be on premises. 1. No audit costs incurred. 1. Users may not be able to collect on losses.

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.

Information risk is the possibility that information upon which a business decision is made is inaccurate. Four causes of information risk are: • remoteness of information, • biases and motives of the provider, • voluminous data, and • complex exchange transactions.

8.

Three primary ways users of information can reduce information risk are: • users can verify the information themselves, • users can share information risk with management, and • users can obtain audited financial statements.

9.

Four factors that are likely to significantly reduce information risk in the next five to ten years are: • technological advances, • more companies will go on–line, reducing the risk of investors obtaining outdated information, • new accounting and auditing standards, and • auditors will find more efficient and effective audit techniques.

10. Refer to pages 84 and 85 of the textbook. 11. A report by an independent public accountant concerning the fairness of a company’s financial statements is commonly required in the following situations: (1) Application for a bank loan. (2) Establishing credit for purchase of merchandise, equipment, or other assets. (3) Reporting operating results, financial position, and cash flows to absentee owners (stockholders or partners). (4) Issuance of securities by a corporation. (5) Annual financial statements by a corporation with securities listed on a stock exchange or traded over the counter. (6) Sale of an ongoing business. (7) Termination of a partnership. 12. To add credibility to financial statements is to increase the likelihood that they have been prepared following the appropriate criteria, usually the relevant and applicable PAS. As such, an increase in credibility results in financial statements that can be believed and relied upon by third parties. 13. Business risk is the risk that the investment will be impaired because a company invested in is unable to meet its financial obligations due to economic conditions or poor management decisions. Information risk is the risk that the information used to assess business risk is not accurate. Auditors can directly reduce information risk, but have only limited effect on business risk. 14. An operational audit attempts to measure the effectiveness and efficiency of a specific unit of an organization. It involves more subjective judgments than a compliance audit or an audit of financial statements because the criteria of effectiveness and efficiency of departmental performance are not as clearly established as are many laws and regulations or financial reporting standards.

The report prepared after completion of an operational audit is usually directed to management of the organization in which the audit work was done. 15. The first quoted sentence overstates the case. Although annual audits by CPA firms are universal practice for large corporations, they are not essential to many small businesses. The financial statements of large corporations go to many stockholders (often hundreds of thousands) who demand the assurance of reliability supplied through independent audits by CPA firms. Moreover the SEC and the stock exchanges require that listed companies have annual audits. For a small business concern, the primary need for annual financial statements is to support an application for a bank loan. If a small business does not need to borrow, or can obtain borrowed funds without providing audited statements, the cost of an audit may not be justified. Often a small business can obtain from a CPA firm specialized services other than an audit, which are more useful and may cost less. Examples are the review or compilation of financial statements, installation of a computer based accounting system, or a study of internal control. Thus, the second quoted sentence, as well as the first, is too sweeping to be correct. A decision not to have an audit is not always “false economy.” 16. (a) An example of possible bias on the part of the provider of financial information is the situation in which an individual or business entity applies for a bank loan. In such circumstances, there is an incentive to overstate assets, income, and owner’s equity, and to overlook or minimize liabilities. Distortions of this type give the appearance of greater financial strength. (b) A bank loan officer may insist that a prospective borrower provide audited financial statements. This provides assurance that the data in the financial statements have been examined by independent competent persons. 17. Financial statements audits, operational audits, and compliance audits are similar in that each type of audit involves accumulating and evaluating evidence about information to ascertain and report on the degree of correspondence between the information and...