Solutions for Chapter 1 The Market for Auditing and Assurance Services Review Questions: 1-1 The two main types of reports that management prepares that are subject to audit are: Annual financial statements Reports on internal control over financial reporting (public companies only) 1-2
Assurance services are needed because there is a: Potential bias in providing information Remoteness between a user and the organization or trading partner Complexity of the transaction, information, or processing systems such that it is difficult to determine their proper presentation without a review by an independent expert Need to minimize financial surprises Interested parties need to have confidence that the information they are using to make choices is reliable and not subjective. The public accounting profession has strict independence rules and has traditionally been in a position of high trust with the investing public, which gives them an important competitive advantage. The public accounting profession also has expertise in a variety of different kinds of business processes to have the ability to deal with many types of transactions.
1-3
The primary reference points (criteria) to determine fairness of presentation are: IFRS – IFRS provide criteria for financial statement audits. COSO – Internal Control, Integrated Framework for reports on internal control over financial reporting. It is important to have criteria against which to judge fairness such that everyone is communicating on the same page. Otherwise it becomes one’s opinion versus that of someone else.
1-4
The audit enhances the quality of financial statements because the user has the assurance that an independent, qualified professional has examined the financial statements and has rendered an opinion on their fairness. The independence and expertise of the auditor serves as a quality control function to overcome the potential bias of management in presenting the financial statements in a manner that most flatters an assessment of their performance. The audit is designed to add credibility to the financial statements. An audit does not necessarily ensure a fair presentation of a company's financial statements although it does dramatically increase the likelihood that there are no material misstatements in the company's financial statements. The caveats about fairness exist for two reasons: a. Fairness is judged within a framework of IFRS. Some question whether IFRS result in the fairest possible presentations when there are significant changes in market values of investments or assets. For example, it is encouraged financial institutions to move from