CHAPTER 2

FINANCIAL STATEMENT AUDITS AND

AUDITORS' RESPONSIBILITIES
Learning Check
2-1. a. The ultimate objective of accounting is the communication of relevant and
reliable financial data that will be useful for decision making. Accounting
methods involve identifying the events and transactions that affect the
entity. Once identified, these items are measured, recorded, classified, and
summaried in the accounting records and re!orted in accordance with
generally acce!ted accounting !rinci!les "#AA$%. The accounting !rocess
is carried out by an entity&s em!loyees, and ultimate res!onsibility for the
financial statements lies with the entity&s management.
The !rimary objective of an audit is to add credibility to management&s
financial statements.
The ty!ical audit !erformed in accordance with generally acce!ted auditing
standards "#AA'% involves obtaining and evaluating evidence concerning
management&s financial statements. Auditing culminates in the issuance of an
audit re!ort that contains the auditor&s o!inion on whether the financial
statements do in fact !resent fairly the entity&s financial !osition, results
of o!erations, and cash flows in conformity with #AA$.
b. Auditing is based on the assum!tion that financial statement data are
verifiable, meaning that two or more (ualified individuals inde!endently
e)amining the data could reach essentially similar conclusions.
2-2. *inancial statement audits are needed to !rovide assurance that the financial
statements are
relevant and reliable. *our factors that contribute to the need for inde!endent
audits are "a%
conflict of interest, "b% conse(uence, "c% com!le)ity, and "d% remoteness.
+ollectively these factors contribute to information risk.
2-,. *inancial statement audits enable com!anies to "a% meet statutory and other
regulatory
re(uirements that must be satisfied in order to gain access to ca!ital markets, "b%
obtain debt and e(uity financing at a lower cost of ca!ital, "c% deter inefficiency
and errors in the accounting function and reduce the risk of fraud in the
accounting and financial re!orting !rocess, and "d%
make internal control and o!erational im!rovements based on suggestions made
by the auditor as a by-!roduct of the audit.
2--. The limitations of a financial statement audit include the fact that an auditor
works within fairly restrictive economic limits that im!ose time and cost
constraints and necessitate the use of selective testing or sam!ling of the
accounting records and su!!orting data. Also, the auditor&s re!ort must usually
be issued within three months of the balance sheet date, which affects the
amount of evidence that can be obtained. The availability of alternative
accounting !rinci!les !ermitted under #AA$, and the im!act of accounting
estimates and uncertainties on the financial statements re!resent additional
inherent limitations on financial statement audits.
2-.. *our im!ortant grou!s related to a client with whom the auditor may maintain
!rofessional relationshi!s are "1% management, "2% the board of directors and
audit committee, ",% internal auditors, and "-% stockholders.
2-/. The ty!ical a!!roach the auditor should take to management&s assertions may be
characteried as one of !rofessional ske!ticism. This means the auditor should
neither disbelieve management&s assertions nor glibly acce!t them without
concern for their truthfulness. 0ather the auditor recognies the need to
objectively evaluate conditions observed and evidence obtained during the audit.
2-1. a. An audit committee is a subgrou! of the board of directors. 2deally, it is
com!osed of outside members of the board "i.e., members who are not
officers or em!loyees of the entity%. There has been a marked increase in the
use of audit committees because by acting as intermediaries between auditors
and management, audit committees strengthen the inde!endence of e)ternal
auditors.
b. The functions of an audit committee include3
4ominating the !ublic accounting firm to conduct the annual audit.
5iscussing the sco!e of the audit with the auditor.
2nviting direct auditor communication on material !roblems encountered
during the course of the audit.
0eviewing the financial statements and the auditor&s re!ort with the
auditor on com!letion of the engagement.
2-6. The work of internal auditors !ertaining to the client&s internal control structure
can affect the work of the inde!endent auditor, and internal auditors can !rovide
direct assistance to the inde!endent auditor in !erforming a financial statement
audit. The internal auditor&s work cannot be a substitute for the inde!endent
auditor&s work, but it can be an im!ortant com!lement. 2n determining the effect
of the internal auditor&s work, the inde!endent auditor should "1% consider the
com!etence and objectivity of the internal auditor and "2% evaluate the (uality of
the internal auditor&s work.
2-7. The A'8, or Auditing 'tandards 8oard, is an arm of the Auditing 'tandards
5ivision of the A2+$A. 2t is the A2+$A&s senior technical committee authoried
to issue !ronouncements on auditing standards, and its 1. members are all
members of the A2+$A.
2-19. 'A's, or 'tatements on Auditing 'tandards, are the !ronouncements of the
Auditing 'tandards 8oard. They e)!lain the nature and e)tent of an auditor&s
res!onsibility and offer guidance to an auditor in !erforming the audit. 8efore
issuance, each 'A' is e)!osed for !ublic comment and e)tensively discussed at
o!en meetings of the A'8. The a!!roval of two-thirds of the 8oard is re(uired
for issuance. They are accessible as individual !ublications of the A2+$A, via a
loose-leaf service entitled $rofessional 'tandards, :olume 1, in annual bound
volumes, and in electronic format on disk and on-line as !art of the $rofessional
;iterature file of the 4ational Automated Accounting 0esearch 'ystem
"4AA0'%.
2-11. a. The three categories of the generally acce!ted auditing standards are "1%
general standards, "2% standards of fieldwork, and ",% standards of re!orting.
b. Of the general standards, the first relates to ade(uate technical training and
!roficiency, the second to inde!endence in mental attitude, and the third to
due !rofessional care. Of the standards of fieldwork, the first relates to
ade(uate !lanning and !ro!er su!ervision, the
second to understanding the internal control structure, and the third to
obtaining sufficient com!etent evidential matter. Of the standards of
re!orting, the first relates to identifying
#AA$ as the criteria used to evaluate management&s financial statements, the
second to consistency in the a!!lication of #AA$, the third to the ade(uacy
of informative disclosures, and the fourth to e)!ressing an o!inion on the
financial statements taken as a whole or stating that an o!inion cannot be
e)!ressed.
2-12. 2nternational 'tandards on Auditing are issued by the 2nternational Auditing
$ractices +ommittee "2A$+% of the 2nternational *ederation of Accountants
"2*A+%. +om!liance with the international standards is voluntary and they do
not override local standards such as the A2+$A&s 'A's.
2-1,. a. 0easonable assurance is not a guarantee that the financial statements are
free of material misstatements. 0ather it !rovides a high level of assurance
that the financial statements are free of material misstatement based on the
work of the auditor.
b. The limitations associated with reasonable assurance include the fact that
economic factors !revent the auditor from e)amining all the evidence
su!!orting the financial statements. The auditor must e)ercise skill and
judgment in deciding what evidence to look at, when to look at it, how much
to look at, and who in the audit team should evaluate the evidence. *urther,
the financial statements themselves are not <e)act= but they include
estimates that cannot !recisely be determined.
2-1-. a. The auditor has a res!onsibility to !lan and !erform an audit to !rovide
reasonable assurance that the financial statements are free of material
misstatement, including fraud. The auditor must assess the risk of fraud,
and design and audit to res!ond to those risks. The auditor must also
evaluate evidence with an a!!ro!riate level of !rofessional ske!ticism.
b. 2f fraud is discovered during the audit, even minor or immaterial fraud, it
should be re!orted to management at least one level above the level where
the fraud occurred. The auditor would normally re!ort to the board of
directors or its audit committee and fraud involving senior management or
any material fraud. The auditor is normally !recluded by ethical and legal
obligation from disclosing fraud outside the client entity. >owever, the
auditor may be re(uired to do so in the following situations3
2n res!onse to a court sub!oena.
To the '?+ when the auditor has withdrawn or been dismissed from the
engagement, or when the auditor has re!orted fraud to the audit
committee or board of directors and the committee or board fails to take
a!!ro!riate action.
To a successor auditor who makes in(uiries in accordance with
!rofessional standards.
To a funding or other agency in accordance with audit re(uirement for
entities that receive governmental financial assistance.
2-1.. a. The auditor&s res!onsibility for misstatements resulting from illegal acts
having a direct and material effect on the determination of financial
statement amounts is the same as for errors or fraud. That is, the auditor
should !lan an audit to detect such illegal acts and im!lement the !lan with
due !rofessional care.
b. The auditor !rimary res!onsibility is for fair !resentation in the financial
statements. @hen illegal acts have a material effect on the financial
statements they should be !ro!erly disclosed. 2n this way the auditor meets
their res!onsibility to management, to the board of directors, and to !arties
outside the entity. 2f management does not !ro!erly disclose such illegal
acts in accordance with #AA$, the auditor should e)!ress a (ualified or
adverse o!inion if management does not revise the financial statements.
c. Ander the $rivate 'ecurities ;itigation 0eform Act of 177. !rovide a safe
harbor where the auditor is not liable for re!orting illegal acts to the '?+ if
the following circumstance a!!ly3
The audit committee or board of directors of a !ublicly held com!any has
been ade(uately informed with res!ect to illegal acts detected in the
audit. 'ubse(uently the auditor determines that the illegal acts have a
material effect on the financial statements, and the senior management or
board of directors has not taken a!!ro!riate remedial actions with res!ect
to such illegal acts, and the failure to take remedial actions is reasonably
e)!ected to warrant de!arture from a standard audit re!ort or warrant
resignation by the auditor, then the auditor shall re!ort these conclusion
to the !ublic com!anyBs board of directors.
A !ublic com!any whose board of directors receives the re!ort referred
to above must so inform the '?+ not later than one business day after the
recei!t of such re!ort and furnish the inde!endent auditor with a co!y of
the notice !rovided to the '?+.
2f the inde!endent auditor fails to receive a co!y of the !ublic com!anyBs
notice to the '?+ before the e)!iration of the re(uired one business day
!eriod, the auditor shall within one additional day furnish to the '?+ a
co!y of the re!ort !reviously !rovided to the !ublic com!anyBs board of
directors. 2n such case the auditor may also wish to consider resigning
from the engagement.
2-1/. 2f the auditor reaches a conclusion that substantial doubt e)ists about an entities
ability to continue as a going concern during the year following the date of the
financial statements, then the auditor should state this conclusion in his or her
audit re!ort. The auditor has no res!onsibility for remaking a statement in his or
her re!ort if substantial doubt about going concern does not e)ist.
2-11. An un(ualified o!inion in not e(uivalent to a clean bill of health on the audit
client. 2t only !rovides the financial statement user with reasonable assurance
that the financial statements are free of material misstatement. The absence of
reference to substantial doubt about going concern should not be viewed as
!roviding assurance about an entityBs ability to continue as a going concern.
2-16. a. The seven basic elements of the auditor&s standard re!ort are3 "1% title, "2%
addressee, ",% introductory !aragra!h, "-% sco!e !aragra!h, ".% o!inion
!aragra!h, "/% firm&s signature, and
"1% date.
b. The auditor&s re!ort is dated as of the last day of field work rather than the
date on which the re!ort is actually issued which may be several days to
several weeks later.
2-17. The concluding !aragra!h of the auditor&s standard re!ort satisfies the first and
fourth standards
of re!orting, res!ectively, by e)!licitly stating that the financial statements are
!resented fairly in conformity with generally acce!ted accounting !rinci!les and
by e)!ressing an o!inion on the financial statements taken as a whole. The
second and third standards of re!orting "i.e.,
consistency in the a!!lication of #AA$ and the ade(uacy of informative
disclosures% are satisfied because these standards are !resumed to be met unless
the auditor&s re!ort states to the contrary.
2-29. a. The two categories of de!artures from the auditor&s standard re!ort are "1%
standard re!ort
with e)!lanatory language and "2% other ty!es of o!inion.
b. Three ty!es of circumstances that re(uire a de!arture from the auditor&s
standard re!ort and
the ty!e or ty!es of o!inion a!!ro!riate for each are3 "1% circumstances
re(uiring e)!lanatory language do e)ist - un(ualified o!inionC "2% financial
statements contain a de!arture from
#AA$ - (ualified o!inion or adverse o!inionC ",% auditor unable to obtain
sufficient
com!etent evidence "sco!e limitation% - (ualified o!inion or disclaimer of
o!inion.
2-21. The wording in the o!inion !aragra!h that distinguishes the four ty!es of
o!inions that may be e)!ressed is as follows3
An(ualified o!inion - 2n our o!inion, the financial statements referred to
above !resent fairly
....
Dualified o!inion - 2n our o!inion, e)ce!t for the effects of "refer to matter
leading to (ualification described in e)!lanatory !aragra!h%, the financial
statements referred to above !resent fairly ....
Adverse o!inion - 2n our o!inion, because of the effects of "refer to effects of
matter leading to adverse o!inion described in e)!lanatory !aragra!h%, the
financial statements referred to
above do not !resent fairly ....
5isclaimer of o!inion - 'ince "refer to effects of matter described in
e)!lanatory !aragra!h
that lead to disclaimer%, we do not e)!ress an o!inion on these financial
statements.
Objective Questions
2.16 1. a 2. b ,. d
2.17 1. d 2. c ,. c
2.29 1. d 2. a ,. a -. a .. b
2.21 1. a 2. d ,. b -. a

Comprehensive Questions
2-22. "?stimated time - 2. minutes%
a.
A++OA4T24#
Analye ?vents and
Transactions
AA52T24#
Obtain and ?valuate ?vidence
+oncerning the *inancial
'tatements
Eeasure and 0ecord
Transaction 5ata
:erify 'tatements Are
$resented *airly in +onformity
@ith #AA$
+lassify and 'ummarie
0ecorded 5ata
$re!are *inancial 'tatements
!er #AA$
5istribute *inancial
'tatements and Auditor&s
0e!ort to 'tockholders
in Annual 0e!ort
?)!ress O!inion in Audit 0e!ort
5eliver Audit 0e!ort
to +lient
b. This contention is incorrect. Eanagement has the res!onsibility for the
!re!aration of the financial statements. The auditor&s res!onsibility is limited
to making an audit of the
statements and re!orting the findings. 2n the course of the audit, the auditor
may suggest adjustments in the financial statements. >owever, management
is res!onsible for all decisions concerning the form and content of the
statements.
2-2,. "?stimated time - 2. minutes%
Statement I
a. ?ach sentence of this statement is !artially true3
1. Test checking is used e)tensively on most audits.
2. The auditor&s judgment is involved in selecting the sam!le, either directly
or through choice of statistical design.
,. A system of 199 !ercent verification would detect errors and !rotect to
some e)tent against fraud.
b. Areas of misconce!tion, incom!leteness, or fallacious reasoning included in
this statement are the following3
1. The auditor does not !erform all !arts of the audit on a test basis. *or
e)am!le, he or she reviews minutes for all meetings of the board of
directors and e)amines all material contracts and agreements.
2. The statement ignores the im!ortance of the auditor&s consideration and
testing of internal control. This is the basis for determining the e)tent of
!rocedures. 2f internal control is weak, he or she may e)amine every
transaction during the transaction !eriod. >owever, such an e)amination
is not a !erfect substitute for good internal control. A 199 !ercent
verification may not detect so!histicated errors or frauds.
,. +om!etent e)ercise of judgment is one of the auditor&s skills.
5eficiencies in the e)ercise of this skill are !ossible, but a 199 !ercent
verification also may be !erformed im!ro!erly.
-. The historical e)!erience of the auditing !rofession su!!orts the
conclusion that material misstatements are disclosed by test checking. 2f
the sam!ling is statistically sound, it is further backed by the
mathematical conce!ts of !robability theory. A 199 !ercent
verification does not add significantly to the auditor&s degree of
assurance. >igh accuracy and !rotection against fraud are better !rovided
by good internal controls and ade(uate bonding of em!loyees.
.. On most engagements the cost of checking every transaction would be
e)cessive in terms of the benefits derived.
/. *inally, a 199 !ercent e)amination unduly delays com!letion of the audit
and issuance of the audited financial statements.
Statement 2
a. This statement is untrue if the +$A is fulfilling his or her res!onsibilities.
b. 2t is fallacious to assume the following3
1. That the attest function has no value to the users of financial statements.
2. That the auditor renders no service beyond the furnishing of an o!inion.
$erha!s the best indication of the value of the auditor&s re!ort is that it is so
often insisted u!on by the users of financial statements. The auditor alerts users
to im!ro!er or inade(uate re!orting by means of a (ualified o!inion. @hen the
o!inion is un(ualified, the auditor increases the reliance which users may !lace
u!on the financial statements. 2t is likely that the (uality of re!orting is
im!roved by the certainty of an audit and by the desire for an un(ualified
o!inion.
The auditor fulfills a vital social role. An e)am!le is the auditor&s contribution to
the maintenance of orderly ca!ital markets and im!rovement of the efficiency of
the economy by reducing the risk !remium that investors re(uire in their return
on investment.
2n addition to rendering an o!inion on financial statements, the auditor usually
!lays an im!ortant advisory role in their !re!aration. The auditor also furnishes
advice to the client on control and other financial matters and makes general
management suggestions.
2-2- "?stimated time - 19 minutes%
1. 'tudent 5 is correct. 2t is the client&s res!onsibility.
2. a. "1% The first sentence of this statement is !artially true. 2t is im!ortant to
read the
footnotes to financial statements because they !rovide im!ortant
su!!lementary information.
"2% *ootnotes often !ertain to com!le) matters and are !resented in
technical language. +ertainly it must be acknowledged that
sometimes they could be !resented in a clearer form.
",% To the e)tent the footnotes su!!lement disclosures in the body of
the financial statements, they could reduce the auditor&s e)!osure
to third-!arty liability.
b. "1% The statement is clearly wrong in asserting that the footnotes can
be used to correct or contradict financial statement !resentation.
*ootnotes are an integral !art of the financial statements. 2f there
is contradiction or if the !resentation is incom!rehensible, this
constitutes inade(uate re!orting and re(uires comment in the
auditor&s re!ort.
"2% The statement fails to recognie that the need for accuracy and
com!leteness sometimes overrides the desire for clarity.
",% The statement incorrectly assigns the !rimary res!onsibility for the
financial statements and footnotes to the auditor instead of to
management. The auditor&s relationshi! to the footnotes is the
same as to the balance sheet and other financial statements. *or
both, the auditor&s actions are governed by the same re!orting
res!onsibilities.
"-% 8ecause footnotes are !re!ared by management, the auditor cannot
control their content. Other advisors, e.g., legal counsel, will
influence the wording of footnotes. The auditor should recommend
im!rovements in !resentation, but will only make an o!inion
e)ce!tion if disclosure is inade(uate or so unclear as to be
misleading.
2-2. "?stimated time - ,9 minutes%
a. Identification of
Standard
b. Statement of Standard
1. Third general 5ue !rofessional care is to be e)ercised in the
!erformance of the audit and the !re!aration of the
re!ort.
2. *irst fieldwork
The work is to be ade(uately !lanned and assistants, if
any, are to be !ro!erly su!ervised.
a. Identification of
Standard
b. Statement of Standard
,. 'econd fieldwork
A sufficient understanding of the internal control
structure is to be obtained to !lan the audit and to
determine the nature, timing, and e)tent of tests to be
!erformed.
-. *irst fieldwork
The work is to be ade(uately !lanned and assistants, if
any, are to be !ro!erly su!ervised.
.. *irst general
The audit is to be !erformed by a !erson or !ersons
having ade(uate technical training and !roficiency as
an
auditor.
/. *irst re!orting The re!ort shall state whether the financial statements
are !resented in accordance with generally acce!ted
accounting !rinci!les.
1. 'econd general 2n all matters relating to the assignment, an
inde!endence in mental attitude is to be maintained by
the auditor or auditors.
6. 'econd re!orting The re!ort shall identify those circumstances in which
such !rinci!les have not been consistently observed in
the current !eriod in relation to the !receding !eriod.
7. Third fieldwork 'ufficient com!etent evidential matter is to be
obtained
through ins!ection, observation, in(uiries, and
confirmations to afford a reasonable basis for an
o!inion
regarding the financial statements under audit.
19. Third re!orting 2nformative disclosures in the financial statements are
to be regarded as reasonably ade(uate unless
otherwise
a. Identification of
Standard
b. Statement of Standard
stated in the re!ort.
11. *ourth re!orting The re!ort shall either contain an e)!ression of
o!inion
regarding the financial statements, taken as a whole, or
an
assertion to the effect that an o!inion cannot be
e)!ressed.
@hen an overall o!inion cannot be e)!ressed, the
reasons
therefor should be stated. 2n all cases where an
auditor&s
name is associated with financial statements, the
re!ort
should contain a clear-cut indication of the character
of
the audit, if any, and the degree of res!onsibility the
auditor is taking.
2-2/. "?stimated time - 19 minutes%
a. #AA' are included in the sco!e !aragra!h. #AA$ are included in the
o!inion !aragra!h.
b. #AA' are a!!roved and ado!ted by the membershi! of the A2+$A. They
a!!ly to all financial statement audits and deal with the (uality of
!erformance and the overall objectives to be achieved. #AA$ re!resents
the !rinci!les to be followed in the !re!aration of financial statements.
#AA$ includes ade(uate disclosure. 'tatements of the *A'8 and #A'8
are recognied as #AA$.
c. #AA$ is the criteria for determining whether the financial statements
!resent fairly, in all material res!ects. The auditor is also re(uired by the
first standard of re!orting to state whether the financial statements are in
conformity with #AA$.
d. #AA' are !art of the 'tatements on Auditing 'tandards.
2.21 "?stimated time - 1. minutes%
a. Paragraph Sentence Sequence
1. 'co!e *irst
2. 'co!e ;ast
,. O!inion ------
-. 2ntroductory *irst
.. 'co!e Third
/. 2ntroductory Third
1. 'co!e 'econd
6. 'co!e *ourth
7. 2ntroductory 'econd
b. The !rimary !ur!ose of each !aragra!h is3
2ntroductory--distinguish between the res!onsibilities of management
and the auditor.
'co!e--describe the nature and sco!e of the audit.
O!inion--satisfy the standards of re!orting.
2.26 "?stimated time - 1. minutes%
a. 5e!artures from the auditor&s standard re!ort occur when "1% e)!lanatory
language is added to
the standard re!ort and "2% other than an un(ualified o!inion is e)!ressed.
b. A change in an accounting !rinci!le made in conformity with #AA$
results in adding
e)!lanatory language to the auditor&s standard re!ort in a !aragra!h
following the o!inion
!aragra!h. There are no other changes in the standard re!ort.
c. The auditor may e)!ress one of the following other ty!es of o!inions3
A (ualified o!inion states that e)ce!t for the effects of the matter"s% to
which the
(ualification relates, the financial statements !resent fairly... in
conformity with #AA$.
An adverse o!inion states that the financial statements do not !resent
fairly... in
conformity with #AA$.
A disclaimer of o!inion states that the auditor does not e)!ress an
o!inion on the financial statements.
d. There are three changes in the auditor&s re!ort when there is nonconformity
with #AA$3 "1%
an e)!lanatory !aragra!h is added before the o!inion !aragra!h that
e)!lains the
nonconformity with #AA$, "2% reference is made to the e)!lanatory
!aragra!h in the o!inion !aragra!h, and ",% the wording of the o!inion
!aragra!h will say &2n our o!inion, e)ce!t for.F
2.27 Omitted, will be !rovided in the classroom discussion
2.,9 "?stimated time - 2. minutes%
a. An illegal act refers to such acts as the !ayment of bribes, the making of
illegal !olitical
contributions, and the violation of other s!ecific laws and governmental
regulations.
b. Two characteristics of illegal acts influence the auditor&s res!onsibility for
detection.
The determination of whether an act is illegal is de!endent on legal
judgment that normally is beyond the auditor&s !rofessional
com!etence.
2llegal acts vary considerably in their relation to financial statements.
'ome laws and
regulations such as income ta) laws have a direct and material effect
on the financial
statements. >owever, other laws such as those !ertaining to
occu!ational safety and health
and to environmental !rotection have only an indirect effect on the
financial statements.
c. 5isagree. The auditor&s res!onsibilities differ for illegal acts that have a
direct and material
effect on the financial statements and all other illegal acts. The auditor&s
res!onsibilities for
the first ty!e of illegal acts are the same as for material errors and fraud
"i.e., he or she
should !lan the audit to detect such acts.% 0es!onsibilities for all other
illegal acts are limited
to a!!lying auditing !rocedures to such acts that come to the auditor&s
attention.
d. 2nformation that may !rovide evidence concerning !ossible illegal acts
includes "1% unauthoried transactions, "2% investigations by governmental
agencies, and ",% failure to file ta) returns. The auditor should res!ond by
discussing the matter with management, consulting with the client&s legal
counsel, and a!!lying additional !rocedures to obtain an understanding
of the act and its effects on the financial statements.
e. The effects on the audit re!ort are the same as for fraud. @hen an illegal
act having a material effect on the financial statements is not accounted for
in conformity with #AA$, the auditor should e)!ress either a (ualified
o!inion or an adverse o!inion. 2f the auditor is unable to obtain sufficient
evidence about an illegal act, there is a sco!e limitation, which should
result in e)!ressing either a (ualified o!inion or disclaimer of o!inion. The
auditor&s re!orting res!onsibilities to other !arties is limited to
communicating with the audit committee.
Cases
2.,1 "?stimated time - -9 minutes%
rief !escription of "enera##$
%ccepted %uditing Standards
&o#mes' %ctions (esu#ting in
)ai#ure to Comp#$ *ith "enera##$
%ccepted %uditing Standards
"enera# Standards
rief !escription of "enera##$
%ccepted %uditing Standards
&o#mes' %ctions (esu#ting in
)ai#ure to Comp#$ *ith "enera##$
%ccepted %uditing Standards
1. The audit is to be !erformed
by a !erson or !ersons having
ade(uate technical training
and !roficiency is an auditor.
2t was ina!!ro!riate for >olmes to hire the
two students to
conduct the audit. The audit must be
conducted by !ersons
with !ro!er education and e)!erience in
the field of
auditing. Although a junior assistant has
not com!leted his
or her formal education, he or she may hel!
in the conduct
of the audit as long as there is !ro!er
su!ervision and
review.
2. 2n all matters relating to the
assignment, an inde!endence
in mental attitude is to be
maintained by the auditor or
auditors.
To satisfy the second general standard,
>olmes must be
without bias with res!ect to the client under
audit. >olmes
has an obligation for fairness to the owners,
management,
and creditors who may rely on the re!ort.
8ecause of the
financial interest in whether the bank loan
is granted to
0ay, >olmes is inde!endent in neither fact
nor a!!earance
with res!ect to the assignment undertaken.
,. 5ue !rofessional care is to be
e)ercised in the !erformance
of the audit and the
!re!aration of the re!ort.
This standard re(uires >olmes to !erform
the audit with due care, which im!oses on
>olmes and everyone in >olmes&
organiation a res!onsibility to observe the
standards of fieldwork and re!orting.
?)ercise of due care re(uires critical
review at every level of su!ervision of the
work done and the judgments e)ercised by
those assisting in the audit. >olmes did not
rief !escription of "enera##$
%ccepted %uditing Standards
&o#mes' %ctions (esu#ting in
)ai#ure to Comp#$ *ith "enera##$
%ccepted %uditing Standards
review the work or the judgments of the
assistants and clearly failed to adhere to
this standard.
Standards of )ie#d *ork
1. The work is to be ade(uately
!lanned and assistants, if any,
are to be !ro!erly su!ervised.
This standard recognies that early
a!!ointment of the auditor has advantages
for the auditor and the client. >olmes
acce!ted the engagement without
considering the availability of com!etent
staff. 2n addition, >olmes failed to
su!ervise the assistants. The work
!erformed was not ade(uately !lanned.
2. A sufficient understanding of
the internal controls is to be
obtained to !lan the audit and
to determine the nature,
timing, and e)tent of tests to
be !erformed.
>olmes did not obtain any understanding
of the internal control structure. There
a!!ears to have been no audit at all. The
work !erformed was more an accounting
service than it was an auditing service.
,. 'ufficient, com!etent
evidential matter is to be
obtained through ins!ection,
observation, in(uiries, and
confirmations to afford a
reasonable basis for an
o!inion regarding the
financial statements under
e)amination.
>olmes ac(uired no evidence that would
su!!ort the financial statements. >olmes
merely checked the mathematical accuracy
of the records and summaried the
accounts. 'tandard audit !rocedures and
techni(ues were not !erformed.
Standards of (eporting
1. The re!ort shall state whether
the financial statements are
!resented in accordance with
generally acce!ted accounting
>olmes& re!ort made no reference to
generally acce!ted accounting !rinci!les.
8ecause >olmes did not conduct a !ro!er
audit, the re!ort should state that no
rief !escription of "enera##$
%ccepted %uditing Standards
&o#mes' %ctions (esu#ting in
)ai#ure to Comp#$ *ith "enera##$
%ccepted %uditing Standards
!rinci!les. o!inion can be e)!ressed as to the fair
!resentation of the financial statements in
accordance with generally acce!ted
accounting !rinci!les.
2. The re!ort shall identify those
circumstances in which such
!rinci!les have not been
consistently observed in the
current !eriod in relation to
the !receding !eriod.
>olmes& im!ro!er audit did not result in a
determination of whether !rinci!les were
consistently observed.
,. 2nformative disclosures in the
financial statements are to be
regarded as reasonably
ade(uate unless otherwise
stated in the re!ort
Eanagement is !rimarily res!onsible for
ade(uate disclosure in the financial
statements, but when the statements do not
contain ade(uate disclosures the auditor
should make such disclosures in the
auditor&s re!ort. 2n this case both the
statements and the auditor&s re!ort lack
ade(uate disclosures.
-. The re!ort shall either contain
an e)!ression of o!inion
regarding the financial
statements taken as a whole or
an assertion to the effect that
an o!inion cannot be
e)!ressed. @hen an overall
o!inion cannot be e)!ressed,
the reasons therefor should be
stated. 2n all cases where an
auditor&s name is associated
with financial statements, the
re!ort should contain a
Although the >olmes re!ort contains an
e)!ression of o!inion, such o!inion is not
based on the results of a !ro!er audit.
>olmes should not e)!ress an o!inion
because he failed to conduct an audit in
accordance with generally acce!ted
auditing standards.
rief !escription of "enera##$
%ccepted %uditing Standards
&o#mes' %ctions (esu#ting in
)ai#ure to Comp#$ *ith "enera##$
%ccepted %uditing Standards
clearcut indication of the
character of the audit, if any,
and the degree of
res!onsibility the auditor is
taking.
2.,2 "?stimated time - ,9 minutes%
a. 2n conducting an ordinary audit, >ill G Associates should be aware of the
!ossibility that fraud may e)it. 5efalcations, fraud, or deliberate
misre!resentations may result in misstated financial statements. The
ordinary audit leading to the e)!ression of an o!inion is not a guarantee that
fraudulent activities will be detected.
Ander #AA', the auditor has the res!onsibility to !lan the audit to
detect errors or fraud that would have a material effect on the financial
statements, and to e)ercise due skill and care in the conduct of the audit.
8ecause the audit is based on the conce!t of selective testing of the data,
there is the risk that material errors or fraud, if they e)ist, will not be
discovered. Eoreover, there is the risk that management override of controls
and collusion by em!loyees may limit the effectiveness of the auditor&s
e)amination.
b. @hen fraud e)ists, the auditor cannot issue an un(ualified o!inion because
the auditor&s standard re!ort im!licitly indicates the belief that the financial
statements taken as a whole are not materially misstated as a result of errors
or fraud.
@hen the auditor has obtained sufficient com!etent evidential matter
concerning the fraud, he or she should e)!ress either a (ualified or adverse
o!inion, de!ending on materiality, because the financial statements are not
in conformity with #AA$.
@hen the audit indicates the !resence of fraud and the auditor remains
uncertain about whether it may materially affect the financial statements, the
auditor should (ualify the o!inion or disclaim an o!inion on the financial
statements because it is not known whether the financial statements are in
conformity with #AA$.
(+S+%(C& Q,+S-IO.S
*or the reasons s!ecified in the introduction to this manual, solutions are not !rovided
for this category of (uestions.