Homework 1 (Chapter 1 & 2)Chapter 1Problem 1-17 (a-e)a. The interest rate for the loan that requires a review report is lower than the loan that did notrequire a review because of lower information risk.The interest rate for the loan that requires an audit report is lower than the interest rate for theother two of loans because a review reportprovides moderate assurance to financial statementusers, which lowers information risk, whereas an audit reportprovides further assurance andlower information risk. As a result of reduced information risk, the interest rate is lowest fortheloan with the audit report.b. Vial-tek’s annual costs under each loan agreement, including interest and costs for CPA firm’sservices are following: LENDER CPA COST OF CPA ANNUAL ANNUAL SERVICE SERVICES INTEREST LOAN COST Existing loan None 0 $ 332,500 $ 332,500 First National Bank Review $ 20,000 $ 297,500 $ 317,500 City First Bank Audit $ 45,000 $ 262,500 $ 307,500Given these circumstances, Vial-tek should select the loan from City First Bank that requires anannual audit. In this situation, the additional cost of the audit is less than the reduction in interestdue to lower information risk.c. Vial-tek should select the loan from First National Bank due to the higher cost of the audit andthe reduced interest rate for the loan from First National Bank. The following is the calculationof total costs for each loan: LENDER CPA COST OF CPA ANNUAL ANNUAL SERVICE SERVICES INTEREST LOAN COST Existing loan None 0 $ 332,500 $ 332,500 First National Bank Review $ 20,000 $ 280,000 $ 300,000 City First Bank Audit $ 50,000 $ 262,500 $ 312,500d. Vial-tek may desire to have an audit because of the many other positive benefits that an auditprovides. The audit will provide Vial-tek’s management with assurance about annual financialinformation used for decision-making purpose, includingdetects errors or fraud, and providesmanagement with information about the effectiveness of controls. In addition, the audit mayresult in recommendations to management that will improve efficiency or effectiveness.
e. The auditor must have a thorough understanding of the client and its environment, includingthe client’s e-commerce technologies, industry, regulatory and operating environment, suppliers,customers, creditors, and business strategies and processes. This thorough analysis helps theauditor identify risks associated with the client’s strategies that may affect whether the financialstatements are fairly stated. This strategic knowledge of the client’s business often helps theauditor identify ways to help the client improve business operations, thereby providing addedvalue to the audit function.Problem 1-19 (a-b)a.The following parts of the definition of auditing are related to the narrative:(1) InformationVirms is being asked to issue a report about qualitative and quantitative information for trucks.The trucks are therefore the information with which the auditor is concerned.(2) Established criteriaThere are four established criteria which must be evaluated and reported by Virms: Existence of the trucks on the night of June 30, 2009 Ownership of each truck by Regional Delivery Service Physical condition of each truck Fair market value of each truck.(3) Accumulating and evaluating evidenceSusan Virms will accumulate and evaluate four types of evidence: Count the trucks to determine their existence. Use registrations documents held by Oatley for comparison to the serial number on each truck to determine ownership. Examine the trucks to determine each trucks physical condition. Examine the blue book to determine the fair market value of each truck.(4) Competent, independent personSusan Virms, CPA, appears qualified, as a competent, independent person. She is a CPA, andshe spends most of her time auditing used automobile and truck dealerships and has extensivespecialized knowledge about used trucks that is consistent with the nature of the engagement.
(5) Reporting resultsThe report results are including: Which of the 35 trucks are parked in Regionals parking lot the night of June 30. Whether all of the trucks are owned by Regional Delivery Service. The condition of each truck, using established guidelines. Fair market value of each truck using the current blue book for trucks.b. There are 2 parts of the audit that will be difficult for Virms: (1) Evaluating the condition, using the guidelines of poor, good, and excellent. It is highly subjective to do so. If she uses a different criterion than the "blue book," the fair market value will not be meaningful. Her experience will be essential in using this guideline. (2) Determining the fair market value, unless it is clearly defined in the blue book for each condition.Problem 1-22 (a-b)a.The conglomerate should either engage the management advisory services division of a CPAfirm or its own internal auditors to conduct the operational audit.b. The auditors will encounter problems in establishing criteria for evaluating the actualquantitative events and in setting the scope to include all operations in which significantinefficiencies might exist. In writing the report, the auditors must choose proper wording to statethat no financial audit was performed, that the procedures were limited in scope and that theresults reported do not necessarily include all the inefficiencies that might exist.
Chapter 2Problem 2-18 (a-b)a. The arguments against the Act can be summarized as four arguments: 1. Costs of complying with the Act are excessively high, especially the requirement to report on internal control over financial reporting, and will discourage companies from becoming public companies. 2. Relative cost for local audit firms is excessively high. 3. Additional oversight is not needed because sufficient quality controls have already been implemented by most audit firms. 4. Three other things already provide assurance of adequate quality: a competitive economic environment, legal liability, and auditing standards.To support these comments, it can be argued that the profession has generally functioned wellwith relatively little controversy and criticism.The arguments against these comments are followings: o Reporting on the effectiveness of internal control over financial reporting will provide benefits in improved controls, resulting in higher quality financial reporting and reduced losses from fraud. o The increased confidence in financial reporting will increase access to capital and lower the cost of capital by reducing information risk. o Changes in the scope of CPA practices and other threats to audit quality required government regulation. o Regulation of public company audits will not affect most audit firms that do not have public company audit clients.b. There is no correct answer to this question. Different people reach different conclusions,depending on the weights put on the various arguments. It needs time to effectively assess boththe costs and benefits of the Act.Problem 2-20 (a-b)a.Rossi and Montgomerys primary ethical consideration is their professional competence toperform all of the audit work for filing with the SEC. In addition, if Rossi and Montgomery have performed bookkeeping services or certainconsulting services for Mobile Home, they will not be independent under PCAOB and SECindependence requirements. The firm must also be a registered firm with the PCAOB.
b. The filing with the SEC, in addition to normal audited financial statements, will require completion and registration with the SEC of Form S-1 which includes an audited summary of operations for the last five fiscal years as well as many additional schedules and descriptions of the business. Each quarter subsequent to the filing, Form 10-Q must be filed; and within 90 days of the end of each fiscal year Form 10-K must be filed with the SEC. In addition, Form 8-K must be filed whenever significant events have occurred which are of interest to public investors. These forms must be filed in conformity with Regulation S-X, which requires considerable disclosures in addition to those normally required in audited financial statements. Problem 2-21 Brief Description of GAAS Holmes’ Actions Resulting in Failure to Comply w/ GAASGeneral Standards1. The auditor must have adequate technical 1. It was inappropriate for Holmes to hire the two students totraining and proficiency to perform the audit. conduct the audit. The audit must 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.2. The auditor must maintain independence in 2. To satisfy the second general standard, Holmes must bemental attitude in all matters relating to the without bias with respect to the client under audit. Holmesaudit. has an obligation for fairness to the owners, management, and creditors who may rely on the report. Because of the financial interest in whether the bank loan is granted to Ray, Holmes is independent in neither fact nor appearance with respect to the assignment undertaken.3. The auditor must exercise due professional 3. This standard requires Holmes to perform the audit withcare in the performance of the audit and the due care, which imposes on Holmes and everyone in Holmespreparation of the report. organization a responsibility to observe the standards of field work and reporting. Exercise of due care requires 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
Brief Description of GAAS Holmes’ Actions Resulting in Failure to Comply w/ GAASStandards of Field Work1. The auditor must adequately plan the work 1. This standard recognizes that early appointment of theand must properly supervise any assistants. auditor has advantages for the auditor 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.2. The auditor must obtain a sufficient 2. Holmes did not obtain an understanding of the entity or itsunderstanding of the entity and its internal control, nor did the assistants obtain such anenvironment, including its internal control, to understanding. There appears to have been no audit at all.assess the risk of material misstatement of the The work performed was more an accounting service than itfinancial statements whether due to error or was an auditing service.fraud, and to design the nature, timing, andextent of further audit procedures.3. The auditor must obtain sufficient 3. Holmes acquired no evidence that would support theappropriate audit evidence by performing financial statements. Holmes merely checked theaudit procedures to afford a reasonable basis mathematical accuracy of the records and summarized thefor an opinion regarding the financial accounts. Standard audit procedures and techniques were notstatements under audit. performed.Standards of Reporting1. The auditor must state in the auditor’s 1. Holmes report made no reference to GAAP. Becausereport whether the financial statements are Holmes did not conduct a proper audit, the report should statepresented in accordance with generally that no opinion can be expressed as to the fair presentation ofaccepted accounting principles (GAAP). the financial statements in accordance with generally accepted accounting principles.2. The auditor must identify in the auditor’s 2. Holmes improper audit would not enable him to determinereport those circumstances in which such whether GAAP were consistently applied. Holmes reportprinciples have not been consistently observed should make no reference to the consistent application ofin the current period in relation to the accounting principles.preceding period.3. When the auditor determines that 3. Management is primarily responsible for adequateinformative disclosures are not reasonably disclosures in the financial statements, but when theadequate, the auditor must so state in the statements do not contain adequate disclosures the auditorauditor’s report. should make such disclosures in the auditors report. In this case both the statements and the auditors report lack adequate disclosures.
Brief Description of GAAS Holmes’ Actions Resulting in Failure to Comply w/ GAAS4. The auditor must either express an opinion 4. Although the Holmes report contains an expression ofregarding the financial statements, taken as a opinion, such opinion is not based on the results of a properwhole, or state that an opinion cannot be audit. Holmes should disclaim an opinion because he failedexpressed, in the auditor’s report. When the to conduct an audit in accordance with generally acceptedauditor cannot express an overall opinion, the auditing standards.auditor should state the reasons therefor in theauditor’s report. In all cases where an auditorsname is associated with financial statements,the auditor should clearly indicate thecharacter of the auditors work, if any, and thedegree of responsibility the auditor is taking,in the auditor’s report. Problem 2-22 (a-f) a. An audit of a German private company w/ no public debt. The engagement is like to be conducted under international auditing standards. b. An audit of a U.S. public company. The engagement is like to be conducted under PCAOB auditing standards. c. An audit of a United Kingdom public company that is listed in the U.S. and whose financial statements will be filed w/ the SEC. The engagement is like to be conducted under PCAOB auditing standards(reporting in the U.K. will be under international auditing standards). d. An audit of a U.S. private company to be used for a loan from a publicly-traded bank. The engagement is like to be conducted under generally accepted auditing standards. e. An audit of a U.S. public company that is a subsidiary of a Japanese company that will be used for reporting by the parent company in Japan. The engagement is like to be conducted under international auditing standards. f. An audit of a U.S. private company that has publicly-traded debt. The engagement is like to be conducted under PCAOB auditing standards(due to the publicly-traded debt).