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OVERVIEW OF AUDITING
I. Review Questions
2. This apparent paradox arises from the distinction between the function of
auditing and the function of accounting.
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 generally accepted accounting principles
(GAAP), as well as generally accepted auditing standards (GAAS).
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.
3.
Audits of Compliance Operational
Financial Audits Audits
Statements
Purpose To determine To determine To evaluate
whether the whether the whether
financial client is operating
statements are following procedures are
presented in specific efficient and
accordance with procedures set effective.
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GAAP. by higher
authority.
Audits of Compliance Operational
Financial Audits Audits
Statements
Users of Different groups Authority Management of
Audit Report for different setting down organization
purposes – procedures,
many outside internal or
entities. external
Nature Highly Not Highly
standardized standardized, nonstandard;
but very specific often very
and usually subjective
objective
Performed
by:
CPAs Almost Occasionally Frequently
universally
COA Occasionally Frequently Frequently
Auditors
BIR Auditors Never Universally Never
Internal Frequently Frequently Frequently
Auditors
3. voluminous data
a. possibly millions of transactions processed daily via sophisticated
computerized systems
b. multiple product lines
c. multiple transaction locations
4. 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
Advantages Disadvantages
User 1. User obtains 1. High cost of obtaining
verifies information desired. information.
informatio 2. User can be more 2. Inconvenience to the
n confident of the person providing the
qualifications and information because
activities of the person large number of users
getting the information. would be on premises.
Users 1. No audit costs incurred. 1. Users may not be able
share to collect on losses.
informatio
n risk with
managem
ent
Audited 1. Multiple users obtain 1. May not meet needs of
financial the information. certain users.
statement 2. Information risk can 2. Cost may be higher
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s are usually be reduced than the benefits in
prepared sufficiently to satisfy some situations, such
users at reasonable as for a small company.
cost.
3. Minimal inconvenience
to management by
having only one
auditor.
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.
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 generally accepted accounting
principles.
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
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sentence, as well as the first, is too sweeping to be correct. A decision not to
have an audit is not always “false economy.”
17. (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.
Case 2. The most likely type of auditor and the type of audit for each of the
examples are:
Example Type of Auditor Type of Audit
1. COA Compliance
2. CPA; Internal Auditor Operational
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3. Internal auditor; CPA Compliance
4. CPA Financial
statements
5. CPA Tax audit; FS audit
6. COA Financial
statements
7. CPA Financial
statements
8. COA Operational audit
9. CPA; Internal Auditor Financial
statements
10. Internal auditor or Operational audit
CPA
11. CPA or COA Operational audit
12. CPA; BIR Compliance