Several Questions About Auditing Intro Level

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Auditing Discussion

a) The public accounting profession has taken a number of steps to minimize potential bias towards important users. The profession has specific standards for auditing, a separation between auditing and consulting roles, and other mechanisms. The audit function itself, and the use of generally accepted accounting principles, is a means of providing neutrality in financial reporting. Standardized reporting thus delivers statements and reporting that are the same across industries, and across all different types of stakeholders.

b) There are many users of financial statements. Four important user groups are management, stockholders, financial institutions and authorities. For unionized companies, unions would also be of a high importance level. Management uses statements to assess performance, as do stockholders as their returns depend on performance. Financial institutions have corporations as clients, and lend to them, thus have an interest in the financial performance. Regulatory authorities either in charge of the tax system or in charge of capital markets use the statements to assess taxes and to ensure that the statements accurately reflect the financial condition of the company. Accounting treatments can portray the company in different ways with respect to things like time horizon, and thus may be more or less beneficial to specific user groups.

1-41a) An audit ensures that the company's financial statements are accurate. This is important for all stakeholder groups. b) An audit of internal controls provides value to the public because it verifies that the company has controls against both error and fraud built into the procedures by which it compiles its financial statements. c) The audit committee selects the auditors, and sets policy with respect to both internal auditing and with respect to the internal controls that govern the audit function. The audit committee also seeks to ensure independence of the audit.

1-42a) Management of Quello might want independent financial statements because they will reveal the current state of the company. First, this will provide the baseline level on which the 20% annual targets are built. Second, it will provide insights into the financial resources that the company has with which to achieve its goals, and also can provide insight into areas of operations that can be improved to help achieve such goals. The independent financial statements are freer of bias than internal statements and it may have been a while since such independent statements were produced.

1-42b) They can set whatever parameters for their search they want. They need an auditor at a low cost who understands the industry and has the resources and experience to do the job. c) Quello is not required to have an audit committee because it is a privately-held company. d) Quello is not compelled to issue a report on the quality of its internal controls, again because it is a privately-held company, which means that it is not bound by SEC rules.

1-43. a. Disagree- this is important but the primary purpose is to ensure that the financial statements accurately reflect the company's financial condition. Fraud detection is a subset of that. B. Disagree. This is self-evident. C. Disagree. Red Cross is not a publicly-traded company. D. Disagree. Most users are fairly savvy about finance, and do not expect more than regulators do. The bar is pretty high from the SEC and PCOAB, and user expectations do not seem to exceed that. E. Agree on the first clause -- this is an independent audit. Disagree on the second clause -- how a company is structured has nothing to do with how well it knows the industry. F. Agree. That is the point of the PCAOB, to restore public confidence in the auditing profession. Conflict of interest has been removed, and there is no evidence to suggest that public confidence is flagging. G. Disagree, because the choices that a company makes under GAAP must be disclosed, and when they change a statement about material changes to the financial statement methodology must be issued, noting the effect of the change. H. Agree. The auditor should have an opinion on the second clause. I. Disagree. It very much does, because consulting pays more than auditing, so audits can be compromised to maintain the consulting revenue stream. This was one of the key issues in SOX.

1-44.a) There are a few issues where auditor judgment must be made: determining materiality, determining business risk, on the quality of the design of the internal controls, on certain financial statement items that may require adjustment, and on the types of reports that should be issued. Thus, there are many areas where auditor judgment is required.

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3-37 Scene 1a) In this situation, the deadline is a threat to the independence and quality of the audit. There is no reason to pay heed to the CFO -- the CFO will have to understand the auditor's time frame and accept that. B) To prevent this situation, the CFO should have been quite well aware of the need for the audit, and been aware that this was going ot happen. The CFO also needs to understand that his/her responsibility is to facilitate the audit and that any interference in the audit process is going to be a problem. The lead auditor should also have had a team with more balance of experienced members, and communicated the audit time frames to the company more clearly.

3-37 Scene 2a) This arrangement creates conflict of interest, because retaining clients and selling them additional services threatens the independence of the auditor, who may feel pressure to make the client happy in order to retain the business and generate additional income. The accounting firm should not have financial incentive to compromise the audit. B) To eliminate this threat, the firm needs to pay auditors higher base pay, so that they are not incentivized to do anything other than perform accurate audits. Performance-based pay in auditing should not be based on sales. Paying people for being great auditors encourages them to be great auditors, not great sales people.

3-38. a) The rationale of this is so that auditing is completely independent of the CEO and CFO. b) The audit committee needs to consider what other work the accounting firm does for the company, and whether the accounting firm has any sort of fiduciary interest in the company other than the auditing function. c) I chose Tesla for this one. The members of the audit committee were chosen as all three are independent directors. The Chair of the audit committee is the designated financial expert. The audit committee has a set of five responsibilities: approving selection of the external auditor, monitoring integrity of financial statements, reviewing the internal controls, discussions with auditors, and preparing audit committee report. Audit committee members are paid $7,500 each, and the Chair gets $15,000.

3-39a) The four guiding principles for auditor independence are reflected in four things that cannot exist: a mutual or conflicting interest between the auditor and client, when the accountant is in the position of auditing his/her own work, when the accountant is managing an employee of the company being audited and when the accountant is in a position of advocating for the audit client. B) these principles only apply to public companies, as only those are covered by the SEC.

4-46. a & b) This scenario does not provide enough information. What is the relationship between benefits and hours? How are hours measured? No auditor would speculate on risk on the basis of two incredibly vague sentences, let alone recommend remediation for vague, unspecified risks.

4-47. a) The second auditor's argument is the most persuasive. I think back to Enron, and how it got away with its fraud for years on the rationale that "you people just don't understand our really complex business." Auditors have to know the business to determine whether the transactions and financial statements being presented make any sense. It is not just about looking at deviations from the norms, because if the statements were wrong all along, then the baseline was wrong and the deviations meaningless. If auditors do not understand the business, they need more training on it. B) Auditors very much need more training on risk management, because those risks sometimes are material to the financial condition of the company (for example, Washington Mutual) c) A risk-based approach to auditing involves examining risk, for example focusing on the areas where the risk is greatest, even if those areas are not on the financial statements. The logic is that risk is what matters most to most stakeholders. The two views are not incompatible. You need to both assess the company's risk management and its current financial condition. An audit team should be able to handle both the quantitative and qualitative side of the job.

4-49. Prior to the fieldwork, the auditor needs to learn as much as possible about the company, its business, its operations and its finances. The team will need to familiarize itself with the company's prior SEC filings, prior audit reports and other standardized documentation. You have to know….....

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