CHAPTER 1

Introduction and Overview of Audit and Assurance

Before You Go On Solutions

1.1 The intended users of assurance services are decision makers, such as investors, creditors,
and regulators.
1.2 Within the context of assurance services, “independent” means that the person performing
the service is not involved with the creation of the information and is objective in the
evaluation of the information.
1.3 Examples of “applicable financial reporting frameworks” are GAAP, IFRS, and a federal
income tax basis of accounting.

2.1 The objective of a financial statement audit is to provide financial statement users with an
opinion by the auditor on whether the financial statements are presented fairly in
accordance with an applicable financial reporting framework.
2.2 An inherent limitation of a financial statement audit is the nature of financial reporting
whereby auditors use judgment when preparing financial statements due to the subjectivity
required when arriving at accounting estimates. Another inherent limitation is the nature of
audit procedures which refers to the reliance on evidence provided by the client and its
management. Also, auditors often use sampling techniques rather than auditing an entire
population of items, therefore there is a risk of arriving at an incorrect conclusion. The final
inherent limitation is the need for the audit to be conducted within a reasonable period of
time at a reasonable cost.
2.3 The three elements of operational audits are economy, efficiency, and effectiveness of an
organization’s activities.
2.4 The most common functions of internal auditors are evaluating and improving risk
management, internal control procedures, and elements of the governance process.

3.1 The main users of company financial statements are current and potential investors,
suppliers, customers, lenders, employees, governments, and the general public.
3.2 Financial statement users demand an audit because of remoteness of the company,
complexity of financial statements, competing incentives among management and users,
and reliability of information.
3.3 Auditors are the appropriate professionals to conduct an audit because they have the
knowledge and expertise to assess the fairness of the information being presented by the
preparers. They have access to company records, so they are not remote. Auditors have
little incentive to aid the company in presenting the results in the best possible light because
their work is regularly reviewed by regulators.
4.1 Management is responsible for ensuring the information included in the financial statements
is presented fairly and complies with the applicable financial reporting framework.

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 Management is also responsible for designing, implementing, and maintaining internal
control relevant to the preparation and fair presentation of the financial statements.
Management provides the auditors with access to all records, documentation, and personnel
relevant to the preparation and fair presentation of financial statements and any additional
information the auditors may consider relevant to complete the audit.
4.2 Professional skepticism is an attitude adopted by auditors when conducting an audit that
includes a questioning mind, being alert to conditions that may indicate possible
misstatement due to fraud or error, and a critical assessment of audit evidence.
4.3 Non-audit services are not assurance services, therefore, the CPA does not need to be
independent. Examples include management consulting, business valuation, mergers and
acquisitions, tax, and accounting.

5.1 The SEC is a federal government agency whose mission is to protect investors, maintain fair
and efficient markets, and facilitate capital formation. The SEC enforces and interprets
securities laws.
5.2 The PCAOB is the organization that sets standards for the audits of public companies. The
ASB sets the standards for the audits of private companies.
5.3 The main functions of the state board of accountancy are issuing CPA licenses to
individuals who meet all the requirements, adopting and enforcing rules of professional conduct
for CPAs, adopting and enforcing rules regarding continuing professional education
requirements, investigating complaints against CPAs, conducting hearings, and taking
appropriate disciplinary actions, such as suspension or revocation of the CPA license.

6.1 Auditors provide reasonable assurance because they give their opinions on whether the
financial statements are presented fairly. An opinion is defined as a judgment about matters that
are subjective. Also, an audit could not be completed in a reasonable amount of time if auditors
had to provide absolute assurance.
6.2 Materiality is an aspect of a financial statement that is significant enough to influence or
make a difference in the judgment of consequential activities of a financial statement user.
Materiality relates to reasonable assurance because auditors design an audit to provide
reasonable assurance that the financial statements are free of material misstatement.
6.3 The term unqualified is used in the context of an audit report for a public company client. It
means in the auditor’s opinion, the financial statements are presented fairly, in all material
respects, in accordance with the applicable financial reporting framework. The term unqualified
is equivalent to the term unmodified which is used for the private company audit report.

7.1 Having effective internal controls over financial reporting provides reasonable assurance
that the financial statements will be reliable and free of material misstatement. An effective
internal control system may not prevent all misstatements, therefore, it can only provide

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reasonable assurance. Similar to an audit of the financial statements, auditors can only provide
reasonable assurance that a company’s internal controls are effective.
7.2 According to the audit report on the effectiveness of internal controls, management is
responsible for maintaining effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over financial reporting.
7.3 The date used on the audit report on the effectiveness of internal controls represents the
end of fieldwork. The date represents the conclusion of gathering and evaluating evidence for
the audit and it should be the same date as the audit report on the financial statements.

8.1 The audit expectation gap occurs when there is a difference between the expectations of
auditors, as dictated by auditing standards, and financial statement users. The performance
gap is the difference between auditor performance and auditing standards and regulations.
8.2 The audit expectation gap is caused by unrealistic user expectations such as:
 Auditor is providing absolute assurance.
 Auditor is guaranteeing future viability of the entity.
 An unmodified opinion is an indicator of complete accuracy of financial statements.
 Auditor will definitely find fraud.
 Auditor has checked all transactions.
In reality, the auditor does not fulfill these unrealistic user expectations.
8.3 The audit expectation gap can be reduced by:
 Auditing standards being reviewed and updated on a regular basis to enhance the work
being done by auditors.
 Education of users as to the responsibilities of preparers and auditors of financial
statements.
The performance gap can be reduced by:
 Auditors performing their duties appropriately and complying with auditing standards.
 Inspections of audits to ensure that auditing standards have been correctly applied.
 Assurance providers reporting accurately the level of assurance being provided.

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