Chapter 2 Homework – Daniel Pinto
2.30 – A. To determine the nature, timing, and extent of substantive
procedures to be performed.
2.31 – B. Inquiry of management.
2.32 – D. Physical observation.
2.33 – D. Inspection of bank statements obtained directly from the client’s
financial institution.
2.34 – C. Adequate planning and supervision.
2.36 – C. Documentary evidence obtained directly from independent external
sources.
2.41 – B. Absolute assurance regarding the fairness of the entity’s financial
statements in accordance with GAAP.
2.45 – A. Auditors are required to prepare a written audit plan during the
planning stages of initial audits but are not required to do so in continuing
audits.
2.55 – Independence
A. Independence in fact refers to the auditor’s actual state of mind,
where they are able to maintain an unbiased attitude throughout the
audit. Independence in appearance is the perception of
independence by reasonable and informed third parties.
B. Two relationships that normally compromise auditors’ independence
are Financial relationships like owning shares of stock or having
outstanding loans. Managerial relationships also compromise
independence.
C. Situations
1. This situation is more than likely a self-interest threat to
independence. The auditor’s firm may not challenge the client’s
accounting practices for fear of losing the consulting work. While
not prohibited, this situation jeopardizes independence in
appearance and potentially in fact.
2. This scenario compromises both independence in fact and
appearance. It creates a serious familiarity threat and a possible
self-interest threat. Most regulatory frameworks would not allow
this relationship due to the close family tie a person in a financial
reporting oversight role.
3. This situation does not compromise independence. The
relationship is distant, an entry level position, and the audit is
conducted by a different office. But the firm should still be aware
of this relationship to ensure it doesn’t create and threats to
independence.
4. While the staff member is not directly involved in the audit this is
still an example of a threat to independence. Many firms prohibit
any covered persons from having financial interests in audit
clients. So, at the very least this is an example compromised
independence in appearance.
2.58 – The short notice audit request presents many critical challenges. For
one not having sufficient time for proper planning and execution of a quality
audit. Not having an adequate planning phase is detrimental to the quality of
the audit, the planning phase is crucial for risk assessment and audit
strategy. Also, there is the chance for oversight of important audit areas due
to rushed work.
Another issue that can come up is not having enough time to compete a
thorough review. A rushed review process can lead to overlooked errors or
inconsistencies. The limited opportunity to critically analyze audit data and
investigate unusual transactions or discrepancies further expands the issue.
This time constraint could possibly compromise the auditors’ ability to
maintain a professional skepticism throughout the audit.
2.65 – Comprehensive Principles Case Study
1. Principle of Regularity
- Description: This principle requires adherence to GAAP rules and
regulations.
Holme’s failures
- Did not conduct a proper audit in accordance with generally accepted
auditing standards
- Failed to mention GAAP in the auditor's report
- Omitted footnotes from the financial statements, which are required
under GAAP
2. Principle of Consistency
- Description: This principle requires consistent application of
accounting methods across reporting periods.
Holme’s failures
- Did not mention the change in accounting standard for capitalizing
interest in the auditor's report
3. Principle of Sincerity
- Description: This principle demands accuracy and an honest,
objective representation of a company's financial position.
Holme’s failures
- Accepted a bonus contingent on the loan approval, compromising his
objectivity
- Instructed students to focus solely on mathematical accuracy rather
than conducting a comprehensive audit
4. Principle of Permanence of Methods
- Description: This principle requires consistent procedures in the
preparation of financial reports to allow for comparison between
accounting periods.
Holme’s failures
- Did not properly review or disclose the change in accounting method
for capitalizing interest
5. Principle of Non-Compensation
- Description: This principle requires full disclosure of all financial
information, without offsetting debits and credits.
Holme’s failures
- Omitted footnotes from the financial statements, which are crucial for
full disclosure
6. Principle of Prudence
- Description: This principle requires a degree of caution in exercising
judgments needed in making estimates under conditions of
uncertainty.
Holme’s failures
- Rushed the audit process, not allowing sufficient time for a thorough
examination and careful consideration of uncertainties
7. Principle of Continuity
- Description: This principle assumes that the business will continue to
operate in the foreseeable future.
Holme’s failures
- The rushed approach may not have allowed for proper assessment of
the entity's going concern status
8. Principle of Periodicity
- Description: This principle assumes that economic activities of an
enterprise can be divided into artificial time periods for reporting.
Holme’s failures
- The hasty three-week timeframe may have compromised the ability to
properly review periodic financial information
9. Principle of Materiality
- Description: This principle requires that all material items that might
influence the decisions of an informed reader should be disclosed in
the financial statements.
Holme’s failures
- Omitted footnotes and failed to disclose the change in accounting
method for capitalizing interest
10. Principle of Utmost Good Faith
- Description: This principle assumes honesty and integrity from all
parties involved in financial reporting and auditing processes.
Holme’s failures
- Accepted a contingent fee, which compromises independence
- Inadequately supervised the audit process by relying on inexperienced
students
- Issued an unmodified opinion without proper evidence
B.23 – B. They want the public at large to have confidence in the profession.
B.26 – C. Public Company Accounting Oversight Board (PCAOB).
B.41 – A. Information about whether a consulting client has paid the CPA’s
fees on time.
B.46 – A. Owned common stock of the audit client but sold it before the
company became a
client.
B.52 – This situation violates the AICPA Code of Professional Conduct,
specifically Rule 101 – Independence. The CPA Alex’s independence would be
flawed if he performs an audit for Harper Corporation. Alex would not be the
right person to complete the audit because he performs the day-to-day
bookkeeping services for Harper, and he also supervises Harper’s part-time
bookkeeper. This creates a self-review threat and involve assuming
management responsibilities, which are prohibited for audit clients. Alex
cannot maintain independence while performing these services and
conducting an audit for the same client.
B.53 – This situation violates the AICPA Code of Professional Conduct,
specifically Rule 101 - Independence. CPA Ellis, a shareholder in Eden,
Benjamin, and Block, P.C., owns 25% of Dove Corporation, which in turn owns
32% of Tale Company, an audit client of Eden, Benjamin, and Block. This
creates a material indirect financial interest in an attest client. According to
Interpretation 101-1, independence is impaired if a covered member has a
material indirect financial interest in the attest client. This situation creates a
self-interest threat that could reasonably be perceived to impair the auditor's
objectivity in auditing Tale Company.