Chapter 2
2-16 a. (1) b. (2) c. (3) d. (3)
2-17 a. (2) b. (1) c. (2) d. (3)
2-21
BRIEF DESCRIPTION OF GAAS / HOLMES' ACTIONS RESULTING IN FAILURE TO COMPLY WITH GAASGENERAL STANDARDS
1. The auditor must have adequate technical training and proficiency to perform the audit. / 1. It was inappropriate for Holmes to hire the two students to 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 mental attitude in all matters relating to the audit. / 2. To satisfy the second general standard, Holmes must be without bias with respect to the client under audit. Holmes 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 care in the performance of the audit and the preparation of the report. / 3. This standard requires Holmes to perform the audit with due care, which imposes on Holmes and everyone in Holmes' 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 standard.
2-21 (continued)
STANDARDS OF FIELD WORK
1. The auditor must adequately plan the work and must properly supervise any assistants. / 1. This standard recognizes that early appointment of the 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 understanding of the entity and its environment, including its internal control, to assess the risk of material misstatement of the financial statements whether due to error or fraud, and to design the nature, timing, and extent of further audit procedures. / 2. Holmes did not obtain an understanding of the entity or its internal control, nor did the assistants obtain such an understanding. There appears to have been no audit at all. The work performed was more an accounting service than it was an auditing service.
3. The auditor must obtain sufficient appropriate audit evidence by performing audit procedures to afford a reasonable basis for an opinion regarding the financial statements under audit. / 3. Holmes acquired no evidence that would support the financial statements. Holmes merely checked the mathematical accuracy of the records and summarized the accounts. Standard audit procedures and techniques were not performed.
STANDARDS OF REPORTING
1. The auditor must state in the auditor’s report whether the financial statements are presented in accordance with generally accepted accounting principles (GAAP). / 1. Holmes' report made no reference to generally accepted accounting principles. Because Holmes did not conduct a proper audit, the report should state that no opinion can be expressed as to the fair presentation of the financial statements in accordance with generally accepted accounting principles.
2-21 (continued)
2. The auditor must identify in the auditor’s report those circumstances in which such principles have not been consistently observed in the current period in relation to the preceding period. / 2. Holmes' improper audit would not enable him to determine whether generally accepted accounting principles were consistently applied. Holmes' report should make no reference to the consistent application of accounting principles.
3. When the auditor determines that informative disclosures are not reasonably adequate, the auditor must so state in the auditor’s report. / 3. Management is primarily responsible for adequate disclosures in the financial statements, but when the statements do not contain adequate disclosures the auditor should make such disclosures in the auditor's report. In this case both the statements and the auditor's report lack adequate disclosures.
4. The auditor must either express an opinion regarding the financial statements, taken as a whole, or state that an opinion cannot be expressed, in the auditor’s report. When the auditor cannot express an overall opinion, the auditor should state the reasons therefor in the auditor’s report. In all cases where an auditor's name is associated with financial statements, the auditor should clearly indicate the character of the auditor's work, if any, and the degree of responsibility the auditor is taking, in the auditor’s report. / 4. Although the Holmes report contains an expression of opinion, such opinion is not based on the results of a proper audit. Holmes should disclaim an opinion because he failed to conduct an audit in accordance with generally accepted auditing standards.
2-22 a. International auditing standards.
b. PCAOB auditing standards.
c. PCAOB auditing standards (reporting in the U.K. will be under international auditing standards).
d. Generally accepted auditing standards.
e. International auditing standards.
f. PCAOB auditing standards (due to the publicly-traded debt).
Chapter 3
3-23 a. (2) b. (3) c. (3)
3-24 a. (3) b. (4) c. (1)
3-25 a. (2) b. (3) c. (3)
3-29
(a)CONDITION
/ (b)MATERIALITY LEVEL / (c)
TYPE OF REPORT / (d) MODIFIED WORDING / ADDITIONAL PARAGRAPHS
(& OTHER COMMENTS)
1. Scope of the audit has been restricted / Highly material / (6) Disclaimer / The client has restricted the scope of the audit and the auditor was not able to satisfy him or herself by alternative procedures. Because it was a client restriction rather than a condition beyond the client’s control causing the limitation, and because the limitation is highly material, a disclaimer is appropriate. Introductory paragraph is modified, second paragraph is added describing the scope restriction, scope paragraph is omitted, and opinion paragraph is a disclaimer of opinion.
2. None / Not applicable / (1) Unqualified— standard wording / There is no indication questioning the ability of the business to continue operations. The auditor does not automatically add an explanatory paragraph simply because there is a risky business.
3. None / Immaterial / (1) Unqualified— standard wording / The amount is immaterial. The facts are adequately disclosed in the footnote.
4. Failure to
follow GAAP / Material / (4) Qualified opinion only —except for / The standards require the use of a qualified opinion for the failure to include a statement of cash flows. Third paragraph must be added stating the omission.
5. Substantial doubt about going concern / Material / (2) Unqualified— explanatory paragraph / There is a question about the ability of the company to continue as a going concern. The auditor therefore must issue an unqualified report with an explanatory paragraph following the opinion.
6. Report involving other auditors / Material / (3) Unqualified— modified wording / This is a shared audit report in which the auditor will identify the portion of work done by the other auditor in the introductory paragraph and still issue an unqualified opinion. The absolute dollar amounts of assets and revenues or percentages must be stated in the introductory paragraph. Introductory paragraph, scope paragraph, and opinion paragraph are all modified.
3-30
(a)CONDITION / (b)
MATERIALITY
LEVEL / (c )
TYPE OF REPORT / COMMENT
1. Failure to follow GAAP. / Highly material or material, depending upon the amount of the loss and the auditor's preliminary judgment about materiality / (7) Adverse (if highly material)
or
(4) Qualified opinion only —except for
(if material) / Disclosure of this information is required in a footnote. Failure to do so is a violation of GAAP and is likely to result in a qualified opinion, or it could be so material that it requires an adverse opinion.
2. Failure to follow GAAP. / Immaterial / (1) Unqualified—standard wording / The amount is immaterial.
3. Scope of the audit has been restricted. / Highly material or material, depending upon the auditor’s preliminary judgment about materiality. / (6) Disclaimer
(if highly material)
or
(5) Qualified scope and opinion
(if material) / Because the auditor was unable to satisfy himself about beginning inventories, it would be necessary to issue either a qualified or disclaimer of opinion on the income statement and statement of cash flows as well as the beginning balance sheet. The use of a qualified or disclaimer would depend upon materiality. An unqualified opinion could be issued for the current period balance sheet.
4. Scope of the audit has been restricted. / Highly material / (6) Disclaimer / Failure of the client to allow the auditor to inspect the minutes book would be a material client-imposed restriction. Due to the importance of the minutes book, a disclaimer would be necessary. The certified copy of all resolutions and actions would not be a satisfactory alternative procedure.
5. Scope of the audit has been restricted. / Not applicable / (1) Unqualified—standard wording / Because the auditor was able to obtain alternative evidence, no scope qualification is necessary. If there were such a qualification, it would be a qualified scope and opinion or a disclaimer, depending on materiality.
6. Failure to follow GAAP. / Material / (4) Qualified opinion only—except for / Retail Auto Parts has used a replacement cost inventory rather than lower of cost or market. It is not sufficiently material to require an adverse opinion.
7. None / Not applicable / (1) Unqualified—standard wording / The change of estimated life is a change of condition and not a change in accounting principles. Therefore, an unqualified opinion is appropriate since there is adequate disclosure.
3-32 Deficiencies in the staff accountant's tentative report include the following:
1. Report title must include the word “independent.”
2. The report should generally be addressed to the board of directors or stockholders, not to the audit committee.
3. The introductory paragraph should state, "we have audited," not "we have examined."
4. When the principal auditor decides to make reference to the audit of another auditor, the report should indicate clearly in the introductory paragraph the division of responsibility regarding the portions of the financial statements audited by each. Also, the opinion paragraph should state that the opinion is based in part on the reports of other auditors. Neither of these was done.
5. When the principal auditor decides to make reference to the audit of the other auditor, the report should disclose the dollar amounts or percentages of the portion of the financial statements audited by the other auditor. This was not done.
6. The second paragraph is an inappropriately worded scope paragraph. It should be stated as follows:
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the report of other auditors provide a reasonable basis for our opinion.
7. Although the introductory paragraph referred to an audit of the financial statements for the years ended December 31, 2009 and 2008, an opinion was expressed only on the 2009 financial statements.
8. The statement of cash flows was not identified in the opinion paragraph, and financial statements were not referred to in the opinion paragraph as "consolidated."
9. The explanatory sentence for consistency should follow the opinion paragraph, not precede it. Also, the second sentence in the third paragraph should be omitted.
10. There is no inclusion of the phrase, "in all material respects" in the opinion paragraph.
Chapter 4
4-18 a. (1) b. (3) c. (1)
4-19 a. (1) b. (3) c. (3)
4-21 a. Rule 101 - Independence. No violation. Jose Martinez is not a partner nor is he assigned to the engagement team for the audit client.
b. Rule 201 - General Standards. Violation. Interpretation 201-1 states that a member who accepts a professional engagement implies that he or she has the necessary competence to complete the engagement according to professional standards. Bacon has violated the rule since he does not have the expertise to review the work of the consultant hired by Bacon. Bacon should have suggested that the company hire the consultant directly.
c. Rule 102 - Integrity and Objectivity. Violation. This rule states that in tax practice, a member may resolve doubt in favor of his or her client as long as there is reasonable support for his or her position. In the example case, the client has provided no support for the unusual deductions. Phyllis Allen has violated Rule 102 by not requiring reasonable support for the deductions.
d. Rule 203 (Accounting Principles). Violation. This rule designates that the International Accounting Standards Board (IASB) is the established body for issuing international financial accounting standards. Sally Blanchard’s assertion that the financial statements are based on international financial accounting standards would be in violation of Rule 203 because she did not use standards issued by the IASB.
e. Rules 101 (Independence) and 102 (Integrity and Objectivity). Violation. Appearance of independence has been impaired by Bill Wendal’s agency’s financial dealing with his audit clients and participation in a business, which impairs his objectivity. It is also a conflict of duties to recommend his own firm to review the adequacy of the existing insurance coverage of existing clients
f. Rule 301 - Confidential Client Information. Violation. The client should have been notified that the review was to take place, and an attempt made to obtain the client's permission for such review because the review was not a part of an AICPA, state CPA society or Board of Accountancy review program. The firms violated Rule 301 by not obtaining consent from the client for the review.