1. Do you think that the auditor’s primary responsibility should

1. Do you think that the auditor’s primary responsibility should be to detect deceptive reporting (e.g., earnings manipulation by management)? Yes or no? Discuss in class.

2. What is information risk? List reasons it is important to society to reduce this risk.

3. Name and describe three theories that explain how audits reduce information risk.

The collapse of Enron and other major corporate scandals of the first decade of this century are a prominent milestone, indicating failure of governance, accounting, auditing, and regulation. The aftermath of these scandals continues to influence 21st-century organizations, including accounting standard setters.1 Important new regulators (such as the Public Company Accounting Oversight Board and regulations (arising from the influence of the Sarbanes-Oxley Act [SOX], 2002) have been created to deal with the many grey areas that characterize corporate activities. Consistent with this concern, accounting standard setters have been urged to take stronger account of how accounting standards can provide relevant information yet not be conducive to fraudulent and unethical reporting.2 Rules-based, compliance-based accounting standards seemingly have strong potential to foster misleading reporting in many contexts, including where corporate leadership is dysfunctional and/or criminal. As a consequence, there is an increasing trend to emphasize ethical reporting, which will have a major impact on the audit function and auditors in the future.

In the chapter, we defined auditing as an activity that reduces information risk. This definition follows from the information hypothesis that is used to explain the demand for external audits. Under the information hypothesis, audit services are demanded to reduce the information risk to users of financial statements. Information risk is the risk that user decisions may be based on incorrect information. Thus, using information risk reduction, auditors must reduce losses due to faulty decisions resulting from errors or irregularities in the financial statements. Losses to investors may also arise because of failure by company management to disclose all the facts about a firm. Auditors help assess whether this information asymmetry is alleviated through proper disclosure. Less-accurate information may also deter investment, so auditing may also alleviate underinvestment in the capital markets and result in better resource allocation in the economy.

According to CPA Canada, the objective of an audit of

According to CPA Canada, the objective of an audit of is

a. An expression of opinion on the fairness with which they present financial position, results of operations, and cash flows in conformity with GAAP.

b. An expression of opinion on the fairness with which they present financial position, results of operations, and cash flows in conformity with accounting standards promulgated by the Financial Accounting Standards Board.

c. An expression of opinion on the fairness with which they present financial position, results of operations, and cash flows in conformity with accounting standards promulgated by the CPA Canada Accounting Standards Committee.

d. To obtain systematic and objective evidence about financial assertions and report the results to interested users.

Adrogué and Ratliff46 recommended that courts adopt the hierarchy of

Adrogué and Ratliff46 recommended that courts adopt the “hierarchy of for of non-governmental entities” published by the AICPA.47 This hierarchy has five strata, listed below in descending order of authority:

1. FASB Statements and Interpretations, APB Opinions, and AICPA Accounting Research Bulletins

2. FASB Technical Bulletins, AICPA Industry Audit and Accounting Guides, and AICPA Statements and Practices

3. Consensus positions of the FASB Emerging Issues Task Force and AICPA Practice Bulletins

4. AICPA accounting interpretations, “Questions and Answers” published by the FASB staff, and widely recognized and prevalent industry practices

5. Other accounting literature, including FASB Concept Statements; AICPA Issues Papers;
International Accounting Standards Committee Statements; GASB Statements; Interpretations and Technical Bulletins; pronouncements of other professional associations or regulatory agencies; AICPA Technical Practice Aids; and accounting textbooks, handbooks, and articles. 

The AICPA’s hierarchy ranks the FASB Concept Statements (components of the conceptual framework) in the bottom stratum. However, on April 28, 2005, pursuant to the FASB’s issuance of an exposure draft titled “The Hierarchy of Generally Accepted Accounting Principles” and associated documentation, the FASB48 (p. i) conceded that the place of the conceptual framework in its hierarchy was too low, out of kilter with the IASB, and that the FASB intended to do something about this. Nonetheless, in May 2008, when it issued a revised version of this exposure draft as FASB 162, it observed in its “Summary” preface that FASB 162 was not expected to result in changes in current practice. It is noteworthy that in FASB 162, FASB Concept Statements remain in the bottom stratum of the hierarchy-although it does mention that they should “normally be more influential than other sources” in the (bottom) category in which they appear (para. 5).


Does the above hierarchy result in a fair presentation framework per CAS 200? Discuss.

1. Are auditors providing high assurance when they fail to

1. Are auditors providing high assurance when they fail to disclose going-concern problems for failing companies?

2. What is wrong with the self-fulfilling prophecy argument from the auditor’s perspective?

3. Identify the perspectives possible and the resulting arguments regarding the expensing of stock option compensation.

4. How does the auditor know if the disclosure of going-concern problems is complete; that is, what criteria tell the auditor that the client needs to disclose going-concern problems?

5. What do you think fair presentation should mean, in addition to not being materially misstated from a number? Can you defend your decision to the rest of the class?

The auditor’s unqualified report claims that the “present fairly” in conformity with Canadian . Note that this is a claim the auditor makes and, therefore, he or she is fully responsible for justifying this claim if challenged. Also note that merely citing references to the CPA Canada Handbook may not be sufficient to support such a claim, since the CPA Canada Handbook does not define fairness of presentation but only provides guidance on and generally accepted auditing standards (GAAS).

How do we know then when this claim is justified? As you will see, the text is devoted to the topic of gathering sufficient appropriate evidence to help support this claim. However, you will also need to make use of the that you learned in your accounting courses as part of the justification. Furthermore, you need to consider other issues, such as the role of ethics, and you may need to consider whether the hidden assumptions of accounting theory apply under the circumstances to fully support this claim from a critical thinking perspective. Proper accounting depends on the legal, cultural, and regulatory aspects of the environment that can affect the economics of the auditee. Critical thinking reminds auditors to consider these broader aspects of financial reporting.

You can think of the accounting issues in auditing as consisting of two basic parts: (1) the financial reporting in conformity with and (2) the financial reporting that is fairly presented. Historically, most auditors assumed that if sufficient appropriate evidence showed that the were within a material difference of numbers, then an unqualified opinion was justified. However, as accounting standards become more “principles based” and accounting standard setters put more focus on the meaning of “present fairly,” auditors need to focus on fairness of presentation within . In other words, there is increasing appreciation that not all will result in fair presentation in all circumstances.

Auditors are expected, instead, to make decisions about the proper application of under the circumstances. And if is vague on an issue, the auditor’s critical thinking is further complicated………….

1. Consider the following quality control policy and identify the

1. Consider the following quality control policy and identify the quality control element it relates to: “Designate individuals as specialists to serve as authoritative sources; provide procedures for resolving differences of opinion between audit personnel and specialists.”

2. What is a practice inspection, and what roles does it play in the quality control self-regulation of the profession?

3. Compare the quality inspection reports of the CPAB and PCAOB. Do the public accounting firms in the United States and Canada have similar quality control problems?

4. What is the meaning of quality control as it relates to a public accounting firm?

CPA Canada’s Guide for Developing Quality Control Systems in Public Accounting was a study that proposed detailed guidance based on five key components or areas: clients, personnel, engagement procedures, practice administration, and a quality control review program.

Exhibit 2B-1 illustrates the implementation of a quality control system using the five key components included in CPA Canada’s study. The study proposed that the areas of client relationships (including independence from the clients) and engagement procedures be given top priority when implementing a system in stages. The right-hand columns in Exhibit 2B-1 suggest priority in setting up a firm-wide quality control system. Note in Exhibit 2B-1 that the five areas have each been subdivided into a series of elements that allow firms to better articulate all the different aspects of quality control. While the exhibit framework is not a standard, it indicates where Canadian guidance may be headed. Note that tax and management advisory services could be included in the framework, but the extent to which they should be considered in the quality control system is controversial.
The International Federation of Accountants (IFAC) issued a standard on quality control, ISQC-1. As a result, CPA Canada added to its Handbook the section, “Canadian Standard on Quality Control, CSQC-1 (was CGSF-QC),” for firms performing assurance engagements. This standard is outlined in Exhibit 2B-2.

There are only minor differences between CSQC-1 and the international equivalent ISQC-1.

Firms can use the evolving quality control standards to develop their own policies and procedures, along with the related documentation. When peer or quality reviews are conducted, the reviewers “audit” the public accounting firm’s policies and procedures designed to ensure compliance with the elements of CSQC-1, and perhaps additional criteria. The statements of policy and procedures may vary in length and complexity, depending on the size of the public accounting firm and the regulatory system affecting it.

Auditors’ activities about which of these generally accepted auditing standards

Auditors’ activities about which of these generally accepted auditing standards (GAAS) are not affected by the auditee’s utilization of a computerized accounting system?

a. The shall state whether the are presented in accordance with GAAP.

b. The work is to be adequately planned, and assistants, if any, are to be properly supervised.

c. Sufficient appropriate evidential matter is to be obtained . . . to afford a reasonable basis for an opinion regarding the under audit.

d. The audit is to be performed by a person or persons having adequate technical training and proficiency as an auditor.

It is going to be a long night! First thing

It is going to be a long night! First thing this morning, the senior partner of your three-partner firm, Peters, Peters, and Paul (PPP), called you into her office to tell you that she had a confidential but exciting assignment for you. The firm has been retained to review the audit working papers of another firm in connection with its audit of TVB Software (TVB), a public company. That firm, Yeller, Louder, and Soft (YLS), had performed the audit of TVB for the last two years, since the date it went public. It appears that the bank did not renew TVB’s loan when it matured some six months ago, and TVB was unable to obtain other financing. As a result, your firm’s client lost a good portion of the $2 million he had invested in the shares of TVB. Your client is suing the auditors of TVB, alleging that they failed to perform the audit in accordance with GAAS and that as a result, your client relied on that were not correct when he made his decision to hold on to his TVB shares. The last audited statements are included in Exhibit EP 3A-3-1.

Victoria Smyth, the partner, has reviewed the contents of YLS’s working papers. Her notes are in Exhibit EP 3A-3-2. You have been asked to review these notes and prepare a report identifying any departures from GAAS to support your client’s view that the audit was not conducted in accordance with GAAS. In this regard, you should note whether each instance is a clear departure from GAAS or whether the matter is grey and, therefore, subject to potential challenge in court. Victoria is also concerned that your firm may have some professional responsibilities under the Rules of Professional Conduct in connection with this agreement. She would like you to identify these for her.


Prepare the report requested by Victoria Smyth.



Extracts from Audited Financial Statements


TVB Software

“PRIVILEGED” Victoria Smyth’s notes on the review of audit working papers of TVB Software prepared by Yeller, Louder, & Soft

1. I reviewed YLS’s working papers at their office. The for the year ended December 31, 20X3, was signed by YLS on February 20, 20X4.
The working papers were neat and appeared to be well organized. All of the files have been prepared by audit staff and have been reviewed by a YLS junior audit partner, though not the one who signed the This is the only public company audited by YLS.

I asked to review the files of the previous year but was told that YLS only retains one year of files. The 20X2 files had been destroyed. I reminded YLS that the 20X2 files had now been subpoenaed by the Court.

2. The audit was staffed by two YLS PAs. Neither had performed audits of a software company before, but one of them had several years of auditing experience. The other PA had recently qualified and had spent the previous two years working for a government internal auditor’s department. The audit partner told me that he was not concerned about this other PA because he was related to TVB’s CFO and, hence, had a good knowledge of some of the workings of the company.

3. The audit was fully substantive in nature. All three of YLS’s files contain working papers documenting the results of its substantive testing. Each section of the work contains a checklist of substantive tests. The tests appear to have been developed specifically for this assignment. The steps on the checklists appear to be signed off and cross-referenced to the appropriate working papers.

4. The first file is called the “TOP FILE” and contains several memos to file. The most significant of these are as follows:

(a) Materiality: A short memo sets materiality at $400,000. The memo notes that the company is not currently profitable although it is expected to be in the near future. As a result, it is more appropriate to use balance sheet numbers to determine materiality. Once the company becomes profitable, YLS would expect to use normalized income as a basis for materiality. Thus, 1% of total assets is approximately $400,000.

(b) Plan: A short memo sets out that the audit will be fully substantive against a materiality of $400,000 and follow the approach used in the previous year, including the tailored audit programs developed that year.

(c) Engagement letter, signed by the client.

(d) Legal letters to each of TVB’s lawyers, each with a standard reply.

(e) A standard management representation letter, containing no unusual or tailored paragraphs.

5. Prepaids: As these amounts were not material, YLS only compared this year’s schedule to that of the previous year. There were no unusual items on either of the schedules.

6. Accounts receivable: The audit work in this section included a confirmation of the 15 largest accounts and 10 other accounts selected at random, covering 79% of the population. All but two of the confirmations (totalling $326,000) were received back with no problems noted. In view of the satisfactory result on the other confirmations, no additional procedures were carried out in relation to these two items.

A review was done to identify subsequent payments, and as at the date of the audit opinion, 85% of the receivables had been collected. Of the remaining accounts, none were above $100,000, so no further work was carried out.

Procedures were carried out to ensure that balances outstanding at year-end related to shipments before year-end. These procedures included agreeing amounts to invoices and shipping documents.

7. Inventory: The inventory consisted of software packages, most of which were manufactured by TVB, and some purchased for modification and resale.

YLS attended the inventory count at year-end and reviewed the procedures necessary to achieve a proper cutoff. As a result of these procedures, YLS found cutoff errors that resulted in an overstatement of sales of $182,500. They concluded that as this amount was not material, no adjustment was necessary. They also reviewed the inventory valuation by reviewing the process for allocating costs to specific products. This is a very complex process, and the audit work seems to be detailed and thorough, with much recomputation and testing in the files. They concluded that the allocation methodology was appropriate under the circumstances. They did not identify any errors.

8. Fixed assets: YLS’s work was limited to reviewing the schedule of purchases (there were none above $100,000) and recomputing the depreciation for the year.

9. Goodwill: YLS recomputed the amortization for the year.

10. Bank indebtedness: YLS confirmed the amount of the bank indebtedness and the long-term debt, which is also owing to the bank. The confirmation noted that the debt was up for renewal in June of the following year. 

There is a note in the file that company management was confident that the debt would be renewed for a five-year term. As well, the file contained copies of some internal TVB memoranda, written over a four-month period in 20X3, summarizing management’s meetings with the bank and supporting the view that the debt would likely be renewed. On this basis, YLS concurred with management’s view that the debt should continue to be classified as long-term debt.

11. Accounts payable: The files contained a confirmation of 100% of the accounts payable. All of the replies were in the file and all discrepancies had been followed up. As a result of these procedures, YLS concluded that accounts payable were understated by $232,000 but that as this amount was immaterial, no adjustment was required.

12. Income taxes: Very detailed work was carried out in this section by a tax manager from YLS. The review appears very thorough, and amounts are reconciled down to the penny.

13. Profit and loss: YLS carried out analytical procedures, comparing the current year’s results to those of the previous year on an account-by-account basis. Explanations were obtained from management for all variances over $50,000 or 5% of the previous year’s balance.

14. The file includes a detailed review of all invoices paid to outside consultants, including several other accounting firms, and copies of their reports. One of the assignments relates to a “business review” of TVB carried out at the request of the bank.

The report for that assignment is not in the file.

Current Canadian GAAS through 2015 do not permit the auditor

Current Canadian GAAS through 2015 do not permit the auditor to refer to a going-concern uncertainty in the when the uncertainty is properly disclosed in the financial statement notes.

a. Describe the strengths and weaknesses of this approach, taking into consideration the perspectives of the company, its financial statement users, and its auditor.

b. Identify one or more alternative reporting methods that may be more beneficial to financial statement users.

c. You have been invited to comment to the Canadian assurance standards-setting board on its current audit reporting standards. What comment would you make to the standard setters on the issue of audit reporting when there is substantial doubt about a company’s ability to continue as a going concern?

According to CPA Canada, what is the objective of an

According to CPA Canada, what is the objective of an audit of financial statements?

a. An expression of opinion on the fairness with which they present financial position, results of operations, and cash flows in conformity with GAAP

b. An expression of opinion on the fairness with which they present financial position, results of operations, and cash flows in conformity with FASB

c. An expression of opinion on the fairness with which they present financial position, results of operations, and cash flows in conformity with GAAS

d. To obtain systematic and objective evidence about financial assertions and report the results to interested users

Miller & Bell (M&B) is a medium-size accounting firm that

Miller & Bell (M&B) is a medium-size accounting firm that was recently approached by Mints, a candy company, to take on their yearend audit engagement. The Director of Marketing at Mints, Valerie, suggested M&B since she had heard good things about M&B and her cousin is a staff accountant for M&B. The main partner at M&B has gathered the following information about Mints:

Mints has eight shareholders. Greg, a creative entrepreneur, started Mints in 2001 and owns 51% of the company, while the remaining 49% is split equally between seven shareholders. Most shareholders are passive investors, but Greg is actively involved in the operations of Mints, as he is currently the CFO.

Mints’ candy is very popular in Europe, so a large part of the sales are made in euros. Mints tries to manage the foreign exchange risk by entering into complex cash flow hedges and purchasing forward contracts in euros.

Mints is looking for a new auditor, as they disagreed with their previous auditor about their revenue recognition policy. Mints indicated that their previous auditor was too conservative. Mints has been showing a profit for the past two years, but it did run into some financial difficulties three years ago. Due to the financial difficulties, Mints had to obtain additional financing from the bank. As a result, Mints is subject to additional debt covenants, and the bank requires an audit of its to be performed.

You work as a senior auditor for M&B, and the partner has asked you to prepare a report that discusses what should be considered in M&B’s decision to accept or decline Mints’ audit engagement. Based on the information provided above, prepare a report to the M&B partner as requested, which discusses each element, explains why it is relevant to the decision, and explains whether the element presents a high/moderate/ low risk for accepting the engagement. Use the table below to identify the key elements that should be covered in your report.