Chapter One

Topics: Auditing, Financial audit, Audit Pages: 19 (5480 words) Published: February 5, 2011

The Role of the
Public Accountant in the
American Economy

Review Questions

1-1The “crisis of credibility” largely arose from the number of companies that restated their previously issued financial statements as a result of accounting irregularities and fraud. Especially responsible were the very visible Enron and WorldCom fraud cases. Both companies filed for bankruptcy and constituted the largest companies in American history to do so. The extent of the accounting irregularities and fraud being investigated and disclosed brought into question the effectiveness of financial statement audits. In addition, the criminal conviction of Arthur Andersen, LLP, one of the then Big 5 accounting firms, on charges of destroying documents related to the Enron case brought into question the ethical standards of the profession.

1-2Assurance services are professional services that enhance the quality of information, or its context, for decision-making. The two types are: (a) those that increase the reliability of information and (b) those that involve putting information in a form or context that facilitates decision-making.

1-3A financial statement audit is, by far, the most common type of attest engagement. The overall assertion, made by management, most frequently is that the financial statements follow generally accepted accounting principles.

1-4A large corporation with securities listed on a stock exchange is required by the rules of the stock exchange and by the rules of the Securities and Exchange Commission to provide an audit report with the annual financial statements furnished to its stockholders. It also is required to engage the auditors to provide an opinion on its internal control. Apart from legal requirements, however, a large listed corporation recognizes that it must maintain investor confidence in the reliability of its financial statements and internal control over financial reporting if it is to continue to be able to secure capital from the public. The report by a firm of certified public accountants adds credibility to the financial statements prepared by the corporation. When a small family-owned enterprise elects to have an audit, the purpose usually is to use the auditors' report to support an application for a bank loan.

1-5A report by an independent public accountant concerning the fairness of a company's financial statements is commonly required in the following situations:

(1)Application for a bank loan.
(2)Establishing credit for purchase of merchandise, equipment, or other assets. (3)Reporting operating results, financial position, and cash flows to absentee owners (stockholders or partners). (4)Issuance of securities by a corporation.

(5)Annual financial statements by a corporation with securities listed on a stock exchange or traded over the counter. (6)Sale of an ongoing business.
(7)Termination of a partnership.

1-6To add credibility to financial statements is to increase the likelihood that they have been prepared following the appropriate criteria, usually generally accepted accounting principles. As such, an increase in credibility results in financial statements that can be believed and relied upon by third parties.

1-7Business risk is the risk that the investment will be impaired because a company invested in is unable to meet its financial obligations due to economic conditions or poor management decisions. Information risk is the risk that the information used to assess business risk is not accurate. Auditors can directly reduce information risk, but have only limited effect on business risk.

1-8At the beginning of the century, the principal objective of auditing was the prevention and detection of fraud. Audit work centered on the balance sheet, because the income statement was regarded as highly confidential and not for public disclosure. Today, the principal objective of auditing is to form an opinion on the...
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