Solutions Guide: This is meant as a solutions guide



Solutions Guide:   This is meant as a solutions guide. Please try reworking the questions and reword the answers to essay type parts so as to guarantee that your answer is an original. Do not submit as your own.

1-38) Purposes of an External Audit, LO 1, 2, 4) The Rasmus Company manufactures small gas engines for use on lawnmowers and other power equipment. Most of its manufacturing has historically been in the Midwest, but it has recently opened plants in Asia that account for about 30% of its production. The company’s stock is listed on the New York Stock Exchange. Required a. Explain the rationale and value of an audit of a publicly held company to investors, creditors, and to the broader community as a whole. b. Explain why an audit of internal controls provides value to the investing public. c. Explain the importance of an audit committee to the reliability of the financial statements and the audit function.   

a. The value of the audit to external users, e.g. investors and creditors is the audit provides an informed and unbiased report on the public company’s operations, its internal controls.

b. An audit of internal controls provides value to the public in three ways:

• it informs users of the accountability that management has assumed in fulfilling its stewardship function,

• it provides confidence in the company’s processes to control its information and to provide reliable information on an interim basis, and

• it helps ensure investors that management has reliable information on which to makes its internal decisions.

c. An audit committee is important for the following reasons:

• it provides oversight of the audit function on behalf of shareholders and the board,

• it is charged with the sole authority to engage the external auditor and therefore the auditor is accountable to the audit committee rather than management,

• it helps ensure the independence and integrity of the audit process.

1-40) (Nature of Auditing and the Public Accounting Profession, LO 1, 2, 4, 8). Do you agree or disagree with the following statements? Explain your rationale. a. A primary purpose of an audit is to ensure that all fraud that might be significant to a user is detected and reported. b. There is a not an independence problem in a privately held company when the auditor is to be engaged by the manager because the manager is also the owner. c. Sarbanes-Oxley requires mandatory reporting on internal control for public companies. That requirement should be extended to major charities like the Red Cross. d. The expectations of the auditors of public companies are too high; the expectations simply cannot be met; the public should be better educated on what the auditor does and is capable of doing. e. Consulting by public accounting firms for privately held companies is a value-added proposition and does not impair the independence of the audit; rather, it enhances the effectiveness of the audit because of greater knowledge of the company. f. The PCAOB greatly enhances the reputation of the public accounting profession because it not only sets standards, but also determines whether firms audit according to those standards. g. Fairly presented in accordance to GAAP is not as precise a criterion as one thinks because GAAP allows a wide variety of choices, e.g., FIFO vs. LIFO accelerated vs. straight-line depreciation.

h. The auditor should be forced to state both (a) whether the financ i- Tax consulting preparing the tax return for top management, does not create a conflict of interest with the conduct of the audit.

a. Most users agree with this statement. Therefore the auditing profession has expanded its approaches to provide greater assurance that it will detect material fraud. However, many misstatements that are made in conjunction with an organization's financial statements are not intentional but are simply the result of errors. The audit function is designed to detect material misstatements -- whether they are due to errors or fraud. Thus, the audit function is actually broader than just looking for fraud. Ensuring that a financial statement contains no material misstatements ensures that the auditor addresses the likelihood that material errors and fraud may have occurred.

b. There is an independence problem, in some views, because the primary purpose of the audit is to furnish financial statements to a bank or to another investor in order to raise capital for the firm. Thus, the control of hiring and firing by the management is seen by some as an impairment of the auditor’s independence. However, there is really no one else to do the hiring in such cases.

c. Many people agree with this. The Red Cross owes accountability to its donors beyond that which is conveyed in financial statements. The Red Cross has been criticized for poor internal controls and poor and inefficient operations. Most donors have a vested interest in understanding that their contributions have been used properly.

d. As time as passed, most observers have come to the conclusion that the expectations are not too high. However, they do need some find tuning in relationship to how much users want to pay for an audit.

e. Many practitioners believe this statement is true. However, there should be good class discussion on this issue as it is germane to raise the question as to whether “if it is good for non-public companies, why is it not good for public companies?” There are various answers to this question, and many of them are dependent on the external users of the company’s financial reports.

f. Many believe this statement is true. However, it has taken a while in order for the PCAOB to get up to date on its inspection process. The PCAOB must prove itself in setting standards that encourage and warrant the public trust.

g. GAAP represents rules and conventions that are acceptable at one point in time. Much of the diversity in accounting principles is necessary to reflect real economic differences between organizations and the types of transactions in which the organization is engaged. Beyond this argument, differences such as LIFO / FIFO accounting have evolved over the years. The profession attempts to mitigate the potential problems associated with the diversity by providing disclosure of the differences and by developing other procedures to make it difficult for firms to change accounting principles. Thus, the financial statements of a company should be comparable over a period of time.

h. This is true. Auditors need to provide clear guidance to the board, the audit committee, and to management as to whether they believe the financial statements best portray the economic events of the entity being audited.

i. This should generate good discussion. Most practitioners do not feel this constitutes a problem. However, the PCAOB has provided guidance where auditors of public companies cannot provide such tax services for executive management of their clients.

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