Homework Questions
1) Answer the following questions based on this scenario.
You happen to be in New York City and have run across a person (person A) who would like to purchase an expensive widget from you. However, your friend (person B), who lives in Baltimore, also has expressed a strong interest in purchasing the widget. Person A has the cash on them to pay for the widget but you would prefer to sell the widget to your friend, B. You call B on her cell phone and she says she has the cash to pay for the widget as well. While you trust B, you would like to avoid the risk of driving all the way back to Baltimore and finding out that she really didn't have the cash on hand. So, you call another friend of yours, person C, and tell them you will buy them lunch if they will contact B; verify that she has the necessary cash to buy the widget; and call you right back. C is a very old friend of yours and you trust them implicitly. However, if C were to tell you that B has the cash and you find out later that she doesn't, you would reconsider your friendship with C.
a) Using the concept of information risk and its components, discuss why you decide to hire C?
b) What steps would you expect C to take to verify that B has the necessary cash and why? For this question, I would like you to be sensitive to scenario and what evidence C could reasonably be expected to gather under the circumstances.
c) Characterize C's activities. Do they represent an audit, an assurance engagement, or an attest engagement and why?
d) There are three roles involved in any financial statement audit - investor or potential investor, firm, and auditor. Which role does each person in the scenario most closely represent and how do the relationships between these roles differ from how these roles are related in a typical financial statement audit? Explain your answer.
2) Briefly list the sources of quality control in auditing firms, both internal and external, and express an opinion on whether you think they are adequate to protect investors in today' capital markets. When describing the sources of quality control, provide a brief explanation of how they work, i.e., how they improve quality. This is a broad question. Internal quality control refers to what audit firms do internal to control the quality of their audits. External quality control refers all the mechanisms that exist in the audit environment to include the client's mechanisms, government regulation of auditing, professional standards, and legal liability.
3) Read the following mini-case. Identify all of the violations of the ten generally accepted auditing standards described in the text (Table 2.3). Be clear on what action violated which standard and why. Note that there may be more than one violation of each of the ten standards and you are to cover all the violations you can find.
John Smith owns a small, privately held firm. He hired you to audit its financial statements. He told you that the audit was to be completed in time to submit audited financial statements to a bank as part of a loan application. You immediately accepted the engagement and agreed to provide an auditor's report within three weeks. John agreed to pay you a fixed fee plus a bonus if the loan was granted. You hired two accounting students to conduct the audit and spent several hours telling them exactly what to do. You told the students not to spend time reviewing John's internal controls but instead to concentrate on proving the mathematical accuracy of the ledger accounts and on summarizing the data in the accounting records that support John's financial statements. The students followed your instructions and, after two weeks, gave you the financial statements, which did not include footnotes. You studied the statements and prepared an unqualified auditor's report. The report, however, did not refer to generally accepted accounting principles or to the fact that John had changed to the accounting standard for capitalized interest.
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Standard Violated
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Explanation of the Violation
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