HW#1 – Chapter 1

Tanvir T Rahman

Q.7. Define Audit Risk and Materiality. How are these concepts reflected in the auditor’s report?

Ans. Audit risk is basically the risk that an auditor takes while innocently failing to discover the
faults, which are acknowledged in the financial statement.

Information is material if omitting it or misstating it could influence decisions that users make
on the basis of the financial information of a specific reporting entity.

The concept of audit risk in the auditor’s standard report states that the auditor provides only
reasonable assurance that the financial statements do not contain material misstatements. The
term ‘reasonable assurance’ implies that there is some risk that a material misstatement could be
present in the financial statements, and the auditor will fail to detect it.

The concept of materiality in the auditor’s standard report states that the audit report includes the
phrase ‘the financial statements present fairly in all respect’. This is the manner in which the
auditor communicates the notion of materiality to the users of the auditor’s report.

Q.21. Which of the following statements best describes what is meant by an unqualified audit
opinion?

= d. Issuance of a standard unqualified auditor’s report indicates that in the auditor’s opinion the
client’s financial statements are fairly presented in accordance with agreed-upon criteria, with no
need for the inclusion of qualifying phrases.

Q.26. John Josephs, an audit manager for Tip, Acanoe & Tylerto, was asked to speak at a dinner
meeting of the local Small Business Administration Association. The presi-dent of the
association has suggested that he talk about the various phases of the audit process to help small
business owners better understand what auditors do. John has asked you, his trusted assistant, to
prepare an outline for his speech. He suggests that you answer the following:

a. List and briefly describe the various phases of an audit.

b. Describe how audit procedures involving tests of controls can provide indirect evidence about
whether financial statement account balances are free of material misstatement.
c. One of the phases involves understanding an entity’s internal control. Why might the
members of the association be particularly interested in the work conducted by auditors in this
phase of the audit?

Ans.
a. Phases of an audit

1. Client Acceptance/Continuance: Professional standards require that public accounting

firms establish policies and procedures for deciding whether to accept new clients and
to retain current clients.
 2. Preliminary Engagement Activities: There are generally three preliminary
engagement activities: (1) determine the audit engagement team requirements; (2)
ensure the independence of the audit firm and audit team; and (3) establish an
understanding with the client regarding the services to be performed and the other
terms of the engagement.

3. Plan the Audit: Proper planning is important to ensure that the audit is conducted in
an effective and efficient manner. In order to plan the audit properly, the audit team
must make a preliminary assessment of the client’s business risks and determine
materiality. Audit planning should take into account the auditor’s understanding of
the entity’s internal control system.

4. Consider and Audit Internal Control: A company’s system of internal control is put in
place by the company’s board of directors and management to help the company
achieve reliable financial reporting, effective and efficient operations, and consistent
compliance with applicable laws and regulations. The quality of a company’s internal
control over financial reporting is of direct relevance to auditors.

5. Audit business processes and related accounts: The auditor verifies properly the
operational activities of the client’s business. The interpretation of the operational
activities made during the verification helps the auditor to assess the risk of material
misstatement.

6. Complete the audit: At this phase, the audit evaluates the evidence gathered related to
the assertions of the financial statements stated by the client. The auditor must
oversee that the evidences are sufficient to draw the final conclusion on the true state
of financial statements.

7. Evaluate results and issue audit report: This is the final phase of an audit where the
auditor evaluates the results and issues an audit report. The auditor justifies his/her
opinion on the findings made while reviewing the financial statements. If the auditor
detects any uncorrected misstatements, and it affects the financial statements, then he
can request the client to rectify the misstatements.

b. While designing the audit procedures to examine a particular assertion, the evidence
assessed by the auditor maybe relevant to other assertions. Thus, the single evidence can
be simultaneously used for many related assertions. For instance, if an auditor finds
evidence regarding the client’s inventory account, this evidence can be used by the
auditor to judge the fairness of the client’s assertion made about the accounts receivable
and account payable at the end of the financial year.

c. In the internal control phase of the audit, the auditor plans the nature and scope of the
audit. While reviewing the internal control system, he/she finds certain lacunas and
drawbacks of the management. He/she communicates his findings and suggest measures
to rectify and modify the internal control system. The audit of the internal control system
creates consciousness in the minds of the existing employees that their work would be
 examined. When the employees become aware of their work to be audited, they become
efficient and do not commit any error or fraud. This phase acts as preventive measure
against any fraud or manipulation. Therefore, the members of the association are
particularly interested in the work conducted by auditors in order to easily track the area
of misstatement and the company’s weaknesses.

Q.28. Using the audit report included in Chapter 1, identify and briefly explain the phrases or
words that indicate to the users that the financial statements are not necessarily an “exact”
representation of the results of operations and financial position of a company

Ans. Scope paragraph:

  "These standards require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement." The use of the
term reasonable assurance indicates that there is no guarantee that the financial statements
are correct, only reasonable assurance. Also, the statement that the financials are "free of
material misstatement" indicates that the financials may have some error that is not
material.
"An audit also includes assessing the accounting principles used and significant estimates
made..." The explanation that management uses estimates indicates that some of the figures
in the financial statements are not exact.
"We believe that our audits provide a reasonable basis for our opinion." This statement
indicates that the audit is not a "proof" that the financial statements are exact, only that
there is reasonable evidence about their accuracy.

Opinion paragraph:
 "...the consolidated financial statements referred to above present fairly, in all material
respects..." This sentence indicates that the financial statements are a "fair", not exact,
representation. Also, the idea of materiality is revisited here, indicating that there may still
be immaterial errors in the financial statements.