Ch.2 Fundamentals

Question 1

Statutory

Answer 1

required by law. Examples include audits of the financial statements of publicly listed companies, as required by securities commissions.

Question 2

Voluntary

Answer 2

Reasons:

• such as obtaining a bank loan
• to show transparency
• written into company by-laws (this is common for not-for-profit organizations).

Question 3

Agency Risk

Answer 3

risk managers are not acting in the best interests of the shareholders
management is reporting results to benefit themselves and not necessarily to provide the best information to shareholders

Question 4

Agency Costs

Answer 4

costs of the audit and the costs incurred in aligning the managers’ and shareholders’ interests such as bonuses based on share price, pay structures, which include company shares, and so on.

Question 5

Information risk and costs

Answer 5

the risk that the financial information presented to shareholders, creditors, is not reliable and that decisions made based on this information may not yield the results expected

Question 6

expectation gaps

Answer 6

• auditors provide reasonable assurance (not 100%)
• understanding of the controls put in place by management (not place them)
• The auditor is responsible for detecting material misstatements in the financial statements due to fraud or error (not catch fraud)
• auditor gives an opinion on financial statements

Question 7

engagement letter

Answer 7

The auditor clarifies their responsibilities with management of the audited company at the start of the engagement by issuing an engagement letter, which specifies the terms of the engagement

Question 8

auditor’s report

Answer 8

his report contains an explanation of the auditor’s responsibilities