Chapter 01 - The Role of the Public Accountant in the American Economy

Chapter 01
The Role of the Public Accountant in the American Economy

True / False Questions

1. Independent audits of today place more emphasis on sampling than did the audits of the
1
th
century.
True !alse

". The American Institute of Certified Public Accountants issues CPA certificates and permits
CPAs to practice.
True !alse

#. A company is either audited by the $A% or internal auditors& but not both.
True !alse

'. The (EC does not pass on the merits of the securities that are registered )ith the agency.
True !alse

*. The American Institute of Certified Public Accountants has the primary authority to
establish accounting standards.
True !alse

+. An annual peer re,ie) is a re-uirement of the AICPA.
True !alse

.. /any small companies elect to ha,e their financial statements re,ie)ed by a CPA firm&
rather than incur the cost of an audit.
True !alse

1-1
Chapter 01 - The Role of the Public Accountant in the American Economy
0. (taff assistants in CPA firms generally are responsible for planning and coordinating audit
engagements.
True !alse

. The (arbanes-%1ley Act re-uires that auditors of publicly traded companies in the 2nited
(tates perform an integrated audit that includes pro,iding assurance on both the financial
statements and on compliance )ith la)s and regulations.
True !alse

10. Auditing is fre-uently only a small part of the practice of local CPA firms.
True !alse


Multiple Choice Questions

11. A summary of findings rather than assurance is most li3ely to be included in a4n56
A. Agreed-upon procedures report.
7. Compilation report.
C. E1amination report.
8. Re,ie) report.

1". The (tatements on Auditing (tandards ha,e been issued by the6
A. Auditing (tandards 7oard.
7. !inancial Accounting (tandards 7oard.
C. (ecurities and E1change Commission.
8. !ederal 7ureau of In,estigation.

1#. The ris3 associated )ith a company9s sur,i,al and profitability is referred to as6
A. 7usiness Ris3.
7. Information Ris3.
C. 8etection Ris3.
8. Control Ris3.

1-"
Chapter 01 - The Role of the Public Accountant in the American Economy
1'. :istorically& )hich of the follo)ing has the AICPA been most concerned )ith pro,iding;
A. Professional standards for CPAs.
7. Professional guidance for regulating financial mar3ets.
C. (tandards guiding the conduct of internal auditors.
8. (taff support to Congress.

1*. The organi<ation charged )ith protecting in,estors and the public by re-uiring full
disclosure of financial information by companies offering securities to the public is the6
A. Auditing (tandards 7oard.
7. !inancial Accounting (tandards 7oard.
C. $o,ernment Accounting (tandards 7oards.
8. (ecurities and E1change Commission.

1+. An engagement in )hich a CPA firm arranges for a critical re,ie) of its practices by
another CPA firm is referred to as a4n56
A. Peer Re,ie) Engagement.
7. =uality Control Engagement.
C. =uality Assurance Engagement.
8. Attestation Engagement.

1.. The serially-numbered pronouncements issued by the Auditing (tandards 7oard o,er a
period of years are 3no)n as6
A. Auditing (tatements of Position 4A(Ps5.
7. Accounting (eries Releases 4A(Rs5.
C. (tatements on Auditing (tandards 4(A(s5.
8. (tatements on Auditing Principles 4(APs5.

10. The $o,ernment Accountability %ffice 4$A%56
A. Is primarily concerned )ith rapid processing of all accounts payable incurred by the
federal go,ernment.
7. Conducts operational audits and reports the results to Congress.
C. Is a multinational organi<ation of professional accountants.
8. Is primarily concerned )ith budgets and forecasts appro,ed by the (EC.

1-#
Chapter 01 - The Role of the Public Accountant in the American Economy
1. The ris3 that information is misstated is referred to as6
A. Information ris3.
7. Inherent ris3.
C. Relati,e ris3.
8. 7usiness ris3.

"0. The ris3 that a company )ill not be able to meet its obligations )hen they become due is
referred to as6
A. Information ris3.
7. Inherent ris3.
C. Relati,e ris3.
8. 7usiness ris3.

"1. >hich of the follo)ing attributes most clearly differentiates a CPA )ho audits
management9s financial statements as contrasted to management;
A. Integrity.
7. Competence.
C. Independence.
8. ?eeping informed on current professional de,elopments.

"". The attest function6
A. Is an essential part of e,ery engagement by the CPA& )hether performing auditing& ta1
)or3& or other ser,ices.
7. Includes the preparation of a report of the CPA9s findings.
C. Re-uires a consideration of internal control.
8. Re-uires a complete re,ie) of all transactions during the period under e1amination.

"#. Attestation ris3 is limited to a lo) le,el in )hich of the follo)ing engagement4s5;
A. 7oth e1aminations and re,ie)s.
7. E1aminations& but not re,ie)s.
C. Re,ie)s& but not e1aminations.
8. @either e1aminations nor re,ie)s.

1-'
Chapter 01 - The Role of the Public Accountant in the American Economy
"'. >hen compared to an audit performed prior to 100& an audit today6
A. Is more li3ely to include tests of compliance )ith la)s and regulations.
7. Is less li3ely to include consideration of the effecti,eness of internal control.
C. :as ban3 loan officers as the primary financial statement user group.
8. Includes a more detailed e1amination of all indi,idual transactions.

"*. >hich of the follo)ing are issued by the (ecurities and E1change Commission;
A. Accounting Research (tudies.
7. Accounting Trends and Techni-ues.
C. Industry Audit $uides.
8. !inancial Reporting Releases.

"+. >hich of the follo)ing is not correct relating to the (arbanes-%1ley Act;
A. It toughens penalties for corporate fraud.
7. It restricts the types of consulting CPAs may perform for audit clients.
C. It created the Public Company Accounting %,ersight 7oard 4PCA%75 as a replacement for
the !inancial Accounting (tandards 7oard.
8. It eliminates a significant portion of the accounting profession9s system of self-regulation.

".. An operational audit differs in many )ays from an audit of financial statements. >hich of
the follo)ing is the best e1ample of one of these differences;
A. The usual audit of financial statements co,ers the four basic statements& )hereas the
operational audit is usually limited to either the balance sheet or the income statement.
7. The boundaries of an operational audit are often dra)n from an organi<ation chart and are
not limited to a single accounting period.
C. %perational audits do not ordinarily result in the preparation of a report.
8. The operational audit deals )ith pre-ta1 income.

"0. The re,ie) of a company9s financial statements by a CPA firm6
A. Is substantially less in scope of procedures than an audit.
7. Re-uires detailed analysis of the maAor accounts.
C. Is of similar scope as an audit and adds similar credibility to the statements.
8. Culminates in issuance of a report e1pressing the CPA9s opinion as to the fairness of the
statements.

1-*
Chapter 01 - The Role of the Public Accountant in the American Economy
". >hich statement is correct )ith respect to continuing professional education 4CPE5
re-uirements of members of the AICPA;
A. %nly members employed by the AICPA are re-uired to ta3e such courses.
7. %nly members in public practice are re-uired to ta3e such courses.
C. /embers& regardless of )hether they are in public practice& are re-uired to meet such
re-uirements.
8. There is no re-uirement for members to participate in CPE.

#0. The !8IC Impro,ement Act re-uires that management of large financial institutions
engage auditors to attest to assertions by management about the effecti,eness of the
institution9s internal controls o,er
A. Compliance )ith la)s and regulations.
7. !inancial reporting.
C. Effecti,eness of operations.
8. Efficiency of operations.

#1. Passage of the (arbanes-%1ley Act led to the establishment of the6
A. Auditing (tandards 7oard.
7. Accounting Enforcement Releases 7oard.
C. Public Company Accounting %,ersight 7oard.
8. (ecurities and E1change Commission.

#". >hich of the follo)ing professionals has primary responsibility for the performance of an
audit;
A. The managing partner of the firm.
7. The senior assigned to the engagement.
C. The manager assigned to the engagement.
8. The partner in charge of the engagement.

##. >hich of the follo)ing types of ser,ices is generally pro,ided only by CPA firms;
A. Ta1 audits.
7. !inancial statement audits.
C. Compliance audits.
8. %perational audits.

1-+
Chapter 01 - The Role of the Public Accountant in the American Economy
#'. The right to practice as a CPA is gi,en by )hich of the follo)ing organi<ations;
A. (tate 7oards of Accountancy.
7. The AICPA.
C. The (EC.
8. The $eneral Accounting %ffice.

#*. >hich of the follo)ing terms best describes the audit of a ta1payer9s ta1 return by an IR(
auditor;
A. %perational audit.
7. Internal audit.
C. Compliance audit.
8. $o,ernment audit.

#+. In-uiries and analytical procedures ordinarily form the basis for )hich type of
engagement;
A. Agreed-upon procedures.
7. Audit.
C. E1amination.
8. Re,ie).

#.. >hich of the follo)ing best describes the reason )hy independent auditors report on
financial statements;
A. A management fraud may e1ist and it is more li3ely to be detected by independent
auditors.
7. 8ifferent interests may e1ist bet)een the company preparing the statements and the
persons using the statements.
C. A misstatement of account balances may e1ist and is generally corrected as the result of the
independent auditors9 )or3.
8. Poorly designed internal control may be in e1istence.

1-.
Chapter 01 - The Role of the Public Accountant in the American Economy
#0. $o,ernmental auditing often e1tends beyond e1aminations leading to the e1pression of
opinion on the fairness of financial presentation and includes audits of efficiency& economy&
effecti,eness& and also6
A. Accuracy.
7. E,aluation.
C. Compliance.
8. Internal control.

#. %perational auditing is primarily oriented to)ard6
A. !uture impro,ements to accomplish the goals of management.
7. The accuracy of data reflected in management9s financial records.
C. The ,erification that a company9s financial statements are fairly presented.
8. Past protection pro,ided by e1isting internal control.

'0. A typical obAecti,e of an operational audit is for the auditor to6
A. 8etermine )hether the financial statements fairly present the entity9s operations.
7. E,aluate the feasibility of attaining the entity9s operational obAecti,es.
C. /a3e recommendations for impro,ing performance.
8. Report on the entity9s relati,e success in attaining profit ma1imi<ation.

'1. An integrated audit performed under the (arbanes-%1ley Act re-uires that auditors report
on6

A. %ption A
7. %ption 7
C. %ption C
8. %ption 8


1-0
Chapter 01 - The Role of the Public Accountant in the American Economy
Essay Questions

'". The (arbanes-%1ley Act of "00" made significant reforms for public companies and their
auditors.
a. 8escribe the e,ents that led up to the passage of the Act.
b. 8escribe the maAor changes made by the Act.




'#. /any people confuse the responsibilities of the independent auditors and the client9s
management )ith respect to audited financial statements.
a. 8escribe management9s responsibility regarding audited financial statements.
b. 8escribe the independent auditors9 responsibility regarding audited financial statements.
c. E,aluate the follo)ing statement6 BIf the auditors disagree )ith management regarding an
accounting principle used in the financial statements the auditors should e1press their ,ie)s in
the notes to the financial statements.B




''. An in,estor is considering in,esting in one of t)o companies. The companies ha,e ,ery
similar reported financial position and results of operations. :o)e,er& only one of the
companies has its financial statements audited.
a. 8escribe )hat creates the demand for an audit in this situation. Include a discussion of ho)
audited financial statements facilitate this in,estment transaction& and the effect of the audit
on business ris3 and information ris3.
b. Identify the potential conse-uences to the company of not ha,ing its financial statements
audited.




1-
Chapter 01 - The Role of the Public Accountant in the American Economy
Chapter 01 The Role of the Public Accountant in the American Economy
Ans)er ?ey


True / False Questions

1. Independent audits of today place more emphasis on sampling than did the audits of the
1
th
century.
TRUE

Difficulty: Medium

". The American Institute of Certified Public Accountants issues CPA certificates and permits
CPAs to practice.
FA!E

Difficulty: Medium

#. A company is either audited by the $A% or internal auditors& but not both.
FA!E

Difficulty: Easy

'. The (EC does not pass on the merits of the securities that are registered )ith the agency.
TRUE

Difficulty: Medium

1-10
Chapter 01 - The Role of the Public Accountant in the American Economy
*. The American Institute of Certified Public Accountants has the primary authority to
establish accounting standards.
FA!E

Difficulty: Easy

+. An annual peer re,ie) is a re-uirement of the AICPA.
FA!E

Difficulty: Medium

.. /any small companies elect to ha,e their financial statements re,ie)ed by a CPA firm&
rather than incur the cost of an audit.
TRUE

Difficulty: Easy

0. (taff assistants in CPA firms generally are responsible for planning and coordinating audit
engagements.
FA!E

Difficulty: Easy

. The (arbanes-%1ley Act re-uires that auditors of publicly traded companies in the 2nited
(tates perform an integrated audit that includes pro,iding assurance on both the financial
statements and on compliance )ith la)s and regulations.
FA!E

Difficulty: Medium

1-11
Chapter 01 - The Role of the Public Accountant in the American Economy
10. Auditing is fre-uently only a small part of the practice of local CPA firms.
TRUE

Difficulty: Medium


Multiple Choice Questions

11. A summary of findings rather than assurance is most li3ely to be included in a4n56
A" Agreed-upon procedures report.
7. Compilation report.
C. E1amination report.
8. Re,ie) report.

Difficulty: Medium

1". The (tatements on Auditing (tandards ha,e been issued by the6
A" Auditing (tandards 7oard.
7. !inancial Accounting (tandards 7oard.
C. (ecurities and E1change Commission.
8. !ederal 7ureau of In,estigation.

Difficulty: Easy

1#. The ris3 associated )ith a company9s sur,i,al and profitability is referred to as6
A" 7usiness Ris3.
7. Information Ris3.
C. 8etection Ris3.
8. Control Ris3.

Difficulty: Easy

1-1"
Chapter 01 - The Role of the Public Accountant in the American Economy
1'. :istorically& )hich of the follo)ing has the AICPA been most concerned )ith pro,iding;
A" Professional standards for CPAs.
7. Professional guidance for regulating financial mar3ets.
C. (tandards guiding the conduct of internal auditors.
8. (taff support to Congress.

Difficulty: Medium

1*. The organi<ation charged )ith protecting in,estors and the public by re-uiring full
disclosure of financial information by companies offering securities to the public is the6
A. Auditing (tandards 7oard.
7. !inancial Accounting (tandards 7oard.
C. $o,ernment Accounting (tandards 7oards.
#" (ecurities and E1change Commission.

Difficulty: Medium

1+. An engagement in )hich a CPA firm arranges for a critical re,ie) of its practices by
another CPA firm is referred to as a4n56
A" Peer Re,ie) Engagement.
7. =uality Control Engagement.
C. =uality Assurance Engagement.
8. Attestation Engagement.

Difficulty: Easy

1.. The serially-numbered pronouncements issued by the Auditing (tandards 7oard o,er a
period of years are 3no)n as6
A. Auditing (tatements of Position 4A(Ps5.
7. Accounting (eries Releases 4A(Rs5.
C" (tatements on Auditing (tandards 4(A(s5.
8. (tatements on Auditing Principles 4(APs5.

Difficulty: Easy

1-1#
Chapter 01 - The Role of the Public Accountant in the American Economy
10. The $o,ernment Accountability %ffice 4$A%56
A. Is primarily concerned )ith rapid processing of all accounts payable incurred by the
federal go,ernment.
$" Conducts operational audits and reports the results to Congress.
C. Is a multinational organi<ation of professional accountants.
8. Is primarily concerned )ith budgets and forecasts appro,ed by the (EC.

Difficulty: Easy

1. The ris3 that information is misstated is referred to as6
A" Information ris3.
7. Inherent ris3.
C. Relati,e ris3.
8. 7usiness ris3.

Difficulty: Easy

"0. The ris3 that a company )ill not be able to meet its obligations )hen they become due is
referred to as6
A. Information ris3.
7. Inherent ris3.
C. Relati,e ris3.
#" 7usiness ris3.

Difficulty: Easy

"1. >hich of the follo)ing attributes most clearly differentiates a CPA )ho audits
management9s financial statements as contrasted to management;
A. Integrity.
7. Competence.
C" Independence.
8. ?eeping informed on current professional de,elopments.

Difficulty: Easy

1-1'
Chapter 01 - The Role of the Public Accountant in the American Economy
"". The attest function6
A. Is an essential part of e,ery engagement by the CPA& )hether performing auditing& ta1
)or3& or other ser,ices.
$" Includes the preparation of a report of the CPA9s findings.
C. Re-uires a consideration of internal control.
8. Re-uires a complete re,ie) of all transactions during the period under e1amination.

Difficulty: Medium

"#. Attestation ris3 is limited to a lo) le,el in )hich of the follo)ing engagement4s5;
A. 7oth e1aminations and re,ie)s.
$" E1aminations& but not re,ie)s.
C. Re,ie)s& but not e1aminations.
8. @either e1aminations nor re,ie)s.

Difficulty: Easy

"'. >hen compared to an audit performed prior to 100& an audit today6
A" Is more li3ely to include tests of compliance )ith la)s and regulations.
7. Is less li3ely to include consideration of the effecti,eness of internal control.
C. :as ban3 loan officers as the primary financial statement user group.
8. Includes a more detailed e1amination of all indi,idual transactions.

Difficulty: Medium

"*. >hich of the follo)ing are issued by the (ecurities and E1change Commission;
A. Accounting Research (tudies.
7. Accounting Trends and Techni-ues.
C. Industry Audit $uides.
#" !inancial Reporting Releases.

Difficulty: Medium

1-1*
Chapter 01 - The Role of the Public Accountant in the American Economy
"+. >hich of the follo)ing is not correct relating to the (arbanes-%1ley Act;
A. It toughens penalties for corporate fraud.
7. It restricts the types of consulting CPAs may perform for audit clients.
C" It created the Public Company Accounting %,ersight 7oard 4PCA%75 as a replacement for
the !inancial Accounting (tandards 7oard.
8. It eliminates a significant portion of the accounting profession9s system of self-regulation.

Difficulty: Medium

".. An operational audit differs in many )ays from an audit of financial statements. >hich of
the follo)ing is the best e1ample of one of these differences;
A. The usual audit of financial statements co,ers the four basic statements& )hereas the
operational audit is usually limited to either the balance sheet or the income statement.
$" The boundaries of an operational audit are often dra)n from an organi<ation chart and are
not limited to a single accounting period.
C. %perational audits do not ordinarily result in the preparation of a report.
8. The operational audit deals )ith pre-ta1 income.

Difficulty: Medium

"0. The re,ie) of a company9s financial statements by a CPA firm6
A" Is substantially less in scope of procedures than an audit.
7. Re-uires detailed analysis of the maAor accounts.
C. Is of similar scope as an audit and adds similar credibility to the statements.
8. Culminates in issuance of a report e1pressing the CPA9s opinion as to the fairness of the
statements.

Difficulty: Easy

1-1+
Chapter 01 - The Role of the Public Accountant in the American Economy
". >hich statement is correct )ith respect to continuing professional education 4CPE5
re-uirements of members of the AICPA;
A. %nly members employed by the AICPA are re-uired to ta3e such courses.
7. %nly members in public practice are re-uired to ta3e such courses.
C" /embers& regardless of )hether they are in public practice& are re-uired to meet such
re-uirements.
8. There is no re-uirement for members to participate in CPE.

Difficulty: Medium

#0. The !8IC Impro,ement Act re-uires that management of large financial institutions
engage auditors to attest to assertions by management about the effecti,eness of the
institution9s internal controls o,er
A. Compliance )ith la)s and regulations.
$" !inancial reporting.
C. Effecti,eness of operations.
8. Efficiency of operations.

Difficulty: Medium

#1. Passage of the (arbanes-%1ley Act led to the establishment of the6
A. Auditing (tandards 7oard.
7. Accounting Enforcement Releases 7oard.
C" Public Company Accounting %,ersight 7oard.
8. (ecurities and E1change Commission.

Difficulty: Medium

#". >hich of the follo)ing professionals has primary responsibility for the performance of an
audit;
A. The managing partner of the firm.
7. The senior assigned to the engagement.
C. The manager assigned to the engagement.
#" The partner in charge of the engagement.

Difficulty: Medium

1-1.
Chapter 01 - The Role of the Public Accountant in the American Economy
##. >hich of the follo)ing types of ser,ices is generally pro,ided only by CPA firms;
A. Ta1 audits.
$" !inancial statement audits.
C. Compliance audits.
8. %perational audits.

Difficulty: Medium

#'. The right to practice as a CPA is gi,en by )hich of the follo)ing organi<ations;
A" (tate 7oards of Accountancy.
7. The AICPA.
C. The (EC.
8. The $eneral Accounting %ffice.

Difficulty: Medium

#*. >hich of the follo)ing terms best describes the audit of a ta1payer9s ta1 return by an IR(
auditor;
A. %perational audit.
7. Internal audit.
C" Compliance audit.
8. $o,ernment audit.

Difficulty: Medium

#+. In-uiries and analytical procedures ordinarily form the basis for )hich type of
engagement;
A. Agreed-upon procedures.
7. Audit.
C. E1amination.
#" Re,ie).

Difficulty: Easy

1-10
Chapter 01 - The Role of the Public Accountant in the American Economy
#.. >hich of the follo)ing best describes the reason )hy independent auditors report on
financial statements;
A. A management fraud may e1ist and it is more li3ely to be detected by independent
auditors.
$" 8ifferent interests may e1ist bet)een the company preparing the statements and the
persons using the statements.
C. A misstatement of account balances may e1ist and is generally corrected as the result of the
independent auditors9 )or3.
8. Poorly designed internal control may be in e1istence.

Difficulty: Medium
Source: AICPA

#0. $o,ernmental auditing often e1tends beyond e1aminations leading to the e1pression of
opinion on the fairness of financial presentation and includes audits of efficiency& economy&
effecti,eness& and also6
A. Accuracy.
7. E,aluation.
C" Compliance.
8. Internal control.

Difficulty: Hard
Source: AICPA

#. %perational auditing is primarily oriented to)ard6
A" !uture impro,ements to accomplish the goals of management.
7. The accuracy of data reflected in management9s financial records.
C. The ,erification that a company9s financial statements are fairly presented.
8. Past protection pro,ided by e1isting internal control.

Difficulty: Hard
Source: AICPA

1-1
Chapter 01 - The Role of the Public Accountant in the American Economy
'0. A typical obAecti,e of an operational audit is for the auditor to6
A. 8etermine )hether the financial statements fairly present the entity9s operations.
7. E,aluate the feasibility of attaining the entity9s operational obAecti,es.
C" /a3e recommendations for impro,ing performance.
8. Report on the entity9s relati,e success in attaining profit ma1imi<ation.

Difficulty: Hard
Source: AICPA

'1. An integrated audit performed under the (arbanes-%1ley Act re-uires that auditors report
on6

A" %ption A
7. %ption 7
C. %ption C
8. %ption 8

Difficulty: Medium


1-"0
Chapter 01 - The Role of the Public Accountant in the American Economy
Essay Questions

'". The (arbanes-%1ley Act of "00" made significant reforms for public companies and their
auditors.
a. 8escribe the e,ents that led up to the passage of the Act.
b. 8escribe the maAor changes made by the Act.
a. The e,ents leading up to the passage of the (arbanes-%1ley Act include6
A large number of misstatements of financial statements& many of )hich resulted from
fraudulent financial reporting. @otably including >orldCom and Enron.
The con,iction of the 7ig * accounting firm of Arthur Andersen on charges of destroying
e,idence.
b. The maAor reforms made the Act include6
Tougher penalties for fraud.
Restrictions on the types of consulting ser,ices that may be pro,ided by auditors to their
public audit clients.
The creation of the Public Company Accounting %,ersight 7oard to create auditing
standards and o,ersee accounting firms that audit public companies.
Re-uirements for management to ma3e a assertion about the effecti,eness of internal
control.
Re-uirements for auditors of public companies to audit and report on internal control.

Difficulty: Hard

'#. /any people confuse the responsibilities of the independent auditors and the client9s
management )ith respect to audited financial statements.
a. 8escribe management9s responsibility regarding audited financial statements.
b. 8escribe the independent auditors9 responsibility regarding audited financial statements.
c. E,aluate the follo)ing statement6 BIf the auditors disagree )ith management regarding an
accounting principle used in the financial statements the auditors should e1press their ,ie)s in
the notes to the financial statements.B
a. /anagement has primary responsibility for the fairness of the financial statements.
b. The auditors are responsible for performing an independent audit of the financial
statements and issuing a report on them in accordance )ith generally accepted auditing
standards.
c. The statement if false. The notes to the financial statements should contain only
representations of management. The auditors should e1press their reser,ations in their report.

Difficulty: Medium

1-"1
Chapter 01 - The Role of the Public Accountant in the American Economy
''. An in,estor is considering in,esting in one of t)o companies. The companies ha,e ,ery
similar reported financial position and results of operations. :o)e,er& only one of the
companies has its financial statements audited.
a. 8escribe )hat creates the demand for an audit in this situation. Include a discussion of ho)
audited financial statements facilitate this in,estment transaction& and the effect of the audit
on business ris3 and information ris3.
b. Identify the potential conse-uences to the company of not ha,ing its financial statements
audited.
a. Audits add credibility to the financial statements of the company. The indi,idual can in,est
in the company 3no)ing that there is a lo) probability that the financial statements depart
materially from generally accepted accounting principles. Audited financial statements
facilitate this transaction by reducing ris3 related to the in,estment. (pecifically& audits reduce
information ris3--the ris3 that information used to ma3e the in,estment decision is misstated--
related to the financial statements. Audited financial statements do not directly affect business
ris3& )hich is the ris3 that the company )ill not be able to meet its financial obligations.
b. The potential conse-uences of not ha,ing an audit are6
If the in,estor is particularly ris3 a,erse& he or she may not in,est in the company at all.
If the in,estor decides to in,est in the company& he or she )ill not be )illing to pay as high
a price because the in,estor )ill )ant to be compensated for the additional ris3 that is
in,ol,ed in relying upon unaudited financial statements.

Difficulty: Medium

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