ACCT460

Principles of Auditing
Assignment 1
Question 1: 4-16 Page 87
The risks of independence of the EA LLC team are as follows:

Tony Kolwalshy, Partner

Relevant Information:

 friends with client’s CEO,

 was employed by the client,
 was the client’s Vice President of Finance 1.5 years ago.

Mr. Kowalsky’s friendship with the CEO exposes him to familiarity threat. As well, having worked for the
client as their Vice President of Finance means that Mr. Kowalsky would likely have to audit his own
work, exposing him to self review threat.

Patrick Sholer, Senior Manager

Relevant Information:

 has purchased and used client’s products.

Mr. Sholer does not have a risk of independence.

Chris Washolc, Manager

Relevant Information:

 was employed by the client,

 was the client’s internal auditor 2 years ago,
 reviewed the internal controls while being employed by the client.

Mr. Washolc’s previous experience as the client’s internal auditor and responsibility of reviewing
internal controls only 2 years ago would result in both a risk of familiarity and self review.
Sam Rivers, Audit Senior

Relevant Information:

 owns shares of the client.

Mr. Rivers is exposed to the threat of self interest, as a positive audit and further success of the client
would benefit him.

Yolanda Ladna, Audit Junior

Relevant Information:

 is on a recreational sports team with client’s employees.

Ms. Ladna does not pose a threat of independence.

Anna Madra, Audit Junior

Relevant Information:

 father is employed as Vice President of Finance by client’s parent company

Ms. Madra is exposed to the threat of self interest as a positive audit and further success of the client
would benefit her family.

In conclusion, EA LLC should not accept the audit proposed by Zaspa. There is a high threat to
independence on many levels within the auditor’s firm.

Question 2: 5-22 page 124

The textbook states that management is responsible for “adopting sound and appropriate financial
reporting standards and accounting policies, maintaining internal controls, and making fair
representations on financial statements (p.96)”. These are derived from the fact that management has
an intimate, day-to-day knowledge of a company’s operation, while an auditor’s knowledge is limited to
the information obtained during the Client Risk Assessment stage of the Risk Assessment Phase of the
audit – the stage in which the auditor investigates and becomes familiar with the client’s industry,
environment, and the client itself. The auditor is then responsible for evaluating the selected accounting
framework to determine if it is acceptable or of a change is necessary. The auditor must also assess
financial statements and their footnotes, offering suggestions and providing an opinion as needed.

Overall, the main objectives of the audit as outlined in the textbook are:
 1. To obtain reasonable assurance about whether the financial statements are free from
misstatement (error or fraud) and issue an opinion on whether they are prepared in accordance
with the selected accounting framework, and;
2. To report on the financial statements, and communicate as required by CAS, in accordance with
the auditor’s findings.

Taking a closer look at those objectives, we see that auditors are not responsible for detecting every
misstatement – only those that are material (that is, misstatements that would change the opinions of
those who use the statements) or are immaterial but cumulatively material. We also see that the
auditor is responsible for providing reasonable assurance, not absolute assurance, that the financial
statements are free of material misstatements. Auditors cannot perform tests of control or substantive
tests on every account or transaction, but they should test a sample of a population to detect potential
for misstatements. Estimates of accounts should also be tested. Management’s more in depth
knowledge can be drawn on here to assist in identifying key areas of business to test, however the
auditor should approach this with an attitude of professional skepticism. As well, the auditor is
responsible for detecting material misstatements that exist due to noncompliance with laws a
regulations. The auditor’s final responsibility is to issue the audit report.

In summary, management is responsible for:

 selecting accounting framework,

 implementing and maintaining internal controls, and
 making fair representations on financial statements

while the auditor is responsible for:

 evaluating accounting framework,

 obtaining reasonable assurance that financial statements are free of material misstatements,
 testing internal controls, and
 creating the audit report.

Question 3: 19-26 p. 598

A. Adverse

The financial statements failed to disclose the essential information about the fire. The loss is material as
the damages are noted to be heavy but will not be covered by insurance. The financial statements
should not be relied upon and the misstatement is therefore pervasive. A material misstatement that is
pervasive requires an adverse report.

B. Unqualified – Explanatory

There financial statements were fairly reported and there were no material misstatements, so the
report should be unqualified. However an explanatory paragraph should be included indicating that an
alternative method was used to determine the accuracy of deposits in transit.
C. Qualified – Material Misstatement

An inappropriate estimate had been used to value inventory, and the resulting revaluation created a
material misstatement of current assets. However since the misstatement was not material to total
assets or net income, the misstatement was not pervasive and the financial statements can still be used
in some aspect. A material misstatement that is not pervasive requires a qualified report.

D. Unqualified – Explanatory

While the misstatement is not material ad the financial statements are fair, E Lotions is not following an
accounting policy – that is, the policy stating that sales should be recognized when they are realized.
This should be disclosed in the auditor’s report in an explanatory paragraph.

(Not sure about this one – it is a bit tricky as it feels like it should be qualified report based on the fact
that an accounting policy has been broken, but the questions specifically indicates that the
misstatement is immaterial and it must be material in order for a qualified report to be issued)

E. Disclaimer

The auditor is unable to obtain sufficient evidence, meaning that the scope has been limited. Without
knowing what misstatements may be present, it is impossible to determine materiality or pervasiveness.
Thus, a disclaimer report should be issued.

F. Unqualified

The limitation of scope has been removed and the auditor can proceed with an unqualified report.