Multiple Choice Questions
Review and Short Case Questions
The objective of external auditing is to provide opinions on the reliability of the financial statements and, as part of an integrated audit, provide opinions on internal control effectiveness. The value of the external auditing profession is affirmed when the public has confidence in its objectivity and the accuracy of its opinions. The capital markets depend on accurate, reliable, and objective (neutral) data that portray the economic nature of an entity’s business and in turn provide a base to judge current progress toward long-term objectives. If the market does not receive reliable data, investors lose confidence in the system, make poor decisions, and may lose a great deal of money; ultimately, the system may fail. By providing an independent audit opinion, the capital markets can be assured that the financial data that they are basing their decisions upon are accurate.
The special function performed by the external auditing profession is the attestation to the fairness of the financial statements of clients. The special function helps ensure the reliability and integrity of the financial reporting system. The auditing profession exists to serve the users of an organization's financial statements. These include lenders, investors, management, government, and (indirectly) all individuals who are ultimately affected by the integrity of the financial reporting process. Auditors need to remember that they are serving the public interest and not the interests of client management.
Audit services are needed because there is a:
Potential bias in providing information.
Remoteness between a user and the organization or trading partner.
Complexity in the transaction, information, or processing systems such that it is difficult to determine their proper presentation without a review by an independent expert.
Need to limit negative consequences that arise from relying on inaccurate information.
The audit enhances the quality of financial statements because the user has the assurance that an independent, qualified professional has examined the financial statements and has rendered an opinion on their fairness. The independence and expertise of the auditor serve as a quality control function to overcome the potential bias of management in presenting the financial statements in a manner that most flatters an assessment of their performance. The audit is designed to add credibility to the financial statements.
An audit does not necessarily guarantee a fair presentation of a company's financial statements, although it does dramatically increase the likelihood that there are no material misstatements in the company's financial statements. The audit provides reasonable, not absolute, assurance about the accuracy of the financial statements. The caveats about fairness exist for two reasons:
Fairness is judged within a framework of GAAP. Some question whether GAAP results in the fairest possible presentations when there are significant changes in market values of investments or assets. For example, the SEC has encouraged financial institutions to move from using historical cost required by GAAP to market values for all investments in securities because it believes that market value presents a better picture of economic reality than does historical cost.
Although designed to detect material fraud, it might be possible that a well-executed audit may still fail to detect fraud.
Independence means objectivity and freedom from bias. The auditor can favor neither the client nor the third party in evaluating the fairness of the financial statements. The auditor must be independent in