Before You Go On Solutions

Chapter 1
Introduction and Overview of Audit and Assurance
1.1 Who are the three parties involved in an assurance engagement? The three parties are:
the practitioner, intended users, and the responsible party. The practitioner, such as a financial
statement auditor, is engaged to issue a written conclusion on a subject matter for which a
responsible party is accountable to intended users. Intended users are the people for whom the
assurance provider prepares the report (for example, the shareholders). The responsible party
is the person or organization (for example, the company) responsible for the preparation of the
subject matter (for example, the financial statements).

1.2 What might an assurance provider express a conclusion about? An assurance provider
might express an opinion on the financial statements of a company.

1.3 What is an assurance engagement? An assurance engagement is an engagement where

a practitioner, such as a financial statement auditor, is engaged to issue a written conclusion on
a subject matter for which a responsible party is accountable to intended users.

2.1 Who are the main users of company financial statements? Financial statement users
include current and potential investors (shareholders if the entity is a company), suppliers,
customers, lenders, employees, governments, and the general public. Each of these groups will
read the financial statements for a slightly different reason. Investors are asking if they should
buy, sell or hold their investment, suppliers want to know if they will be paid for goods or
services provided, lenders want to know if they will be repaid, customers are looking to
determine if the entity will continue to be a going concern, employees want to know if they will
continue to be employed, and the government wants to ensure that a fair share of tax being
paid.

2.2 Why might financial statement users demand an audit? The primary reason users
demand an audit is to reduce information risk which is the risk that users will rely on incorrect
information to make a decision.

2.3 What are the three most common theories used to explain the origins of the demand
for audit and assurance services? The three common theories are agency theory, the
information hypothesis, and the insurance hypothesis. Agency theory tells us that, due to the
remoteness of the owners from the entity, the complexity of items included in the financial
statements, and competing incentives between the owners and managers, the owners
(principals) have an incentive to hire an auditor (incur a monitoring cost) to assess the fair
presentation of the information contained in the financial statements prepared by their managers
(agents). The information hypothesis tells us that, due to the demand for reliable, high-quality
information, various user groups, including shareholders, banks, and other lenders, will demand
that financial statements be audited to aid their decision-making. The insurance hypothesis tells
us that investors will demand that financial statements be audited as a way of insuring against
some of their loss should their investment fail.

© 2021 John Wiley and Sons, Auditing, 4e

3.1 What are the three elements of a performance audit? Performance audits are concerned
with the economy, efficiency, and effectiveness of an organization’s activities. Economy refers
to the cost of inputs, including wages and materials. Efficiency refers to the relationship between
inputs and outputs; specifically, the use of the minimum amount of inputs to achieve a given
output. Effectiveness refers to the achievement of certain goals or the production of a certain
level of outputs.

3.2 What is the objective of a financial statement audit? The objective of a financial
statement audit is for the auditor to express an opinion about whether the financial statements
are prepared in all material respects in accordance with a financial reporting framework. Within
a Canadian context, this means that the financial statements have been prepared in accordance
with Canadian generally accepted accounting principles (GAAP) and any relevant legislation,
such as the Canada Business Corporations Act.

3.3 What are the most common tasks of the internal audit function? While the functions of
internal audits vary widely from one organization to another, they are often concerned with
evaluating and improving risk management, internal control procedures, and elements of the
governance process. The internal audit function often conducts performance audits, compliance
audits, internal control assessments, and reviews.

4.1 What are the main differences between reasonable and limited assurance
engagements? The objective of a reasonable assurance engagement is to gather sufficient
evidence upon which to form a positive expression of an opinion regarding whether the
information being assured is presented fairly. An auditor performs adequate work to report with
reasonable certainty that the information being assured is, or is not, reliable. This does not
reflect absolute assurance, as an auditor can never be 100 percent certain that there are no
errors or omissions. The objective of a limited assurance engagement is to perform sufficient
procedures and gather sufficient evidence to support the practitioner’s conclusion. This means
that the practitioner has done adequate work to report whether or not anything came to their
attention that would lead them to believe that the information is not prepared in accordance with
the applicable financial framework. The practitioner is required to at least do enough work so
that the report enhances the user’s confidence about the information.

4.2 What is the level of assurance required for an annual financial statement for a
reporting issuer? The level of assurance required for an annual financial statement is
reasonable assurance.

4.3 What level of assurance does a compilation engagement provide? A compilation

engagement provides no assurance. A practitioner compiles the financial information provided
by the client and arranges it into a set of financial statements.

5.1 What are the different types of unmodified audit opinions? An unmodified opinion is
also known as a clean opinion. An audit report may have an unmodified opinion and include an
emphasis of matter paragraph which draws the attention of the reader to an issue the auditor
believes has been adequately and accurately explained in a note to the financial statements.

5.2 What are the different types of modified audit opinions? There are three types of
modifications. The first is a qualified opinion and is issued when the auditor believes that
“except for” the effects of a matter that is explained in the audit report, the financial statements
can be relied upon by the reader. A qualified opinion is used when the matter of concern can be
identified, quantified, and explained in the audit report. If the matter of concern is pervasive to

© 2021 John Wiley and Sons, Auditing, 4e

the financial statements, an adverse opinion or a disclaimer of opinion is required. “Pervasive”
means that the misstatement(s) are not confined to individual accounts or elements of the
financial statements, or, if confined, the misstatements affect an extensive portion of the
financial statements or there are missing disclosures that are vital to a user’s understanding of
the financial statements. An adverse opinion is appropriate if the auditor has evidence of
identified misstatement(s) which have a material and pervasive affect on the financial
statements. A disclaimer of opinion is used when the auditor is unable to obtain sufficient
appropriate audit evidence on which to base the opinion and concludes that the possible effects
on the financial statements could be material and pervasive.

5.3 What type of audit opinion is unmodified and modified? An audit report may have an
unmodified and modified opinion if the unmodified opinion report includes an emphasis of matter
paragraph (modified) which draws the attention of the reader to an issue the auditor believes
has been adequately and accurately explained in a note to the financial statements.

6.1 A financial statement must be relevant and reliable. What do these terms mean in this
context? Information is relevant if it has an impact on the decisions made by users regarding
the performance of the entity and information is reliable when it is free from material
misstatements (errors or fraud).

6.2 What three characteristics should an auditor have when conducting an audit? When
undertaking an audit, the auditor should use professional scepticism, professional judgement,
and due care. Professional scepticism is an attitude adopted by the auditor when conducting the
audit. It means that the auditor is independent, maintains a questioning mind, and thoroughly
investigates all evidence presented by the client. Professional judgement relates to the level of
expertise, knowledge, and training that an auditor uses while conducting an audit. Due care
refers to being diligent while conducting an audit, applying technical and statute-backed
standards, and documenting each stage in the audit process.

6.3 What are non-audit services? Non-assurance (non-audit) services include management
consulting, mergers and acquisitions, insolvency, tax, and accounting services.

7.1 What is CPA Canada? CPA Canada is the Chartered Professional Accountants of Canada.
CPA integrated the former Canadian Institute of Chartered Accountants (CAs), Certified General
Accountants Association of Canada (CGAs), and the Society of Management Accountants of
Canada (CMAs).

7.2 What is the AASB and what is its role? The AASB is the Auditing and Assurance
Standards Board (AASB). The purpose of the Canadian AASB is to serve the public interest by
setting high-quality auditing and assurance standards.

7.3 What are the main functions of the CSA? CSA stands for the Canadian Securities
Administrators. The CSA is a voluntary umbrella organization with the objective of improving,
coordinating, and harmonizing regulation of the Canadian capital markets. Part of its mandate is
to regulate listed entity disclosure requirements. As such, it requires the annual filing of audited
financial statements in accordance with Canadian GAAP, which in Canada is now IFRS for
listed entities. It also requires that the CEOs and CFOs of reporting issuers certify that the
annual financial statements are fairly presented. In addition, the CSA issues staff notices to
provide reporting issuers with guidance on various issues, such as environmental disclosures.

© 2021 John Wiley and Sons, Auditing, 4e

8.1 Define the audit expectation gap. The audit expectation gap occurs when there is a
difference between the expectations of assurance providers and financial statement users. The
gap occurs when user beliefs do not align with what an auditor has actually done.

8.2 What causes the audit expectation gap? The gap is caused by unrealistic user
expectations, such as:
• The auditor is providing complete assurance.
• The auditor is guaranteeing the future viability of the entity.
• An unqualified (clean) audit opinion is an indicator of complete accuracy.
• The auditor will definitely find any fraud.
• The auditor has checked all transactions.

8.3 What can be done to reduce the audit expectation gap? The audit expectation gap can
be reduced by:
• auditors performing their duties appropriately, complying with auditing standards, and
meeting the minimum standards of performance that should be expected of all auditors
• peer reviews of audits to ensure that auditing standards have been applied correctly
• auditing standards being reviewed and updated on a regular basis to enhance the work
being done by auditors
• education of the public
• enhanced reporting to explain what processes have been followed in arriving at an audit
(reasonable assurance) or a review (limited assurance) opinion
• assurance providers reporting accurately the level of assurance being provided
(reasonable, limited, or none)

© 2021 John Wiley and Sons, Auditing, 4e