End of Chapter Question­ Chapter Two

Fundamental Principles (Comprehensive). In each of the following, identify which of the elements of the fundamental principles (responsibilities, performance, or reporting) is most applicable. In addition, discuss what action(s) (if any) you believe auditors should take with respect to these issues.

1. An entity has contacted you about performing its audit engagement. You have not previously served a client in the entity’s industry, which has many industry­specific accounting issues that are both technical and complex.

The responsibility principle stands out as the most relevant of the fundamental principles. This principle is relevant here because a successful audit depends on the auditor’s knowledge and experience within the field.

In order to conduct an accurate audit, the auditor must first acquire the necessary knowledge and skills.

1. An entity has entered into a number of lease agreements. Based on the requirements of GAAP, you believe that these obligations meet the criteria for being classified as capital leases; however, the entity has elected to treat these leases as operating leases, providing

full and complete disclosure of this treatment in the footnotes to the financial statements.

The reporting principle is the most relevant of the basic principles. This principle is relevant because it states that auditors are obligated to comment in the auditor’s report that the footnotes are inadequate, which is exactly what happens in this scenario.

The auditor has a different opinion than the firm on how the leases should be categorized. As a result, if the auditor and the entity cannot agree on the leases, the auditor must state in the report that the report is complete but the leases do not meet GAAP standards.

1. Because of a disagreement with its current auditors, an entity has contacted you about conducting its current­year audit. However, because the previous auditors have just recently resigned from the engagement, you have some questions as to whether an audit can be completed in time to meet the entity’s deadlines for providing audited financial statements to a lender.

The performance principle is the most relevant foundational principle. According to this principle, the auditor needs to properly plan the work, as well as advise and supervise the assistances, if he or she wants to obtain reasonable assurance. The auditor in this case needs to figure out how to get the audit done in a timely manner by delegating tasks to each member of the team.

1. Based on the effectiveness of the entity’s internal control, you have assessed control risk at low levels and decided that a smaller number of customer accounts need to be confirmed.

The performance principle is the most relevant foundational principle. This principle is relevant because it identifies and evaluates risks in light of knowledge about the entity, its surroundings, and its own internal control. Because of the low risk, the auditor can proceed with the audit as planned.

1. An entity has contacted you about performing its audit engagement. This entity became aware of your firm because the husband of one of your partners is currently serving as the entity’s chief financial officer.

The responsibility principle is the underlying principle most applicable to the current situation. According to the responsibility principle, an auditor has a duty to act independently and with reasonable diligence throughout the audit process and report writing.

This is a case where the auditor must politely decline the opportunity to perform the audit. The auditor would be acting contrary to the guidelines set forth by the fundamental principles if they did not decline.

1. One of your clients is currently a potential defendant in several cases because of the damage caused by one of its products. Because this entity does not believe that it is likely to page 74receive an unfavorable outcome from this litigation, it did not disclose the potential litigation in the footnotes accompanying their financial statements.

The reporting principle is the most fundamental principle that adequately describes this situation. According to the principle of reporting, auditors must reveal how much of a personal role they are playing in the audit.

The auditor’s role here is to inform the client why the litigation needs to be made public. This information, in the auditor’s opinion, must be disclosed, even if the client disagrees.

1. You are performing tests of the client’s controls over the processing of revenue transactions to determine whether these controls are operating effectively and can be relied upon to prevent or detect misstatements.

The performance principle is the underlying principle that most accurately characterizes this situation. According to the performance principle, an auditor needs to determine how likely it is that internal controls will result in a material misstatement.

The auditor must continue to learn about the client’s financial statements and gather the right evidence by carrying out all of the required audit procedures.

1. One of your supervisors has requested a number of clarifications based on her review of your work on an audit engagement. A subsequent meeting with her has resolved these clarifications, and you both have concluded that your work supports the opinion on the client’s financial statements.

The reporting principle is the underlying principle that most accurately describes this situation. According to the principle of reporting, an auditor must either provide an opinion on the financial statements or state that no such opinion can be issued.

To be safe, the auditor should issue an unqualified opinion in this case.