1. Homework 1 (Chapter 1 & 2)
Chapter 1
Problem 1-17 (a-e)
a. The interest rate for the loan that requires a review report is lower than the loan that did not
require a review because of lower information risk.
The interest rate for the loan that requires an audit report is lower than the interest rate for the
other two of loans because a review reportprovides moderate assurance to financial statement
users, which lowers information risk, whereas an audit reportprovides further assurance and
lower information risk. As a result of reduced information risk, the interest rate is lowest for
theloan with the audit report.
b. Vial-tek’s annual costs under each loan agreement, including interest and costs for CPA firm’s
services are following:
LENDER CPA COST OF CPA ANNUAL ANNUAL
SERVICE SERVICES INTEREST LOAN COST
Existing loan None 0 $ 332,500 $ 332,500
First National Bank Review $ 20,000 $ 297,500 $ 317,500
City First Bank Audit $ 45,000 $ 262,500 $ 307,500
Given these circumstances, Vial-tek should select the loan from City First Bank that requires an
annual audit. In this situation, the additional cost of the audit is less than the reduction in interest
due to lower information risk.
c. Vial-tek should select the loan from First National Bank due to the higher cost of the audit and
the reduced interest rate for the loan from First National Bank. The following is the calculation
of total costs for each loan:
LENDER CPA COST OF CPA ANNUAL ANNUAL
SERVICE SERVICES INTEREST LOAN COST
Existing loan None 0 $ 332,500 $ 332,500
First National Bank Review $ 20,000 $ 280,000 $ 300,000
City First Bank Audit $ 50,000 $ 262,500 $ 312,500
d. Vial-tek may desire to have an audit because of the many other positive benefits that an audit
provides. The audit will provide Vial-tek’s management with assurance about annual financial
information used for decision-making purpose, includingdetects errors or fraud, and provides
management with information about the effectiveness of controls. In addition, the audit may
result in recommendations to management that will improve efficiency or effectiveness.

2. e. The auditor must have a thorough understanding of the client and its environment, including
the client’s e-commerce technologies, industry, regulatory and operating environment, suppliers,
customers, creditors, and business strategies and processes. This thorough analysis helps the
auditor identify risks associated with the client’s strategies that may affect whether the financial
statements are fairly stated. This strategic knowledge of the client’s business often helps the
auditor identify ways to help the client improve business operations, thereby providing added
value to the audit function.
Problem 1-19 (a-b)
a.The following parts of the definition of auditing are related to the narrative:
(1) Information
Virms is being asked to issue a report about qualitative and quantitative information for trucks.
The trucks are therefore the information with which the auditor is concerned.
(2) Established criteria
There are four established criteria which must be evaluated and reported by Virms:
Existence of the trucks on the night of June 30, 2009
Ownership of each truck by Regional Delivery Service
Physical condition of each truck
Fair market value of each truck.
(3) Accumulating and evaluating evidence
Susan Virms will accumulate and evaluate four types of evidence:
Count the trucks to determine their existence.
Use registrations documents held by Oatley for comparison to the serial number on each
truck to determine ownership.
Examine the trucks to determine each truck's physical condition.
Examine the blue book to determine the fair market value of each truck.
(4) Competent, independent person
Susan Virms, CPA, appears qualified, as a competent, independent person. She is a CPA, and
she spends most of her time auditing used automobile and truck dealerships and has extensive
specialized knowledge about used trucks that is consistent with the nature of the engagement.

3. (5) Reporting results
The report results are including:
 Which of the 35 trucks are parked in Regional's parking lot the night of June 30.
 Whether all of the trucks are owned by Regional Delivery Service.
 The condition of each truck, using established guidelines.
 Fair market value of each truck using the current blue book for trucks.
b. There are 2 parts of the audit that will be difficult for Virms:
(1) Evaluating the condition, using the guidelines of poor, good, and excellent. It is highly
subjective to do so. If she uses a different criterion than the "blue book," the fair market
value will not be meaningful. Her experience will be essential in using this guideline.
(2) Determining the fair market value, unless it is clearly defined in the blue book for each
condition.
Problem 1-22 (a-b)
a.The conglomerate should either engage the management advisory services division of a CPA
firm or its own internal auditors to conduct the operational audit.
b. The auditors will encounter problems in establishing criteria for evaluating the actual
quantitative events and in setting the scope to include all operations in which significant
inefficiencies might exist. In writing the report, the auditors must choose proper wording to state
that no financial audit was performed, that the procedures were limited in scope and that the
results reported do not necessarily include all the inefficiencies that might exist.

4. Chapter 2
Problem 2-18 (a-b)
a. The arguments against the Act can be summarized as four arguments:
1. Costs of complying with the Act are excessively high, especially the requirement to
report on internal control over financial reporting, and will discourage companies from
becoming public companies.
2. Relative cost for local audit firms is excessively high.
3. Additional oversight is not needed because sufficient quality controls have already been
implemented by most audit firms.
4. Three other things already provide assurance of adequate quality: a competitive economic
environment, legal liability, and auditing standards.
To support these comments, it can be argued that the profession has generally functioned well
with relatively little controversy and criticism.
The arguments against these comments are followings:
o Reporting on the effectiveness of internal control over financial reporting will provide
benefits in improved controls, resulting in higher quality financial reporting and reduced
losses from fraud.
o The increased confidence in financial reporting will increase access to capital and lower
the cost of capital by reducing information risk.
o Changes in the scope of CPA practices and other threats to audit quality required
government regulation.
o Regulation of public company audits will not affect most audit firms that do not have
public company audit clients.
b. There is no correct answer to this question. Different people reach different conclusions,
depending on the weights put on the various arguments. It needs time to effectively assess both
the costs and benefits of the Act.
Problem 2-20 (a-b)
a.Rossi and Montgomery's primary ethical consideration is their professional competence to
perform all of the audit work for filing with the SEC.
In addition, if Rossi and Montgomery have performed bookkeeping services or certain
consulting services for Mobile Home, they will not be independent under PCAOB and SEC
independence requirements. The firm must also be a registered firm with the PCAOB.

5. b. The filing with the SEC, in addition to normal audited financial statements, will require
completion and registration with the SEC of Form S-1 which includes an audited summary of
operations for the last five fiscal years as well as many additional schedules and descriptions of
the business.
Each quarter subsequent to the filing, Form 10-Q must be filed; and within 90 days of
the end of each fiscal year Form 10-K must be filed with the SEC.
In addition, Form 8-K must be filed whenever significant events have occurred which
are of interest to public investors. These forms must be filed in conformity with Regulation S-X,
which requires considerable disclosures in addition to those normally required in audited
financial statements.
Problem 2-21
Brief Description of GAAS Holmes’ Actions Resulting in Failure to Comply w/ GAAS
General Standards
1. The auditor must have adequate technical 1. It was inappropriate for Holmes to hire the two students to
training and proficiency to perform the audit. conduct the audit. The audit must be conducted by persons
with proper education and experience in the field of auditing.
Although a junior assistant has not completed his formal
education, he may help in the conduct of the audit as long as
there is proper supervision and review.
2. The auditor must maintain independence in 2. To satisfy the second general standard, Holmes must be
mental attitude in all matters relating to the without bias with respect to the client under audit. Holmes
audit. has an obligation for fairness to the owners, management, and
creditors who may rely on the report. Because of the financial
interest in whether the bank loan is granted to Ray, Holmes is
independent in neither fact nor appearance with respect to the
assignment undertaken.
3. The auditor must exercise due professional 3. This standard requires Holmes to perform the audit with
care in the performance of the audit and the due care, which imposes on Holmes and everyone in Holmes'
preparation of the report. organization a responsibility to observe the standards of field
work and reporting. Exercise of due care requires critical
review at every level of supervision of the work done and the
judgments exercised by those assisting in the audit. Holmes
did not review the work or the judgments of the assistants and
clearly failed to adhere to this

6. Brief Description of GAAS Holmes’ Actions Resulting in Failure to Comply w/ GAAS
Standards of Field Work
1. The auditor must adequately plan the work 1. This standard recognizes that early appointment of the
and must properly supervise any assistants. auditor has advantages for the auditor and the client. Holmes
accepted the engagement without considering the availability
of competent staff. In addition, Holmes failed to supervise the
assistants. The work performed was not adequately planned.
2. The auditor must obtain a sufficient 2. Holmes did not obtain an understanding of the entity or its
understanding of the entity and its internal control, nor did the assistants obtain such an
environment, including its internal control, to understanding. There appears to have been no audit at all.
assess the risk of material misstatement of the The work performed was more an accounting service than it
financial statements whether due to error or was an auditing service.
fraud, and to design the nature, timing, and
extent of further audit procedures.
3. The auditor must obtain sufficient 3. Holmes acquired no evidence that would support the
appropriate audit evidence by performing financial statements. Holmes merely checked the
audit procedures to afford a reasonable basis mathematical accuracy of the records and summarized the
for an opinion regarding the financial accounts. Standard audit procedures and techniques were not
statements under audit. performed.
Standards of Reporting
1. The auditor must state in the auditor’s 1. Holmes' report made no reference to GAAP. Because
report whether the financial statements are Holmes did not conduct a proper audit, the report should state
presented in accordance with generally that no opinion can be expressed as to the fair presentation of
accepted accounting principles (GAAP). the financial statements in accordance with generally
accepted accounting principles.
2. The auditor must identify in the auditor’s 2. Holmes' improper audit would not enable him to determine
report those circumstances in which such whether GAAP were consistently applied. Holmes' report
principles have not been consistently observed should make no reference to the consistent application of
in the current period in relation to the accounting principles.
preceding period.
3. When the auditor determines that 3. Management is primarily responsible for adequate
informative disclosures are not reasonably disclosures in the financial statements, but when the
adequate, the auditor must so state in the statements do not contain adequate disclosures the auditor
auditor’s report. should make such disclosures in the auditor's report. In this
case both the statements and the auditor's report lack
adequate disclosures.

7. Brief Description of GAAS Holmes’ Actions Resulting in Failure to Comply w/ GAAS
4. The auditor must either express an opinion 4. Although the Holmes report contains an expression of
regarding the financial statements, taken as a opinion, such opinion is not based on the results of a proper
whole, or state that an opinion cannot be audit. Holmes should disclaim an opinion because he failed
expressed, in the auditor’s report. When the to conduct an audit in accordance with generally accepted
auditor cannot express an overall opinion, the auditing standards.
auditor should state the reasons therefor in the
auditor’s report. In all cases where an auditor's
name is associated with financial statements,
the auditor should clearly indicate the
character of the auditor's work, if any, and the
degree of responsibility the auditor is taking,
in the auditor’s report.
Problem 2-22 (a-f)
a. An audit of a German private company w/ no public debt.
The engagement is like to be conducted under international auditing standards.
b. An audit of a U.S. public company.
The engagement is like to be conducted under PCAOB auditing standards.
c. An audit of a United Kingdom public company that is listed in the U.S. and whose financial
statements will be filed w/ the SEC.
The engagement is like to be conducted under PCAOB auditing standards(reporting in
the U.K. will be under international auditing standards).
d. An audit of a U.S. private company to be used for a loan from a publicly-traded bank.
The engagement is like to be conducted under generally accepted auditing standards.
e. An audit of a U.S. public company that is a subsidiary of a Japanese company that will be used
for reporting by the parent company in Japan.
The engagement is like to be conducted under international auditing standards.
f. An audit of a U.S. private company that has publicly-traded debt.
The engagement is like to be conducted under PCAOB auditing standards(due to the
publicly-traded debt).