Increased global activities of many businesses
Multiple product lines and transaction locations
Foreign exchange affects transactions
Complex accounting and exchange transactions
Increasing use of derivatives and hedging activities
Increasingly complex accounting standards in areas such as revenue recognition
More complex information systems
Possibly millions of transactions processed daily through on-line and traditional sales channels
Voluminous data requires interpretation
1-4 1. Risk-free interest rate This is approximately the rate the bank could earn by investing in U.S. treasury notes for the same length of time as the business loan.
Business risk for the customer This risk reflects the possibility that the business will not be able to repay its loan because of economic or business conditions such as a recession, poor management decisions, or unexpected competition in the industry.
Information risk This risk reflects the possibility that the information upon which the business risk decision was made was inaccurate. A likely cause of the information risk is the possibility of inaccurate financial statements.
1-4 (continued)
Auditing has no effect on either the risk-free interest rate or business risk. However, auditing can significantly reduce information risk.
1-5 The three main ways to reduce information risk are:
User verifies the information.
User shares the information risk with management.
Audited financial statements are provided.
The advantages and disadvantages of each are as follows:
ADVANTAGES
DISADVANTAGES
USER VERIFIES INFORMATION
User obtains information desired.
User can be more confident of the qualifications and activities of the person getting the information.High cost of obtaining information.
Inconvenience to the person providing the information because large number of users would be on premises.
USER SHARES INFORMATION RISK WITH MANAGEMENT
No audit costs incurred.User may not be able to collect on losses.
AUDITED FINANCIAL STATEMENTS ARE PROVIDED
Multiple users obtain the information.
Information risk can usually be reduced sufficiently to satisfy users at reasonable cost.
Minimal inconvenience to management by having only one auditor.May not meet needs of certain users.
Cost may be higher than the benefits in some situations, such as for a small company.
1-6 Information risk is the risk that information upon which a business decision is made is inaccurate. Fair value accounting is often based on estimates and requires judgment. Fair value can be estimated using multiple methods with some estimates being more subjective than others. Fair value estimates are made at a point in time, but can also change rapidly, depending on market conditions. All of these factors increase information risk.
1-7 An assurance service is an independent professional service to improve the quality of information for decision makers. An attestation service is a form of assurance service in which the CPA firm issues a report about the reliability of an assertion that is the responsibility of another party.
1-7 (continued)
The most common form of audit service is an audit of historical financial statements, in which the auditor expresses a conclusion as to whether the financial statements are presented in accordance with an applicable financial reporting framework such as U.S. GAAP or IFRS. An example of an attestation service is a report on the effectiveness of an entity’s internal control over financial reporting. There are many possible forms of assurance services, including services related to business performance measurement, health care performance, and information system reliability.
1-8 Some organizations issue sustainability reports to highlight the work they are doing related to the environment, social issues, and governance (often referred to as ESG). These reports include different types of data that reflect the organization’s overall performance related to their sustainability efforts. For example, some organizations provide data related to carbon emissions, resource usage, and waste generation to highlight their impact on the environment. Others report demographic data about the types of individuals they hire as employees or serve as customers. Investors and other users of these sustainability reports may desire assurance from CPAs about the accuracy and reliability of these data items.
1-9 The primary evidence the internal revenue agent will use in the audit of the Jones Company's tax return include all available documentation and other information available in Jones’ office or from other sources. For example, when the internal revenue agent audits taxable income, a major source of information will be bank statements, the cash receipts journal and deposit slips. The internal revenue agent is likely to emphasize unrecorded receipts and revenues. For expenses, major sources of evidence are likely to be cancelled checks and electronic funds transfers, vendors' invoices, and other supporting documentation.