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Unformatted text preview: Chapter 02 - The Financial Statement Auditing Environment CHAPTER 2 THE FINANCIAL STATEMENT AUDITING ENVIRONMENT Answers to Review Questions 2-1 During the late 1990s and early 2000s, accounting firms aggressively sought opportunities to expand their business in nonaudit services such as consulting. This expansion from their core audit practice, combined with allegations of auditors refusing to challenge managements actions, resulted in conflict between regulators and the accounting profession. A result was that new SEC guidelines for materiality, independence, and the disclosure of audit service fees were established. However, subsequent financial fiascos such as those at Enron, WorldCom, Tyco, and many others, caused investors to doubt the fundamental integrity of the financial reporting system. Under pressure to restore the publics confidence, Congress passed the Sarbanes-Oxley Act and created the PCAOB in 2002. 2-2 The accounting professions expansion into new areas, combined with changes in the overall business environment, resulted in new regulations and guidelines. The scandals of the late 1990s and early 2000s brought into the question the professions ability to self- regulate, resulting in new legislation. While these changes have caused pain and turmoil, they highlight the essential importance of auditing in our economic system. Ultimately, the back to basics emphasis, along with auditing firms renewed focus on thorough and effective financial statement audits, will likely prove healthy for the U.S. financial reporting system and for the profession. Further, somewhat ironically the SOX-mandated audit of internal control over financial reporting has brought significant new revenues to accounting firms. 2-3 The essential components of the high-level model of business offered in the chapter are: corporate governance, objectives, strategies, processes, controls, transactions, and financial statements. Corporate governance is carried out by management and the board of directors in order to ensure that business objectives are carried out and that company assets are safeguarded. To achieve its objectives, management must formulate strategies and implement various processes which are in turn carried out through business transactions. The entitys information and internal control systems must be designed to ensure that these transactions are properly executed, captured, and processed in order to produce accurate financial statements. It is important that the auditor obtain a firm understanding of these components in order to understand relevant risks and to plan the nature, timing, and extent of the audit so that it is efficient and effective....
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- Spring '08