Chapter 13 homework solution - Questions 1 Quality of...

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Questions 1. Quality of earnings is determined by (1) level of conservatism in the choices of accounting principles (more conservative = higher quality), (2) the amount of internal and external risk faced by the firm (less risk = higher quality), and (3) timing of revenue recognition (early recognition = lower quality) and expense recognition (late recognition = lower quality). 2. Earnings are the focus of analysts and investors, and stock prices are thought to be directly affected by a firm’s earnings. 3. The financial accounting scandals of Enron, WorldCom, and others in the early 2000’s were the impetus for congressional action and the passage of the Sarbanes- Oxley Act. 4. The PCAOB has the responsibility of setting auditing standards for audits of public companies and policing auditing firms that audit public companies. 5. The PCAOB, a group appointed by the SEC and related groups, is responsible for establishing auditing standards, while the Financial Accounting Standards Board (FASB), a private sector standards-setting body, is responsible for setting accounting standards (GAAP). The first set of standards addresses how auditing firms examine and report on a firm’s financial statements. The second set of standards (GAAP) addresses how firms prepare their financial statements. 6. Auditing firms can no longer provide certain consulting services to their audit clients. For example, if an auditing firm designs or consults with a firm on its information systems, that auditing firm cannot provide audit services. This should remove the incentive to go along with management on controversial audit issues in order to protect consulting revenue. In addition, auditing firms are required to report to the client’s audit committee instead of client’s management. This increases the auditor’s independence. 7. A firm’s board of director (BOD) must have an audit committee made up of independent board members, and this committee is now responsible for hiring and compensating the external auditors. The BOD must also make sure that a whistle- blower hotline is operational. The board must have some non-management directors. 8. Internal controls are processes designed to provide reasonable assurance regarding the achievement of the firm’s objectives in these areas: (1) reliability of financing reporting, (2) the effectiveness and efficiency of operations, and (3) compliance with applicable laws and regulations. A firm’s management is responsible for their effectiveness. 9.
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Chapter 13 homework solution - Questions 1 Quality of...

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