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ch05 - Chapter 5 Multiple Choice 5-1 C 5-2 B 5-3 B 5-4 B...

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Chapter 5 Multiple Choice 5-1. C 5-2. B 5-3. B 5-4. B 5-5. B 5-6. A 5-7. A 5-8. C 5-9. A 5-10. C 5-11. B 5-12. A 5-13. D 5-14. B 5-15. D 5-16. B 5-17. D 5-18. A 5-19. B 5-20. D Discussion Question 5-21 [LO 1, 3] What happens to client companies that are not desired as clients by the CPA firms that are very concerned about client reputation? These might be companies with known management integrity issues or fee disputes with prior auditors. Will these companies still be able to get audits? From whom? What do you think this means regarding protecting the public interest and integrity of the capital markets? Answer: The client companies that are not desired as clients by the CPA firms will be serviced by those CPA firms that are less concerned about client reputation. There will (almost) always be a service provider willing to weigh the risks presented by a client’s reputation against the rewards of collecting a (sufficiently generous) fee. There are some serious issues with the way auditors are hired and compensated in terms of how well the public interest is served. The integrity of the capital markets is questionable for many reasons. Auditor selection, retention and compensation are among many problem areas that are being considered for further regulation.
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5-22 [LO 3] Why does a recent or upcoming IPO create more risk for the auditor? Which audit firms seem best positioned to accept the risk? Which audit firms likely have the greatest expertise with that type of client? What would be the ultimate outcome if the most qualified audit firms turn down companies with IPOs because they do not want the risk, and the companies must use audit firms with less experience and expertise? How does this scenario fit in with protecting the public interest? Answer: The client company’s institutional lack of experience with the reporting and regulatory requirements for public companies creates a difficult risk profile for any company taking on an initial public offering. The company will be operating in an environment of accelerated growth as the result of the infusion of capital and there will be a new group of outside investors to deal with for the first time. Investors invest in IPOs in spite of their risks because they perceive an opportunity that justifies the risk. Auditors have a similar risk-reward analysis to undertake in setting their fees and making proposals for an audit of this (or any) kind of client. The several large audit firms that perform most of the audits of publicly traded companies are likely to have the greatest expertise with this type of client. If the most qualified audit forms turned down companies with IPOs, smaller firms would quickly step in and do this work. Experienced auditors from the larger firms would form or join the smaller firms. The supply of auditors will grow if there is demand even if there is risk. The auditors will charge more to do riskier audits because they require more work. Audit quality is important in protecting the public interest and is also an important concern for auditors determined to minimize their liabilities for malpractice.
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