Accounting 4632 Midterm Exam 1 Study Guide Professor s Instructions Regarding Exam Preparation The following study guide was prepared with the intention of directing students attention toward many of the important concepts covered in the course that they should know I caution students that it is not an exhaustive list However students can expect that the vast majority of exam questions will relate to the issues referenced in this study guide The study guide was prepared in reference to the textbook as the course structure tends to follow the textbook All Topics That Are Considered Fair Game Material covered from slides and lectures Practice problems from class and posted to BB Information from announcements on BB Important Notes Take caution against trying to memorize lists of items from the slides The course is highly conceptual and there should be more focus on why the auditor is required to or should perform various activities Rather than memorizing always seek to identify the structure underlying the concepts Author s Note Seriously try not to memorize this Anything in red print like this is my own additional information to help make some concepts more concrete or repeat stuff I think needs repeating If you re like me you didn t pay attention in class because it sucked so hopefully these notes will help That being said study the best way you know how You re an adult and you ve gotten this far hopefully on your own Side note this took me forever to make Don t be a dick buy it If you give it to your friends or get it for free I curse your accounting career MGP Chapter 1 1 Information asymmetry and the role of auditing assurance services We talked about the Lemons Dilemma in class Be sure to understand the issues involved Information asymmetry means that the manager generally has more information about the true financial position and results of operations of the entity than does the absentee owner shareholder Because their goals may not coincide there is a natural conflict of interest between the manager and the absentee owner shareholder If both parties seek to maximize their self interest the manager may not always act in the best interest of the owner shareholder Lemon Dilemma Used car example You know more information about your used car then a buyer will this creates information asymmetry seller may charge more than they should You may want to purchase an inspection so you can reduce the cost of information If buyers cannot spot the quality difference though as is often the case in the real world there will be only one market for all used cars and buyers will be ready to pay only the average price of a good car and a lemon This result when bad quality pushes good quality from the market because of an information gap is known as adverse selection 2 Differences among Audit Attest and Assurance engagements Auditing is a systematic process of objectively obtaining and evaluating evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between those assertions and established criteria and communicating the results to interested users Audits provide positive assurance that the financial statements are presented fairly in accordance with GAAP and give reasonable assurance that the financial statements are free from material misstatement whether from error or fraud Attest services occur when a practitioner is engaged to issue a report on subject matter or an assertion about subject matter which is the responsibility of another party The subject matter of attest services can take many forms including prospective information analyses systems and processes and even the actions of specified parties Note that financial statement auditing is a specialized form of an attest service The three types of attest engagements are 1 Examination positive assurance 2 Review negative assurance 3 Agreed Upon Procedures no assurance Assurance services are independent professional services that improve the quality of information or its context for decision makers To summarize assurance services can capture information improve its quality and enhance its usefulness for decision makers What is positive and negative assurance Simply put it s how sure you are of something If you re giving someone positive assurance you re saying Yeah dude it s right I checked it When you give someone negative assurance it s because you didn t research the material enough and you say Ummm I don t know for sure if it s right but I sure as heck didn t see anything wrong with it 3 Concepts of Materiality and Risk and why they are relevant to an audit Materiality is the magnitude of an omission or misstatement of accounting information that in the light of surrounding circumstances makes it probable that the judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement A common rule of thumb is that total aggregated misstatements of more than about 3 to 5 percent of net income before tax would cause the financial statements to be materially misstated The auditor provides no assurance that immaterial misstatements will be detected Material it matters Material witness ever heard of it The witness saw something VERY IMPORTANT In an AUDIT the auditor is looking for material misstatements Nothing else matters as long as not material Audit risk is the risk that the auditor may unknowingly give a clean opinion on financial statements that are materially misstated The auditor s standard report states that the audit provides only reasonable assurance that Reasonable assurance the financial statements do not contain material misstatements financial statements and the auditor will fail to detect it implies some risk that a material misstatement could be present in the The auditor controls the level of audit risk by the effectiveness and extent of audit work conducted D The risk that an auditor will mistakenly issue a clean opinion on financial statements that are materially misstated cannot be driven to zero Ever 4 Understand what audit evidence is and relevance reliability trade off A major concept involved in auditing is evidence regarding management s assertions Audit evidence consists of the underlying accounting data and any additional information available to the auditor whether originating from the client or externally Audit evidence provides the basis for the auditor s opinion on whether or not the financial