1. There are people who believe that the analysis of financial statements has limitations. Which of the statements below would qualify as a limitation of financial statement analysis? a) Ratio analysis requires the analyst to evaluate a firm's performance over a period of time to be of any value. b) Proper ratio analysis requires the analyst to rely upon audited financial statements, which can be easily manipulated. c) Thorough ratio analysis requires the analyst to refer to benchmarking, which is very easy to misinterpret.

1. There are people who believe that the analysis of financial statements has limitations. Which of the statements below would qualify as a limitation of financial statement analysis? a) Ratio analysis requires the analyst to evaluate a firm's performance over a period of time to be of any value. b) Proper ratio analysis requires the analyst to rely upon audited financial statements, which can be easily manipulated. c) Thorough ratio analysis requires the analyst to refer to benchmarking, which is very easy to misinterpret.

Auditing: A Risk Based-Approach to Conducting a Quality Audit

10th Edition

ISBN:9781305080577

Author:Karla M Johnstone, Audrey A. Gramling, Larry E. Rittenberg

Publisher:Karla M Johnstone, Audrey A. Gramling, Larry E. Rittenberg

Chapter6: A Framework For Audit Evidence

Section: Chapter Questions

Problem 32MCQ

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The results in using ratio analysis may be distorted if _? a. There is inflation. b. The data used are different in the way it was developed. c. The financial statements are not audited. d. All of the above.
a. It is impossible for an auditor to "guarantee" that a company's finanical statements are free of all errors because the cost to the company to achieve absolute accuracy (even if that were possible) and the cost of the auditor's verfication would be prohibitively expensive. How does the auditors' opinion recognize this absence of absolute accuracy? b. To what extent is the auditors' opinion an indicator of a company's future financial success and future cash dividends to stockholders?
Financial analysts are aware of the many limitations of ratio analysis as a technique of financial statement analysis. Describe the advantages and disadvantages of ratio analysis. Explain ways that ratios may be misleading to an analyst. For example, ratios are retrospective and do not directly incorporate forecasts of future performance.
The amount of subjectivity involved in establishing fair value estimates can be complex for management responsible for making the fair value measurements and disclosures contained in financial statements. This is particularly true for fair value measurements for which observable market prices are not available. Auditing standards require auditors to obtain sufficient appropriate audit evidence to provide reasonable assurance that fair value measurements and disclosures are in conformity with accounting standards, and auditing standards provide guidance for auditing those measurements and disclosures contained in financial statements. a. Visit the PCAOB's web site (pcaobus.org) to identify where in the PCAOB Auditing Standards guidance is provided for auditing fair value measurements and disclosures. b. PCAOB auditing standards require the auditor to obtain an understanding of the entity's process for determining fair value measurements and disclosures. Identify 5 things the auditor…
In Arthur Levitt’s speech, referred to in the opening quote, he also said, “I fear that we are witnessing an erosion in the quality of earnings, and therefore, the quality of financial reporting. Managing may be giving way to manipulation; integrity may be losing out to illusion.” Explain what you think Levitt meant by this statement. What role do financial analysts’ earnings expectations play in the quality of earnings?
Which of the following questions best describes why an independent auditor is asked to give an opinion on the fairness of financial statement presentation?a. It is difficult to prepare financial statements that fairly present the company's financial position, operations and cash flows without the expertise of an independent auditorb. It is the responsibility of management to seek independent expert assistance in assessing the financial information presented in its financial statementsc. Opinions from independent parties are needed because companies may not have objectivity towards their own financial statementsd. It is customary that all company shareholders receive independent reports of management's accountability for business events that occur
A trade-off between the fundamental qualitative characteristics of relevance and faithful representation may need to be made in order to meet the objective of financial reporting. True False
Which of the following is least likely to be considered a financial statement audit risk factor? Management operating and financing decisions are dominated by top management, A new client with no prior audit history, Rate of change in the entity's industry is rapid, Profitability of the entity relative to its industry is inconsistent
Which of the following statements is false regarding planning analytical procedures in the revenue cycle? a. As revenue is typically regarded as a high-risk account, planning analytical procedures related to revenue are not required. b. The first step in planning analytical procedures includes developing an expectation of recorded amounts or ratios, and evaluating whether that expectation is precise enough to accomplish the relevant objective. c. Trend analysis would not be appropriate as a plan-fling analytical procedure in the revenue cycle. d. All of the above statements are false.
Maines and Wahlen94 state in their research paper on the reliability of accounting information: “Accrual estimates require judgment and discretion, which some firms under certain incentive conditions will exploit to report non-neutral accruals estimates within GAAP. Accounting standards can enhance the information in accrual estimates by linking them to the underlying economic constructs they portray.” Explain what the authors meant by this statement with respect to the possible existence of earnings management.
Simplified approaches for preparing pro forma statements assume that the firm’s past financial condition is an accurate indicator of the future. There are several examples from the past where organizations were not accurately reporting their financial information. Discuss the relationship between the external auditor and the organization. What steps have been taken to ensure that the relationship is truly neutral and no bias is shown by the external auditing firm?
How can the qualitative faithful representation (reliability) characteristic be improved in high-quality accounting information? Do not simply repeat what it is, provide suggestions as to how a particular part of the qualitative characteristics could be improved. Please provide different answers and explanations than copy and pasting: “Accounting information is reliable if these are-Complete - Financial statements should not exclude any transaction, Neutral - The degree to which information is free from bias. Note that there are subjectivity and estimation involved in financial statements, therefore information cannot be truly "neutral." However, if a company polled 1,000 accountants and took the average of their answers, that would be considered neutral and free from bias. and Free from error - The degree to which information is free from errors.”