1. IndividuaI Assignment: Ch.

5, 6, & 7 Textbook Exercises

O #esources: Ch. 5, 6, & 7 of Modern Auditing: Assurance Services and the Integrity of
Financial Reporting
O !repare ritten ansers to the folloing assignments from Modern Auditing: Assurance
Services and the Integrity of Financial Reporting.

4 Ch. 5: Comprehensive Questions 5-30 Assertions
4 Ch. 6: Comprehensive Questions 6-22 Audit Evidence
4 Ch. 7: Comprehensive Questions 7-22 Understanding the Entity and its Environment

AudlL Cb[ecLlve AsserLlon
1 valuaLlon or allocaLlon
2 CompleLeness
3 LxlsLence and occurrence
4 CompleLeness
3 8lghLs and obllgaLlons
6 CompleLeness
7 valuaLlon and allocaLlon
8 LxlsLence and occurrence
9 resenLaLlon and dlsclosures
10 valuaLlon or allocaLlon
11 resenLaLlon and dlsclosure


6-22.
a. 1. Directly from outsiders 7. Entirely internal
2. ndirectly from outsiders 8. ndirectly from outsiders
3. Entirely internal 9. Entirely internal
4. Entirely internal 10. nternally but validated externally
5. Entirely internal 11. ndirectly from outsiders
6. Entirely internal 12. Entirely internal

b. AU326.19 states the folloing general presumption among others about the reliability of
various types of evidence: "When evidential matter can be obtained from independent sources outside an
enterprise, it provides greater assurance of reliability for the purposes of an independent audit than that
secured solely ithin the enterprise."
Using this presumption as a guide, the four sources of evidence listed in requirement (a) may be ranked
from most to least reliable as follos: (1) directly from outsiders, (2) indirectly from outsiders, (3) internal
but validated externally, (4) entirely internal.
7.22
Following is a brieI description oI how knowledge oI the business and industry would assist the
auditor oI a start-up company in the music industry that plans to deliver music to customers over
the internet.


Key Issue
Describe knowledge used to develop
a knowledgeable perspective about
HipStar
Describe how knowledge would be
useful in performing the audit.
O Industry
conditions
O Knowledge oI the market and
competition. This is a growing
market area and has some very big,
well capitalized companies competing
Ior this market space.
O Knowledge oI how has competition
aIIected the entity`s pricing structure.
O Knowledge oI how the client`s
technology has been accepted in the
market space with respect to ease oI
downloading products and ability to
store songs Ior use on computers,
MP3 players, or other technologies.
O This knowledge will assist the
auditor in developing an
expectation oI revenue growth. In
addition, competitive pressures and
acceptance oI the entity`s
technology will aIIect the
companies ability to compete with
well established competitors that
might be better capitalized.
O Regulatory
environment
O Knowledge oI how the client`s
process meets copyright and other
legal requirements.
O Knowledge oI the entity`s legal
requirements that must be met when
customers exist in other countries.
O Regulatory risks are signiIicant,
given the experience oI major
record labels suing companies that
allow customers to download music
over the internet. The auditor needs
to consider this when evaluating the
disclosure oI commitments and
contingencies.
O Other external
Iactors aIIecting the
business
O General consumer demand Ior
downloading songs rather than
purchasing music through traditional
channels. This area may grow Iaster
than the economy as a whole.
O II the company is able to address
competitive pressures, the company
may be able to experience
signiIicant growth rates. However,
the auditor needs to be sensitive to
the entity`s product liIe cycle.
Again, this will assist the auditor in
evaluating the reasonableness oI

Key Issue
Describe knowledge used to develop
a knowledgeable perspective about
HipStar
Describe how knowledge would be
useful in performing the audit.
revenue recognition.
O The client`s
business operations
O How does the client obtain new
recording artists or rights to sell songs
where rights are held by others?
O What are the level oI Iixed costs
associated with storing music to be
downloaded by customers?
O How does the entity obtain payment
Ior songs sold to customers?
O Are there other sources oI revenues in
addition to selling music to
customers?
O How does the entity promote is
products? What are the costs
associated with product promotion?
O What is the level oI the entity`s
general and administrative costs?
O Are there any signiIicant transactions
with related parties?
O What is the entity`s burn rate iI the
company is not cash Ilow positive?
O
O Understanding the entity`s cost
structure will help the auditor
evaluate the reasonableness oI
reported proIitability, particularly in
terms oI the volume oI sales need to
break even.
O Evaluating the reasonableness oI
the entity`s proIitability depends on
the mix oI Iixed costs, variable
costs, and contribution margins.
O II the entity is unable to proIitable
in early years, the auditor needs to
consider how well capitalized the
entity is. II the entity is
inadequately capitalized, the auditor
needs to evaluate the signiIicance oI
going concern issues.
O The entity`s
investing and
Iinancing activities
O What level oI investments in
technology are needed to meet
customer demands?
O Does the entity need to invest in
intangible assets (whether capitalized
or directly expensed)?
O What Iinancing sources and terms are
available to Iund the needed
investments?
O Is Iinancing need because the client is
growing Iaster than its sustainable
growth rate?
O Knowledge oI expected investing
activities will help the auditor
evaluate the existence oI recorded
assets.
O Knowledge oI expected Iinancing
activities to cover investments or
growth in operations will help the
auditor evaluate the completeness
oI recorded debt obligations.
O The entity`s
Iinancial reporting
activities
O What accounting principles are used?
O Are there industry speciIic practices?
O How is revenue recognized?
O What are the signiIicant accounts and
transaction classes?
O Knowledge oI the accounting
principles used will aid in the
determination oI proper
presentation in accordance with
GAAP.
O Knowledge oI revenue recognition
policies (especially with internet
sales) will aid the auditor in
determination oI proper recognition
in accordance with GAAP.
O The entity`s
objectives,
O What are the entity`s overall
strategies Ior obtaining rights to sell
O II the entity obtains rights to music
that is not marketable, the entity

Key Issue
Describe knowledge used to develop
a knowledgeable perspective about
HipStar
Describe how knowledge would be
useful in performing the audit.
strategies and
related business
risks
the music oI new and existing artists?
O Does the entity have suIIicient
inIrastructure to meet growth iI it
materializes?
O Does the entity have contingency
plans iI actual demand does not meet
estimated demand?
may have net realizable value issues
with various recorded assets.
O II the client over invests in
inIrastructure the auditor should
consider whether asset impairment
issues exist.
O How the entity
measures and
reviews its
Iinancial
perIormance
O How does management review and
approve day-to-day revenues and
expenditures?
O How does management and the board
oI directors review the overall
perIormance oI the entity?
O What non-Iinancial measures are used
to monitor entity perIormance?
O What review exists oI the entity`s
selection oI accounting policies?
O Extensive and careIul review oI
accounting data by management
may improve the reliability oI
accounting inIormation.
Particularly iI the inIormation is
used in making business decisions.
O II accounting data is not used Ior
evaluating perIormance or Ior
holding management accountable,
there is less reason to believe that
controls are eIIective over
developing reliable inIormation.
O The auditor may be concerned by
whether the business risks are
heightened by management pushing
the boundaries oI accounting
principles, revenue recognition,
capitalizing transactions that should
be expensed, and accounting
estimates to improve reported
Iinancial results.