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6.6 End-of-Chapter Exercises


  1. Why do people and organizations need to have trust in the financial reporting process?
  2. What is the Securities and Exchange Commission (SEC)?
  3. What types of companies fall under the jurisdiction of the SEC?
  4. According to the SEC, who has the responsibility for setting generally accepted accounting principles in the United States (U.S. GAAP)?
  5. What is the purpose of the Accounting Standards Codification?
  6. What is a Form 10-K and a Form 10-Q?
  7. Within the SEC, what is the purpose of EDGAR?
  8. What role in the setting of financial accounting standards is played by the Emerging Issues Task Force (EITF)?
  9. Why does the SEC not examine all the submitted financial statements to ensure their fair presentation?
  10. Why must public companies hire an independent auditing firm before they submit their financial statements to the SEC?
  11. Why do nonpublic companies often have their financial statements audited?
  12. What is a CPA? How does a person become a CPA?
  13. What organization regulates and sets the standards for the firms that audit public companies?
  14. What legislation established the Public Company Accounting Oversight Board (PCAOB)?
  15. What organization sets the standards for the firms that do not audit public companies?
  16. An independent auditor examines the financial statements prepared by the management of Simon Corporation. Who is the primary beneficiary of the audit work?
  17. An independent auditor examines the financial statements prepared by the management of Garfunkel Corporation. The auditor believes the financial information is fairly presented according to U. S. GAAP. What type of assurance does the auditor provide?
  18. Why do auditors not provide absolute assurance that examined financial statements are presented fairly according to U.S. GAAP?
  19. What are internal controls?
  20. How is an auditor’s work affected by the presence and quality of a company’s internal controls?
  21. What is an unqualified audit opinion?
  22. Why might an auditor include an explanatory paragraph in an audit report between the scope paragraph and the opinion paragraph?
  23. Under what conditions does an auditor not render an unqualified opinion?

True or False

  1. ____ The Howard Company has exceptionally good internal control. The quality of that internal control has no effect on the work of the company’s independent auditor.
  2. ____ An accountant becomes a CPA based on federal rules and regulations.
  3. ____ A person who works as an accountant for a significant number of years becomes known as a CPA.
  4. ____ The SEC is the current accounting standard-setting body in the United States.
  5. ____ The inclusion of an added paragraph in an audit report after the scope (second) paragraph indicates that the financial statement contains a material misstatement.
  6. ____ The PCAOB oversees the work of CPAs who audit companies that issue publicly traded securities.
  7. ____ Nonpublic companies rarely have an audit performed on their financial statements because they do not issue publicly traded securities.
  8. ____ The Auditing Standards Board works under FASB to resolve relatively simple issues.
  9. ____ The Red Company creates a new type of transaction and is not sure how to apply current U.S. GAAP for its reporting. The EITF might be called on to provide guidance.
  10. ____ Janice Hough serves as an investment analyst for a number of wealthy clients. She is likely to make use of EDGAR.
  11. ____ The Accounting Standards Codification is one portion of U.S. GAAP.
  12. ____ Audits are paid for by the creditors and investors of a company that receive the actual benefit of the CPA’s work.
  13. ____ A CPA firm rarely has more than 100 auditors in its employment.
  14. ____ The term “presents fairly” means that the financial information contained in a set of financial statements is correct.
  15. ____ FASB is a governmental agency that works under the jurisdiction of the SEC.

Multiple Choice

  1. Whittington and Company is a CPA firm that audits publicly traded companies in the state of Oregon. Which of the following is true concerning Whittington and Company?

    1. Whittington and Company is regulated by FASB.
    2. Whittington and Company is hired by the companies that the firm audits.
    3. Whittington and Company should follow the auditing standards set forth by the Auditing Standards Board (ASB).
    4. Whittington and Company prepares the financial statements for the companies that the firm audits.
  2. Which of the following is not true about an audit report?

    1. An extra paragraph inserted after the scope paragraph indicates that the auditor has given something other than an unqualified opinion.
    2. If a material misstatement is discovered in the financial statements, the auditor should not issue an unqualified opinion.
    3. The report is addressed to the company’s board of directors and shareholders.
    4. To ensure that the opinion is properly noted, it is provided in the very first sentence of the first paragraph.
  3. Which of the following is true about the Financial Accounting Standards Board (FASB)?

    1. FASB sets standards that apply to companies throughout the world.
    2. FASB was created by the EITF to handle smaller issues in a timely manner.
    3. FASB produces accounting standards that apply to virtually all companies in the United States.
    4. FASB was created by the Securities Exchange Act of 1934.
  4. Which organization is a governmental entity?

    1. SEC
    2. FASB
    3. EITF
    4. ASB
  5. Which of the following is true about the Securities and Exchange Commission (SEC)?

    1. The SEC sets accounting standards in the United States.
    2. The SEC was not given any enforcement powers by the U.S. Congress.
    3. The SEC was charged with ensuring that adequate and fair information is made available about publicly traded companies.
    4. The SEC is an international agency that monitors financial reporting around the world.
  6. Which of the following is true about the PCAOB?

    1. It regulates firms that audit companies that issue publicly traded securities.
    2. It sets accounting standards for smaller U.S. companies.
    3. It was created in 1934 during the Great Depression.
    4. Its standards apply to all companies within the United States.
  7. An independent auditor provides an unqualified opinion on the financial statements of the O’Neil Corporation. Which of the following statements is true?

    1. The auditor must have followed the standards produced by the Auditing Standards Board (ASB).
    2. The first paragraph of the audit report indicates the auditor’s responsibility and the company’s responsibility.
    3. The SEC oversees the financial reporting by O’Neil.
    4. An added paragraph before the scope paragraph indicates that the auditor has not provided an unqualified audit opinion.
  8. Which of the following is not a reason why an auditor only provides reasonable assurance in an audit report?

    1. Financial statements contain numerous estimations.
    2. The sheer volume of transactions means that the auditor cannot examine every transaction or other event.
    3. U.S. GAAP have only been produced since 2002 and do not cover all possible transactions.
    4. Fraud can be hidden from the independent auditor by the management of the reporting company.
  9. Which of the following is not necessary to become a Certified Public Accountant (CPA)?

    1. A specified amount of education
    2. Two years of work with one of the Big Four firms
    3. A passing grade on every part of the CPA Exam
    4. Practical experience

Video Problems

Professor Joe Hoyle discusses the answers to these two problems at the indicated links. After formulating your answers, watch each video to see how Professor Hoyle answers these questions.

  1. Your roommate is an English major. The roommate’s parents own a chain of ice cream shops throughout Florida. One day, on the way to a psychology class, your roommate poses this question: “Each year, my parents produce a set of financial statements for their business. The statements look great. Then, after all the work is finished, they go out and hire a CPA who charges them a hefty fee. That seems like such a waste of money. The financial statements have already been prepared before the CPA ever shows up. What are they getting for their money?” How would you respond?

  2. Your uncle and two friends started a small office supply store several years ago. The company has expanded and now has several large locations. Your uncle knows that you are taking a financial accounting class and asks you the following question: “Our growth has been moving forward very nicely. We have an excellent business that is poised to continue getting bigger. Recently, our accountant came to us and indicated that we would need to start following the rules and regulations of the Securities and Exchange Commission. I realize that this can be time consuming and costly. Why do we need to worry about the SEC now when we have not had to do so in the past?” How would you respond?


  1. Match the following organizations to their descriptions.

    • ____ FASB
    • ____ PCAOB
    • ____ SEC
    • ____ EITF
    • ____ ASB
    1. Sets auditing standards for auditors of publicly traded companies
    2. Sets U.S. Generally Accepted Accounting Principles
    3. Helps apply U.S. Generally Accepted Accounting Principles to new situations
    4. Sets auditing standards for auditors of private companies
    5. Created by the Securities Exchange Act of 1934 to protect investors
  2. In an unqualified audit report, the first three paragraphs are the introductory paragraph, scope paragraph, and opinion paragraph. Describe the purpose of each and list several items included in each.
  3. Explain the difference between the work of the PCAOB and the ASB.
  4. Explain the difference between the work of the EITF and FASB.
  5. Provide a short description of the role that each of the following plays in the financial reporting process.

    • FASB
    • Big Four
    • Unqualified audit opinion
    • EDGAR
    • Internal control

Research Assignments

  1. The role of the CPA in the world of business is often misunderstood. Go to the Web site On the left side of the homepage, there are several links including “The Profession,” “Education,” “Career Tools,” and “Exam & Licensure.” Click on the link that seems most interesting. Make a list of four things that you learned by exploring the information provided through the chosen link.
  2. Assume that you take a job as a summer employee for an investment advisory service. Your boss tells you that you need to learn to use the SEC Web site and EDGAR to locate information about various companies. For example, the boss wants to know whether the inventory held by PepsiCo increased or decreased between 2009 and 2010. That information will be found in the Form 10-K, which is the annual report filed by the company with the SEC. To get started, the boss jots down the following steps to find that desired piece of information. Follow the steps and determine the change. The boss also gives one more suggestion: “As you search through the Form 10-K for this company, start to notice all of the other types of information that are readily available to help us understand this company, its financial health and future prospects.”

    1. Go to
    2. Scroll down to “Filings & Forms.”
    3. Click on “Search for Company Filings.”
    4. Click on “Company or fund name, ticker symbol, CIK (Central Index Key), file number, state, country, or SIC (Standard Industrial Classification).”
    5. Type in “PepsiCo” in the “Company Name” box and click on “Find Companies.”
    6. On the “Filter Results” line, type “10-K” into the “Filing Type” box and type “20110701” into the “Prior to” box and click on “Search.”
    7. The top line for the list of filings should be the 10-K that was filed by the company on 2011-02-18. Click on the “Documents” link for that 10-K.
    8. On the top line is listed the original 10-K filed on that date. Click on the link “d10k.htm.”
    9. The original Form 10-K filed by PepsiCo for the fiscal year ended December 25, 2010, should appear.
    10. Scroll to page 75 and find the consolidated balance sheet for 2010 and 2009. Determine the amount of inventory reported by PepsiCo as of the end of both of these years and the increase or decrease that took place.