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7/15/13

auditing and assurance services, 15/e alvin a arens solutions manaual and test bank

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Alvin A Arens, Michigan State University
Randal J. Elder, Syracuse University
Mark S. Beasley, North Carolina State University

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    auditing and assurance services, 15/e alvin a arens solutions manaual and test bank





     Solutions Manual


     
     




    Auditing and
    Assurance Services
    Fifteenth Edition
    Alvin A. Arens
    Randal J. Elder
    Mark S. Beasley
    Chris Hogan


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    This work is protected by United States copyright laws and is provided solely for the use of instructors in teaching their courses and assessing student learning.  Dissemination or sale of any part of this work (including on the World Wide Web) will destroy the integrity of the work and is not permitted.   The work and materials from it should never be made available to students except by instructors using the accompanying text in their classes.   All recipients of this work are expected to abide by these restrictions and to honor the intended pedagogical purposes and the needs of other instructors who rely on these materials.







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    Copyright © 2014, 2012, 2010 Pearson Education, Inc. All rights reserved.
    Manufactured in the United States of America. This publication is protected by Copyright, and permission should be obtained from the publisher prior to any prohibited reproduction, storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise. To obtain permission(s) to use material from this work, please submit a written request to
    Pearson Education, Inc., Permissions Department, One Lake Street, Upper Saddle River, New Jersey 07458, or you may fax your request to 201-236-3290.

    Many of the designations by manufacturers and sellers to distinguish their products are claimed as trademarks. Where those designations appear in this book, and the publisher was aware of a trademark claim, the designations have been printed in initial caps or all caps.

    ISBN-13:   978-0-13-312571-9
    ISBN-10:          0-13-312571-8
     



    CONTENTS


    I.    THE AUDITING PROFESSION
                 1      The Demand for Audit and Other Assurance Services...        1-1
                 2      The CPA Profession........................................           2-1
                 3      Audit Reports................................................           3-1
                 4      Professional Ethics.........................................           4-1
                 5      Legal Liability................................................           5-1
    II.   THE AUDIT PROCESS
                 6      Audit Responsibilities and Objectives.....................           6-1
                 7      Audit Evidence..............................................           7-1
                 8      Audit Planning and Analytical Procedures................           8-1
                 9      Materiality and Risk.........................................           9-1
               10      Internal Control, Control Risk, and Section 404 Audits...         10-1
               11      Fraud Auditing...............................................         11-1
               12      The Impact of Information Technology on the Audit Process       12-1
               13      Overall Audit Strategy and Audit Program................         13-1
    III.   APPLICATION OF THE AUDIT PROCESS TO THE SALES AND COLLECTION CYCLE
               14      Audit of the Sales and Collection Cycle: Tests of Controls
                         and Substantive Tests of Transactions....................         14-1
               15      Auditing Sampling for Tests of Controls
                         and Substantive Tests of Transactions....................         15-1
               16      Completing the Tests in the Sales and Collection Cycle:
                         Accounts Receivable.......................................         16-1
               17      Audit Sampling for Tests of Details of Balances..........         17-1
    IV.  APPLICATION OF THE AUDIT PROCESS TO OTHER CYCLES
               18      Audit of the Acquisition and Payment Cycle:
                         Tests of Controls, Substantive Tests of Transactions,
                         and Accounts Payable......................................         18-1
               19      Completing the Tests in the Acquisition and Payment Cycle:
                         Verification of Selected Accounts..........................         19-1
               20      Audit of the Payroll and Personnel Cycle.................         20-1
               21      Audit of the Inventory and Warehousing Cycle...........         21-1
               22      Audit of the Capital Acquisition and Repayment Cycle...         22-1
               23      Audit of Cash and Financial Instruments..................         23-1
    V.   COMPLETING THE AUDIT
               24      Completing the Audit........................................         24-1
    VI.  OTHER ASSURANCE AND NONASSURANCE SERVICES
               25      Other Assurance Services..................................         25-1
               26      Internal and Governmental Financial Auditing
                         and Operational Auditing...................................         26-1




     Chapter 1

    The Demand for Audit and Other Assurance Services


    <   Review Questions

    1-1 The relationship among audit services, attestation services, and assurance services is reflected in Figure 1-3 on page 12 of the text. An assurance service is an independent professional service to improve the quality of information for decision makers. An attestation service is a form of assurance service in which the CPA firm issues a report about the reliability of an assertion that is the responsibility of another party. Audit services are a form of attestation service in which the auditor expresses a written conclusion about the degree of correspondence between information and established criteria.
          The most common form of audit service is an audit of historical financial statements, in which the auditor expresses a conclusion as to whether the financial statements are presented in accordance with an applicable financial reporting framework such as U.S. GAAP or IFRS. An example of an attestation service is a report on the effectiveness of an entity’s internal control over financial reporting. There are many possible forms of assurance services, including services related to business performance measurement, health care performance, and information system reliability.

    1-2 An independent audit is a means of satisfying the need for reliable information on the part of decision makers. Factors of a complex society that contribute to this need are:

    1.               Remoteness of information
    a.               Owners (stockholders) divorced from management
    b.               Directors not involved in day-to-day operations or decisions
    c.               Dispersion of the business among numerous geographic locations and complex corporate structures
    2.               Biases and motives of provider
    a.               Information will be biased in favor of the provider when his or her goals are inconsistent with the decision maker’s goals.
    3.               Voluminous data
    a.               Possibly millions of transactions processed daily via sophisticated computerized systems
    b.               Multiple product lines
    c.               Multiple transaction locations
    4.               Complex exchange transactions
    a.               New and changing business relationships lead to innovative accounting and reporting problems
    b.               Potential impact of transactions not quantifiable, leading to increased disclosures


    1-3     1.       Risk-free interest rate  This is approximately the rate the bank could earn by investing in U.S. treasury notes for the same length of time as the business loan.
    2.               Business risk for the customer  This risk reflects the possibility that the business will not be able to repay its loan because of economic or business conditions such as a recession, poor management decisions, or unexpected competition in the industry.
    3.               Information risk  This risk reflects the possibility that the information upon which the business risk decision was made was inaccurate. A likely cause of the information risk is the possibility of inaccurate financial statements.

          Auditing has no effect on either the risk-free interest rate or business risk. However, auditing can significantly reduce information risk.

    1-4 The four primary causes of information risk are remoteness of information, biases and motives of the provider, voluminous data, and the existence of complex exchange transactions.
          The three main ways to reduce information risk are:

    1.               User verifies the information.
    2.               User shares the information risk with management.
    3.               Audited financial statements are provided.

          The advantages and disadvantages of each are as follows:


    ADVANTAGES
    DISADVANTAGES
    USER VERIFIES INFORMATION
    1.     User obtains information desired.
    2.     User can be more confident of the qualifications and activities of the person getting the information.
    1.     High cost of obtaining information.
    2.     Inconvenience to the person providing the information because large number of users would be on premises.
    USER SHARES INFORMATION RISK WITH MANAGEMENT
    1.     No audit costs incurred.
    1.     User may not be able to collect on losses.
    AUDITED FINANCIAL STATEMENTS ARE PROVIDED
    1.     Multiple users obtain the information.
    2.     Information risk can usually be reduced sufficiently to satisfy users at reasonable cost.
    3.     Minimal inconvenience to management by having only one auditor.
    1.     May not meet needs of certain users.
    2.     Cost may be higher than the benefits in some situations, such as for a small company.


    1-5 To do an audit, there must be information in a verifiable form and some standards (criteria) by which the auditor can evaluate the information. Examples of established criteria include generally accepted accounting principles and the Internal Revenue Code. Determining the degree of correspondence between information and established criteria is determining whether a given set of information is in accordance with the established criteria. The information for Jones Company’s tax return is the federal tax returns filed by the company. The established criteria are found in the Internal Revenue Code and all interpretations. For the audit of Jones Company’s financial statements, the information is the financial statements being audited and the established criteria are generally accepted accounting principles.

    1-6 The primary evidence the internal revenue agent will use in the audit of the Jones Company’s tax return include all available documentation and other information available in Jones’ office or from other sources. For example, when the internal revenue agent audits taxable income, a major source of information will be bank statements, the cash receipts journal, and deposit slips. The internal revenue agent is likely to emphasize unrecorded receipts and revenues. For expenses, major sources of evidence are likely to be cancelled checks and electronic funds transfers, vendors’ invoices, and other supporting documentation.

    1-7 This apparent paradox arises from the distinction between the function of auditing and the function of accounting. The accounting function is the recording, classifying and summarizing of economic events to provide relevant information to decision makers. The rules of accounting are the criteria used by the auditor for evaluating the presentation of economic events for financial statements and he or she must therefore have an understanding of accounting standards, as well as auditing standards. The accountant need not, and frequently does not, understand what auditors do, unless he or she is involved in doing audits, or has been trained as an auditor.



    1-8


    AUDITS OF
    FINANCIAL
    STATEMENTS
    OPERATIONAL
    AUDITS
    COMPLIANCE
    AUDITS
    PURPOSE
    To determine whether the overall financial statements are presented in accordance with specified criteria (usually GAAP)
    To evaluate whether operating procedures are efficient and effective
    To determine whether the client is following specific procedures set by higher authority
    USERS OF AUDIT REPORT
    Different groups for different purposes — many outside entities
    Management of organization
    Authority setting down procedures, internal or external
    NATURE
    Highly standardized
    Highly nonstandard; often subjective
    Not standardized, but specific and usually objective
    PERFORMED BY:
    CPAs
    Almost universally
    Frequently
    Occasionally
    GAO
    AUDITORS
    Occasionally
    Frequently
    Frequently
    IRS
    AUDITORS
    Never
    Never
    Universally
    INTERNAL
    AUDITORS
    Frequently
    Frequently
    Frequently

    1-9 Five examples of specific operational audits that could be conducted by an internal auditor in a manufacturing company are:

    1.               Examine employee time records and personnel records to determine if sufficient information is available to maximize the effective use of personnel.
    2.               Review the processing of sales invoices to determine if it could be done more efficiently.
    3.               Review the acquisitions of goods, including costs, to determine if they are being purchased at the lowest possible cost considering the quality needed.


    1-9 (continued)

    4.               Review and evaluate the efficiency of the manufacturing process.
    5.               Review the processing of cash receipts to determine if they are deposited as quickly as possible.

    1-10   When auditing historical financial statements, an auditor must have a thorough understanding of the client and its environment. This knowledge should include the client’s regulatory and operating environment, business strategies and processes, and measurement indicators. This strategic understanding is also useful in other assurance or consulting engagements. For example, an auditor who is performing an assurance service on information technology would need to understand the client’s business strategies and processes related to information technology, including such things as purchases and sales via the Internet. Similarly, a practitioner performing a consulting engagement to evaluate the efficiency and effectiveness of a client’s manufacturing process would likely start with an analysis of various measurement indicators, including ratio analysis and benchmarking against key competitors.

    1-11     The major differences in the scope of audit responsibilities are:

    1.               CPAs perform audits in accordance with auditing standards of published financial statements prepared in accordance with U.S. GAAP or IFRS.
    2.               GAO auditors perform compliance or operational audits in order to assure the Congress of the expenditure of public funds in accordance with its directives and the law.
    3.               IRS agents perform compliance audits to enforce the federal tax laws as defined by Congress, interpreted by the courts, and regulated by the IRS.
    4.               Internal auditors perform compliance or operational audits in order to assure management or the board of directors that controls and policies are properly and consistently developed, applied, and evaluated.

    1-12     The four parts of the Uniform CPA Examination are: Auditing and Attestation, Financial Accounting and Reporting, Regulation, and Business Environment and Concepts.

    1-13     Information risk is the risk that information upon which a business decision is made is inaccurate. Fair value accounting is often based on estimates and requires judgment. Fair value can be estimated using multiple methods with some estimates being more subjective than others. Fair value estimates are made at a point in time, but can also change rapidly, depending on market conditions. All of these factors increase information risk.


    <   Multiple Choice Questions From CPA Examinations

    1-14   a.    (3)          b.    (2)          c.    (2)          d.    (1)

    1-15   a.    (2)          b.    (3)          c.    (4)          d.    (2)


    <   Discussion Questions And Problems

    1-16   a.       The relationship among audit services, attestation services, and assurance services is reflected in Figure 1-3 on page 12 of the text. Audit services are a form of attestation service, and attestation services are a form of assurance service. In a diagram, audit services are located within the attestation service area, and attestation services are located within the assurance service area.

    b.               1.       (2)     An attestation service other than an audit service
    2.               (1) An audit of historical financial statements
    3. (2)       An attestation service other than an audit service
    4.               (2) An attestation service other than an audit service; or
    (3)      An assurance service that is not an attestation service (WebTrust developed from the AICPA Special Committee on Assurance Services, but the service meets the criteria for an attestation service.)
    5. (2)  An attestation service other than an audit service
    6. (2)  An attestation service other than an audit service
    7. (2)  An attestation service other than an audit service
    8. (2)  An attestation service that is not an audit service
    (Review services are a form of attestation, but are performed according to Statements on Standards for Accounting and Review Services.)
    9. (2)       An assurance service that is not an attestation service
    10.         (2)       An attestation service other than an audit service
    11.         (3)  An assurance service that is not an attestation service

    1-17   a.       The interest rate for the loan that requires a review report is lower than the loan that did not require a review because of lower information risk. A review report provides moderate assurance to financial statement users, which lowers information risk. An audit report provides further assurance and lower information risk. As a result of reduced information risk, the interest rate is lowest for the loan with the audit report.

    b.               Given these circumstances, Busch should select the loan from First City Bank that requires an annual audit. In this situation, the additional cost of the audit is less than the reduction in interest due to lower information risk. The following is the calculation of total costs for each loan:

    test bank for Auditing and Assurance Services, 15e (Arens)
    Chapter 6   Audit Responsibilities and Objectives

    Learning Objective 6-1

    1) The objective of an audit of the financial statements is an expression of an opinion on:
    A) the fairness of the financial statements in all material respects.
    B) the accuracy of the financial statements.
    C) the accuracy of the annual report.
    D) the accuracy of the balance sheet and income statement.
    Answer:  A
    Terms:  Objective of ordinary audit of financial statements
    Diff:  Easy
    Objective:  LO 6-1
    AACSB:  Reflective thinking skills

    2) If the auditor believes that the financial statements are not fairly stated or is unable to reach a conclusion because of insufficient evidence, the auditor:
    A) should withdraw from the engagement.
    B) should request an increase in audit fees so that more resources can be used to conduct the audit.
    C) has the responsibility of notifying financial statement users through the auditor's report.
    D) should notify regulators of the circumstances.
    Answer:  C
    Terms:  Auditor believes that financial statements are nor fairly presented
    Diff:  Easy
    Objective:  LO 6-1
    AACSB:  Reflective thinking skills

    3) Auditors accumulate evidence to:
    A) defend themselves in the event of a lawsuit.
    B) determine if the financial statements are correct.
    C) satisfy the requirements of the Securities Acts of 1933 and 1934.
    D) reach a conclusion about the fairness of the financial statements.
    Answer:  D
    Terms:  Auditors accumulate evidence
    Diff:  Easy
    Objective:  LO 6-1
    AACSB:  Reflective thinking skills


    Learning Objective 6-2

    1) The responsibility for adopting sound accounting policies and maintaining adequate internal control rests with the:
    A) board of directors.
    B) company management.
    C) financial statement auditor.
    D) company's internal audit department.
    Answer:  B
    Terms:  Responsibility for adopting sound accounting policies and maintaining adequate internal controls
    Diff:  Easy
    Objective:  LO 6-2
    AACSB:  Reflective thinking skills
    2) If management insists on financial statement disclosures that the auditor finds unacceptable, the auditor can withdraw from the engagement or:
    A)
    Issue an adverse audit report
    Issue a qualified audit report
    Yes
    Yes

    B)
    Issue an adverse audit report
    Issue a qualified audit report
    No
    No

    C)
    Issue an adverse audit report
    Issue a qualified audit report
    Yes
    No

    D)
    Issue an adverse audit report
    Issue a qualified audit report
    No
    Yes

    Answer:  A
    Terms:  Auditor insists on financial statement disclosures that management finds unacceptable
    Diff:  Easy
    Objective:  LO 6-2
    AACSB:  Reflective thinking skills


    3) In certifying their annual financial statements, the CEO and CFO of a public company certify that the financial statements comply with the requirements of:
    A) GAAP.
    B) the Sarbanes-Oxley Act.
    C) the Securities Exchange Act of 1934.
    D) GAAS.
    Answer:  C
    Terms:  Certifying annual financial statements by CEO and CFO
    Diff:  Easy
    Objective:  LO 6-2
    AACSB:  Reflective thinking skills
    Topic:  Public

    4) Which of the following statements is true of a public company's financial statements?
    A) Sarbanes-Oxley requires the CEO only to certify the financial statements.
    B) Sarbanes-Oxley requires the CFO only to certify the financial statements.
    C) Sarbanes-Oxley requires the CEO and CFO to certify the financial statements.
    D) Sarbanes-Oxley requires neither the CEO nor the CFO to certify the financial statements.
    Answer:  C
    Terms:  Public company's financial statements
    Diff:  Easy
    Objective:  LO 6-2
    AACSB:  Reflective thinking skills
    Topic:  SOX
    5) The responsibility for the preparation of the financial statements and the accompanying footnotes belongs to:
    A) the auditor.
    B) management.
    C) both management and the auditor equally.
    D) management for the statements and the auditor for the notes.
    Answer:  B
    Terms:  Responsibility for preparation of the financial statements and the accompanying footnotes
    Diff:  Moderate
    Objective:  LO 6-2
    AACSB:  Reflective thinking skills

    6) Because they operate the business on a daily basis, a company's management knows more about the company's transactions and related assets, liabilities, and equity than the auditors.
    A) True
    B) False
    Answer:  A
    Terms:  Responsibility for fair presentation of financial statements
    Diff:  Easy
    Objective:  LO 6-2
    AACSB:  Reflective thinking skills

    7) The annual reports of many public companies include a statement about management's responsibilities and relationship with the CPA firm.
    A) True
    B) False
    Answer:  A
    Terms:  Management's responsibility and relationship with CPA firm
    Diff:  Easy
    Objective:  LO 6-2
    AACSB:  Reflective thinking skills

    8) The auditors determine which disclosures must be presented in the financial statements. 
    A) True
    B) False
    Answer:  B
    Terms:  Responsibility for fair presentation of financial statements
    Diff:  Easy
    Objective:  LO 6-2
    AACSB:  Reflective thinking skills
    Learning Objective 6-3

    1) The auditor's best defense when material misstatements are not uncovered is to have conducted the audit:
    A) in accordance with generally accepted auditing standards.
    B) as effectively as reasonably possible.
    C) in a timely manner.
    D) only after an adequate investigation of the management team.
    Answer:  A
    Terms:  Auditors' best defense when material misstatements are not uncovered
    Diff:  Easy
    Objective:  LO 6-3
    AACSB:  Reflective thinking skills

    2) An audit must be performed with an attitude of professional skepticism. Professional skepticism consists of two primary components: a questioning mind and:
    A) the assumption that upper-level management is dishonest.
    B) a critical assessment of the audit evidence.
    C) the assumption that all employees are motivated by greed.
    D) verification of all critical information by independent third parties.
    Answer:  B
    Terms:  Attitude of professional skepticism
    Diff:  Easy
    Objective:  LO 6-3
    AACSB:  Reflective thinking skills


    3) Which of the following is not one of the reasons that auditors provide only reasonable assurance on the financial statements?
    A) The auditor commonly examines a sample, rather than the entire population of transactions.
    B) Accounting presentations contain complex estimates which involve uncertainty.
    C) Fraudulently prepared financial statements are often difficult to detect.
    D) Auditors believe that reasonable assurance is sufficient in the vast majority of cases.
    Answer:  D
    Terms:  Reasons auditors provide only reasonable assurance on financial statements
    Diff:  Easy
    Objective:  LO 6-3
    AACSB:  Reflective thinking skills

    4) Which of the following statements is the most correct regarding errors and fraud?
    A) An error is unintentional, whereas fraud is intentional.
    B) Frauds occur more often than errors in financial statements.
    C) Errors are always fraud and frauds are always errors.
    D) Auditors have more responsibility for finding fraud than errors.
    Answer:  A
    Terms:  Errors and fraud
    Diff:  Easy
    Objective:  LO 6-3
    AACSB:  Reflective thinking skills
    5) When an auditor believes that an illegal act may have occurred, the auditor should first:
    A) obtain an understanding of the nature and circumstances of the act.
    B) consult with legal counsel or others knowledgeable about the illegal act.
    C) discuss the matter with the audit committee.
    D) withdraw from the engagement.
    Answer:  A
    Terms:  Auditor believes and illegal act may have occurred
    Diff:  Easy
    Objective:  LO 6-3
    AACSB:  Reflective thinking skills

    6) The auditor has no responsibility to plan and perform the audit to obtain reasonable assurance that misstatements, whether caused by errors or fraud, that are not ________ are detected.
    A) important to the financial statements
    B) statistically significant to the financial statements
    C) material to the financial statements
    D) identified by the client
    Answer:  C
    Terms:  Auditor has no responsibility to plan and perform audit to obtain reasonable assurance
    Diff:  Easy
    Objective:  LO 6-3
    AACSB:  Reflective thinking skills


    7) Fraudulent financial reporting is most likely to be committed by whom?
    A) Line employees of the company
    B) Outside members of the company's board of directors
    C) Company management
    D) The company's auditors
    Answer:  C
    Terms:  Fraudulent financial reporting
    Diff:  Easy
    Objective:  LO 6-3
    AACSB:  Reflective thinking skills

    8) Which of the following would most likely be deemed a direct-effect illegal act?
    A) Violation of federal employment laws
    B) Violation of federal environmental regulations
    C) Violation of federal income tax laws
    D) Violation of civil rights laws
    Answer:  C
    Terms:  Direct-effect illegal act
    Diff:  Easy
    Objective:  LO 6-3
    AACSB:  Reflective thinking skills
    9) The concept of reasonable assurance indicates that the auditor is:
    A) not a guarantor of the correctness of the financial statements.
    B) not responsible for the fairness of the financial statements.
    C) responsible only for issuing an opinion on the financial statements.
    D) responsible for finding all misstatements.
    Answer:  A
    Terms:  Concept of reasonable assurance
    Diff:  Easy
    Objective:  LO 6-3
    AACSB:  Reflective thinking skills

    10) Which of the following is the auditor least likely to do when aware of an illegal act?
    A) Discuss the matter with the client's legal counsel.
    B) Obtain evidence about the potential effect of the illegal act on the financial statements.
    C) Contact the local law enforcement officials regarding potential criminal wrongdoing.
    D) Consider the impact of the illegal act on the relationship with the company's management.
    Answer:  C
    Terms:  Illegal acts
    Diff:  Easy
    Objective:  LO 6-3
    AACSB:  Reflective thinking skills


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