Auditing: The Art And Science Of Assurance Engagements, Fourteenth Canadian Edition Solution Manual

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SOLUTIONS MANUAL
Auditing
The Art and Science of Assurance Engagements
Fourteenth Canadian Edition
Alvin A. Arens
Former PricewaterhouseCoopers Emeritus Professor, Michigan State University
Randal J. Elder
Syracuse University
Mark S. Beasley
North Carolina State University, Deloitte Professor of Enterprise Risk Management
Chris E. Hogan
Michigan State University
Joanne C. Jones
York University

Contents
Chapters
1 The demand for audit and other assurance services ............................. 1-1
2 The public accounting profession and audit quality ................................ 2-1
3 Professional ethics and legal liability ......................................................... 3-1
4 Audit responsibilities and objectives.......................................................... 4-1
5 Audit evidence............................................................................................... 5-1
6 Client acceptance, planning, and materiality ........................................... 6-1
7 Assessing the risk of material misstatement ............................................ 7-1
8 Internal control and COSO framework ...................................................... 8-1
9 Assessing control risk and designing tests of controls ........................... 9-1
10 Develop risk response: Audit strategy and audit program ...................10-1
11 Audit sampling concepts ...........................................................................11-1
12 Audit of the revenue cycle .........................................................................12-1
13 Audit of the acquisition and payment cycle ............................................13-1
14 Audit of the inventory and distribution cycle ...........................................14-1
15 Audit of the human resources and payroll cycle....................................15-1
16 Audit of the capital acquisition and repayment cycle ............................16-1
17 Audit of cash balances...............................................................................17-1
18 Completing the audit ..................................................................................18-1
19 Audit reports on financial statements ......................................................19-1
20 Other assurance and nonassurance services .......................................20-1

1-1
Chapter 1
The Demand for Audit and Other Assurance
Services
Concept Checks
C1-1 What is meant by determining the degree of correspondence between information and
established criteria? What is the criteria for the audit of a company’s financial statements?
To do an audit, there must be information in a verifiable form and some standards (criteria) by
which the auditor can evaluate the information. 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. For an audit of a company’s financial statements
the criteria are International Financial Reporting Standards, Accounting Standards for Private
Enterprises, Accounting Standards for Not-for-Profits.
C1-2 What are the major causes of information risk. How can information risk be reduced?
Information risk reflects the possibility that the information upon which the business risk
decision was made was inaccurate. The major causes of information risk are: remoteness of
information, biases and motives of the provider, voluminous data, and complex exchange
transactions. Users can reduce information risk by examining the information directly, sharing
the risk with the information preparer, or requesting some assurance over the information (either
an audit or a review engagement).
C1-3 Explain how and why the auditor makes information trustworthy and credible.
External users value the auditor’s assurance because of the auditor’s integrity, independence,
expertise, and knowledge of the subject matter. This makes the information credible and
trustworthy.
C1-4 Describe and explain the differences and similarities between financial statement,
compliance, and operational audits.
Differences—are based upon the information and criteria being audited: a financial statement
audit (e.g., historical financial statements) assesses evidence with respect to potential material
misstatements; a compliance audit (e.g., compliance with environmental legislation) assesses the
organization’s ability to comply with legislation; and an operational audit (e.g., effective factory
production) helps to provide good quality control and manage costs.
Similarities—The auditor is acting with due care, meaning that he/she is following some type of
systematic process governed by auditing standards (financial statements: CPA Canada
Handbook (GAAS); compliance: CPA Canada Handbook or IIA standards, depending upon
whether a public accountant is conducting the audit; and operational: most likely IIA standards).
The auditor is also independent and competent (although the degree of independence will vary
according to who is conducting the audit).

Instructor’s Solutions Manual for Auditing, Fourteenth Canadian Edition
1-2
C1-5 Describe and explain the difference and similarities among the various types of auditors.
Auditor Types of Engagements and Employers Type of Training
Internal Auditor Tend to perform compliance, financial,
and operational audits (although can
include fraud audits). Work for large for-
profit and not-for-profit organizations
(e.g., hospitals, universities).
Although there is no requirement
for a designation, internal auditors
often have a CPA or a CIA
designation. Internal auditors
receive extensive training on how
to conduct operational audits.
Government Auditor Performs value-for-money audits,
financial statement audits, and operational
audits. Increasing opportunity for
experience in operational auditing.
Employed by provincial or federal
government.
Government auditors generally
have a CPA designation (if
employed by the auditor general),
although some have a CIA
designation.
CRA Auditor Performs compliance audits related to
personal, corporate, and value-added
taxes (GST/HST). Works for the Canada
Revenue Agency.
Many CRA auditors have a CPA
designation (although not
required).
Fraud and forensic
auditors
Performs forensic and fraud audits. Many
forensic accountants and fraud auditors
work for public accounting firms (or firms
that specialize in forensic accounting
services). Some also work in industry,
government, and large not-for-profits (as
part of internal audit).
Many forensic accountants and
fraud auditors have a CPA
designation (although not
required). Some have a CIA
designation or one of the fraud
specialist designations.
Public Accountant The main engagements are related to
assurance of financial information for a
wide range of enterprises and industries –
particularly financial statement audits.
However, can also perform compliance
and operational audits. Opportunity for
experience in auditing, tax consulting, and
management consulting practices.
Public accountants have a CPA
designation as well as a public
accountant’s license.
Review Questions
1-1 You will be looking at his accounting records (evidence) and evaluating and collecting
information about those records. Your evaluation process will be done using relatively standard
audit procedures (part of GAAS – generally accepted auditing standards). Your objective is to
compare the evidence (his accounting records) to the financial statements that he has prepared
(which will become information available to others, such as the Canada Revenue Agency). To
help you evaluate his records (the evidence) you will use criteria (likely ASPE – Accounting
Standards for Private Enterprises). You are able to add value to the financial statements because
you are an independent professional qualified accountant.

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Instructor’s Solutions Manual for Auditing, Fourteenth Canadian Edition
1-4
1-6 The auditor will use risk assessment skills for several purposes:
 To assess the quality and effectiveness of the client’s risk assessment processes
 To assess the likelihood of fraud, error, or other misstatements in the client’s financial
statements
 To select the type of audit evidence that will need to be accumulated to mitigate the risks of
fraud, error or misstatement in the client’s financial statements
 For other assurance engagements (i.e. non-financial statements), the auditor will similarly
need to assess potential risks of error or fraud and design or select audit procedures in
response to those risks
1-7 The auditor must assess risks to select the appropriate evidence to be collected. If the
auditor does not know the risks, then the wrong evidence might be collected, or the wrong
quality or amount of evidence might be collected.
1-8 Assuming a bank is deciding to make a loan to a business, the bank will charge a rate of
interest determined primarily by the following three factors:
 Risk-free interest rate. This is approximately the rate the bank could earn by investing in
Canadian treasury bills for the same length of time as the business loan.
 Business risk. 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.
 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.
1-9 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.
1-10 The major differences in the scope of audit responsibilities are:
 Public accountants perform audits in accordance with generally accepted auditing standards
of published financial statements prepared in accordance with an acceptable financial
reporting framework
 Government auditors from the auditors general (federal or provincial) perform compliance or
operational (value-for-money) audits in order to assure the Parliament that the expenditure of
public funds is in accordance with its directives and the law and is done with efficiency,
economy and effectiveness. They also do financial statement audits of Crown Corporations,
or sub-contract this work to external public accountants.
 Canada Revenue Agency auditors perform compliance audits to enforce the federal tax laws
as defined by Parliament, interpreted by the courts, and regulated by the Income Tax Act.

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Chapter 1: The Demand for Audit and Other Assurance Services
1-5
 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.
1-11 Some Potential Engagements Include:
Financial Information Non Financial Information
Internal Auditor Audit of credit card expenditures
and accounts payable expenses to
determine if well-supported and
for legitimate business purpose
Business Continuity Audit to test if
systems can continue in the event of
unforeseen incidences
Government Auditor Costs associated with a capital
project funded by government.
A variety of value for money audits
– such as a direct report on
management and use of surgical
facilities
Forensic Auditor Fraud investigation into
misappropriation of funds at
community clinics
Attestation report on internal
controls over payroll
Public Accountant Financial statements and other
financial information
Attestation Report on Internal
Control over Financial Reporting
WebTrust or SysTrust report could
be prepared for transactions made
via the hospital’s secure web site or
with respect to the quality of
information systems used to process
prescription medication
Compliance with Agreements
Note: These are examples, and the list can be endless, depending upon the Hospital’s needs.
1-12
Audits of Financial
Statements
Compliance
Audits
Operational Audits
Objective To determine whether the
financial statements are
presented in accordance
with an acceptable
financial reporting
framework
To determine
whether the client is
following specific
procedures set by
higher authority
To evaluate whether
operating procedures
are efficient and
effective
Users of Audit
Report
Different groups for
different purposesmainly
outside entities
Authority setting
down procedures,
internal or external
Management of
organization

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