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Auditing: The Art And Science Of Assurance Engagements, Fourteenth Canadian Edition Class Notes

Auditing: The Art And Science Of Assurance Engagements, Fourteenth Canadian Edition Class Notes provides helpful chapter hints to guide your studying and ensure you focus on the most important concepts.

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    INSTRUCTOR’S RESOURC E MANUAL Bartosz Amerski York University Joanne Jones York University 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 CLASS NOTES

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    Introduction: An overview of the instructor’s resource manual ii Contents Page An Overvi ew of the Instructor’s Resource Manual ........................................ iv Chapters 1 The demand for audit and other assurance services ............................. 1 2 The public accounting profession and audit quality .............................. 10 3 Professional ethics and legal liability .................................................... 16 4 Audit responsibilities and objectives .................................................... 25 5 Audit evidence ..................................................................................... 39 6 Client acceptance, planning, and materiality ........................................ 50 7 Assessing the risk of material misstatement ........................................ 61 8 Internal control and COSO framework ................................................. 69 9 Assessing control risk and designing tests of controls ......................... 74 10 Develop risk response: Audit strategy and audit program .................... 80 11 Audit sampling concepts ...................................................................... 88 12 Audit of the revenue cycle .................................................................... 99 13 Audit of the acquisition and payment cycle ........................................ 108 14 Audit of the inventory and distribution cycle ....................................... 116 15 Audit of the human resources and payroll cycle................................. 124 16 Audit of the capital acquisition and repayment cycle .......................... 130 17 Audit of cash balances ....................................................................... 136 18 Completing the audit .......................................................................... 142 19 Audit reports on financial statements ................................................. 150 20 Other assurance and nonassurance services .................................... 160

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    Introduction: An overview of the instructor’s resource manual iv An Overview of the Instructor’s Resource Manual The purpose of the Instructor’s Resource Manual is to help you teach auditing courses more efficiently and, perhaps more importantly, to encourage student engagement. Naturally, we do not want to interfere with your present approach or imply that our suggestions are the only good alternatives. This resource manual has several parts:  An illustrative course outline for a traditional 12 - week university introductory auditing course.  Some resources, from accounting education journals we have used for group and individual projects.  Some group and individual projects we and other instructors have successfully used.  Mapping the chapters to the CPA Competency Map’s Fundamental Assurance Concepts and Related Technical Competencies  Chapter - by - chapter suggestions for teaching the content in each chapter. The suggestions for each chapter include the following:  Ideas we find useful in teaching introductory auditing.  Discussion and practice questions we have found to be effective in facilitating student learning and keeping the class interesting.  Additional teaching resources and videos to reinforce and integrate the learning objectives.  A matrix illustrating how learning objectives correlate with chapter problem material. The matrix for each chapter is designed to provide a one - page summary of this information in order to assist you in assigning problem material. The chapters are designed so that their arrangement and selection provide maximum flexibility in course design.

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    Instructor's Resource Manual for Auditing , 14Ce, by Arens/Elder/Beasley/Hogan/Jones v Suggested Syllabi In this section, we provide a possible schedule for use in a one - semester university - level introductory - level audit course. We also provide suggested problem assignments that could easily be presented in your syllabus as well as the course evaluation scheme. Some of the questions we use for 4 individual graded assignments. You will note that we cover the three key cycles (revenue, acquisition and payment, and inventory and distribution) as well as cash. Some of you may wish to cover some of the other cycles as well. From the last chapter, which covers special reports and other assurance engagements, we only cover reviews and compilation engagements. The remaining material, we cover in our advanced auditing course. Following our suggested syllabi, we briefly overview other teaching materials that you might find helpful as you develop your plan for coverage of the course content.

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    Introduction: An overview of the instructor’s resource manual vi Organization of the Course (assumes two 1 ½ hour classes or one three - hour class per week) Week Topics Chapters Practice or Discussion Questions 1 Introduction, audit and other assurance services T he public accounting profession and audit quality 1 and 2 1 - 1 9 , 1 - 2 8 , 2 - 2 4 , 2 - 2 6 2 P rofessional ethics and legal liability Audit responsibilities and objectives 3 and 4 3 - 29, 3 - 32, 4 - 31, 4 - 33 3 Audit evidence Client acceptance , planning , and materiality 5 and 6 5 - 33, 5 - 35, 5 - 36 6 - 40 , 6 - 41 , 6 - 44 4 Assessing the risk of material misstatement 7 7 - 35 , 7 - 36 5 Internal controls , COSO framework Assessing control risk and test of controls 8 and 9 8 - 27, 8 - 31, 9 - 26, 9 - 32 6 Midterm 7 A udit strategy and program Sampling concepts 10 and 11 10 - 2 7 , 10 - 2 8 , 10 - 31 , 11 - 3 4 8 Audit of revenue cycle 1 2 12 - 41, 12 - 42, 12 - 4 7 , 12 - 4 8 9 Audit of acquisition and payment and inventory and distribution cycles 1 3 and 14 13 - 28, 13 - 3 5 , 14 - 26, 14 - 2 7 1 0 Audit of cash and c ompleting the audit 17 and 18 17 - 2 3 , 17 - 2 5 , 18 - 2 6 , 18 - 33 11 A udit reporting Group Presentations 1 9 19 - 2 8 , 19 - 3 2 , 19 - 3 3 Group Risk Assessment Due 12 Other assurance and non - assurance services Group Presentations 20 20 - 2 3 , 20 - 2 5 , 20 - 2 7 , 20 - 2 8

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    Instructor's Resource Manual for Auditing , 14Ce, by Arens/Elder/Beasley/Hogan/Jones vii Chapter Vignettes and Other Chapter Material ― Lessons from Practice Each chapter begins with a short vignette, the majority of them are based upon real - life events. In addition, each chapter contains several Auditing in Action vignettes, related to the chapter content, that highlight real - world issues. Some of these auditing in actions (and figures) provide a glimpse into the real world of auditing. Others highlight recent events in Canada and abroad, news articles, fraud cases, and/or thought papers and academic articles. These opening vignettes and Auditing in Action features provide instructors with some meaningful examples and can be helpful in generating some great class discussion. One of our colleagues has used them as a “Lesson for the Day” for students. Each opening vignette illustrates the point implied by its title and is followed by several questions that students should consider while reading the chapter. The questions can also be used as concept checks throughout the lecture or serve as an end of the lecture summary of what was covered. The vignettes and Auditing in Action can be assigned as pre - reading for discussion of a particular point or as short cases on a stand - alone basis. The suggested syllabus includes some end - of - chapter questions that are related to various chapter vignettes. From our experience, students enjoy “real life” cases and find them useful in helping them learn the course material. A brief discussion of each of the vignettes appears in each chapter ’ s material in this resource guide and many of the vignettes are related to end - of - chapter questions. Professional Judgment Problems and Cases Each chapter has several questions that require students to apply their professional judgment. In addition, most chapters include Cases that challenge students beyond what is required in other end of chapter problems. They are generally more complex than other homework problems. Thus, we sometimes assign these as individual or group assignments that can be worked outside of class (we often use them for our individual assignments in the syllabus). W e also assign them as in - class assignments whereby students work together to develop a group solution to the case for subsequent class discussion. Research Activities Research activities that require students to search for information using a number of Internet - based resources are included in the end of chapter material for most of the 20 chapters. These assignments require students to use the Internet and the CPA Canada Handbook — Assurance to research relevant auditing issues and they expose students to real - world events, such as CPAB reports, OSC statement of allegations, as well as SEC enforcement actions related to fraud investigations, actual audit committee charters that outline the audit committee ’ s role in the oversight of the external auditor selection process. We believe these assignments provide opportunities for students to engage in research activities outside traditional homework problems to learn about issues affecting the audit process and the profession. Some of these can be assigned as individual

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    Introduction: An overview of the instructor’s resource manual viii assignments while others could be assigned to groups for in - class presentation and discussion. Applying Professional Judgment to Real Life Events Some of the end - of - chapter problems and research activities provide instructors with an opportunity to examine the real - life events discussed in the chapter in more depth as well as aiding in students’ professional judgment. Below is a summary: Chapter Vignette or Auditing in Action Related Questions Assurance Concepts 1 Auditing in Action 1-3 - And the Oscar goes To…La, La, Opps! Wrong Envelope! Question 1 - 28 Need for assurance engagements 2 Vignette - A focus on audit quality Question 2 - 25 Professional Judgment , Quality Control, Ethical Reasoning 3 Auditing in Action 3-2 - The High Costs of Legal Liability - Sino Forest Question 3 - 35 Evaluation of evidence, professional skepticism , professional standards 4 Auditing in Action 4-3 - It’s a Matter of Professional Judgment — The Livent Audits Question 4 - 34 Professional Judgment 5 Vignette - CEO Confesses to Falsifying Documents to Hide Fraud for Over 20 Years Question 5 - 36 Control deficiencies, confirmations 6 Vignette - the Fall Of Enron: Did Anyone Understand Its Business? and Auditing in Action 6 - 1 - Professional Judgement and the Client Continuance Decision at Enron Question 6 - 38 Client Acceptance, Professional Judgment 8 Auditing in Action 8-3- Cyberattacks: a New Reality Question 8 - 35 Control deficiencies, COSO guidance 9 Auditing in Action 9-3 - Audit Regulators Identify Deficiencies in Control Testing Question 9 - 33 Control testing, evidence 12 Auditing in Action 12 - 5 – Revenue Recognition at Tesco: It’s a Matter of Timing Question 12 - 50 Inherent risk - revenue, audit strategy 13 Auditing in Action 13 - 4 – Question 13 - 3 5 Substantive tests

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    Instructor's Resource Manual for Auditing , 14Ce, by Arens/Elder/Beasley/Hogan/Jones ix Incorrect Classifications Hide a Greater Loss - expenses, professional judgment 14 Auditing in Action 14 - 1 – Blackberrry’s Inventory Obsolescence Woes Question 14 - 26 Evaluation of inventory obsolescence, inherent risk - inventory Hillsburg Hardware Hillsburg Hardware continues to be the fictional company used to illustrate many of the concepts – particularly in relation to documentation of key planning decisions, including: preliminary analytical review (Figures 6 - 2 and 6 - 4), preliminary decisions for overall materiality (Figure 6 - 7), internal control questionnaire (9 - 2), the audit strategy memo (Figure 10 - 1), Documentation of Understanding of the Entity (Figure 10 - 2), and Audit Team Planning Memo (Figure 10 - 3). Pinnacle Manufacturing and Hillsburg Hardware Integrated Cases For instructors who are interested in providing more complex cases that students can work across multiple chapters, we have included the Pinnacle Manufacturing Integrated Case on MyLab Accounting. This four - part case gives students a hands - on experience that begins in Chapter 6 and concludes in Chapter 10. As well, the Appendix in the textbook now includes a new integrated case based on Hillsburg Hardware. Both of these cases can be worked individually or in small teams, or assigned as an individual or group project. Downloadable Instructor Resources The Pearson Canada eCatalogue offers a number of downloadable resources prepared to accompany the 14 th Canadian edition of Auditing: The Art and Science of Assurance Engagements , including PowerPoints, Test Bank, and Instructor’s Solution Manual. Other Resources That We Use In addition to the many features included in this 14 th edition of Auditing: The Art and Science of Assurance Engagements , there are several other resources that you might find useful as complementary materials and assignments. These are briefly highlighted next. Use of Auditing Cases Auditing Cases: An Interactive Learning Approach , Sixth Edition (2015) by Beasley, Buckless, Glover, and Prawitt is an excellent supplement to the textbook.

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    Introduction: An overview of the instructor’s resource manual x This collection of 48 auditing cases addresses most major activities performed during the conduct of an audit, from client acceptance to issuance of an audit report. (Since it is an American textbook, some of the questions may need to be adapted to refer to relevant CASs). Many of the cases are based on actual companies, some of which were engaged in financial reporting fraud. Several cases involve students working with realistic audit evidence and preparing and evaluating audit documentation. Auditing Cases: An Interactive Learning Approach provides instructors an easy opportunity to introduce short active learning exercises to promote in - class discussions of real - world audit issues throughout the introductory (or advanced) auditing course. Some cases we have used in the past are:  Asher Farms Inc. (Understanding of Client’s Business Environment)  Ocean Manufacturing Inc. (New Client Acceptance Decision)  EyeMax Corporation (Evaluation of Audit Differences)  Longeta Corporation (Auditing Revenue Contracts)  Burlingham Bees (Using Analytical Procedures as Substantive Tests) Use of Peer - Reviewed Published Cases Over the years, we have used several cases published in accounting education journals, below is a list of some that we have found to be effective: Phillips, F., & Martin, R. D. (1998). Instructional case: Northern Frontier Park. Issues in Accounting Education , 13 (4), 1005. We find that this case serves as a great foundation to help students understand audit risk and risk assessment. We assign it as a pre-class reading when we cover the topics of client acceptance and materiality and risk and discuss it in the weeks that we cover client acceptance, and materiality and risk. Sanchez, M. H., Brown, K. F., & Agoglia, C. P. (2007). Consideration of control environment and fraud risk: A set of instructional exercises. Journal of Accounting Education , 25 (4), 207-221. We have used this case as a group assignment several times and find it very effective in helping students perform an integrated analysis of control risk. It provides the students with a completed internal control environment questionnaire which they must evaluate and assess the risk of misappropriation of assets and/or financial reporting fraud. There are four different versions of the questionnaire and different case facts, which will change the students’ assessment (and enable instructors to use the assignment multiple times). Peaden, D. and Stephens, N. (2013) Old Main Manufacturing: The Case of Unrecorded Sales Discounts. Issues in Accounting Education .

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    Instructor's Resource Manual for Auditing , 14Ce, by Arens/Elder/Beasley/Hogan/Jones xi We have used this case as an individual assignment. It is fairly straightforward; however, it requires the students to refer to the relevant auditing standards (which they often have limited exposure to) regarding audit sampling. Note: Instructors will need to modify the case requirements to make reference to the relevant CASs. Student feedback has been overwhelmingly positive since they feel that they have had an opportunity to perform some “real” audit work - vouching, preparing a working paper and evaluating and concluding on the results of their testing. Suggested Term Projects 1. Have students teams obtain the annual report of a public company through SEDAR and prepare an analysis of business risks which impact financial reporting risk, perform some preliminary planning activities and develop an audit strategy for the revenue cycle for the company selected. 2. Have students go through the audit process for the acquisition and payment cycle of a small manufacturing company from flowcharting the system to designing the audit program. 3. Have students evaluate the sampling approach used by an auditor for sales and cash receipts for a small business. The case can be used with nonstatistical sampling, difference estimation, or monetary unit sampling. The requirements should be modified depending on the alternative you select. Student guidelines for each project follow.

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    Introduction: An overview of the instructor’s resource manual xii SAMPLE TERM PROJECT Developing an Audit Strategy Based upon Analysis of Business Risks and Financial Reporting Risk The group term project is a hands-on exercise in planning a financial statement audit. The project will give you an opportunity to consider how the concepts and techniques discussed in the course apply in auditing an actual business. Your team will take on the role of the audit engagement team for a publicly-traded Canadian company. Assume that your audit firm has already conducted its client retention procedures (this is not the first year that you are auditors), independence analysis, and has determined that the members of your team are the best people for the job. Now that has been done, your team is required to develop the client risk profile and plan the audit of the ‘client company’ (with a focus on the revenue cycle) for its upcoming year-end. Your team is expected to provide two deliverables – A Planning Memo (more details on each part are provided below) and Group Presentation: Description Allocation Planning Memo Part 1 - Assess Client Business Risk 25 Part 2 - Perform Preliminary Analytical Review Determine Audit Risk, Materiality 45 Part 3 - Audit Strategy for Revenue Cycle 30 100 Group Presentation 50 Total 150 You are expected to use the company’s most recent quarterly results, the most recent annual report, and other publicly-available information. State any assumptions you find it necessary to make. You should not contact the organization or interview people for this project. You should not contact the actual auditors as they will need to keep all the client information confidential. Please feel free to ask the instructor for further guidance if any of the requirements are not clear. Assess Client Business Risk (limit of 3-4 pages, including appendices) The aim of this part of your assignment is to prepare a detailed industry and business risk analysis for the company you have been assigned: In preparing the analysis, be sure to include the following:  Business objectives & strategies (explain how the organization makes money)  Industry and External Environment (Include Key competitors and industry trends)

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    Instructor's Resource Manual for Auditing , 14Ce, by Arens/Elder/Beasley/Hogan/Jones xiii  Key Business Operations & Processes  Financial Resources and Availability  Management & Governance  Measurement & Performance (ensure to consider what are some of the key non-financial performance indicators for the industry) In your analysis, you need to make a conclusion on the company’s risk and its implications for financial reporting risk. You are expected to perform a thorough search, using a variety of electronic sources such as:  The company’s annual report (ensure you look at management’s discussion and analysis along with the financial statements)  The company’s website  Sources of industry data  Stock broker or investment analyses  Business press  CPA Canada Handbook – Assurance and Accounting Standards  CPA Canada Risk Alerts * Note – You may find that the industry guides prepared by many of the Big Four Firms (PWC, Deloitte, KPMG, and E&Y) to be useful for your industry. Part 2 – Preliminary Analytical Review & Implications for the Audit ( limit of 3-4 pages, not including appendices) Preliminary Analytical Review In this part of your assignment, you are expected to conduct an analytical analysis of your company that includes: (1) common-size financial statements for the past three years (you will need to decide what expectations you have regarding the interim statements for your company) and (2) financial ratios that are commonly used for that particular industry Your financial ratio analysis should include: (1) a three-year ratio comparison by year (for the company), relevant comparisons to (2) industry and (3) a relevant competitor. Categories (more details on the various categories have been posted to the course website in Assignments folder) for your ratios should be:  Stock valuation  Growth  Financial Strength  Profitability  Management Effectiveness  Efficiency

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    Introduction: An overview of the instructor’s resource manual xiv All of the above ratios should be presented in an appendix (2 page max). Your analysis should relate to your client business risk analysis and highlight which account balances warrant further concern/attention in terms of audit planning. You should not comment on all ratios and changes. Only comment on changes that warrant further attention. Please ensure you relate your concerns to management assertions for the particular accounts. Inherent Risk In this report you need to include a discussion of what your conclusions in your business risk analysis and your analytical analysis means for the conduct of the audit. In particular, you should discuss what accounts/cycles you feel are high inherent risk and which are at lower levels of risk. In making these decisions, you should consider factors such as unusual or unexpected fluctuations, audit complexity, and risk of material misstatement due to management bias. Refer to your textbook and Audit Standards for further guidance. As in Part 1, you are expected to perform a thorough search, using a variety of electronic sources. This is necessary in order to obtain explanations for fluctuations, deviations, etc… Acceptable Audit risk Now that you have familiarized yourself with your client, you should have enough information to set acceptable audit risk. Ensure that you consider the relevant factors that would heighten the risk of the engagement to the auditor (refer to your textbook, and audit standards regarding how to set acceptable audit risk). Materiality Another important decision is determination of overall and performance materiality. In order to determine overall and performance materiality you should refer to the Audit Standards, and the textbook, and any other relevant professional materials. Part 3 – Audit Strategy of Revenue Cycle – (limit 4 pages, including appendices) Using your previous analyses, your team is expected to prepare an audit strategy for the revenue cycle. In this section, you are expected to discuss:  What are your company’s key revenue cycle accounts? What are the critical accounting policies and estimates for these accounts?  What does your company say in its footnotes about its use of estimates related to the revenue cycle? How informative are these footnotes?  What risk do the revenue estimates pose for your audit?  Using your analytical analysis you conducted in Part 2, discuss the key findings that are relevant to the revenue cycle.

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    Instructor's Resource Manual for Auditing , 14Ce, by Arens/Elder/Beasley/Hogan/Jones xv o Outline what inquiries and follow-up procedures might be performed understand unusual fluctuations, trends, etc...  Based upon your risk analysis conducted in Part 1, discuss those risks that are most relevant to the revenue cycle. o Outline what inquires and follow-up procedures to you need to make in order to understand the risk  Assuming you have developed a good understanding of the components of internal control, you assessed control risk at medium and your tests were consistent with your planned assessment, outline your audit strategy for the revenue cycle using the following format: Balance – Related Assertions Audit Objectives Assessment of Inherent Risk Assessment of Control Risk Planned Substantive Testing (Timing, Nature, & Extent) Medium Transaction – Related Assertions Audit Objectives Assessment of Inherent Risk Assessment of Control Risk Planned Substantive Testing (Timing, Nature, & Extent) Medium Part 4 – Group Presentation Video Your group will be expected to prepare a 5-minute video related to your client company:  PART I: Overview of Client Business Risk  PART II: Summary of Key Findings and Identification of High Risk Accounts, Audit Risk and Materiality Question Period Class members will act as the audit committee and will ask your group questions on your video. All group members are expected to be at the presentation and to answer the questions. You will be assessed on the quality of your responses and understanding of the material.

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    Introduction: An overview of the instructor’s resource manual xvi SAMPLE TERM PROJECT Internal Control and Audit Program Case You are provided with the following description of the accounting system and internal controls for materials purchases by the Johnson Machinery Company, a medium - sized firm that builds special machinery to order. Materials purchase requisitions are first approved by the plant foreman, who then sends them to the purchasing department. Purchasing department employees enter the purchase requisition information into the computer, which automatically generates a purchase order in sequential order. The system automatically generates a paper copy of the purchase order, which is sent by purchasing department employees to the vendor. The receiving department electronically accesses a copy of the purchase order, which is printed to serve as a receiving report. Delivered materials are immediately sent to the storeroom. The completed receiving report, which is a printed copy of the purchase order, is sent to the purchasing department. A copy of the receiving report is sent to the storeroom. Materials are issued to factory employees subsequent to the verbal request by one of the foremen. When the mailroom clerk receives vendors ’ invoices, he or she forwards them to the purchasing department employee who placed the order. The invoice is compared with the electronic copy of the purchase order for price and terms by the employee. The invoice quantity is compared with the receiving department ’ s report. After checking footings, extensions, and discounts on the vendor invoice, the employee indicates approval for payment by initialing the invoice. The invoice is then forwarded to the accounting department (voucher section) where it is coded for account distribution, assigned a voucher number, and entered into the accounting system for recording in the voucher register. The system tracks invoices due by payment date due. The purchase order and receiving report are filed in the purchasing department. On payment dates, the system automatically generates a request for payment. The system automatically prepares cheques and a transaction list for preparation of a cash disbursements journal, updates the accounts payable master file, and indicates the payment date for the voucher register. Prenumbered cheques are sent to the cashier, who puts them through the check-signing machine. The cheques are then sent to the voucher section that makes sure that the checks were correctly prepared. The cheques are placed in envelopes and sent to the mailroom. The vouchers are subsequently filed in numerical order. At the end of each month, a computer listing of voucher and cash disbursement transactions, and an outstanding accounts payable list is prepared.

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