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

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INSTRUCTOR’S RESOURCE MANUALBartosz AmerskiYork UniversityJoanne JonesYork UniversityAuditingThe Art and Science of Assurance EngagementsFourteenth Canadian EditionAlvin A. ArensFormer PricewaterhouseCoopers Emeritus Professor, Michigan State UniversityRandal J. ElderSyracuse UniversityMark S. BeasleyNorth Carolina State University, Deloitte Professor of Enterprise Risk ManagementChris E. HoganMichigan State UniversityJoanne C. JonesYork UniversityCLASS NOTES

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Introduction: An overview of the instructor’s resource manualiiContentsPageAn Overview of the Instructor’s Resource Manual........................................ ivChapters1The demand for audit and other assurance services .............................12The public accounting profession and audit quality..............................103Professional ethics and legal liability....................................................164Audit responsibilities and objectives ....................................................255Audit evidence .....................................................................................396Client acceptance, planning, and materiality........................................507Assessing the risk of material misstatement ........................................618Internal control and COSO framework .................................................699Assessing control risk and designing tests of controls .........................7410Develop risk response: Audit strategy and audit program....................8011Audit sampling concepts ......................................................................8812Audit of the revenue cycle....................................................................9913Audit of the acquisition and payment cycle ........................................10814Audit of the inventory and distribution cycle .......................................11615Audit of the human resources and payroll cycle.................................12416Audit of the capital acquisition and repayment cycle..........................13017Audit of cash balances.......................................................................13618Completing the audit ..........................................................................14219Audit reports on financial statements .................................................15020Other assurance and nonassurance services ....................................160

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Introduction: An overview of the instructor’s resource manualivAn Overview of the Instructor’s Resource ManualThe purpose of theInstructor’s Resource Manualis to help you teach auditingcoursesmoreefficientlyand,perhapsmoreimportantly,toencouragestudentengagement. Naturally, we do not want to interfere with your present approach orimply that our suggestions are the only good alternatives.This resource manual has several parts:Anillustrativecourseoutlineforatraditional12-weekuniversityintroductory auditing course.Some resources, from accounting education journals we have used forgroup and individual projects.Somegroupandindividualprojectsweandotherinstructorshavesuccessfully used.MappingthechapterstotheCPACompetencyMap’sFundamentalAssurance 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.Discussionandpracticequestionswehavefoundtobeeffectiveinfacilitating student learning and keeping the class interesting.Additional teaching resources and videos to reinforce and integrate thelearning objectives.A matrix illustrating how learning objectives correlate with chapter problemmaterial. The matrix for each chapter is designed to provide a one-pagesummary of this information in order to assist you in assigning problemmaterial.The chapters are designed so that their arrangement and selection providemaximum flexibility in course design.

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Instructor's Resource Manual forAuditing, 14Ce, by Arens/Elder/Beasley/Hogan/JonesvSuggested SyllabiIn this section, we provide a possible schedule for use in a one-semesteruniversity-level introductory-level audit course. We also provide suggested problemassignments that could easily be presented in your syllabus as well as the courseevaluationscheme.Someofthequestionsweusefor4individualgradedassignments.You will note that we cover the three key cycles (revenue, acquisition andpayment, and inventory and distribution) as well as cash. Some of you may wish tocover some of the other cycles as well. From the last chapter, which covers specialreports and other assurance engagements, we only cover reviews and compilationengagements. The remaining material, we cover in our advanced auditing course.Following our suggested syllabi, we briefly overview other teaching materialsthat you might find helpful as you develop your plan for coverage of the coursecontent.

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Introduction: An overview of the instructor’s resource manualviOrganization of the Course(assumes two 1 ½ hour classes or one three-hourclass per week)WeekTopicsChaptersPractice or DiscussionQuestions1Introduction, audit andotherassurance servicesThe public accountingprofessionandaudit quality1 and 21-19,1-28,2-24, 2-262Professionalethicsand legal liabilityAudit responsibilities and objectives3and 43-29, 3-32,4-31, 4-333Audit evidenceClient acceptance,planning, andmateriality5and 65-33,5-35, 5-366-40,6-41, 6-444Assessing the risk of materialmisstatement77-35, 7-365Internal controls, COSO frameworkAssessing control risk and test ofcontrols8and 98-27,8-31,9-26, 9-326Midterm7Audit strategyand programSampling concepts10and 1110-27, 10-28,10-31,11-348Audit of revenue cycle1212-41, 12-42,12-47, 12-489Audit of acquisition and paymentand inventory and distributioncycles13 and 1413-28, 13-35,14-26, 14-2710Audit of cash and completing theaudit17 and 1817-23, 17-25,18-26,18-3311Audit reportingGroup Presentations1919-28,19-32, 19-33Group Risk AssessmentDue12Other assurance and non-assuranceservicesGroup Presentations2020-23, 20-25,20-27,20-28

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Instructor's Resource Manual forAuditing, 14Ce, by Arens/Elder/Beasley/Hogan/JonesviiChapter Vignettes and Other Chapter Material―Lessons from PracticeEach chapter begins with a short vignette, the majority of them are based uponreal-lifeevents.Inaddition,eachchaptercontainsseveralAuditingin Actionvignettes, related to the chapter content, that highlight real-world issues. Some ofthese auditing in actions (and figures) provide a glimpse into the real world ofauditing. 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 instructorswith some meaningful examples and can be helpful in generating some great classdiscussion. One of our colleagues has used them as a “Lesson for the Day” forstudents. Each opening vignette illustrates the point implied by its titleand isfollowed by several questions that students should consider whilereading thechapter. The questions can also be used as concept checks throughout the lectureor serve as an end of the lecture summary of what was covered.Thevignettesand Auditingin Actioncanbeassignedaspre-readingfordiscussionofa particular pointor as short cases on a stand-alone basis. Thesuggested syllabus includes some end-of-chapter questions that are related to variouschapter vignettes. From our experience, students enjoy “real life” cases and find themuseful in helping them learn the course material. A brief discussion of each of thevignettes appears in each chapter’s material in this resource guide and many of thevignettes are related to end-of-chapter questions.Professional Judgment Problems and CasesEach chapter has several questions that require students to apply theirprofessional judgment. In addition, most chapters include Cases that challengestudents beyond what is required in other end of chapter problems. Theyaregenerally more complex than other homework problems. Thus, we sometimesassign these as individual or group assignments that can be worked outside ofclass (we often use them for our individual assignments in the syllabus). W e alsoassign them as in-class assignments whereby students work together to develop agroup solution to the case for subsequent class discussion.Research ActivitiesResearch activities that require students to search for information using anumber of Internet-based resources are included in the end of chapter material formost of the 20 chapters. These assignments require students to use the Internetand theCPA Canada Handbook—Assuranceto research relevant auditing issuesandthey exposestudents toreal-worldevents,such as CPAB reports, OSCstatement of allegations, as well asSEC enforcement actions related to fraudinvestigations, actual audit committee charters that outline the audit committee’srole in the oversight of the external auditor selection process. We believe theseassignments provide opportunities for students to engage in research activitiesoutside traditional homework problems to learn about issues affecting the auditprocessandtheprofession.Someofthesecanbeassignedasindividual

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Introduction: An overview of the instructor’s resource manualviiiassignments while others could be assigned to groups for in-class presentation anddiscussion.Applying Professional Judgment to Real Life EventsSomeoftheend-of-chapterproblemsandresearchactivitiesprovideinstructors with an opportunity to examine the real-life events discussed in thechapter in more depth as well as aiding in students’ professional judgment. Below isa summary:ChapterVignetteor Auditing in ActionRelatedQuestionsAssuranceConcepts1Auditing in Action 1-3 - And theOscar goes To…La, La, Opps!Wrong Envelope!Question 1-28Need forassuranceengagements2Vignette - A focus on auditqualityQuestion2-25ProfessionalJudgment, QualityControl, EthicalReasoning3Auditing in Action 3-2 - TheHigh Costs of Legal Liability -Sino ForestQuestion 3-35Evaluation ofevidence,professionalskepticism,professionalstandards4Auditing in Action 4-3 -It’s aMatter of ProfessionalJudgment—The Livent AuditsQuestion 4-34ProfessionalJudgment5Vignette - CEO Confesses toFalsifying Documents to HideFraud for Over 20 YearsQuestion 5-36Controldeficiencies,confirmations6Vignette - the Fall Of Enron:Did Anyone Understand ItsBusiness? andAuditing in Action 6-1-Professional Judgement andthe Client ContinuanceDecision at EnronQuestion 6-38ClientAcceptance,ProfessionalJudgment8Auditing in Action 8-3-Cyberattacks: a New RealityQuestion 8-35Controldeficiencies,COSO guidance9Auditing in Action 9-3 - AuditRegulators IdentifyDeficiencies in Control TestingQuestion 9-33Control testing,evidence12AuditinginAction12-5–RevenueRecognitionatTesco: It’s a Matter of TimingQuestion12-50Inherent risk-revenue, auditstrategy13AuditinginAction13-4–Question 13-35Substantive tests

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Instructor's Resource Manual forAuditing, 14Ce, by Arens/Elder/Beasley/Hogan/JonesixIncorrectClassificationsHidea Greater Loss-expenses,professionaljudgment14Auditing in Action 14-1–Blackberrry’sInventoryObsolescence WoesQuestion 14-26Evaluation ofinventoryobsolescence,inherent risk-inventoryHillsburg HardwareHillsburg Hardware continues to be the fictional company used to illustratemany of the concepts–particularly in relation to documentation of key planningdecisions, including: preliminary analytical review (Figures 6-2 and 6-4), preliminarydecisions for overall materiality (Figure 6-7), internal control questionnaire (9-2), theaudit 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 CasesFor instructors who are interested in providing more complex cases thatstudents can work across multiple chapters, we have included the PinnacleManufacturing Integrated Case on MyLab Accounting. This four-part case givesstudents a hands-on experience that begins in Chapter 6 and concludes in Chapter10. As well, the Appendix in the textbook now includes a new integrated casebased on Hillsburg Hardware. Both of these cases can be worked individually orin small teams, or assigned as an individual or group project.Downloadable Instructor ResourcesThePearsonCanadaeCatalogueoffersanumberofdownloadableresources prepared to accompany the 14thCanadian edition ofAuditing: TheArtandScienceof AssuranceEngagements,includingPowerPoints,TestBank, and Instructor’s Solution Manual.Other Resources That We UseIn addition to the many features included in this 14thedition ofAuditing: The Artand Science of Assurance Engagements, there are several other resources thatyou might find useful as complementary materials and assignments. These arebriefly highlighted next.Use ofAuditing CasesAuditing Cases: An Interactive Learning Approach, Sixth Edition (2015) byBeasley, Buckless, Glover, and Prawitt is an excellent supplement to the textbook.

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Introduction: An overview of the instructor’s resource manualxThis collection of 48 auditing cases addresses most major activities performedduring the conduct of an audit, from client acceptance to issuance of an auditreport. (Since it is an American textbook, some of the questions may need tobe adapted to refer to relevant CASs). Many of the cases are based on actualcompanies, some of which were engaged in financial reporting fraud. Severalcases involve students working with realistic audit evidence and preparing andevaluating audit documentation.Auditing Cases: An Interactive Learning Approachprovides instructors an easy opportunity to introduce short active learning exercisestopromotein-classdiscussionsofreal-worldauditissuesthroughouttheintroductory (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 CasesOver the years, we have used several cases published in accounting educationjournals, below is a list of some that we have found to be effective:Phillips, F., & Martin, R. D. (1998). Instructional case: Northern Frontier Park.Issuesin Accounting Education,13(4), 1005.We find that this case serves as a great foundation to help students understand auditrisk and risk assessment. We assign it as a pre-class reading when we cover thetopics of client acceptance and materiality and risk and discuss it in the weeks thatwe cover client acceptance, and materiality and risk.Sanchez, M. H., Brown, K. F., & Agoglia, C. P. (2007). Consideration of controlenvironment and fraud risk: A set of instructional exercises.Journal of AccountingEducation,25(4), 207-221.We have used this case as a group assignment several times and find it veryeffective in helping students perform an integrated analysis of control risk. It providesthe students with a completed internal control environment questionnaire which theymust evaluate and assess the risk of misappropriation of assets and/or financialreporting fraud. There are four different versions of the questionnaire and differentcase facts,which will change the students’ assessment(and enable instructors touse the assignment multiple times).Peaden,D.andStephens,N.(2013)OldMainManufacturing:TheCaseofUnrecorded Sales Discounts.Issues in Accounting Education.

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Instructor's Resource Manual forAuditing, 14Ce, by Arens/Elder/Beasley/Hogan/JonesxiWe have used this case as an individual assignment. It is fairly straightforward;however, it requires the students to refer to the relevant auditing standards (whichthey often have limited exposure to) regarding audit sampling.Note:Instructors willneed to modify the case requirements to make reference to the relevant CASs.Student feedback has been overwhelmingly positive since they feel that they havehad an opportunity to perform some “real” audit work-vouching, preparing aworking paper and evaluating and concluding on the results of their testing.Suggested Term Projects1.Have students teams obtain the annual report of a public company throughSEDARand prepare an analysis of business risks which impact financialreporting risk, perform some preliminary planning activities and develop anaudit strategy for the revenue cycle for the company selected.2.Have students go through the audit process for the acquisition and paymentcycle of a small manufacturing company from flowcharting the system todesigning the audit program.3.Have students evaluate the sampling approach used by an auditor for salesandcashreceiptsforasmallbusiness.Thecasecanbeusedwithnonstatistical sampling, difference estimation, or monetary unit sampling.The requirements should be modified depending on the alternative youselect.Student guidelines for each project follow.

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Introduction: An overview of the instructor’s resource manualxiiSAMPLE TERM PROJECTDeveloping an Audit Strategy Based upon Analysis of BusinessRisks and Financial Reporting RiskThe 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 techniquesdiscussed in the course apply in auditing an actual business.Your team will take on the role of the audit engagement team for a publicly-tradedCanadian company. Assume that your audit firm has already conducted its clientretention procedures (this isnotthe first year that you are auditors), independenceanalysis, and has determined that the members of your team are the best people forthe job. Now that has been done, your team is required to develop the client riskprofile 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 detailson each part are provided below) and Group Presentation:DescriptionAllocationPlanning MemoPart 1 - Assess Client Business Risk25Part 2 - Perform Preliminary AnalyticalReview Determine Audit Risk, Materiality45Part 3 - Audit Strategy for Revenue Cycle30100Group Presentation50Total150You are expected to use the company’s most recent quarterly results, the mostrecent annual report, and other publicly-available information. State any assumptionsyou find it necessary to make. You should not contact the organization or interviewpeople for this project. You should not contact the actual auditors as they will need tokeep all the client information confidential. Please feel free to ask the instructor forfurther 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 businessrisk 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 industrytrends)

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Instructor's Resource Manual forAuditing, 14Ce, by Arens/Elder/Beasley/Hogan/JonesxiiiKey Business Operations & ProcessesFinancial Resources and AvailabilityManagement & GovernanceMeasurement & Performance (ensure to consider what are some of the keynon-financial performance indicators for the industry)In your analysis, you need to make a conclusion on the company’s riskand itsimplications for financial reporting risk.You are expected to perform a thorough search, using a variety of electronic sourcessuch as:The company’s annual report (ensure you look at management’s discussionand 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 FourFirms (PWC, Deloitte, KPMG, and E&Y) to be useful for your industry.Part 2–Preliminary Analytical Review & Implications for the Audit (limit of 3-4pages, not including appendices)Preliminary Analytical ReviewIn this part of your assignment, you are expected to conduct an analytical analysis ofyour company that includes: (1) common-size financial statements for the past threeyears (you will need to decide what expectations you have regarding the interimstatements for your company) and (2) financial ratios that are commonly used for thatparticular industryYour 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 coursewebsite 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 manualxivAll 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 whichaccount balances warrant further concern/attention in terms of audit planning. Youshould not comment on all ratios and changes. Only comment on changes thatwarrant further attention. Please ensure you relate your concerns to managementassertions for the particular accounts.Inherent RiskIn this report you need to include a discussion of what your conclusions in yourbusiness risk analysis and your analytical analysis means for the conduct of theaudit. In particular, you should discuss what accounts/cycles you feel are highinherent risk and which are at lower levels of risk. In making these decisions, youshould consider factors such as unusual or unexpected fluctuations, audit complexity,and risk of material misstatement due to management bias. Refer to your textbookand Audit Standards for further guidance.As in Part 1, you are expected to perform a thorough search, using a variety ofelectronic sources. This is necessary in order to obtain explanations for fluctuations,deviations, etc…Acceptable Audit riskNow that you have familiarized yourself with your client, you should have enoughinformation to set acceptable audit risk. Ensure that you consider the relevant factorsthat would heighten the risk of the engagement to the auditor (refer to your textbook,and audit standards regarding how to set acceptable audit risk).MaterialityAnother important decision is determination of overall and performance materiality. Inorder to determine overall and performance materiality you should refer to the AuditStandards, 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 forthe revenue cycle. In this section, you are expected to discuss:What are your company’s key revenue cycle accounts? What are the criticalaccounting policies and estimates for these accounts?What does your company say in its footnotes about its use of estimatesrelated 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 keyfindings that are relevant to the revenue cycle.

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Instructor's Resource Manual forAuditing, 14Ce, by Arens/Elder/Beasley/Hogan/JonesxvoOutline what inquiries and follow-up procedures might be performedunderstand unusual fluctuations, trends, etc...Based upon your risk analysis conducted in Part 1, discuss those risks that aremost relevant to the revenue cycle.oOutline what inquires and follow-up procedures to you need to make inorder to understand the riskAssuming you have developed a good understanding of the components ofinternal control, you assessed control risk at medium and your tests wereconsistent with your planned assessment, outline your audit strategy for therevenue cycle using the following format:Balance–RelatedAssertionsAuditObjectivesAssessmentof InherentRiskAssessmentof ControlRiskPlanned SubstantiveTesting (Timing, Nature,& Extent)MediumTransaction–RelatedAssertionsAuditObjectivesAssessmentof InherentRiskAssessmentof ControlRiskPlanned SubstantiveTesting (Timing, Nature,& Extent)MediumPart 4–Group PresentationVideoYour group will be expected to prepare a 5-minute video related to your clientcompany:PART I: Overview of Client Business RiskPART II: Summary of Key Findings and Identification of High Risk Accounts,Audit Risk and MaterialityQuestion PeriodClass members will act as the audit committee and will ask your group questions onyour video. All group members are expected to be at the presentation and to answerthequestions.Youwillbeassessedonthequalityofyourresponsesandunderstanding of the material.

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Introduction: An overview of the instructor’s resource manualxviSAMPLE TERM PROJECTInternal Control and Audit Program CaseYou are provided with the following description of the accounting system and internalcontrols 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, whothen sends them to the purchasing department. Purchasing department employeesenter the purchase requisition information into the computer, which automaticallygenerates a purchase order in sequential order. The system automatically generatesa paper copy of the purchase order, which is sent by purchasing department employeesto the vendor. The receiving department electronically accesses a copy of the purchaseorder, which is printed to serve as a receiving report.Delivered materials are immediately sent to the storeroom. The completedreceiving report, which is a printed copy of the purchase order, is sent to the purchasingdepartment. A copy of the receiving report is sent to the storeroom. Materials areissued to factory employees subsequent to the verbal request by one of the foremen.When the mailroom clerk receives vendors’invoices, he or she forwards themto the purchasing department employee who placed the order. The invoice is comparedwith 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 checkingfootings, extensions, and discounts on the vendor invoice, the employee indicatesapproval for payment by initialing the invoice. The invoice is then forwarded to theaccounting department (voucher section) where it is coded for account distribution,assigned a voucher number, and entered into the accounting system for recording inthe voucher register. The system tracks invoices due by payment date due. Thepurchase 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 acash disbursements journal, updates the accounts payable master file, and indicatesthe payment date for the voucher register. Prenumbered cheques are sent to thecashier, who puts them through the check-signing machine. The cheques are thensent 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 vouchersare subsequently filed in numerical order. At the end of each month, a computerlisting of voucher and cash disbursement transactions, and an outstanding accountspayable list is prepared.

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