Auditing and Assurance Services 14th Edition Arens Solutions Manual

Full Download: https://alibabadownload.com/product/auditing-and-assurance-services-14th-edition-arens-solutions-manual/

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 which
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

1-1

This is sample only, Download all chapters at: AlibabaDownload.com

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

1-2
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 a nd 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.

1-3
1-8

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

1-4
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 It is important for CPAs to be knowledgeable about information technology,

including e-commerce, because many of their clients rely extensively on these
technologies. Examples of commonly used e-commerce technologies include
purchases and sales of goods through the Internet, automatic inventory
reordering via direct connection to inventory suppliers, and online banking. CPAs
who perform audits or provide other assurance services about information
generated with these technologies need a basic knowledge and understanding of
information technology and e-commerce in order to identify and respond to risks
in the financial and other information generated by these technologies.

1-5
 Multiple Choice Questions From CPA Examinations

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

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

 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 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.)
8. (2) An attestation service other than an audit service
9. (2) An attestation service other than an audit service
10. (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:

1-6
1-17 (continued)

CPA COST OF CPA ANNUAL ANNUAL

LENDER SERVICE SERVICES INTEREST LOAN COST
Existing loan None 0 $ 247,500 $ 247,500
United National Bank Review $ 20,000 $ 202,500 $ 222,500
First City Bank Audit $ 45,000 $ 157,500 $ 202,500

c. Busch should select the loan from United National Bank due to the
higher cost of the audit and the reduced interest rate for the loan
from United National Bank. The following is the calculation of total
costs for each loan:

CPA COST OF CPA ANNUAL ANNUAL

LENDER SERVICE SERVICES INTEREST LOAN COST
Existing loan None 0 $ 247,500 $ 247,500
United National Bank Review $ 20,000 $ 180,000 $ 200,000
First City Bank Audit $ 55,000 $ 157,500 $ 212,500

d. Busch may desire to have an audit because of the many other

benefits that an audit provides. The audit will provide Busch’s
management with assurance about annual financial information used
for decision-making purposes. The audit may detect errors or fraud, and
provide management with information about the effectiveness of
controls. In addition, the audit may result in recommendations to
management that will improve efficiency or effectiveness.

e. The auditor must have a thorough understanding of the client and its
environment, including the client’s e-commerce technologies, industry,
regulatory and operating environment, suppliers, customers, creditors,
and business strategies and processes. This thorough analysis helps
the auditor identify risks associated with the client’s strategies that
may affect whether the financial statements are fairly stated. This
strategic knowledge of the client’s business often helps the auditor
identify ways to help the client improve business operations, thereby
providing added value to the audit function.

1-18 a. The services provided by Consumers Union are very similar to

assurance services provided by CPA firms. The services provided
by Consumers Union and assurance services provided by CPA
firms are designed to improve the quality of information for decision
makers. CPAs are valued for their independence, and the reports
provided by Consumers Union are valued because Consumers
Union is independent of the products tested.

1-7
1-18 (continued)

b. The concepts of information risk for the buyer of an automobile and

for the user of financial statements are essentially the same. They
are both concerned with the problem of unreliable information being
provided. In the case of the auditor, the user is concerned about
unreliable information being provided in the financial statements.
The buyer of an automobile is likely to be concerned about the
manufacturer or dealer providing unreliable information.

c. The four causes of information risk are essentially the same for a
buyer of an automobile and a user of financial statements:
(1) Remoteness of information It is difficult for a user to obtain
much information about either an automobile manufacturer
or the automobile itself without incurring considerable cost.
The automobile buyer does have the advantage of possibly
knowing other users who are satisfied or dissatisfied with a
similar automobile.
(2) Biases and motives of provider There is a conflict between
the automobile buyer and the manufacturer. The buyer wants
to buy a high quality product at minimum cost whereas the
seller wants to maximize the selling price and quantity sold.
(3) Voluminous data There is a large amount of available
information about automobiles that users might like to have
in order to evaluate an automobile. Either that information is
not available or too costly to obtain.
(4) Complex exchange transactions The acquisition of an
automobile is expensive and certainly a complex decision
because of all the components that go into making a good
automobile and choosing between a large number of
alternatives.

d. The three ways users of financial statements and buyers of

automobiles reduce information risk are also similar:
(1) User verifies information him or herself That can be obtained
by driving different automobiles, examining the specifications of
the automobiles, talking to other users and doing research in
various magazines.
(2) User shares information risk with management The
manufacturer of a product has a responsibility to meet its
warranties and to provide a reasonable product. The buyer
of an automobile can return the automobile for correction of
defects. In some cases a refund may be obtained.
(3) Examine the information prepared by Consumer Reports
This is similar to an audit in the sense that independent
information is provided by an independent party. The
information provided by Consumer Reports is comparable to
that provided by a CPA firm that audited financial statements.

1-8
1-19 a. The following parts of the definition of auditing are related to the
narrative:
(1) Altman is being asked to issue a report about qualitative and
quantitative information for trucks. The trucks are therefore
the information with which the auditor is concerned.
(2) There are four established criteria which must be evaluated
and reported by Altman: existence of the trucks on the night
of June 30, 2011, ownership of each truck by Regional
Delivery Service, physical condition of each truck and fair
market value of each truck.
(3) Samantha Altman will accumulate and evaluate four types of
evidence:
(a) Count the trucks to determine their existence.
(b) Use registrations documents held by Burrow for
comparison to the serial number on each truck to
determine ownership.
(c) Examine the trucks to determine each truck's physical
condition.
(d) Examine the blue book to determine the fair market
value of each truck.
(4) Samantha Altman, CPA, appears qualified, as a competent,
independent person. She is a CPA, and she spends most of
her time auditing used automobile and truck dealerships and
has extensive specialized knowledge about used trucks
that is consistent with the nature of the engagement.
(5) The report results are to include:
(a) which of the 25 trucks are parked in Regional's
parking lot the night of June 30.
(b) whether all of the trucks are owned by Regional
Delivery Service.
(c) the condition of each truck, using established
guidelines.
(d) fair market value of each truck using the current blue
book for trucks.

b. The only parts of the audit that will be difficult for Altman are:
(1) Evaluating the condition, using the guidelines of poor, good,
and excellent. It is highly subjective to do so. If she uses a
different criterion than the "blue book," the fair market value
will not be meaningful. Her experience will be essential in
using this guideline.
(2) Determining the fair market value, unless it is clearly defined
in the blue book for each condition.

1-9
1-20 a. The major advantages and disadvantages of a career as an IRS
agent, CPA, GAO auditor, or an internal auditor are:

EMPLOYMENT ADVANTAGES DISADVANTAGES

INTERNAL 1. Extensive training in 1. Experience limited to
REVENUE individual, corporate, gift, taxes.
AGENT trust and other taxes is 2. No experience with
available with concentration operational or financial
in area chosen. statement auditing.
2. Hands-on experience with 3. Training is not extensive
sophisticated selection with any business
techniques. enterprise.
CPA 1. Extensive training in audit of 1. Exposure to taxes and to
financial statements, the business enterprise
compliance auditing and may not be as in-depth as
operational auditing. the internal revenue agent
2. Opportunity for experience in or the internal auditor.
auditing, tax consulting, and 2. Likely to be less exposed
management consulting to operational auditing
practices. than is likely for internal
3. Experience in a diversity of auditors.
enterprises and industries
with the opportunity to
specialize in a specific
industry.
GAO AUDITOR 1. Increasing opportunity for 1. Little exposure to diversity
experience in operational of enterprises and
auditing. industries.
2. Exposure to highly 2. Bureaucracy of federal
sophisticated statistical government.
sampling and computer
auditing techniques.
INTERNAL 1. Extensive exposure to all 1. Little exposure to taxation
AUDITOR segments of the enterprise and the audit of taxes.
with which employed. 2. Experience is limited to
2. Constant exposure to one one enterprise, usually
industry presenting within one or a limited
opportunity for expertise in number of industries.
that industry.
3. Likely to have exposure to
compliance, financial and
operational auditing.

(b) Other auditing careers that are available are:

 Auditors within many of the branches of the federal government
(e.g., Atomic Energy Commission)
 Auditors for many state and local government units (e.g.,
state insurance or bank auditors)

1-10
1-21 The most likely type of auditor and the type of audit for each of the examples
are:

EXAMPLE TYPE OF AUDITOR TYPE OF AUDIT

1. IRS Compliance
2. GAO Operational
3. Internal auditor or CPA Operational
4. CPA or Internal auditor Financial statements
5. GAO Operational
6. CPA Financial statements
7. GAO Financial statements
8. IRS Compliance
9. CPA Financial statements
10. Internal auditor or CPA Compliance
11. Internal auditor or CPA Financial statements or operational
12. GAO Compliance

1-22 a. Financial statement audits reduce information risk, which lowers

borrowing costs. An audit also provides assurances to management
about information used for decision-making purposes, and may also
provide recommendations to improve efficiency or effectiveness of
operations.

b. Hogan and Czarnecki likely provide tax services, accounting

services, and management advisory services. They may also provide
additional assurance and attestation services other than audits of
financial statements.

c. Student answers will vary. They may identify new types of information
that require assurance, such as environmental or corporate
responsibility reporting. Students may also identify opportunities
for consulting or management advisory services, such as assistance
with the adoption of international financial reporting standards.

 Internet Problem Solution: CPA Requirements

Internet Problem 1-1

a. Answers will vary by state. Most states require 150 hours of

education, with specific requirements for number of accounting hours
and credit hours in other subject areas.

b. Most states have frequently addressed questions. Many of these

address education requirements, as well as information on how to
prepare for the exam, as well as information on applying for licensure.

1-11
Auditing and Assurance Services 14th Edition Arens Solutions Manual
Full Download: https://alibabadownload.com/product/auditing-and-assurance-services-14th-edition-arens-solutions-manual/

Internet Problem 1-1 (continued)

c. The Elijah Watt Sells award program was established in 1923

by the American Institute of Certified Public Accountants
(AICPA) to recognize outstanding performance on the Uniform
CPA Examination. The Sells award is presented annually to ten
candidates with the highest cumulative scores who completed
testing during the previous calendar year and passed all four
sections of the Uniform CPA Examination on their first attempt.

d. Passing information is available on the CPA Examination portion of

the AICPA web site. Recent passing rates have been approximately
45% for each section.

(Note: Internet problems address current issues using Internet sources. Because
Internet sites are subject to change, Internet problems and solutions may change. Current
information on Internet problems is available at www.pearsonhighered.com/arens.)

1-12

This is sample only, Download all chapters at: AlibabaDownload.com