SOLUTION MANUAL For Auditing & Assurance Services A
c c c c c c c
c Systematic Approach c c
12th Edition By William Messier Jr, Steven Glover,
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Chapters 1 - 21 / Complete
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1
,• Table of Contents c c
Chapter 1: An Introduction to Assurance and Financial Statement Auditing
c c c c c c c c c
Chapter 2: The Financial Statement Auditing Environment
c c c c c c
Chapter 3: Audit Planning, Types of Audit Tests, and Materiality
c c c c c c c c c
Chapter 4: Risk Assessment
c c c
Chapter 5: Evidence and Documentation
c c c c
Chapter 6: Internal Control in a Financial Statement Audit
c c c c c c c c
Chapter 7: Auditing Internal Control over Financial Reporting
c c c c c c c
Chapter 8: Audit Sampling: An Overview and Application to Tests of Controls
c c c c c c c c c c c
Chapter 9: Audit Sampling: An Application to Substantive Tests of Account Balances
c c c c c c c c c c c
Chapter 10: Auditing the Revenue Process
c c c c c
Chapter 11: Auditing the Purchasing Process
c c c c c
Chapter 12: Auditing the Human Resource Management Process
c c c c c c c
Chapter 13: Auditing the Inventory Management Process
c c c c c c
Chapter 14: Auditing the Financing/Investing Process:Prepaid Expenses, Intangible Assets, and Property, Plant, and
c c c c c c c c c c c c
Equipment
c
Chapter 15: Auditing the Financing/Investing Process:Long-Term Liabilities, Stockholders’ Equity, and Income Statement
c c c c c c c c c c c
Accounts
c
Chapter 16: Auditing the Financing/Investing Process: Cashand Investments
c c c c c c c
Chapter 17: Completing the Audit Engagement
c c c c c
Chapter 18: Reports on Audited Financial Statements
c c c c c c
Chapter 19: Professional Conduct, Independence, and Quality Management
c c c c c c c
Chapter 20: Legal Liability
c c c
Chapter 21: Assurance, Attestation, and Internal Auditing Services
c c c c c c c
2
,CHAPTER 1 c
AN INTRODUCTION TO ASSURANCE AND FINANCIAL STATEMENT AUDITING
c c c c c c c
Answers to Review Questions c c c
1-1 The study of auditing is more conceptual in nature compared to other accounting courses.
c c c c c c c c c c c c c
Rather than focusing on learning the rules, techniques, and computations required to prepare
c c c c c c c c c c c c c
financial statements, auditing emphasizes learning a framework of analytical and logicalskills to
c c c c c c c c c c c c c
evaluate the relevance and reliability of the systems and processes responsible for financial
c c c c c c c c c c c c c
information, as well as the information itself. To be successful, students must learn the framework
c c c c c c c c c c c c c c c
and then learn to use logic and common sense in applying auditing concepts to various
c c c c c c c c c c c c c c c
circumstances and situations.
c c c
Understanding auditing can improve the decision making ability of consultants, business c c c c c c c c c c
managers, and accountants by providing a framework for evaluating the usefulness and
c c c c c c c c c c c c
reliability of information.
c c c
1-2 There is a demand for auditing in a free-market economy because the agency relationship c c c c c c c c c c c c c
between an absentee owner and a manager produces a natural conflict of interest due to the
c c c c c c c c c c c c c c c c
information asymmetry that exists between the owner and manager. As a result, theagent agrees
c c c c c c c c c c c c c c c
to be monitored as part of his/her employment contract. Auditing appears to be acost-effective
c c c c c c c c c c c c c c c
form of monitoring.
c c c
The empirical evidence suggests auditing was demanded prior to government regulation
c c c c c c c c c c
such as statutory audit requirements. Additionally, many private companies and other entities not
c c c c c c c c c c c c c
subject to government auditing regulations also demand auditing.
c c c c c c c c
1-3 The agency relationship between an owner and manager produces a natural conflict of
c c c c c c c c c c c c
interest because of differences in the two parties’ goals and because of information asymmetry
c c c c c c c c c c c c c c
that exists between them. That is, the manager generally has more information about the ‘true’
c c c c c c c c c c c c c c c
financial position and results of operations of the entity than the absentee owner does. If both
c c c c c c c c c c c c c c c c
parties seek to maximize their own self-interest, it is likely that the manager will not act in the best
c c c c c c c c c c c c c c c c c c c
interest of the owner and may manipulate the information provided to the owner accordingly.
c c c c c c c c c c c c c c
1-4 Independence is an important standard for auditors. If an auditor is not independent ofthe c c c c c c c c c c c c c c
client, users may lose confidence in the auditor’s ability to report truthfully on the financial
c c c c c c c c c c c c c c c
statements, and the auditor’s work loses its value. From an agency perspective, if the principal
c c c c c c c c c c c c c c c
(owner) knows that the auditor is not independent, the owner will not trust the auditor’s work.
c c c c c c c c c c c c c c c c
Thus, the agent will not hire the auditor because the auditor’s report will not be effective inreducing
c c c c c c c c c c c c c c c c c
information risk from the perspective of the owner.
c c c c c c c c
1-5 Auditing (broadly defined) is a systematic process of objectively obtaining and c c c c c c c c c c
evaluating evidence regarding assertions about economic actions and events to ascertain the
c c c c c c c c c c c c
degree of correspondence between those assertions and established criteria and
c c c c c c c c c c
communicating the results to interested users.
c c c c c c
Assurance is engagement in which a practitioner expresses a conclusion designed to c c c c c c c c c c c
enhance the degree of confidence of the intended users other than the responsible party aboutthe
c c c c c c c c c c c c c c c c
outcome of the evaluation or measurement of a subject matter against criteria.
c c c c c c c c c c c c
Examples of assurance services are assurance (audit) of financial statements, assurance c c c c c c c c c c
of prospective financial information, assurance of reporting on internal control,assurance of
c c c c c c c c c c c c
sustainability reporting, and assurance of electronic commerce.
c c c c c c c
3
, 1-6 The phrase systematic process implies that there should be a well-planned, logical
c c c c c c c c c c c
approach for conducting an audit that involves objectively obtaining and evaluating evidence.
c c c c c c c c c c c c
1-7 Materiality: "Omissions or misstatements of items are material if they could, individuallyor c c c c c c c c c c c c
collectively, influence the economic decisions of users taken on the basis of the financial
c c c c c c c c c c c c c c
statements. Materiality depends on the size and nature of the omission or misstatement judged in
c c c c c c c c c c c c c c c
the surrounding circumstances. The size or nature of the item, or a combination of both, couldbe the
c c c c c c c c c c c c c c c c c c
determining factor." (IASB).
c c c
Audit risk is defined as the risk that the auditor expresses an inappropriate audit opinion
c c c c c c c c c c c c c c
when the financial statements are materially misstated (ISA 200).
c c c c c c c c c
The audit report states that the auditor obtains “reasonable assurance” whether the
c c c c c c c c c c c
financial statements are free from “material” misstatement. The term reasonable assurance
c c c c c c c c c c c
informs the reader that there is some level of risk that the audit did not detect all material
c c c c c c c c c c c c c c c c c c
misstatements. In addition, the auditor’s opinion commonly uses the wording that the financial
c c c c c c c c c c c c c
statements present fairly, “in all material respects.” These phrases communicate to third partiesthat
c c c c c c c c c c c c c c
the audit report is limited to material information.
c c c c c c c c
1-8 On most audits, it is not feasible or cost-effective to audit all transactions. For example, in a
c c c c c c c c c c c c c c c c
small business, the auditor might be able to examine all transactions that occurred during the
c c c c c c c c c c c c c c c
period. However, it is unlikely that the owner of the business could afford to pay for such an
c c c c c c c c c c c c c c c c c c
extensive audit. For a large organization, the sheer volume of transactions prevents the auditor
c c c c c c c c c c c c c c
from examining every transaction. Thus, there is a trade-off between the exactness or precisionof
c c c c c c c c c c c c c c c
the audit and its cost.
c c c c c
1-9 The major phases of the audit are: c c c c c c
• Client acceptance/continuance and establishing engagement terms c c c c c
• Preplanning
• Assess risks and establish materiality c c c c
• Plan the audit c c
• Consider internal control c c
• Audit business processes and related accounts c c c c c
• Complete the audit c c
• Evaluate results and issue audit report c c c c c
1-10 The auditor’s understanding of the entity and its environment includes knowledge
c c c c c c c c c c
about: (1) the nature of the entity, (2) its objectives and strategies, (3) its industry, regulatory,and
c c c c c c c c c c c c c c c c c
other external factors, (4) its management, (5) its governance, (6) its measurement and
c c c c c c c c c c c c c
performance process, and (7) its business processes.
c c c c c c c
1-11 Sometimes auditors will face situations where no standard audit procedure exists, suchas c c c c c c c c c c c c
the example from the text of verifying the inventory of reindeer. Such circumstances require that
c c c c c c c c c c c c c c c
the auditor possess creativity and innovation when planning and administering audit procedures
c c c c c c c c c c c c
where little or no precedent exists. Every client is different, and applying auditing concepts in
c c c c c c c c c c c c c c c
different situations requires logic and common sense, and frequently creativity and innovation.
c c c c c c c c c c c c
Solutions to Problems c c
1-12 The memo should cite the following facts:
c c c c c c
• There is a historical relationship between accounting and auditing. c c c c c c c c
4
c c c c c c c
c Systematic Approach c c
12th Edition By William Messier Jr, Steven Glover,
c c c c c c c c
Chapters 1 - 21 / Complete
c c c c c
1
,• Table of Contents c c
Chapter 1: An Introduction to Assurance and Financial Statement Auditing
c c c c c c c c c
Chapter 2: The Financial Statement Auditing Environment
c c c c c c
Chapter 3: Audit Planning, Types of Audit Tests, and Materiality
c c c c c c c c c
Chapter 4: Risk Assessment
c c c
Chapter 5: Evidence and Documentation
c c c c
Chapter 6: Internal Control in a Financial Statement Audit
c c c c c c c c
Chapter 7: Auditing Internal Control over Financial Reporting
c c c c c c c
Chapter 8: Audit Sampling: An Overview and Application to Tests of Controls
c c c c c c c c c c c
Chapter 9: Audit Sampling: An Application to Substantive Tests of Account Balances
c c c c c c c c c c c
Chapter 10: Auditing the Revenue Process
c c c c c
Chapter 11: Auditing the Purchasing Process
c c c c c
Chapter 12: Auditing the Human Resource Management Process
c c c c c c c
Chapter 13: Auditing the Inventory Management Process
c c c c c c
Chapter 14: Auditing the Financing/Investing Process:Prepaid Expenses, Intangible Assets, and Property, Plant, and
c c c c c c c c c c c c
Equipment
c
Chapter 15: Auditing the Financing/Investing Process:Long-Term Liabilities, Stockholders’ Equity, and Income Statement
c c c c c c c c c c c
Accounts
c
Chapter 16: Auditing the Financing/Investing Process: Cashand Investments
c c c c c c c
Chapter 17: Completing the Audit Engagement
c c c c c
Chapter 18: Reports on Audited Financial Statements
c c c c c c
Chapter 19: Professional Conduct, Independence, and Quality Management
c c c c c c c
Chapter 20: Legal Liability
c c c
Chapter 21: Assurance, Attestation, and Internal Auditing Services
c c c c c c c
2
,CHAPTER 1 c
AN INTRODUCTION TO ASSURANCE AND FINANCIAL STATEMENT AUDITING
c c c c c c c
Answers to Review Questions c c c
1-1 The study of auditing is more conceptual in nature compared to other accounting courses.
c c c c c c c c c c c c c
Rather than focusing on learning the rules, techniques, and computations required to prepare
c c c c c c c c c c c c c
financial statements, auditing emphasizes learning a framework of analytical and logicalskills to
c c c c c c c c c c c c c
evaluate the relevance and reliability of the systems and processes responsible for financial
c c c c c c c c c c c c c
information, as well as the information itself. To be successful, students must learn the framework
c c c c c c c c c c c c c c c
and then learn to use logic and common sense in applying auditing concepts to various
c c c c c c c c c c c c c c c
circumstances and situations.
c c c
Understanding auditing can improve the decision making ability of consultants, business c c c c c c c c c c
managers, and accountants by providing a framework for evaluating the usefulness and
c c c c c c c c c c c c
reliability of information.
c c c
1-2 There is a demand for auditing in a free-market economy because the agency relationship c c c c c c c c c c c c c
between an absentee owner and a manager produces a natural conflict of interest due to the
c c c c c c c c c c c c c c c c
information asymmetry that exists between the owner and manager. As a result, theagent agrees
c c c c c c c c c c c c c c c
to be monitored as part of his/her employment contract. Auditing appears to be acost-effective
c c c c c c c c c c c c c c c
form of monitoring.
c c c
The empirical evidence suggests auditing was demanded prior to government regulation
c c c c c c c c c c
such as statutory audit requirements. Additionally, many private companies and other entities not
c c c c c c c c c c c c c
subject to government auditing regulations also demand auditing.
c c c c c c c c
1-3 The agency relationship between an owner and manager produces a natural conflict of
c c c c c c c c c c c c
interest because of differences in the two parties’ goals and because of information asymmetry
c c c c c c c c c c c c c c
that exists between them. That is, the manager generally has more information about the ‘true’
c c c c c c c c c c c c c c c
financial position and results of operations of the entity than the absentee owner does. If both
c c c c c c c c c c c c c c c c
parties seek to maximize their own self-interest, it is likely that the manager will not act in the best
c c c c c c c c c c c c c c c c c c c
interest of the owner and may manipulate the information provided to the owner accordingly.
c c c c c c c c c c c c c c
1-4 Independence is an important standard for auditors. If an auditor is not independent ofthe c c c c c c c c c c c c c c
client, users may lose confidence in the auditor’s ability to report truthfully on the financial
c c c c c c c c c c c c c c c
statements, and the auditor’s work loses its value. From an agency perspective, if the principal
c c c c c c c c c c c c c c c
(owner) knows that the auditor is not independent, the owner will not trust the auditor’s work.
c c c c c c c c c c c c c c c c
Thus, the agent will not hire the auditor because the auditor’s report will not be effective inreducing
c c c c c c c c c c c c c c c c c
information risk from the perspective of the owner.
c c c c c c c c
1-5 Auditing (broadly defined) is a systematic process of objectively obtaining and c c c c c c c c c c
evaluating evidence regarding assertions about economic actions and events to ascertain the
c c c c c c c c c c c c
degree of correspondence between those assertions and established criteria and
c c c c c c c c c c
communicating the results to interested users.
c c c c c c
Assurance is engagement in which a practitioner expresses a conclusion designed to c c c c c c c c c c c
enhance the degree of confidence of the intended users other than the responsible party aboutthe
c c c c c c c c c c c c c c c c
outcome of the evaluation or measurement of a subject matter against criteria.
c c c c c c c c c c c c
Examples of assurance services are assurance (audit) of financial statements, assurance c c c c c c c c c c
of prospective financial information, assurance of reporting on internal control,assurance of
c c c c c c c c c c c c
sustainability reporting, and assurance of electronic commerce.
c c c c c c c
3
, 1-6 The phrase systematic process implies that there should be a well-planned, logical
c c c c c c c c c c c
approach for conducting an audit that involves objectively obtaining and evaluating evidence.
c c c c c c c c c c c c
1-7 Materiality: "Omissions or misstatements of items are material if they could, individuallyor c c c c c c c c c c c c
collectively, influence the economic decisions of users taken on the basis of the financial
c c c c c c c c c c c c c c
statements. Materiality depends on the size and nature of the omission or misstatement judged in
c c c c c c c c c c c c c c c
the surrounding circumstances. The size or nature of the item, or a combination of both, couldbe the
c c c c c c c c c c c c c c c c c c
determining factor." (IASB).
c c c
Audit risk is defined as the risk that the auditor expresses an inappropriate audit opinion
c c c c c c c c c c c c c c
when the financial statements are materially misstated (ISA 200).
c c c c c c c c c
The audit report states that the auditor obtains “reasonable assurance” whether the
c c c c c c c c c c c
financial statements are free from “material” misstatement. The term reasonable assurance
c c c c c c c c c c c
informs the reader that there is some level of risk that the audit did not detect all material
c c c c c c c c c c c c c c c c c c
misstatements. In addition, the auditor’s opinion commonly uses the wording that the financial
c c c c c c c c c c c c c
statements present fairly, “in all material respects.” These phrases communicate to third partiesthat
c c c c c c c c c c c c c c
the audit report is limited to material information.
c c c c c c c c
1-8 On most audits, it is not feasible or cost-effective to audit all transactions. For example, in a
c c c c c c c c c c c c c c c c
small business, the auditor might be able to examine all transactions that occurred during the
c c c c c c c c c c c c c c c
period. However, it is unlikely that the owner of the business could afford to pay for such an
c c c c c c c c c c c c c c c c c c
extensive audit. For a large organization, the sheer volume of transactions prevents the auditor
c c c c c c c c c c c c c c
from examining every transaction. Thus, there is a trade-off between the exactness or precisionof
c c c c c c c c c c c c c c c
the audit and its cost.
c c c c c
1-9 The major phases of the audit are: c c c c c c
• Client acceptance/continuance and establishing engagement terms c c c c c
• Preplanning
• Assess risks and establish materiality c c c c
• Plan the audit c c
• Consider internal control c c
• Audit business processes and related accounts c c c c c
• Complete the audit c c
• Evaluate results and issue audit report c c c c c
1-10 The auditor’s understanding of the entity and its environment includes knowledge
c c c c c c c c c c
about: (1) the nature of the entity, (2) its objectives and strategies, (3) its industry, regulatory,and
c c c c c c c c c c c c c c c c c
other external factors, (4) its management, (5) its governance, (6) its measurement and
c c c c c c c c c c c c c
performance process, and (7) its business processes.
c c c c c c c
1-11 Sometimes auditors will face situations where no standard audit procedure exists, suchas c c c c c c c c c c c c
the example from the text of verifying the inventory of reindeer. Such circumstances require that
c c c c c c c c c c c c c c c
the auditor possess creativity and innovation when planning and administering audit procedures
c c c c c c c c c c c c
where little or no precedent exists. Every client is different, and applying auditing concepts in
c c c c c c c c c c c c c c c
different situations requires logic and common sense, and frequently creativity and innovation.
c c c c c c c c c c c c
Solutions to Problems c c
1-12 The memo should cite the following facts:
c c c c c c
• There is a historical relationship between accounting and auditing. c c c c c c c c
4
