AUDITING AND ASSURANCE SERVICES - Pearson

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AUDITINGAND ASSURANCESERVICESAN INTEGRATED APPROACHSEVENTEENTH EDITIONALVIN A. ARENSFormer PricewaterhouseCoopersEmeritus ProfessorMichigan State UniversityRANDAL J. ELDERThe University of North Carolina at GreensboroDixon Hughes Goodman Professor and Department HeadMARK S. BEASLEYNorth Carolina State UniversityDeloitte Professor of Enterprise Risk ManagementCHRIS E. HOGANMichigan State UniversityRussell E. Palmer Endowed Professor and DepartmentChairpersonA01 AREN7431 17 SE FM.indd 115/12/18 3:42 AM

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CONTINUINGTHE LEGACY OFALVIN A. ARENSALVIN A. ARENS: The author team of Randy Elder,Mark Beasley, and Chris Hogan, are pleased to continuethe outstanding legacy of our book’s founding author,Al Arens, in this 17th edition of Auditing and AssuranceServices: An Integrated Approach. As was done for the 15thand 16th editions, we again dedicate this new edition toAl’s memory.Randy and Mark joined Al as coauthors on this textbookin the 8th edition, and have been honored to continueAl’s leadership in helping shape classroom instructionand student learning about auditing concepts and theirpractical implementation around the world. Since thefirst edition was published, this textbook has impactedaudit education for nearly 40 years in the U.S. and globNovember 24, 1935 – December 6, 2010ally, including seven different language translations. Al’sleadership at national and international levels and hiscommitment to expanding knowledge through the development of educational materials, including this textbook, continue to inspire us as we strive to advance his legacyfor future generations of auditing professionals.Al was the PricewaterhouseCoopers Auditing Professor and member of the Accounting & Information Systems faculty in the Eli Broad College of Business at MichiganState University from 1968 through 2007. Thus, we are especially pleased that ChrisHogan, Professor at Michigan State University, joined the author team in the 16th edition, continuing the Michigan State connection started by Al.Among his many honors, Al was selected as one of five national auditing educatorsto hold a Price Waterhouse Auditing professorship, was honored as AICPA Educatorof the Year, served on the AICPA Auditing Standards Board, and was President of theAmerican Accounting Association. Al taught accounting, mainly auditing, with a passion that is legendary. He had a heart for sharing his knowledge of auditing with students throughout his career.This 17th edition continues his outstanding legacy in audit education.iiiA01 AREN7431 17 SE FM.indd 315/12/18 3:42 AM

ABOUT THEAUTHORSALVIN A. ARENSAl Arens, founding author of this textbook, was the PricewaterhouseCoopersProfessor of Accounting Emeritus at Michigan State University. In addition to writingbooks on auditing, he was a coauthor of computerized accounting supplements andhe was actively involved in the continuing education of practitioners with local andregional CPA firms. Al was a past president of the American Accounting Associationand a former member of the AICPA Auditing Standards Board. He practiced publicaccounting with both a local CPA firm and the predecessor firm to Ernst & Young.He received many awards including the AAA Auditing Section Outstanding Educatoraward, the AICPA Outstanding Educator award, the national Beta Alpha Psi Professorof the Year award, and many teaching and other awards at Michigan State.RANDAL J. ELDERRandy Elder, who has served as a coauthor of this textbook since the 8th edition, is Dixon Hughes Goodman Professor and Department Head of Accounting andFinance at the University of North Carolina at Greensboro. He teaches undergraduateand graduate auditing courses, and has received several teaching awards. His researchfocuses on audit quality and current audit firm practices and he served as the teamleader for the American Accounting Association Auditing Section PCAOB researchsynthesis teams on audit confirmations and audit sampling. He has extensive publicaccounting experience with a large regional CPA firm, frequently teaches continuingeducation for a large international CPA firm, and is a member of the AICPA.MARK S. BEASLEYMark Beasley, who has also served as a coauthor of this textbook since the 8thedition, is the Deloitte Professor of Enterprise Risk Management and Professorof Accounting at North Carolina State University. He has taught undergraduateand graduate auditing courses, and has received several teaching awards including membership in NC State’s Academy of Outstanding Teachers. He has extensiveprofessional audit experience with the predecessor firm to Ernst & Young and has extensive standards-setting experience working with the Auditing Standards Board asa Technical Manager in the Audit and Assurance Division of the AICPA. He servedon the ASB Fraud Standard Task Force responsible for developing SAS 99, the ASBAntifraud Programs and Controls Task Force, and the Advisory Council overseeingthe COSO Enterprise Risk Management—Integrated Framework project. He servedover seven years as a member of the COSO Board, representing the AAA.CHRIS E. HOGANWe are pleased that Chris Hogan joined us as a coauthor starting with the 16th edition. Chris is the Russell E. Palmer Endowed Professor of Accounting and DepartmentChairperson in the Eli Broad College of Business at Michigan State University. We arethrilled to continue the Michigan State connection started by Al Arens. Chris teachesgraduate auditing and her research focuses on internal controls and integrated audits, audit firm client portfolios, and the impact of regulation on audit markets.Chris has auditing experience with Price Waterhouse, one of the predecessor firmsto PricewaterhouseCoopers, LLP. She has served in multiple leadership roles withinthe American Accounting Association, including serving as President of the AuditingSection and on the Audit Committee of the AAA.ivA01 AREN7431 17 SE FM.indd 415/12/18 3:42 AM

CONTENTSPREFACE XVIITHE AUDITING PROFESSIONTHE DEMAND FOR AUDITAND OTHER ASSURANCE SERVICESLEARNING OBJECTIVES 3Nature of Auditing 4Distinction Between Auditing and Accounting 6Economic Demand for Auditing 6Assurance Services 8Types of Audits 12Types of Auditors 14Certified Public Accountant 16Summary 17Essential Terms 17Review Questions 18Multiple Choice Questions From CPA Examinations 18Multiple Choice Questions From Becker CPA Exam Review* 19Discussion Questions and Problems 20THE CPA PROFESSIONLEARNING OBJECTIVES 24Certified Public Accounting Firms 25Structure of CPA Firms 27Sarbanes–Oxley Act and Public Company Accounting Oversight Board 29Securities and Exchange Commission 30American Institute of Certified Public Accountants (AICPA) 31International and U.S. Auditing Standards 32Organization of U.S. Auditing Standards 34Quality Control 38Summary 40Essential Terms 41Review Questions 42*PART1CHAPTER1CHAPTER2Multiple Choice Questions Becker Professional Education.vA01 AREN7431 17 SE FM.indd 515/12/18 3:42 AM

Multiple Choice Questions From CPA Examinations 42Multiple Choice Questions From Becker CPA Exam Review* 43Discussion Questions and Problems 44CHAPTER3CHAPTER4CHAPTER5viAUDIT REPORTSLEARNING OBJECTIVES 47Standard Unmodified Opinion Audit Report for Nonpublic Entities 48Conditions for Standard Unmodified Opinion Audit Report 51Standard Audit Report and Report on Internal Control Over FinancialReporting Under PCAOB Auditing Standards 52Unmodified Opinion Audit Report With Emphasis-of-Matter ExplanatoryParagraph or Nonstandard Report Wording 58Modifications to the Opinion in the Audit Report 62Materiality 63Discussion of Conditions Requiring a Modification of Opinion 67Auditor’s Decision Process for Audit Reports 71International Accounting and Auditing Standards 73Summary 73Essential Terms 74Review Questions 74Multiple Choice Questions From CPA Examinations 75Multiple Choice Questions From Becker CPA Exam Review* 76Discussion Questions and Problems 77PROFESSIONAL ETHICSLEARNING OBJECTIVES 82What Are Ethics? 83Ethical Dilemmas 84Special Need for Ethical Conduct in Professions 87Code of Professional Conduct 89Independence Rule 94Sarbanes–Oxley and Related Independence Requirements 98Other Rules of Conduct 101Enforcement 108Summary 110Essential Terms 111Review Questions 111Multiple Choice Questions From CPA Examinations 112Multiple Choice Questions From Becker CPA Review* 113Discussion Questions and Problems 113Cases 117LEGAL LIABILITYLEARNING OBJECTIVES 119Legal Environment for CPAs 120Distinguishing Business Failure, Audit Failure, and Audit Risk 121Legal Concepts Affecting Liability 122CONTENTSA01 AREN7431 17 SE FM.indd 615/12/18 3:42 AM

Liability to Clients 124Liability to Third Parties Under Common Law 127Civil Liability Under the Federal Securities Laws 129Criminal Liability 135The Profession’s Response to Legal Liability 136Summary 137Essential Terms 138Review Questions 139Multiple Choice Questions From CPA Examinations 139Multiple Choice Questions From Becker CPA Exam Review* 140Discussion Questions and Problems 141Case 146THE AUDIT PROCESSAUDIT RESPONSIBILITIES AND OBJECTIVESLEARNING OBJECTIVES 148Objective of Conducting an Audit of Financial Statements 149Management’s Responsibilities 150Auditor’s Responsibilities 151Professional Skepticism 155Professional Judgment 156Financial Statement Cycles 159Setting Audit Objectives 163Management Assertions 164Transaction-Related Audit Objectives 167Balance-Related Audit Objectives 169How Audit Objectives Are Met 172Summary 175Essential Terms 175Review Questions 176Multiple Choice Questions From CPA Examinations 177Multiple Choice Questions From Becker CPA Exam Review* 178Discussion Questions and Problems 179AUDIT EVIDENCELEARNING OBJECTIVES 185Nature of Evidence 186Audit Evidence Decisions 187Persuasiveness of Evidence 188Types of Audit Evidence 191Analytical Procedures 199Use of Data Analytics and Other Advanced Technologies 202Common Financial Ratios 206Audit Documentation 209Contents and Organization 210Summary 216PART26CHAPTERCHAPTER7CONTENTSA01 AREN7431 17 SE FM.indd 7vii15/12/18 3:42 AM

Essential Terms 216Review Questions 218Multiple Choice Questions From CPA Examinations 219Multiple Choice Questions From Becker CPA Exam Review* 220Discussion Questions and Problems 221CHAPTER8CHAPTER9viiiAUDIT PLANNING AND MATERIALITYLEARNING OBJECTIVES 229Planning 230Accept Client and Perform Initial Audit Planning 231Understand the Client’s Business and Industry 236Perform Preliminary Analytical Procedures 241Materiality 244Materiality for Financial Statements as a Whole 245Determine Performance Materiality 248Estimate Misstatement and Compare With Preliminary Judgment 250Summary 252Essential Terms 254Review Questions 255Multiple Choice Questions From CPA Examinations 256Multiple Choice Questions From Becker CPA Exam Review* 257Discussion Questions and Problems 258Case 266Integrated Case Application —Pinnacle Manufacturing: Part I 267ASSESSING THE RISK OF MATERIALMISSTATEMENTLEARNING OBJECTIVES 270Audit Risk 271Risk Assessment Procedures 272Considering Fraud Risk 276Identification of Significant Risks 277Audit Risk Model 278Assessing Acceptable Audit Risk 282Assessing Inherent Risk 285Relationship of Risks to Evidence and Factors Influencing Risks 288Relationship of Risk and Materiality to Audit Evidence 292Summary 293Essential Terms 294Review Questions 294Multiple Choice Questions From CPA Examinations 295Multiple Choice Questions From Becker CPA Exam Review* 297Discussion Questions and Problems 297Case 302Integrated Case Application—Pinnacle Manufacturing: Part II 302CONTENTSA01 AREN7431 17 SE FM.indd 815/12/18 3:42 AM

ASSESSING AND RESPONDINGTO FRAUD RISKSLEARNING OBJECTIVES 304Types of Fraud 305Conditions for Fraud 306Assessing the Risk of Fraud 310Corporate Governance Oversight to Reduce Fraud Risks 314Responding to the Risk of Fraud 318Specific Fraud Risk Areas 321Responsibilities When Fraud is Suspected 326Documenting the Fraud Assessment 330Summary 331Essential Terms 331Review Questions 332Multiple Choice Questions From CPA Examinations 333Multiple Choice Questions From Becker CPA Exam Review* 334Discussion Questions and Problems 335Integrated Case Application—Pinnacle Manufacturing: Part III 341INTERNAL CONTROL AND COSOFRAMEWORKLEARNING OBJECTIVES 342Internal Control Objectives 343Management and Auditor Responsibilities for Internal Control 344COSO Components of Internal Control 347Internal Controls Specific to Information Technology 356Impact of IT Infrastructure on Internal Control 363Summary 365Essential Terms 365Review Questions 367Multiple Choice Questions From CPA Examinations 368Multiple Choice Questions From Becker CPA Exam Review* 369Discussion Questions and Problems 369Case 373ASSESSING CONTROL RISK AND REPORTINGON INTERNAL CONTROLSLEARNING OBJECTIVES 375Obtain and Document Understanding of Internal Control 376Assess Control Risk 379Tests of Controls 384Decide Planned Detection Risk and Design Substantive Tests 390Auditor Reporting On Internal Control 390CHAPTER10CHAPTER11CHAPTER12CONTENTSA01 AREN7431 17 SE FM.indd 9ix15/12/18 3:42 AM

Evaluating, Reporting, and Testing Internal Control for Nonpublic andSmaller Public Companies 393Impact of IT Environment on Control Risk Assessment and Testing 395Summary 399Essential Terms 399Review Questions 401Multiple Choice Questions From CPA Examinations 402Multiple Choice Questions From Becker CPA Exam Review* 403Discussion Questions and Problems 404Case 412Integrated Case Application—Pinnacle Manufacturing: Part IV 413CHAPTER13PART3CHAPTER14OVERALL AUDIT STRATEGYAND AUDIT PROGRAMLEARNING OBJECTIVES 416Types of Tests 417Selecting Which Types of Tests to Perform 423Evidence Mix 426Design of the Audit Program 428Summary of Key Evidence-Related Terms 437Summary of the Audit Process 438Summary 442Essential Terms 442Review Questions 443Multiple Choice Questions From CPA Examinations 444Multiple Choice Questions From Becker CPA Exam Review* 445Discussion Questions and Problems 446Cases 451APPLICATION OF THE AUDIT PROCESS TOTHE SALES AND COLLECTION CYCLEAUDIT OF THE SALES AND COLLECTIONCYCLE: TESTS OF CONTROLS ANDSUBSTANTIVE TESTS OF TRANSACTIONSLEARNING OBJECTIVES 455Accounts and Classes of Transactions in the Sales and Collection Cycle 456Business Functions in the Cycle and Related Documents and Records 457Methodology for Designing Tests of Controls and Substantive Tests ofTransactions for Sales 462Sales Returns and Allowances 474Methodology for Designing Tests of Controls and Substantive Tests ofTransactions for Cash Receipts 474Audit Tests for Uncollectible Accounts 478xCONTENTSA01 AREN7431 17 SE FM.indd 1015/12/18 3:42 AM

Effect of Results of Tests of Controls and Substantive Tests ofTransactions 479Summary 480Essential Terms 481Review Questions 481Multiple Choice Questions From CPA Examinations 482Multiple Choice Questions From Becker CPA Exam Review* 484Discussion Questions and Problems 484Case 491Integrated Case Application—Pinnacle Manufacturing: Part V 492AUDIT SAMPLING FOR TE

Al Arens, in this 17th edition of Auditing and Assurance Services: An Integrated Approach. As was done for the 15th and 16th editions, we again dedicate this new edition to Al’s memory. Randy and Mark joined Al as coauthors on this textbook in the 8th edition, and have been honored to continue Al’s leadership in helping shape classroom instruction and student learning about auditing .

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