Auditing and Assurance Services » (13rd Edition)

An integrated and current approach to auditing.

KEY TOPICS: The Auditing Profession; The Audit Process; Application of the Audit Process to the Sales and Collection Cycle; Application of the Audit Process to Other Cycles; Completing the Audit; Other Assurance and Nonassurance Services

MARKET: For individuals interested in the auditing, accounting, and consulting fields.

Preface  xi

PART 1 The Auditing Profession
1. The Demand for Audit and Other Assurance Services  3
Learning Objectives  3
Nature of Auditing  4
Distinction Between Auditing and Accounting  6
Economic Demand for Auditing  6
Assurance Services  8
Types of Audits  13
Types of Auditors  15
Certified Public Accountant  17
Summary  18
Essential Terms  18
Review Questions  19
Multiple Choice Questions from CPA Examinations  20
Discussion Questions and Problems  21
Internet Problem 1-1: Sarbanes–Oxley Act Internal Control Reporting Requirements  24
2. The CPA Profession  25
Learning Objectives  25
Certified Public Accounting Firms  26
Activities of CPA Firms  27
Structure of CPA Firms  28
Sarbanes–Oxley Act and Public Company Accounting Oversight Board  30
Securities and Exchange Commission  31
American Institute of Certified Public Accountants (AICPA)  32
Generally Accepted Auditing Standards  33
Statements on Auditing Standards  36
International Standards on Auditing  37
Quality Control  37
Summary  39
Essential Terms  40
Review Questions  41
Multiple Choice Questions from CPA Examinations  41
Discussion Questions and Problems  43
Internet Problem 2-1: International Auditing and Assurance Standards Board  44
3. Audit Reports  45
Learning Objectives  45
Standard Unqualified Audit Report  46
Combined Reports on Financial Statements and Internal Control Over Financial Reporting Under Section 404 of the Sarbanes–Oxley Act  49
Unqualified Audit Report with Explanatory Paragraph or Modified Wording  51
Departures from an Unqualified Audit Report  55
Materiality  56
Discussion of Conditions Requiring a Departure  59
Auditor’s Decision Process for Audit Reports  63
Impact of E-Commerce on Audit Reporting  65
Summary  65
Essential Terms  66
Review Questions  66
Multiple Choice Questions from CPA Examinations  67
Discussion Questions and Problems  69
Internet Problem 3-1: Research Annual Reports  74
4. Professional Ethics  75
Learning Objectives  75
What Are Ethics?  76
Ethical Dilemmas  77
Special Need for Ethical Conduct in Professions  80
Code of Professional Conduct  81
Independence  85
Independence Rule of Conduct and Interpretations  88
Other Rules of Conduct  93
Enforcement  100
Summary  100
Essential Terms  102
Review Questions  102
Multiple Choice Questions from CPA Examinations  103
Discussion Questions and Problems  104
Cases  107
Internet Problem 4-1: PCAOB Disciplinary Actions  110
5. Legal Liability  111
Learning Objectives  111
Changed Legal Environment  112
Distinguishing Business Failure, Audit Failure, and Audit Risk  113
Legal Concepts Affecting Liability  114
Liability to Clients  116
Liability to Third Parties Under Common Law  119
Civil Liability Under the Federal Securities Laws  121
Criminal Liability  125
The Profession’s Response to Legal Liability  127
Protecting Individual CPAs from Legal Liability  128
Summary  129
Essential Terms  130
Review Questions  131
Multiple Choice Questions from CPA Examinations  131
Discussion Questions and Problems  133
Case  137
Internet Problem 5-1: SEC Enforcement  137
PART 2 The Audit Process
6. Audit Responsibilities and Objectives  139
Learning Objectives  139
Objective of Conducting an Audit of Financial Statements  140
Management’s Responsibilities  141
Auditor’s Responsibilities  142
Financial Statement Cycles  146
Setting Audit Objectives  150
Management Assertions  151
Transaction-Related Audit Objectives  154
Balance-Related Audit Objectives  156
Presentation and Disclosure-Related Audit Objectives  159
How Audit Objectives Are Met  159
Summary  162
Essential Terms  162
Review Questions  163
Multiple Choice Questions from CPA Examinations  164
Discussion Questions and Problems  165
Case  169
Internet Problem 6-1: International and PCAOB Audit Objectives  170
7. Audit Evidence  171
Learning Objectives  171
Nature of Evidence  172
Audit Evidence Decisions  173
Persuasiveness of Evidence  174
Types of Audit Evidence  177
Audit Documentation  185
Summary  194
Essential Terms  195
Review Questions  196
Multiple Choice Questions from CPA Examinations  197
Discussion Questions and Problems  198
Cases  203
ACL Problem  205
Internet Problem 7-1: Use of Audit Software for Fraud Detection and Data Quality Assurance  205
8. Audit Planning and Analytical Procedures  207
Learning Objectives  207
Planning  208
Accept Client and Perform Initial Audit Planning  209
Understand the Client’s Business and Industry  214
Assess Client Business Risk  218
Perform Preliminary Analytical Procedures  220
Summary of the Parts of Audit Planning  221
Analytical Procedures  223
Five Types of Analytical Procedures  224
Common Financial Ratios  230
Summary  232
Essential Terms  232
Review Questions  232
Multiple Choice Questions from CPA Examinations  234
Discussion Questions and Problems  236
Cases  241
Integrated Case Application—Pinnacle Manufacturing: Part I  243
ACL Problem  246
Internet Problem 8-1: Obtain Client Background Information  246
9. Materiality and Risk  247
Learning Objectives  247
Materiality  248
Set Preliminary Judgment about Materiality  249
Allocate Preliminary Judgment about Materiality to Segments
(Tolerable Misstatement)  252
Estimate Misstatement and Compare with Preliminary Judgment  255
Risk  257
Types of Risks  259
Assessing Acceptable Audit Risk  261
Assessing Inherent Risk  263
Relationship of Risks to Evidence and Factors Influencing Risks  266
Evaluating Results  271
Summary  273
Essential Terms  274
Review Questions  275
Multiple Choice Questions from CPA Examinations  276
Discussion Questions and Problems  277
Cases  283
Integrated Case Application—Pinnacle Manufacturing: Part II  287
Internet Problem 9-1: Materiality and Tolerable Misstatement  288
10. Section 404 Audits of Internal Control and Control Risk  289
Learning Objectives  289
Internal Control Objectives  290
Management and Auditor Responsibilities for Internal Control  291
COSO Components of Internal Control  294
Obtain and Document Understanding of Internal Control  303
Assess Control Risk  307
Tests of Controls  313
Decide Planned Detection Risk and Design Substantive Tests  315
Section 404 Reporting on Internal Control  316
Evaluating, Reporting, and Testing Internal Control for Nonpublic Companies  318
Summary  321
Essential Terms  321
Review Questions  324
Multiple Choice Questions from CPA Examinations  326
Discussion Questions and Problems  328
Case  333
Integrated Case Application—Pinnacle Manufacturing: Part III  334
Internet Problem 10-1: Disclosure of Material Weaknesses in Internal Control Over Financial Reporting  335
11. Fraud Auditing  337
Learning Objectives  337
Types of Fraud  338
Conditions for Fraud  340
Assessing the Risk of Fraud  343
Corporate Governance Oversight to Reduce Fraud Risks  346
Responding to the Risk of Fraud  351
Specific Fraud Risk Areas  353
Responsibilities when Fraud is Suspected  358
Summary  362
Essential Terms  363
Review Questions  363
Multiple Choice Questions from CPA Examinations  364
Discussion Questions and Problems  365
Case  369
ACL Problem  370
Internet Problem 11-1: Brainstorming About Fraud Risks  370
12. The Impact of Information Technology on the Audit Process  371
Learning Objectives  371
How Information Technologies Improve Internal Control  372
Assessing Risks of Information Technology  372
Internal Controls Specific to Information Technology  374
Impact of Information Technology on the Audit Process  380
Issues for Different IT Environments  387
Summary  390
Essential Terms  390
Review Questions  392
Multiple Choice Questions from CPA Examinations  392
Discussion Questions and Problems  394
Case  400
ACL Problem  401
Internet Problem 12-1: Assessing IT Governance  402
13. Overall Audit Plan and Audit Program  403
Learning Objectives  403
Types of Tests  404
Selecting Which Types of Tests to Perform  409
Impact of Information Technology on Audit Testing  412
Evidence Mix  413
Design of the Audit Program  414
Summary of Key Evidence-Related Terms  424
Summary of the Audit Process  425
Essential Terms  429
Review Questions  429
Multiple Choice Questions from CPA Examinations  431
Discussion Questions and Problems  433
Cases  438
Internet Problem 13-1: Assessing Effects of Evidence Mix  440
PART 3 Application of the Audit Process to the Sales and Collection Cycle
14. Audit of the Sales and Collection Cycle: Tests of Controls and Substantive Tests of Transactions  443
Learning Objectives  443
Accounts and Classes of Transactions in the Sales and Collection Cycle  444
Business Functions in the Cycle and Related Documents and Records  445
Methodology for Designing Tests of Controls and Substantive Tests of Transactions for Sales  450
Sales Returns and Allowances  460
Methodology for Designing Tests of Controls and Substantive Tests of Transactions for Cash Receipts  461
Audit Tests for the Write-off of Uncollectible Accounts  465
Additional Internal Controls over Account Balances and Presentation and Disclosure  466
Effect of Results of Tests of Controls and Substantive Tests of Transactions  466
Summary  467
Essential Terms  468
Review Questions  468
Multiple Choice Questions from CPA Examinations  469
Discussion Questions and Problems  471
Case  477
Integrated Case Application—Pinnacle Manufacturing: Part IV  478
ACL Problem  479
Internet Problem 14-1: Point of Sales Systems Controls  479
15. Audit Sampling for Tests of Controls and Substantive Tests of Transactions  481
Learning Objectives  481
Representative Samples  482
Statistical Versus Nonstatistical Sampling and Probabilistic Versus Nonprobabilistic Sample Selection  483
Nonprobabilistic Sample Selection Methods  484
Probabilistic Sample Selection Methods  485
Sampling for Exception Rates  488
Application of Nonstatistical Audit Sampling  489
Statistical Audit Sampling  505
Sampling Distribution  505
Application of Attributes Sampling  506
Summary  512
Essential Terms  512
Review Questions  513
Multiple Choice Questions from CPA Examinations  514
Discussion Questions and Problems  516
Case  520
Integrated Case Application—Pinnacle Manufacturing: Part V  521
Internet Problem 15-1: Applying Statistical Sampling  523
16. Completing the Tests in the Sales and Collection Cycle: Accounts Receivable  525
Learning Objectives  525
Methodology for Designing Tests of Details of Balances  526
Designing Tests of Details of Balances  533
Confirmation of Accounts Receivable  539
Developing Tests of Details Audit Program  545
Essential Terms  548
Review Questions  549
Multiple Choice Questions from CPA Examinations  550
Discussion Questions and Problems  552
Case  557
Integrated Case Application—Pinnacle Manufacturing: Part VI  558
ACL Problem  560
Internet Problem 16-1: Revenue Recognition  560
17. Audit Sampling for Tests of Details of Balances  565
Learning Objectives  565
Comparisons of Audit Sampling for Tests of Details of Balances and for Tests of Controls and Substantive Tests of Transactions  566
Nonstatistical Sampling  567
Monetary Unit Sampling  576
Variables Sampling  586
Illustration Using Difference Estimation  592
Summary  598
Essential Terms  599
Review Questions  599
Multiple Choice Questions from CPA Examinations  601
Discussion Questions and Problems  602
Cases  606
Internet Problem 17-1: Monetary Unit Sampling Considerations  607
PART 4 Application of the Audit Process to Other Cycles
18. Audit of the Payroll and Personnel Cycle  609
Learning Objectives  609
Accounts and Transactions in the Payroll and Personnel Cycle  610
Business Functions in the Cycle and Related Documents and Records  610
Methodology for Designing Tests of Controls and Substantive Tests of Transactions  614
Methodology for Designing Tests of Details of Balances  619
Summary  623
Essential Terms  624
Review Questions  624
Multiple Choice Questions from CPA Examinations  625
Discussion Questions and Problems  627
Case  631
Internet Problem 18-1: Accounts Payable Fraud  632
19. Audit of the Acquisition and Payment Cycle: Tests of Controls,
Substantive Tests of Transactions, and Accounts Payable  633
Learning Objectives  633
Accounts and Classes of Transactions in the Acquisition and Payment Cycle  634
Business Functions in the Cycle and Related Documents and Records  634
How E-Commerce Affects the Acquisition and Payment Cycle  638
Methodology for Designing Tests of Controls and Substantive Tests of Transactions  639
Methodology for Designing Tests of Details of Balances for Accounts Payable  645
Summary  653
Essential Terms  654
Review Questions  655
Multiple Choice Questions from CPA Examinations  656
Discussion Questions and Problems  657
Case  664
Internet Problem 19-1: Managing the Accounts Payable Function  666
20. Completing the Tests in the Acquisition and Payment Cycle:
Verification of Selected Accounts  667
Learning Objectives  667
Types of Other Accounts in the Acquisition and Payment Cycle  668
Audit of Property, Plant, and Equipment  668
Audit of Prepaid Expenses  677
Audit of Accrued Liabilities  679
Audit of Income and Expense Accounts  681
Summary  685
Essential Terms  685
Review Questions  685
Multiple Choice Questions from CPA Examinations  686
Discussion Questions and Problems  688
Cases  691
Internet Problem 20-1: Risks of Outsourcing the Payroll Function  693
21. Audit of the Inventory and Warehousing Cycle  695
Learning Objectives  695
Business Functions in the Cycle and Related Documents and Records  696
How E-Commerce Affects Inventory Management  698
Parts of the Audit of Inventory  699
Audit of Cost Accounting  701
Analytical Procedures  704
Methodology for Designing Tests of Details of Balances  705
Physical Observation of Inventory  706
Audit of Pricing and Compilation  709
Integration of the Tests  713
Summary  714
Essential Terms  715
Review Questions  715
Multiple Choice Questions from CPA Examinations  716
Discussion Questions and Problems  718
Case  724
Internet Problem 21-1: Using Inventory Count Specialists  725
22. Audit of the Capital Acquisition and Repayment Cycle  727
Learning Objectives  727
Accounts in the Cycle  728
Notes Payable  730
Owners’ Equity  735
Summary  741
Essential Terms  741
Review Questions  741
Multiple Choice Questions from CPA Examinations  743
Discussion Questions and Problems  743
Internet Problem 22-1: Stock Exchange Requirements  748
23. Audit of Cash Balances  749
Learning Objectives  749
Cash in the Bank and Transaction Cycles  750
Types of Cash Accounts  752
Audit of the General Cash Account  753
Fraud-Oriented Procedures  760
Audit of the Imprest Payroll Bank Account  765
Audit of Imprest Petty Cash  765
Summary  766
Essential Terms  766
Review Questions  767
Multiple Choice Questions from CPA Examinations  768
Discussion Questions and Problems  769
Case  772
Internet Problem 23-1: Automated Clearing House System for Electronic Funds Transfers  774
PART 5 Completing the Audit
24. Completing the Audit  777
Learning Objectives  777
Perform Additional Tests for Presentation and Disclosure  778
Review for Contingent Liabilities and Commitments  779
Review for Subsequent Events  784
Final Evidence Accumulation  788
Evaluate Results  791
Issue the Audit Report  796
Communicate with the Audit Committee and Management  796
Subsequent Discovery of Facts  798
Summary  799
Essential Terms  799
Review Questions  800
Multiple Choice Questions from CPA Examinations  801
Discussion Questions and Problems  803
Case  807
Internet Problem 24-1: Audit Committee Responsibilities  807
PART 6 Other Assurance and Nonassurance Services
25. Other Assurance Services  809
Learning Objectives  809
Review and Compilation Services  810
Review of Interim Financial Information for Public Companies  814
Attestation Engagements  815
WebTrust Services  818
SysTrust Services  820
Prospective Financial Statements  820
Agreed-Upon Procedures Engagements  823
Other Audits or Limited Assurance Engagements  823
Summary  827
Essential Terms  827
Review Questions  828
Multiple Choice Questions from CPA Examinations  828
Discussion Questions and Problems  830
Internet Problem 25-1: Accounting and Review Services Committee  834
26. Internal and Governmental Financial Auditing and Operational Auditing  835
Learning Objectives  835
Internal Financial Auditing  836
Governmental Financial Auditing  839
Operational Auditing  842
Summary  850
Essential Terms  850
Review Questions  851
Multiple Choice Questions from CPA, IIA, and CMA Examinations  852
Cases  854
Internet Problem 26-1: University Internal Audit Departments  858

Appendix: ACL Installation and Instructions  859

Index  865