Auditing and Assurance Services: An Integrated Approach

Preface  xiPART 1 The Auditing Profession 1. The Demand for Audit and Other Assurance Services  3Learning Objectives  3Nature of Auditing  4Distinction Between Auditing and Accounting  6Economic Demand for Auditing  6Assurance Services  8Types of Audits  13Types of Auditors  15Certified Public Accountant  17Summary  18Essential Terms  18Review Questions  19Multiple Choice Questions from CPA Examinations  20Discussion Questions and Problems  21Internet Problem 1-1: Sarbanes–Oxley Act Internal Control Reporting Requirements  242. The CPA Profession  25Learning Objectives  25Certified Public Accounting Firms  26Activities of CPA Firms  27Structure of CPA Firms  28Sarbanes–Oxley Act and Public Company Accounting Oversight Board  30Securities and Exchange Commission  31American Institute of Certified Public Accountants (AICPA)  32Generally Accepted Auditing Standards  33Statements on Auditing Standards  36International Standards on Auditing  37Quality Control  37Summary  39Essential Terms  40Review Questions  41Multiple Choice Questions from CPA Examinations  41Discussion Questions and Problems  43Internet Problem 2-1: International Auditing and Assurance Standards Board  443. Audit Reports  45Learning Objectives  45Standard Unqualified Audit Report  46Combined Reports on Financial Statements and Internal Control Over Financial Reporting Under Section 404 of the Sarbanes–Oxley Act  49Unqualified Audit Report with Explanatory Paragraph or Modified Wording  51Departures from an Unqualified Audit Report  55Materiality  56Discussion of Conditions Requiring a Departure  59Auditor’s Decision Process for Audit Reports  63Impact of E-Commerce on Audit Reporting  65Summary  65Essential Terms  66Review Questions  66Multiple Choice Questions from CPA Examinations  67Discussion Questions and Problems  69Internet Problem 3-1: Research Annual Reports  744. Professional Ethics  75Learning Objectives  75What Are Ethics?  76Ethical Dilemmas  77Special Need for Ethical Conduct in Professions  80Code of Professional Conduct  81Independence  85Independence Rule of Conduct and Interpretations  88Other Rules of Conduct  93Enforcement  100Summary  100Essential Terms  102Review Questions  102Multiple Choice Questions from CPA Examinations  103Discussion Questions and Problems  104Cases  107Internet Problem 4-1: PCAOB Disciplinary Actions  1105. Legal Liability  111Learning Objectives  111Changed Legal Environment  112Distinguishing Business Failure, Audit Failure, and Audit Risk  113Legal Concepts Affecting Liability  114Liability to Clients  116Liability to Third Parties Under Common Law  119Civil Liability Under the Federal Securities Laws  121Criminal Liability  125The Profession’s Response to Legal Liability  127Protecting Individual CPAs from Legal Liability  128Summary  129Essential Terms  130Review Questions  131Multiple Choice Questions from CPA Examinations  131Discussion Questions and Problems  133Case  137Internet Problem 5-1: SEC Enforcement  137PART 2 The Audit Process6. Audit Responsibilities and Objectives  139Learning Objectives  139Objective of Conducting an Audit of Financial Statements  140Management’s Responsibilities  141Auditor’s Responsibilities  142Financial Statement Cycles  146Setting Audit Objectives  150Management Assertions  151Transaction-Related Audit Objectives  154Balance-Related Audit Objectives  156Presentation and Disclosure-Related Audit Objectives  159How Audit Objectives Are Met  159Summary  162Essential Terms  162Review Questions  163Multiple Choice Questions from CPA Examinations  164Discussion Questions and Problems  165Case  169Internet Problem 6-1: International and PCAOB Audit Objectives  1707. Audit Evidence  171Learning Objectives  171Nature of Evidence  172Audit Evidence Decisions  173Persuasiveness of Evidence  174Types of Audit Evidence  177Audit Documentation  185Summary  194Essential Terms  195Review Questions  196Multiple Choice Questions from CPA Examinations  197Discussion Questions and Problems  198Cases  203ACL Problem  205Internet Problem 7-1: Use of Audit Software for Fraud Detection and Data Quality Assurance  2058. Audit Planning and Analytical Procedures  207Learning Objectives  207Planning  208Accept Client and Perform Initial Audit Planning  209Understand the Client’s Business and Industry  214Assess Client Business Risk  218Perform Preliminary Analytical Procedures  220Summary of the Parts of Audit Planning  221Analytical Procedures  223Five Types of Analytical Procedures  224Common Financial Ratios  230Summary  232Essential Terms  232Review Questions  232Multiple Choice Questions from CPA Examinations  234Discussion Questions and Problems  236Cases  241Integrated Case Application—Pinnacle Manufacturing: Part I  243ACL Problem  246Internet Problem 8-1: Obtain Client Background Information  2469. Materiality and Risk  247Learning Objectives  247Materiality  248Set Preliminary Judgment about Materiality  249Allocate Preliminary Judgment about Materiality to Segments(Tolerable Misstatement)  252Estimate Misstatement and Compare with Preliminary Judgment  255Risk  257Types of Risks  259Assessing Acceptable Audit Risk  261Assessing Inherent Risk  263Relationship of Risks to Evidence and Factors Influencing Risks  266Evaluating Results  271Summary  273Essential Terms  274Review Questions  275Multiple Choice Questions from CPA Examinations  276Discussion Questions and Problems  277Cases  283Integrated Case Application—Pinnacle Manufacturing: Part II  287Internet Problem 9-1: Materiality and Tolerable Misstatement  28810. Section 404 Audits of Internal Control and Control Risk  289Learning Objectives  289Internal Control Objectives  290Management and Auditor Responsibilities for Internal Control  291COSO Components of Internal Control  294Obtain and Document Understanding of Internal Control  303Assess Control Risk  307Tests of Controls  313Decide Planned Detection Risk and Design Substantive Tests  315Section 404 Reporting on Internal Control  316Evaluating, Reporting, and Testing Internal Control for Nonpublic Companies  318Summary  321Essential Terms  321Review Questions  324Multiple Choice Questions from CPA Examinations  326Discussion Questions and Problems  328Case  333Integrated Case Application—Pinnacle Manufacturing: Part III  334Internet Problem 10-1: Disclosure of Material Weaknesses in Internal Control Over Financial Reporting  33511. Fraud Auditing  337Learning Objectives  337Types of Fraud  338Conditions for Fraud  340Assessing the Risk of Fraud  343Corporate Governance Oversight to Reduce Fraud Risks  346Responding to the Risk of Fraud  351Specific Fraud Risk Areas  353Responsibilities when Fraud is Suspected  358Summary  362Essential Terms  363Review Questions  363Multiple Choice Questions from CPA Examinations  364Discussion Questions and Problems  365Case  369ACL Problem  370Internet Problem 11-1: Brainstorming About Fraud Risks  37012. The Impact of Information Technology on the Audit Process  371Learning Objectives  371How Information Technologies Improve Internal Control  372Assessing Risks of Information Technology  372Internal Controls Specific to Information Technology  374Impact of Information Technology on the Audit Process  380Issues for Different IT Environments  387Summary  390Essential Terms  390Review Questions  392Multiple Choice Questions from CPA Examinations  392Discussion Questions and Problems  394Case  400ACL Problem  401Internet Problem 12-1: Assessing IT Governance  40213. Overall Audit Plan and Audit Program  403Learning Objectives  403Types of Tests  404Selecting Which Types of Tests to Perform  409Impact of Information Technology on Audit Testing  412Evidence Mix  413Design of the Audit Program  414Summary of Key Evidence-Related Terms  424Summary of the Audit Process  425Essential Terms  429Review Questions  429Multiple Choice Questions from CPA Examinations  431Discussion Questions and Problems  433Cases  438Internet Problem 13-1: Assessing Effects of Evidence Mix  440PART 3 Application of the Audit Process to the Sales and Collection Cycle14. Audit of the Sales and Collection Cycle: Tests of Controls and Substantive Tests of Transactions  443Learning Objectives  443Accounts and Classes of Transactions in the Sales and Collection Cycle  444Business Functions in the Cycle and Related Documents and Records  445Methodology for Designing Tests of Controls and Substantive Tests of Transactions for Sales  450Sales Returns and Allowances  460Methodology for Designing Tests of Controls and Substantive Tests of Transactions for Cash Receipts  461Audit Tests for the Write-off of Uncollectible Accounts  465Additional Internal Controls over Account Balances and Presentation and Disclosure  466Effect of Results of Tests of Controls and Substantive Tests of Transactions  466Summary  467Essential Terms  468Review Questions  468Multiple Choice Questions from CPA Examinations  469Discussion Questions and Problems  471Case  477Integrated Case Application—Pinnacle Manufacturing: Part IV  478ACL Problem  479Internet Problem 14-1: Point of Sales Systems Controls  47915. Audit Sampling for Tests of Controls and Substantive Tests of Transactions  481Learning Objectives  481Representative Samples  482Statistical Versus Nonstatistical Sampling and Probabilistic Versus Nonprobabilistic Sample Selection  483Nonprobabilistic Sample Selection Methods  484Probabilistic Sample Selection Methods  485Sampling for Exception Rates  488Application of Nonstatistical Audit Sampling  489Statistical Audit Sampling  505Sampling Distribution  505Application of Attributes Sampling  506Summary  512Essential Terms  512Review Questions  513Multiple Choice Questions from CPA Examinations  514Discussion Questions and Problems  516Case  520Integrated Case Application—Pinnacle Manufacturing: Part V  521Internet Problem 15-1: Applying Statistical Sampling  52316. Completing the Tests in the Sales and Collection Cycle: Accounts Receivable  525Learning Objectives  525Methodology for Designing Tests of Details of Balances  526Designing Tests of Details of Balances  533Confirmation of Accounts Receivable  539Developing Tests of Details Audit Program  545Essential Terms  548Review Questions  549Multiple Choice Questions from CPA Examinations  550Discussion Questions and Problems  552Case  557Integrated Case Application—Pinnacle Manufacturing: Part VI  558ACL Problem  560Internet Problem 16-1: Revenue Recognition  56017. Audit Sampling for Tests of Details of Balances  565Learning Objectives  565Comparisons of Audit Sampling for Tests of Details of Balances and for Tests of Controls and Substantive Tests of Transactions  566Nonstatistical Sampling  567Monetary Unit Sampling  576Variables Sampling  586Illustration Using Difference Estimation  592Summary  598Essential Terms  599Review Questions  599Multiple Choice Questions from CPA Examinations  601Discussion Questions and Problems  602Cases  606Internet Problem 17-1: Monetary Unit Sampling Considerations  607PART 4 Application of the Audit Process to Other Cycles18. Audit of the Payroll and Personnel Cycle  609Learning Objectives  609Accounts and Transactions in the Payroll and Personnel Cycle  610Business Functions in the Cycle and Related Documents and Records  610Methodology for Designing Tests of Controls and Substantive Tests of Transactions  614Methodology for Designing Tests of Details of Balances  619Summary  623Essential Terms  624Review Questions  624Multiple Choice Questions from CPA Examinations  625Discussion Questions and Problems  627Case  631Internet Problem 18-1: Accounts Payable Fraud  63219. Audit of the Acquisition and Payment Cycle: Tests of Controls,Substantive Tests of Transactions, and Accounts Payable  633Learning Objectives  633Accounts and Classes of Transactions in the Acquisition and Payment Cycle  634Business Functions in the Cycle and Related Documents and Records  634How E-Commerce Affects the Acquisition and Payment Cycle  638Methodology for Designing Tests of Controls and Substantive Tests of Transactions  639Methodology for Designing Tests of Details of Balances for Accounts Payable  645Summary  653Essential Terms  654Review Questions  655Multiple Choice Questions from CPA Examinations  656Discussion Questions and Problems  657Case  664Internet Problem 19-1: Managing the Accounts Payable Function  66620. Completing the Tests in the Acquisition and Payment Cycle:Verification of Selected Accounts  667Learning Objectives  667Types of Other Accounts in the Acquisition and Payment Cycle  668Audit of Property, Plant, and Equipment  668Audit of Prepaid Expenses  677Audit of Accrued Liabilities  679Audit of Income and Expense Accounts  681Summary  685Essential Terms  685Review Questions  685Multiple Choice Questions from CPA Examinations  686Discussion Questions and Problems  688Cases  691Internet Problem 20-1: Risks of Outsourcing the Payroll Function  69321. Audit of the Inventory and Warehousing Cycle  695Learning Objectives  695Business Functions in the Cycle and Related Documents and Records  696How E-Commerce Affects Inventory Management  698Parts of the Audit of Inventory  699Audit of Cost Accounting  701Analytical Procedures  704Methodology for Designing Tests of Details of Balances  705Physical Observation of Inventory  706Audit of Pricing and Compilation  709Integration of the Tests  713Summary  714Essential Terms  715Review Questions  715Multiple Choice Questions from CPA Examinations  716Discussion Questions and Problems  718Case  724Internet Problem 21-1: Using Inventory Count Specialists  72522. Audit of the Capital Acquisition and Repayment Cycle  727Learning Objectives  727Accounts in the Cycle  728Notes Payable  730Owners’ Equity  735Summary  741Essential Terms  741Review Questions  741Multiple Choice Questions from CPA Examinations  743Discussion Questions and Problems  743Internet Problem 22-1: Stock Exchange Requirements  74823. Audit of Cash Balances  749Learning Objectives  749Cash in the Bank and Transaction Cycles  750Types of Cash Accounts  752Audit of the General Cash Account  753Fraud-Oriented Procedures  760Audit of the Imprest Payroll Bank Account  765Audit of Imprest Petty Cash  765Summary  766Essential Terms  766Review Questions  767Multiple Choice Questions from CPA Examinations  768Discussion Questions and Problems  769Case  772Internet Problem 23-1: Automated Clearing House System for Electronic Funds Transfers  774PART 5 Completing the Audit24. Completing the Audit  777Learning Objectives  777Perform Additional Tests for Presentation and Disclosure  778Review for Contingent Liabilities and Commitments  779Review for Subsequent Events  784Final Evidence Accumulation  788Evaluate Results  791Issue the Audit Report  796Communicate with the Audit Committee and Management  796Subsequent Discovery of Facts  798Summary  799Essential Terms  799Review Questions  800Multiple Choice Questions from CPA Examinations  801Discussion Questions and Problems  803Case  807Internet Problem 24-1: Audit Committee Responsibilities  807PART 6 Other Assurance and Nonassurance Services25. Other Assurance Services  809Learning Objectives  809Review and Compilation Services  810Review of Interim Financial Information for Public Companies  814Attestation Engagements  815WebTrust Services  818SysTrust Services  820Prospective Financial Statements  820Agreed-Upon Procedures Engagements  823Other Audits or Limited Assurance Engagements  823Summary  827Essential Terms  827Review Questions  828Multiple Choice Questions from CPA Examinations  828Discussion Questions and Problems  830Internet Problem 25-1: Accounting and Review Services Committee  83426. Internal and Governmental Financial Auditing and Operational Auditing  835Learning Objectives  835Internal Financial Auditing  836Governmental Financial Auditing  839Operational Auditing  842Summary  850Essential Terms  850Review Questions  851Multiple Choice Questions from CPA, IIA, and CMA Examinations  852Cases  854Internet Problem 26-1: University Internal Audit Departments  858Appendix: ACL Installation and Instructions  859Index  865