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M o d e r n A u d it in g A s s u r a n c e S e r v ic e s a n d t h e In t e g r it y o f F in a n c ia l R e p o r t in g

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9 views10 pages

Contents

M o d e r n A u d it in g A s s u r a n c e S e r v ic e s a n d t h e In t e g r it y o f F in a n c ia l R e p o r t in g

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mcolmenares8
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Modern A u d it in g

A s s u r a n c e S e r v ic e s a n d t h e
In t e g r i t y o f F i n a n c i a l R e p o r t i n g
E ig h th E d itio n

William c. Boynton
Raymond N. Johnson

WILEY

John Wiley & Sons, Inc.


P A R T 1 / TH E A U D IT IN G E N V I R O N M E N T
1. Auditing and the Public Accounting Profession— Integrity in
Financial Reporting
2. A uditors' Responsibilities and Reports
3. Professional Ethics
4. A uditors' Legal Liability

P A R T 2 / A U D IT IN G P L A N N IN G
5. O verview of the Financial Statem ent A udit
6. A udit Evidence
7. Accepting the Engagem ent and Planning the Audit
8. M ateriality D ecisions and A nalytical Procedures
9. A udit Risk, Including the Risk of Fraud
10. Understanding Internal Control

P A R T 3 / A U D IT T E S T I N G M E T H O D O L O G Y
11. A udit Procedures in Response to A ssessed Risks: Tests of Controls
12. A udit Procedures in Response to A ssessed Risks: Substantive Tests
13. Audit Sampling

part 4 / A U D IT IN G TH E T R A N S A C T I O N C Y C L E S
14. Auditing the R evenue Cycle
15. Auditing the Expenditure Cycle
16. Auditing the Production and Personnel Services Cycles
17. Auditing the Investing and Financing Cycles
18. Auditing Investm ents and C ash Balances

P A R T 5 / C O M P L E T I N G TH E A U D IT / O T H E R S E R V I C E S
AND R E P O R T S
19. Com pleting the A udit/Postaudit Responsibilities
20. A ttest and A ssurance Services and Related Reports
21. Internal, O perational, and G overnm ental Auditing

ix in
P A R T 1 / TH E A U D ITIN G Relationship Between Accounting and Auditing
EN V IR O N M EN T 1 44
Verifiability, Professional Judgment, and Fair
1 Auditing and the Public A ccounting Presentation 45
Profession-Integrity of Financial Reporting 3 Independent Auditor Relationships 47
Auditing Standards 50
Internal Auditors Uncover Financial Fraud at
Generally Accepted Auditing Standards (G AAS)
Worldcom 3
50
Preview of Chapter 1 4
Statements on Auditing Standards (SAS) 54
Auditing and Assurance Sendees Defined 5
PCAOB Auditing Standards 54
Auditing Defined 6
Assurance Provided by an Audit 55
Types of Audits 8
Auditor independence 56
Types of Auditors 10
Reasonable Assurance 56
Assurance Services Defined 11
Detecting and Reporting Fraud 57
Value of Audit and Assurance Sendees 15
Detecting and Reporting Illegal Acts 59
The Demand for Auditing 18
Evaluation of Internal Control 61
The Roots o f Auditing 18
Assurance About a Going Concern 61
Need for Financial Statement Audits 20
A Clean Bill of Health? 62
Economic Benefits of an Audit 21
The Auditor's Report on Financial Statements 64
Limitations of an Audit 22
The Standard Report on Financial Statements 64
Organizations Associated with the Public
Departures from the Standard Report 68
Accounting Profession 23
Other Types of Opinions 69
Public Sector Organizations 23
Thé Auditor's Report on Internal Control 72
Private Sector Organizations 25
The Standard Report 72
Regulatory Framework for Ensuring High-Quality
Departures From the Standard Report 78
Services 29
Focus on Auditor Knowledge and Audit Decisions
Standard Setting 29
82
Firm Regulation 33
Appendix 84
Inspection and Peer Review 33
Objective Questions 94
Government Regulation 34
Comprehensive Questions 94
Focus on Auditor Knowledge 35
Cases 98
Objective Questions 37
Professional Simulation 100
Comprehensive Questions 37
Professional Simulation 41
3 Professional Ethics 101
2 A uditors' Responsibilities and Reports 42 Independence and Nonaudit Services 101
Preview of Chapter 3 102
Auditor Responsibility for Going Concern. 42
Ethics and Morality 103
Preview of Chapter 2 43
General Ethics 103
Fundamentals Underlying Financial Statement
Professional Ethics 104
Audits 44
[x ív ] CONTENTS

AICPA Code of Professional Ethics 105 Case 177


AICPA Professional Ethics Division 106 Professional Simulation 178
Composition of the AICPA Code of Professional
Conduct 106
Ethical Principles 107 P A R T 2 / A U D IT P L A N N IN G 181
Rules of Conduct 110
Rule 101— Independence 112 5 Overview of the Financial Statem ent
Rule 102— Integrity and Objectivity 124 Audit 183
Rule 201— General Standards 124
How Much of What Do I Audit? 183
Rule 202— Compliance with Standards 125 Preview of Chapter 5 183
Rule 203— Accounting Principles 125 Overview of the Audit Process 185
Rule 301— Confidential Client Information 126
Phase I: Perform Risk Assessment Procedures 185
Rule 302— Contingent Fees 127 Identify Relevant Financial Statement Assertions
Rule 501— Acts Discreditable 128 186
Rule 502— Advertising and Other Forms of Understand the Entity and its Environment 190
Solicitation 129 Make Decisions About Materiality 193
Rule 503-Commissions and Referral Fees 129' Perform Analytical Procedures 193
Rule 505-Form of Organization and Name 130 Identify the Risks that May Lead to Material
Enforcement of the Rules of Conduct 132 Misstatement, Including the Risk of Fraud 194
State Boards of Acountancy and Public Develop Preliminary Audit Strategies 199
Companies Accounting Oversight Board 132 Understand Internal Control 199
Enforcing the AICPA Code of Professional Phase II: Assess the Risk of Material Misstatement
Conduct 132 202 '

Focus on Auditor Knowledge and Audit Relate Risk Factors to Potential Financial Statement
Decisions 134 Misstatements 202
Objective Questions 137 Determine the Magnitude of Potential
Comprehensive Questions 137 Misstatements 203
Cases 140 Determine the Likelihood of Material
Professional Simulation 142 Misstatments 203
Determine Significant Inherent Risks 204
4 A uditor's Legal Liability 344 Phase III: Respond to Assessed Risks 205
The Cost of Malpractice 144 Staffing and Supervision 206
Preview of Chapter 4 145 Nature of Audit Tests 206
Liability Under Common Law 146 Timing of Audit Tests 207
Liability to Clients 146 Extent of Audit Tests 208
Liability to Third Parties 147 Respond to Significant Inherent Risks 208
Common Law Defenses 153 Phase IV: Perform Further Audit Procedures 209
Liability Under Securities Law 155 Further Risk Assessment Procedures 210
Securities Act of 1933 155 Test of Controls 210
Securities Exchange Act of 1934 159 Substantive Tests 211
Private Securities Litigation Reform Act Phase V: Evaluate Evidence 212
of 1995 163 Reevaluate Risk Assessment Procedures 212
Sarbanes-Oxley Act of 2002 165 Determine the Significance of Findings 212
Other Considerations 168 Form and Document Conclusions 213
Liability Under Racketeer Influenced and Corrupt Phase VI: Communicate Audit Findings 214
Organizations Act (RICO) 168 The Auditor's Opinion 214
Minimizing the Risk of Litigation 169 Other Required Communications 215
Summary 170 Other Assurance Service Findings 215
Focus on Auditor Knowledge 171 Focus on Auditor Knowledge 217
Objective Questions 174 Focus on Audit Decisions 218
Comprehensive Questions 174 Objective Questions 219
CONTENTS [XV]

Comprehensive Questions 219 Making the Decision to Accept or Decline the


Professional Simulation 225 Audit 279
Prepare the Engagement Letter 279
6 Audit Evidence 227 Audit Planning and Risk Assessment Procedures
- Sunbeam Corporation 227 • 283
Preview of Chapter 6 228 Steps in Performing Risk Assessment Procedures
Audit Evidence and Assertions 229 284
Audit Evidence Defined 229 Understanding the Entity and Its Environment 285
Assertions and Specific Audit Objectives 231 Industry, Regulatory, and Other External
Sufficient Competent Evidence 236 Factors 286
Sufficiency of Audit Evidence 237 The Nature of the Entity, Including its Selection
Competency of Audit Evidence 238 and Application of Accounting Policies 291
Audit Procedures 241 The Entity's Objectives, Strategies, and Related
Inspection of Documents and Records 241 Business Risks 294
Inspection o f Tangible Assets 243 Measurement and Review of the Entity's
Observation 244 Financial Performance 295
Inquiry 244 Illustrative Case Study 295
Confirmation 245 Focus on Auditor Knowledge and Audit
Recalculation 245 Decisions 302
Reperformance 245 Objective Questions 303
Analytical Procedures 246 Comprehensive Questions 303
Computer-Assisted Audit Techniques 246 Cases 308
Four Decisions About Audit Procedures 247 Professional Simulation 312
Staffing and Supervising the Audit 248
Nature of Audit Procedures 248
8 M ateriality Decisions and Perform ing
Timing of Audit Procedures 249
Analytical Procedures 314
Extent of AudiËProcedures 249
Documenting Audit Decisions and Audit What Size of Misstatement is Material? 314
Evidence 251 Preview of Chapter 8 315
Audit Programs 251 Materiality Decisions 316
Working Papers 254 The Concept of Materiality 316
Preparing Working Papers 259 Preliminary Judgments About Materiality 317
Working Paper Files 260 Materiality and the Evaluation of Evidence 322
Focus on Auditor Knowledge and Audit Performing Analytical Procedures 324
Decisions 261 Identify Calculations and Comparisons to Be
Objective Questions 263 Made 325
Comprehensive Questions 263 Develop an Expectation Range 328
Cases 268 Perform the Calculations 329
Professional Simulation 269 Analyze Data and Identify Significant
Differences 329
7 Accepting the Engagem ent and Planning the Investigate Significant Unexpected
Audit 270 Differences 330
Z7.ZZ Best: Client Acceptance and Client Determine Effects on Audit Planning 330
Resignation 270 Illustrative Case Study 330
Preview of Chapter 7 271 Focus on Auditor Knowledge and Audit Decisions
Client Acceptance and Retention 272 336
Evaluate the Integrity of Management 273 Appendix 8 338
Identify Special Circumstances and Unusual Risks Objective Questions 340
275 Comprehensive Questions 340
Assess Competence to Perform the Audit 276 Comprehensive Case 343
Evaluate Independence 278 Professional Simulation 348
[x v ¡] CONTENTS

9 A u d it R isk , Inclu d in g the R isk of Fraud 350 Focus on Auditor Knowledge and Audit
Decisions 436
Fraud is on the Rise: Results of the KPMG Fraud
Appendix 10a 438
Survey 2003
Preview of Chapter 9 351 Appendix 10b 447
Audit Risk—An Overview 352 Appendix 10c 453
Assessing the Risk of Fraud 353 Objective Questions 456
Comprehensive Questions 456
How Significant is Fraud? 353
Cases 461
Fraud Defined 353
Professional Simulation 463
The Fraud Triangle 355
Auditing for Fraud 360
The Audit Risk Model 364
Illustrating the Audit Risk Model 364
Assessing the Components of Audit Risk 366 P A R T 3 / A U D IT T E S T I N G
Relationship Between Audit Risk and Audit M ETHODOLOGY 4 6 5
Evidence 371
Preliminary Audit Strategies 373 11 A u d it Procedures in R esponse to A ssessed
Components of Preliminary Audit Strategies 374 R isks: Tests o f C ontrols 467
Three Basic Preliminary Audit Strategies 374 Internal Controls at Enron 402
Focus on Auditor Knowledge and Audit Preview of Chapter 11 468
Decisions 379 Process for Assessing Control Risk 469
Objective Questions 381
Consider Knowledge Acquired from Procedures
Comprehensive Questions 381 to Obtain an Understanding 470
Cases 386
Identify Potential Misstatements 470
Professional Simulation 387
Identify Necessary Controls 471
Perform Tests of Controls 474
10 U nderstanding Internal C ontrol 389 Evaluate Evidence and Make Assessment 475
The Importance of Internal Control 389 Assessing Control Risk in an Information
Preview of Chapter 10 390 Technology Environment 476
Introduction to Internal Control 391 Strategies for Performing Tests of Controls 476
Definition and Components 391 Computer-Assisted Audit Techniques 478
Entity Objectives and Related Internal Control Assessing Information Technology Controls 481
Relevant to an Audit 392 Effects of Preliminary Audit Strategies 484
Limitations of an Entity's System of Internal Primarily Substantive Approaches 484
Control 393 Lower Assessed Level of Control Risk 487
Roles and Responsibilities 394 Designing Tests of Controls 487
Components of Internal Control 396 Nature of Tests of Controls 488
Control Environment 397 Timing of Tests of Controls 489
Risk Assessment 402 Extent of Tests of Controls 491
Information and Communication 404 Staffing Tests of Controls 492
Control Activities 405 Audit Programs for Tests of Controls 492
Monitoring 413 Dual-Purpose Tests 492
Antifraud Programs and Controls 414 Additional Considerations 495
Applications of Components to Small and Assessing Control Risk for Account Balance
Midsized Entities 415 Assertions Affected by a Single Transaction
Summary 416 Class 495
Understanding Internal Control 422 Assessing Control Risk for Account Balance
What to Understand About Internal Control 422 Assertions Affected by Multiple Transaction
Effects of Preliminary Audit Strategies 425 Class 495
Procedures to Obtain an Understanding 426 Documenting the Assessed Level of Control Risk
Documenting the Understanding 429 497
Flowcharts 430 Communicating Internal Control Matters 498
CONTENTS [xVii]

Focus on Auditor Knowledge and Audit Framework for Audit Sampling for Substantive
Decisions 500 Tests 567
Objective Questions 502 Summary 582
Comprehensive Questions 502 Focus on Auditor Knowledge and Audit
__ Cases 508 Decisions 583
Professional Simulation 511 Appendix 13a 585
Appendix 13b 593
12 Audit Procedures in Response to Assessed Appendix 13c 604
Risks: Substantive Tests 513 Objective Questions 609
Comprehensive Questions 609
The Importance of Risk Assessment Procedures and
Cases 616
Audit Programs 523
Professional Simulation 623
Preview of Chapter 12 514
Assessing the Risk of Material Misstatement 515
Steps for Assessing the Risk of Material
Misstatement 515 P A R T 4 / A U D ITIN G THE
Determining Detection Risk 518 T R A N SA C T IO N C Y C L E S 625
Designing Substantive Tests 520
Performing Further Audit Procedures 520 14 Auditing the Revenue Cycle 627
Using Information Technology to Support What is the Most Frequent Cause of Financial
Substantive Tests 520 Statement Restatements? 627
Audit Choices in the Design of Substantive Tests Preview of Chapter 14 628
523 Risk Assessment Procedures in the Revenue
Special Considerations in Designing Substantive Cycle 629
Tests 533 Develop Audit Objectives 629
Developing Audit Programs for Substantive Tests Understand the Entity and Its Environment 630
535 Inherent Risk, Including the Risk of Fraud 633
A General Framework for Developing an Audit Analytical Procedures 634
Program for Substantive Tests 535 Consideration of Internal Control Components
Focus on Auditor Knowledge and Audit 636
Decisions 540 Control Activities for Credit Sales Transactions 639
Objective Questions 542 Common Documents and Records 640
Comprehensive Questions 542 Functions and Control Activities 640
Professional Simulation 549 Illustrative System for Credit Sales 644
Control Activities for Cash Receipts Transactions
647
13 Audit Sam pling 551
Common Documents and Records 647
What is an Appropriate Sample Size? 551 Functions and Central Activities 648
Preview of Chapter 13 552 Illustrative System for Cash Receipts 651
Basic Audit Sampling Concepts 553 Control Activities for Sales Adjustment Transactions
Nature and Purpose of Audit Sampling 553 and Other Controls 651
Uncertainty and Audit Sampling 553 Common Documents and Records 651
Sampling Risk and Nonsampling Risk 553 Function and Control Activities 651
Nonstatistical and Statistical Sampling 555 Other Controls in the Revenue Cycle 653
Tests of Controls 558 Revenue Cycle Tests of Controls 654
Tests of Controls That Do Not Involve Audit Substantive Tests of Accounts Receivable 655
Sampling 558 Determining Detection Risk 655 ,
Framework for Audit Sampling for Tests of Designing Substantive Tests 658
Controls 559 Other Assurance Services 672
Substantive Tests 566 Focus on Audit Decisions 672
Substantive Tests That Do Not Involve Audit Objective Questions 675
Sampling 566 Comprehensive Questions 675
[ XV Ï Ï i ] CONTENTS

Cases 679 Analytical Procedures 746


Comprehensive Case 679 Inherent Risk 749
Professional Simulations 684 Consideration of Internal Controls 749
Preliminary Audit Strategies 757
15 A u ditin g the Expenditure C ycle 688 Substantive Tests of Inventory 757
Poor Internai Controls Result in a Material Auditing the Personnel Sendee Cycle 769
Understatement of Accounts Payable and Audit Objectives 770
Net Income 688 Understanding the Entity and Its Environment
770
' Preview of Chapter 15 689
Analytical Procedures 772
Risk Assessment Procedures in the Expenditure
Inherent Risk 772
Cycle 690
Consideration of Internal Controls 773
Develop Audit Objectives 691
Preliminary Audit Strategies 780
Understand the Entity and Its Environment 691
Substantive Tests of the Personnel Sendees
Inherent Risk, Including the Risk of Fraud 692
Cycle 782
Analytical Procedures 695
Other Sendees in the Production and Personnel
Consideration of Internal Control Components 696
Services Cycles 786
Control Activities—Purchase Transactions 699
Focus on Audit Decisions 787
Common Documents and Records 700
Objective Questions 790
Functions and Control Activities 701
Comprehensive Questions 790
Illustrative System for Purchase Transactions 706 Cases 797
Control Activities— Cash Disbursement Transactions Professional Simulations 801
707
Common Documents and Records 708
17 A uditing the In vestin g and Financing
Functions and Control Activities 708
C ycles 801
Illustrative System for Cash Disbursement
Transactions 710 Worldcom and Enron: Lessons for the Investing and
Control Activities for Purchase Adjustment Financing Cycles 804
Transactions and Other Controls 712 Preview of Chapter 17 805
Common Documents and Records 712 Nature of the Investing and Financing Cycles 806
Overview of the Investing and Financing Cycles
Functions and Control Activities 713
806
Other Controls in the Expenditure Cycle 713
Understanding the Entity and Its Environment
Test of Controls 714
807
Substantive Tests of Accounts Payable Balances 715
The Investing Cycle 807
Determining Detection Risk for Tests of
Audit Objectives 809
Details 715
Analytical Procedures 810
Designing Substantive Tests 718
Inherent Risk 810
Other Assurance Services 725
Consideration of Internal Controls 811
Focus on Audit Decisions 726
Preliminary Audit Strategies 812
Objective Questions 728
Substantive Tests for Plant Assets 814
Comprehensive Questions 729
The Financing Cycle 821
Cases 734
Audit Objectives 821
Professional Simulations 738 Analytical Procedures 821
Inherent Risk 821
16 A u d itin g the Production and Personnel Consideration of Internal Controls 822
Services C ycles 742 Preliminary Audit Strategies for Long-Term
Overstating Inventory and Profits 742 Debt 824
Preview of Chapter 16 743 Substantive Tests of Long-Term Debt 826
Auditing the Production Cycle 744 Preliminary Audit Strategies for Shareholders'
Audit Objectives 744 Equity 831
Understanding the Entity and Its Environment 745 Substantive Tests of Stockholders' Equity 832
CONTENTS [XÍX]

Other Services 838 Obtaining Evidence Concerning Litigation,


Focus on Audit Decisions 838 Claims, and Assessments 898
Objective Questions 841 Obtaining Client Representation Letter 900
Comprehensive Questions 841 Performing Analytical Procedures 901
__Cases 843________ Evaluating the Findings 904
Professional Simulations 844 Making Final Assessment of Materiality and
Audit Risk 904
18 Auditing Investments and Cash Balances 847 Evaluating Going Concern 905
' Where's the Cash? Auditor's Uncover Massive Fraud Making Technical Review of Financial Statements
907
847
Preview of Chapter 18 847 Formulating Opinion and Drafting Audit Report
Auditing Investments 849 on the Financial Statements 908
Overview of Investments 849 Formulating Opinion and Drafting Audit Report
Audit Objectives 850 on the Internal Controls Over Financial
Understanding.the Entity and Its Environment 850 Reporting 908
Analytical Procedures 851 Making Final Review(s) of Working Papers 909
Inherent Risk 851 Communicating with the Client 910
Consideration of Internal Controls 852 Communicating Internal Control Matters 910
Preliminary Audit Strategies 854 Communicating Matters Pertaining to Conduct of
Substantive Tests of Short-Term and Long-Term Audit 913
Investments. 856 Preparing Management Letter 914
Auditing Cash Balances 862 Postaudit Responsibilities 916
Relationship of Cash Balances to Transaction Subsequent Events Between Report Date and
Cycles 862 Issuance of Report 916
Audit Objectives 862 Discovery of Facts Existing at Report Date 917
Analytical Procedures 864 Discovery of Omitted Procedures 917
Inherent Risk^864 Focus on Audit Decisions 918
Consideration'of Internal Controls 865 Objective Questions 922
Preliminary Audit Strategies for Investments 865 Comprehensive Questions 922
Substantive Tests of Cash Balances 867 Cases 926
Other Related Services 878 Professional Simulations 929
Focus on Audit Decisions 879
Objective Questions 881 20 Attest and Assurance Services, and Related
Comprehensive Questions 882 Reports 933
Cases 887 A Busy Day with Lots of Questions 933
Professional Simulation 888 Preview of Chapter 20 934
Overview of Attest and Assurance Services 935
Universe of Assurance Sendees 935
Financial Statement Audits 935
P A R T 5 / C O M P L E T I N G TH E AUDIT,
Levels of Assurance 936
R E P O R T IN G , AND OTHER Types of Engagements 937
S E R V IC E S 891 Other SAS Engagements 937
Special Reports 937
19 Completing the Audit and Postaudit Other Comprehensive Bases of Accounting 939
Responsibilities 893 Specified Elements, Accounts, or Items of a
Auditor's Responsibilities for Events Occurring Financial Statement 940
After Balance Sheet Date 893 Compliance Reports Related to Audited Financial
Preview of Chapter 19 893 Statements 942
Completing the Fieldwork 895 Accepting and Performing Attest Engagements
Making Subsequent Events Review 896 943
Reading Minutes of Meetings 898 Attestation Standards 944
[xx] CONTENTS

Engagements Performed Under Attestation ILA Code of Ethics 986


Standards 946 DA Attribute and Performance Standards 986
SSAE 101 Engagements 946 Relationship with External Auditors 990
Agreed-Upon Procedures Engagements 951 Operational Auditing 991
Reporting on Prospective Financial Information Operational Auditing Defined 991
953 Phases of an Operational Audit 992
Compliance Attestations 955 - Standards for Independent Public Accountants
Accounting and Review Services 958 995
Review of Financial Statements 959 Governmental Auditing 996
Compilation of Financial Statements 961 Types of Government Audits 996
Other Assurance Services 964 Generally Accepted Government Auditing
CPA Risk Advisory 965 Standards (GAGAS) 997
CPA Performance View 967 Reporting on Compliance with Laws and
CPA ElderCare 969 Regulations 1003
Focus on Audit Decisions 971 Reporting on Internal Control 1005
Objective Questions 974 The Single Audit Act 1006
Comprehensive Questions 974 Objectives of the Act 1006
Case 979 Applicability and Administration 1006
Professional Simulation 980 Scope of an Audit Under the Single Audit Act
1007
21 Internal, Operational, and Governmental Focus on Auditor Knowledge 1011
A uditing 983 Objective Questions 1013
Comprehensive Questions 1013
Understanding the Risk of Fraud in Governmental
Cases 1017
Audits 983
Professional Simulation 1018
Preview of Chapter 21 984
Internal Auditing 985
Internal Auditing Defined 985 Index 1020
Evolution of Internal Auditing 986

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