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Part One Introduction to Auditing and Financial Statement Audits 1

1 AN INTRODUCTION TO AUDITING 3

Learning Objectives 3

Relevant Accounting and Auditing Pronouncements 3

The Demand for Auditing 3

Auditing，Attestation，and Assurance 5

Types of Audits 8

Types of Auditors 11

The Public Accounting Profession 14

Organizations That Affect Financial Audits 20

Generally Accepted Auditing Standards 24

Statements on Auditing Standards 27

Review Questions 28

Multiple-Choice Questions from CPA Examinations 28

Problems 31

Discussion Cases 34

2 AN OVERVIEW OF FINANCIAL STATEMENT AUDITS 36

Learning Objectives 36

Relevant Accounting and Auditing Pronouncements 36

Generally Accepted Accounting Principles as an Audit Criterion 37

Financial Statements：Management Assertions and Audit Objectives 38

Three Fundamental Concepts in Conducting an Audit 40

Sampling：Inferences Based on Limited Observations 42

Ethics and Independence 43

Overview of the Audit Process 45

Audit Reporting 48

Case Illustration：Calabro Paging Services 54

Review Questions 62

Multiple-Choice Questions from CPA Examinations 62

Problems 65

Discussion Cases 67

Part Two Basic Auditing Concepts：Materiality，Audit Risk，and Evidence 71

Relevant Accounting and Auditing Pronouncements 73

3 MATERIALITY AND AUDIT RISK 73

Learning Objectives 73

Materiality 74

Audit Risk 84

Appendix：A Quantitative Approach to Allocating Materiality 96

Review Questions 98

Multiple-Choice Questions from CPA Examinations 98

Problems 100

Discussion Case 104

Relevant Accounting and Auditing Pronouncements 106

4 EVIDENTIAL MATTER，TYPES OF AUDIT EVIDENCE，AND WORKPAPER DOCUMENTATION 106

Learning Objectives 106

The Relationship of Evidential Matter to the Audit Report 107

Management Assertions 108

Audit Objectives and Audit Procedures 111

Basic Concepts of Evidential Matter 114

Types of Audit Evidence 117

Working Papers 123

Review Questions 131

Multiple-Choice Questions from CPA Examinations 131

Problems 133

Discussion Case 137

SCAD Assignment 138

Part Three Planning the Audit and Understanding Internal Control 139

5 AUDIT PLANNING AND TYPES OF AUDIT TESTS 141

Learning Objectives 141

Relevant Accounting and Auditing Pronouncements 141

Preengagement Activities 142

Engagement Planning 149

Types of Audit Tests 159

Analytical Procedures 161

Appendix：Selected Financial Ratios Useful as Analytical Procedures 169

Review Questions 173

Multiple-Choice Questions from CPA Examinations 174

Problems 177

Discussion Case 181

SCAD Assignment 185

6 INTERNAL CONTROL IN A FINANCIAL STATEMENT AUDIT 186

Learning Objectives 186

Relevant Accounting and Auditing Pronouncements 186

Internal Control 187

The Components of Internal Control 188

Consideration of Internal Control in Planning and Performing an Audit 197

Timing of Audit Procedures 212

Communication of Internal Control-Related Matters 214

Appendix：Flowcharting Techniques 216

Review Questions 217

Multiple-Choice Questions from CPA Examinations 219

Problems 222

Discussion Case 224

SCAD Assignment 225

Relevant Accounting and Auditing Pronouncements 226

7 THE EFFECT OF COMPUTER PROCESSING ON THE AUDIT FUNCTION 226

Learning Objectives 226

Changes in Computer Technology and Their Effect on Auditing 227

The Effect of EDP on Internal Control 231

Controls in an EDP Environment 233

The Complexity of EDP Systems 244

The Audit Process in an EDP Environment 245

Computer-Assisted Audit Techniques 247

Use of Microcomputers as an Audit Tool 255

Auditing Accounting Applications Processed by Outside Service Organizations 257

Review Questions 258

Multiple-Choice Questions from CPA Examinations 259

Problems 262

Discussion Case 267

Part Four Statistical Tools for Auditing 271

8 AUDIT SAMPLING：AN OVERVIEW AND APPLICATION TO TESTS OF CONTROLS 271

Learning Objectives 271

Relevant Accounting and Auditing Pronouncements* 271

Introduction 271

Terminology 273

Types of Audit Sampling 275

Requirements of SAS No．39 276

Attribute Sampling Applied to Tests of Controls 278

An Example of an Attribute-Sampling Plan 287

Nonstatistical Sampling for Tests of Control 298

Review Questions 300

Multiple-Choice Questions from CPA Examinations 301

Problems 304

Discussion Case 306

SCAD Assignment 306

Learning Objectives 307

Relevant Accounting and Auditing Pronouncements 307

9 AUDIT SAMPLING：AN APPLICATION TO SUBSTANTIVE TESTS OF ACCOUNT BALANCES 307

A Sampling Plan for Substantive Tests of Account Balances 308

Monetary-Unit Sampling 314

Nonstatistical Sampling for Tests of Account Balances 324

Appendix：Classical Variables Sampling 329

Review Questions 334

Multiple-Choice Questions from CPA Examinations 335

Problems 338

Discussion Case 341

Relevant Accounting and Auditing Pronouncements 345

Learning Objectives 345

10 AUDITING THE REVENUE CYCLE 345

Part Five Auditing Accounting Applications and Related Accounts 345

Revenue Recognition 346

Inherent Risk Assessment 347

Overview of the Revenue Cycle 350

Control Risk Assessment 361

Control Procedures and Tests of Controls-Revenue Transactions 363

Control Procedures and Tests of Controls-Cash Receipts Transactions 370

Control Procedures and Tests of Controls-Sales Returns and Allowances Transactions 375

Review Questions 376

Relating the Assessed Level of Control Risk to Substantive Testing 376

Multiple-Choice Questions from CPA Examinations 377

Problems 380

Discussion Case 385

SCAD Assignment 386

11 AUDITING ACCOUNTS RECEIVABLE AND RELATED ACCOUNTS 387

Learning Objectives 387

Relevant Accounting and Auditing Pronouncements 387

Substantive Tests of Revenue-Related Accounts 388

Substantive Tests of Transactions 389

Tests of Account Balances-Accounts Receivable 390

Analytical Procedures 390

The Confirmation Process-Accounts Receivable 399

Auditing Other Receivables 405

Evaluating the Audit Findings-Accounts Receivable and Related Accounts 406

Review Questions 407

Multiple-Choice Questions from CPA Examinations 408

Problems 410

Discussion Case 414

SCAD Assignment 415

Relevant Accounting and Auditing Pronouncements 416

Learning Objectives 416

12 AUDITING THE PURCHASING CYCLE AND RELATED ACCOUNTS 416

Expense and Liability Recognition 417

Inherent Risk Assessment 418

Overview of the Purchasing Cycle 420

Control Risk Assessment 428

Control Procedures and Tests of Controls-Purchase Transactions 432

Control Procedures and Tests of Controls-Cash Disbursement Transactions 437

Control Procedures and Tests of Controls-Purchase Return Transactions 441

Auditing Accounts Payable and Accrued Expenses 442

Relating the Assessed Level of Control Risk to Substantive Testing 442

Substantive Tests of Transactions 443

Analytical Procedures 443

Tests of Account Balances-Accounts Payable and Accrued Expenses 445

Accounts Payable Confirmations 450

Evaluating the Audit Findings-Accounts Payable and Related Accounts 451

Review Questions 453

Multiple-Choice Questions from CPA Examinations 454

Problems 456

Discussion Case 461

13 AUDITING THE PAYROLL CYCLE AND RELATED ACCOUNTS 462

Learning Objectives 462

Relevant Accounting and Auditing Pronouncements 462

Inherent Risk Assessment 463

Overview of the Payroll Cycle 463

Control Risk Assessment 469

Control Procedures and Tests of Controls-Payroll Transactions 471

Relating the Assessed Level of Control Risk to Substantive Testing 475

Auditing Payroll-Related Accounts 475

Analytical Procedures 476

Substantive Tests of Transactions 476

Tests of Account Balances 478

Evaluating the Audit Findings-Payroll-Related Accounts 482

Review Questions 482

Multiple-Choice Questions from CPA Examinations 483

Problems 485

Discussion Case 490

14 AUDITING THE INVENTORY CYCLE AND RELATED ACCOUNTS 491

Learning Objectives 491

Relevant Accounting and Auditing Pronouncements 491

Inherent Risk Assessment 492

Overview of the Inventory Cycle 494

Control Risk Assessment 501

Control Procedures and Tests of Controls-Inventory Transactions 503

Auditing Inventory 507

Substantive Tests of Transactions 507

Analytical Procedures 508

Auditing Standard Costs 509

Observation of Physical Inventory 510

Tests of Account Balances 511

Evaluating the Audit Findings-Inventory 515

Multiple-Choice Questions from CPA Examinations 516

Review Questions 516

Problems 519

Discussion Case 523

15 AUDITING SELECTED ASSET ACCOUNTS：PREPAID EXPENSES AND PROPERTY，PLANT，AND EQUIPMENT 525

Learning Objectives 525

Relevant Accounting and Auditing Pronouncements 525

Auditing Prepaid Expenses 526

Inherent Risk Assessment-Prepaid Expenses 527

Control Risk Assessment-Prepaid Expenses 527

Substantive Testing-Prepaid Insurance 527

Auditing Property，Plant，and Equipment 530

Inherent Risk Assessment-Property，Plant，and Equipment 531

Control Risk Assessment-Property，Plant，and Equipment 533

Substantive Testing-Property，Plant，and Equipment 535

Analytical Procedures-Property，Plant，and Equipment 535

Tests of Account Balances-Property，Plant，and Equipment 537

Review Questions 541

Multiple-Choice Questions from CPA Examinations 542

Problems 544

Discussion Case 547

Relevant Accounting and Auditing Pronouncements 550

16 AUDITING LONG-TERM LIABILITIES，STOCKHOLDESRS EQUITY，AND INCOME STATEMENT ACCOUNTS 550

Learning Objectives 550

Auditing Long-term Debt 551

Control Risk Assessment-Long-term Debt 552

Substantive Tests of Long-term Debt 554

Auditing Stockholders Equity 555

Control Risk Assessment-Stockholders Equity 557

Auditing Capital-Stock Accounts 559

Auditing Dividends 560

Auditing Income Statement Accounts 561

Auditing Retained Earnings 561

Multiple-Choice Questions from CPA Examinations 564

Review Questions 565

Problems 567

Discussion Cases 570

17 AUDITING CASH AND INVESTMENTS 572

Learning Objectives 572

Relevant Accounting and Auditing Pronouncements 572

Cash and the Effect of Other Accounting Cycles 573

Types of Bank Accounts 575

Tests of Account Balances-Cash 576

Analytical Procedures-Cash 576

Substantive Tests of Transactions-Cash 576

Investments 588

Control Risk Assessment-Investments 590

Substantive Tests of Investments 593

Review Questions 595

Multiple-Choice Questions from CPA Examinations 596

Problems 598

Part Six Completing the Audit and Reporting Responsibilities 607

Relevant Accounting and Auditing Pronouncements 609

Learning Objectives 609

18 COMPLETING THE ENGAGEMENT 609

Review for Contingent Liabilities 610

Commitments 615

Review for Subsequent Events 616

Final Evidential Evaluation Processes 619

Communications with the Audit Committee and Management 625

Subsequent Discovery of Facts Existing at the Date of the Auditor s Report 626

Review Questions 629

Multiple-Choice Questions from CPA Examinations 629

Problems 632

Discussion Cases 635

19 REPORTS ON AUDITED FINANCIAL STATEMENTS AND SPECIAL REPORTING ISSUES 639

Learning Objectives 639

Relevant Accounting and Auditing Pronouncements 639

The Auditor s Standard Unqualified Audit Report 640

Explanatory Language Added to the Standard Unqualified Audit Report 640

Departures from an Unqualified Audit Report 646

Discussion of Conditions Requiring Other Types of Reports 648

Special Reporting Issues 652

Reports on Comparative Financial Statements 653

Other Information in Documents Containing Audited Financial Statements 658

Going-Concern Evaluation 659

Special Reports 662

Review Questions 670

Multiple-Choice Questions from CPA Examinations 671

Problems 674

Discussion Cases 678

Part Seven Professional Responsibilities and Other Forms of Services 683

20 THE CODE OF PROFESSIONAL CONDUCT AND QUALITY CONTROL STANDARDS 685

Learning Objectives 685

Relevant Accounting and Auditing Pronouncements 685

An Ethical Framework 686

Code of Professional Conduct 691

Principles of Professional Conduct 692

Rules of Conduct 693

Independence，Integrity，and Objectivity 696

General Standards and Accounting Principles 704

Responsibilities to Clients 706

Other Responsibilities and Practices 707

Quality Control Standards 711

Review Questions 714

Multiple-Choice Questions from CPA Examinations 715

Problems 718

Discussion Cases 724

21 LEGAL LIABILITY 726

Learning Objectives 726

Relevant Accounting and Auditing Pronouncements 726

The Legal Environment 727

Overview 728

Common Law—Clients 729

Common Law—Third Parties 733

Statutory Liability 739

Criminal Liability 747

Approaches to Minimizing Legal Liability 748

Appendix：Summary of Significant Legal Cases 750

Review Questions 756

Multiple-Choice Questions from CPA Examinations 757

Problems 761

Discussion Case 765

22 ATTESTATION ENGAGEMENTS AND OTHER ACCOUNTING SERVICES 766

Learning Objectives 766

Relevant Accounting and Auditing Pronouncements 766

Attestation Engagements 767

Attestation Standards 769

Reporting on an Entity s Internal Control over Financial Reporting 772

Financial Forecasts and Projections 776

Accounting and Review Services 782

Compilation of Financial Statements 785

Review of Financial Statements 787

Review Questions 790

Multiple-Choice Questions from CPA Examinations 791

Problems 794

Discussion Case 799

INDEX 801