1 The Role of the Auditor in the American Economy 1
What Is the Attest Function？ 2
Financial Statement Audits 4
What Creates the Demand for Audits？ 6
Major Auditing Developments of the 20th Century 8
Types of Audits 11
Types of Auditors 12
The Public Accounting Profession 13
American Institute of Certified Public Accountants 13
The CPA Examination 16
State Boards of Accountancy 16
Financial Accounting Standards Board 16
Governmental Accounting Standards Board 17
Securities and Exchange Commission 17
Other Types of Professional Services 18
Organization of the Public Accounting Profession 19
Industry Specialization—The Wave of the Future 20
Responsibilities of the Professional Staff 21
Professional Development for CPA Firm Personnel 22
Seasonal Fluctuations in Public Accounting Work 23
Relationship with Clients 23
2 Professional Standards 32
Generally Accepted Auditing Standards （GAAS） 33
Application of Auditing Standards 34
Training and Proficiency 34
Independence 34
Due Professional Care 35
Standards of Field Work—Accumulating and Evaluating Evidence 35
Adequate Planning and Supervision 35
Sufficient Understanding of Internal Control 35
Sufficient Competent Evidential Matter 35
Standards of Reporting 36
Statements on Auditing Standards（SASs） 36
The Auditors’ Responsibility for Detecting Misstatements 37
Errors and Fraud 38
Illegal Acts by Clients 38
The Auditors’ Report 39
The Introductory Paragraph of the Auditors’ Report 40
The Scope Paragraph of the Auditors’Report 41
The Opinion Paragraph of the Auditors’ Report 41
Generally Accepted Accounting Principles （GAAP） 43
Other Types of Auditors’ Reports 45
The Attestation Standards 45
The Assurance Function 47
Quality Control in CPA Firms 47
Division for CPA Firms 48
The Public Oversight Board 49
Peer Reviews 50
International Accounting and Auditing Standards 50
3 Professional Ethics 61
The Nature of Ethics 62
What Are Ethical Dilemmas？ 62
A Framework for Ethical Decisions 62
Making Ethical Decisions—A Professional Example 63
The Need for Professional Ethics 66
Professional Ethics in Public Accounting 67
The AICPA Code of Professional Conduct 68
Section Ⅰ—Principles 69
Preamble 69
Article Ⅰ—Responsibilities 69
Article Ⅱ—The Public Interest 69
Article Ⅲ—Integrity 70
Article Ⅳ—Objectivity and Independence 70
Article Ⅴ—Due Care 70
Article Ⅵ—Scope and Nature of Services 70
Section Ⅱ—Rules 70
Applicability 70
Rule 101—Independence 70
Analysis of Independence 72
Rule 102—Integrity and Objectivity 77
Analysis of Integrity and Objectivity 77
Rule 201—General Standards 78
Analysis of General Standards 78
Rule 202—Compliance with Standards 78
Analysis of Compliance with Standards 78
Rule 203 —Accounting Principles 79
Analysis of Accounting Principles 80
Rule 301—Confidential Client Information 80
Analysis of Confidential Client Information 80
Rule 302 —Contingent Fees 81
Analysis of Contingent Fees 82
Rule 501—Acts Discreditable 82
Analysis of Acts Discreditable 82
Rule 502 —Advertising and Other Forms of Solicitation 83
Analysis of Advertising and Other Forms of Solicitation 83
Rule 504—Commissions and Referral Fees 83
Analysis of Commissions and Referral Fees 84
Rule 505 —Form of Organization and Name 84
Analysis of Form of Organization and Name 84
The CPA as Tax Adviser—Ethical Problems 85
Enforcement of Professional Ethics 86
Ethics for Internal Auditors 86
4 Legal Liability of Auditors 97
Unique Vulnerability of Accountants to Lawsuits 98
Definitions of Terms 98
Litigation Placed in Perspective 98
Auditors’ Liability to Their Clients under Common Law 101
Auditors’ Common Law Liability to Third Parties 103
Ultramares Approach 103
Restatement of Torts Approach 104
Rosenblum Approach 104
Joint and Several Liability 105
Liability to Third Parties under Statutory Law 106
Securities Act of 1933 106
Securities Exchange Act of 1934 108
Comparison of the 1933 and 1934 Acts 110
The Racketeer Influenced and Corrupt Organizations Act 111
Auditors’ Criminal Liability under the Securities Acts 112
The SEC’s Regulation of Accountants 113
Accountants’ Liabityty for Accounting and Review Services 113
The CPAs’ Posture in the Age of Litigation 115
5 Audit Evidence 128
The Relationship of Audit Risk to Evidence 129
Financial Statement Asseerions 129
Audit Risk at the Asseerion Level 130
Audit Risk Illustrated 131
Measuring Audit Risk 131
Audit Evidence 133
Types of Evidence 134
Audit Procedures 141
The Nature of Audit Procedures 141
Timing of Audit Procedures 141
Extent of Audit Procedures 141
The Cost of Audit Procedures 141
Analytical Procedures 143
Developing an Expectation 143
Timing of Analytical Procedures 147
Extent of Analytical Procedures 148
Evidence on Accounting Estimates 148
Evidence on Related Party Transactions 149
6 Planning the Audit； Designing Audit Programs 162
Client Acceptance 163
Communication with Predecessor Auditors 164
Other Communications 165
Other Considerations in Accepting an Audit Client 165
Obtaining the Engagement 165
Audit Committees 166
Fee Arrangements 166
Engagement Letters 167
Audit Planning 167
Obtaining an Understanding of the Client’s Business 167
Developing an Overall Audit Strategy 170
Audit Plans 181
Time Budgets for Audit Engagements 181
Planning a Recurring Engagement 182
Designing Audit Programs 183
The Audit Trail 183
Organization of the Audit Program 184
Objectives of Audit Programs 187
General Objectives of Audit Programs for Asset Accounts 188
Substantiation of Account Balances 188
Existence of Assets 188
Rights to the Assets 189
Establishing Completeness 189
Valuation of Assets 190
Clerical Accuracy of Records 190
Financial Statement Presentation and Disclosure 191
An Illustration of Audit Program Design 191
Audit Process 191
Timing of Audit Work 194
Appendix 6A：Selected Internet Addresses 205
Appendix 6B：Illustrative Audit Case 205
Part 1：Audit Planning 205
7 Internal Control 216
The Meaning of Internal Control 217
The Foreign Corrupt Practices Act of 1977 219
Means of Achieving Internal Control 219
The Control Environment 219
Integrity and Ethical Values 220
Commitment to Competence 220
Board of Directors or Audit Committee 220
Management Philosophy and Operating Style 220
Organizational Structure 221
Assignment of Authority and Responsibityty 223
Human Resource Policies and Procedures 223
Risk Assessment 224
The Accounting Information and Communication System 225
Control Activities 225
Performance Reviews 226
Information Processing 226
Physical Controls 227
Segregation of Duties 228
Monitoring 229
The Internal Audit Function 229
Limitations of Internal Control 229
The Auditors’ Consideration of Internal Control 230
Obtaining an Understanding of Internal Control to Plan the Audit 230
Assess Control Risk 239
Decision Aids for Audit Program Modification 241
Consideration of the Work of Internal Auditors 244
Communication of Control Related Matters 245
Internal Control in the Small Company 245
8 Consideration of Intern Control in a Computer Environment 260
Nature of Computer Systems 261
Characteristics of Various Types of Computer Systems 262
Impact of Computers on the Audit Trail 265
Internal Control in a Computer Environment 266
Organizational Structure of the Information System Function 266
Computer-Centered Fraud 269
Internal Auditing in a Computer Environment 271
Control Activities in a Computer System 271
General Control Activities 272
Application Control Activities 275
User Control Activities 276
Control in Microcomputer Systems 277
The Auditors’ Consideration of Internal Control in a Computer Environment 277
Obtaining an Understanding of Computerized Intern Control 278
Documenting Computerized Internal Control 278
Assessing Control Risk—Testing Computer System Controls 280
Substantive Testing with Computers 286
Using Audit Software：An Illustration 287
Computer Service Centers and Outsourced Computer Processing 287
9 Audit Sampling 299
Comparison of Statistical and Nonstatistical Sampling 300
Selecting a Random Sample 301
Other Methods of Sample Selection 304
Stratification 304
Types of Statistical Sampling Plans 305
Allowance for Sampling Risk（Precision） 306
Sample Size 307
Audit Sampling for Tests of Controls 307
Sampling Risk for Tests of Controls 307
Attributes Sampling 308
Determine the Objective of the Test 309
Define the Attributes and “Deviation” Conditions 309
Define the Population 310
Specify the Risk of Assessing Control Risk Too Low and the Tolerable Deviation Rate 310
Estimate the Expected Population Deviation Rate 311
Determine the Sample Size 311
Select the Sample 313
Test the Sample Items 313
Evaluate the Sample Results 313
Document the Sampling Procedure 315
Detailed Illustration of Attributes Sampling 315
Other Statistical Attributes Sampling Approaches 317
Nonstatistical Attributes Sampling 319
Audit Sampling for Substantive Tests 320
Sampling Risk for Substantive Tests 320
Classical Variables Sampling 321
Mean-per-Unit Estimation 321
Controlling Sampling Risk 321
Determination of Sample Size 322
Evaluation of Sample Results 324
Illustration of Mean-per-Unit Estimation 324
Ratio and Difference Estimation 328
Illustration of Ratio and Difference Estimation 329
Nonstatistical Sampling for Substantive Tests 330
Illustration of Nonstatistical Sampling 331
Appendix 9A：Probability-Proportional-to-Size （PPS） Sampling 343
Determination of Sample Size 343
Controlling Sampling Risk 344
Method of Sample Selection 344
Evaluation of Sample Results 345
Illustration of PPS Sampling 346
Considerations in Using PPS Sampling 348
Appendix 9B：Audit Risk 349
10 Audit Working Papers； Examination of the General Records 355
What Are Audit Working Papers？ 356
Functions of Working Papers 356
Confidential Nature of Working Papers 358
Ownership of Audit Working Papers 358
Working Papers and Auditors’ Liability 358
Types of Working Papers 360
Organization of the Working Papers 362
Guidelines for Preparation of WorkingPapers 363
Computer-Generated Working Papers 365
The Review of Audit Working Papers 365
Examination of the General Records 368
Articles of Incorporation and Bylaws 369
Partnership Contract 369
Corporate Minutes Book 369
Contracts Held or Issued by Client 371
Laws and Regulations 372
Correspondence Files 374
Income Tax Returns of Prior Years 374
Financial Statements and Annual Reports of Prior Years 374
Reports to the SEC 375
Review and Testing of the Accounting Records 375
The General Ledger 376
The General Journal 377
Audit Working Papers for the Examination of Accounting Records 379
11 Cash and Marketable Securities 391
Cash 392
Sources and Nature of Cash 392
The Auditors’ Objectives in the Audit of Cash 392
How Much Audit Time for Cash？ 394
Internal Control over Cash Transactions 394
Internal Control over Cash Receipts 395
Internal Control over Cash Disbursements 397
Internal Control and the Computer 403
Audit Working Papers for Cash 403
Audit Program for Cash 403
Interim Audit Work on Cash 417
Marketable Securities 417
The Auditors’ Objectives in Examination of Marketable Securities 417
Internal Control over Marketable Securities 418
Internal Control Questionnaire 419
Audit Program for Securities 420
Substantive Tests for Investments in Securities 420
12 Accounts Receivable，Notes Receivable，and Sales Transactions 436
Receivables 437
Sources and Nature of Accounts Receivable 437
Sources and Nature of Notes Receivable 437
The Auditors’ Objectives in Auditing Receivables and Sales 437
Internal Control of Sales Transactions and Accounts Receivable 438
Internal Control over Notes Receivable 444
Internal Control and the Computer 444
Audit Working Papers for Receivables and Sales 445
Audit Program for Receivables and Sales Transactions 445
Interim Audit Work on Receivables and Sales 468
Appendix 12A Illustrative Audit Case：Key-stone Computers ＆ Networks，Inc 480
Part Ⅱ：Consideration of Internal Control 480
Obtaining and Documenting an Understanding of the Sales and Collections Cycle 481
Testing Controls and Assessing Control Risk 481
Appendix 12B Illustrative Audit Case：Keystone Computers ＆ Networks，Inc. 495
Part Ⅲ：Substantive Tests—Accounts Receivable and Sales 495
13 Inventories and Cost of Goods Sold 499
Sources and Nature of Inventories and Cost of Goods Sold 500
The Auditors’ Approach to Auditing Inventories and Cost of Goods Sold 500
Internal Control over Inventories and Cost of Goods Sold 502
Internal Control and the Computer 507
Audit Working Papers for Inventories and Cost of Goods Sold 507
Audit Program for Inventories and Cost of Goods Sold 508
Problems Associated with Inventory of First Year Audit Clients 528
14 Property，Plant，and Equipment：Depreciation and Depletion 540
The Auditors’ Approach to Auditing Property，Plant，and Equipment 541
Contrast with Audit of Current Assets 541
Internal Control over Plant and Equipment 542
Audit Working Papers 543
Initial Audits and Repeat Engagements 545
Audit Program for Property，Plant，and Equipment 545
Depreciation 554
The Auditors’ Perspective Toward Depreciation 554
The Auditors’ Objectives in Auditing Depreciation 555
Audit Program—Depreciation Expense and Accumulated Depreciation 555
Testing the Client’s Provision for Depreciation 556
Examination of Natural Resources 556
Examination of Intangible Assets 557
Examination of Plant and Equipment in Advance of the Balance Sheet Date 558
15 Accounts Payable and Other Liabilities 567
Accounts Payable 568
Sources and Nature of Accounts Payable 568
The Auditors’ Approach to Auditing Accounts Payable 568
Internal Control over Accounts Payable 569
Internal Control and the Computer 571
Audit Working Papers for Accounts Payable 571
Audit Program 571
Other Liabilities 585
Amounts Withheld from Employees’Pay 585
Sales Tax Payable 586
Unclaimed Wages 586
Customers’ Deposits 586
Accrued Liabilities 587
Balance Sheet Presentation 590
Time of Examination 591
Appendix 15A Illustrative Audit Case：Keystone Computers ＆ Networks，Inc. 599
Part Ⅳ：Consideration of Internal Control 599
16 Debt and Equity Capital 603
Interest-Bearing Debt 604
Sources and Nature of Interest-Bearing Debt 604
The Auditors’ Approach to Auditing Interest-Bearing Debt 604
Internal Control over Interest-Bearing Debt 605
Audit Working Papers 606
Audit Program for Interest-Bearing Debt 606
Time of Examination—Interest-Bearing Debt 613
Equity Capital 614
Sources and Nature of Owners’ Equity 614
The Auditors’ Approach to Auditing Owners’ Equity 614
Internal Control over Owners’ Equity 614
Control of Capital Stock Transactions by the Board of Directors 615
Independent Registrar and Stock Transfer Agent 615
The Stock Certificate Book and Stockholders Ledger 616
Internal Control over Dividends 616
Audit Working Papers for Owners’Equity 617
Audit Program—Capital Stock 617
Retained Earnings and Dividends 620
Time of Examination—Stockholders’Equity 621
Financial Statement Presentation of Stockholders’ Equity 622
Audit of Sole Proprietorships and Partnerships 622
17 Auditing Operations and Completing the Audit 633
Auditing Operations 634
The Auditors’ Approach to Examining Operations 634
Revenue 635
Relationship of Revenue to Balance Sheet Accounts 635
Miscellaneous Revenue 635
Expenses 636
Relationship of Expenses to Balance Sheet Accounts 636
Substantive Tests for Selling，General，and Administrative Expenses 636
The Audit of Payroll 638
Internal Control over Payroll 641
Description of Internal Control for Payroll 643
Audit Program for Payrolls 643
Audit of the Statement of Cash Flows 645
Completing the Audit 645
Search for Unrecorded Liabilities 646
Review the Minutes of Meetings 646
Perform Final Analytical Procedures 646
Perform Procedures to Identify Loss Contingencies 646
Perform the Review for Subsequent Events 651
Obtain Representation Letter 655
Evaluating Audit Findings 655
Reviewing the Engagement 656
Responsibilities for Other Information in the Financial Report 658
Opinion Formulation and Report Issuance 659
Communicating with the Audit Committee 660
Post-Audit Responsibilities 660
The Auditors’ Subsequent Discovery of Facts Existing at the Date of Their Report 660
Subsequent Discovery of Omitted Audit Procedures 661
18 Auditors’ Reports 674
Financial Statements 675
Financial Statement Disclosures 676
Comparative Financial Statements 676
The Auditors’ Standard Report 677
Expression of an Opinion 678
The Unqualified Opinion 679
Explanatory Language Added to the Auditors’ Report 678
Qualified Opinions 684
Adverse Opinions 687
Disclaimer of Opinion 688
Summary of Auditors’ Reports 690
Two or More Report Modifications 690
Different Opinions on DifferentStatements 693
Reporting on Comparative Financial Statements 693
Reports to the SEC 694
19 Other Attestation and Accounting Services 710
The Attestation Function 712
Attestation Engagements—Historical Financial Information 713
Special Reports 713
Financial Statements Prepared for Use in Other Countries 718
Audits of Personal Financial Statements 718
Reviews of the Interim Information of Public Companies 719
Review Services for Nonpublic Companies 722
Accountants’ Reports on Comparative Statements 725
Letters for Underwriters 726
Condensed Financial Statements 726
Attestation Engagements—Other Information 727
Prospective Financial Statements 727
Reporting on a Company’s Internal Control 729
Other Agreed-Upon Procedures Engagements 732
Accounting Services 732
Compilation Engagements for Financial Statements of Nonpublic Companies 732
Other “Association” with the Financial Statements of Public Companies 735
Compilations of Prospective Financial Statements 736
Summary of Reporting 736
20 Internal，Operational，and Compliance Auditing 749
Internal Auditing 750
What Is the Purpose of Internal Auditing？ 750
Evolution of Internal Auditing 750
Professional Standards of Internal Auditing 752
Certification of Internal Auditors 755
Operational Auditing 756
Objective of Operational Audits 756
General Approach to Operational Audits 757
Compliance Auditing 759
Attesting to Compliance with Laws and Regulations 760
Compliance Auditing of Federal Financial Assistance Programs 764
Audits in Accordance with Generally Accepted Auditing Standards 764
Audits in Accordance with Government Auditing Standards 765
Audits in Accordance with the Single Audit Act 767
Compliance Auditing—A Summary 771
Index 781