CHAPTER 1 The Audit Function-An Overvie?v 1
HISTORY OF THE AUDIT FUNCTION 2
Independent Audits Prior to 1900 2
Twentieth-Century Developments 3
AUDITING DEFINED 4
Financial Auditing 4
Other Types of Audits 5
The Need for Audits of Financial Statements 5
The Standard Report 6
THE AUDIT REPORT 6
Generally Accepted Accounting Principles 10
Report Title,Address,Signature,and Date 11
Departures from the Standard Report 12
Generally Accepted Auditing Standards 13
THE INDEPENDENT AUDITOR 16
Types of CPA Firms 16
Internal Structure of a CPA Firm 18
OTHER TYPES OF AUDITORS AND AUDITS 20
Compliance Audits 21
Operational Audits 25
Internal Audits 25
CHAPTER I ASSIGNMENTS 26
CHAPTER 2 Professional Ethics and the Auditing Environment 38
PROFESSIONAL STATUS―FRAMEWORK OF THE ENVIRONMENT 39
Systematic Theory 40
Professional Authority 40
Community Sanction 40
Regulative Code 41
A Culture 41
NATURE OF THE ENVIRONMENT 41
SELF-REGULATION BY THE PUBLIC ACCOUNTING PROFESSION 42
The Organizations Involved 43
The Code of Professional Conduct 45
Quality Control within CPA Firms 54
Mandatory Continuing Professional Education 55
Monitoring and Enforcement 55
EXTERNAL REGULATION 56
The Securities and Exchange Commission 57
Legal Liability 59
CHAPTER 2 ASSIGNMENTS 59
CHAPTER 3 Legal Liability 69
THE LEGAL ENVIRONMENT 70
CIVIL LIABILITY 71
Liability to Clients 72
Liability to Third Parties―Common Law 73
Liability to Third Parties―Statutory Law 78
CRIMINAL LIABILITY 81
NOTED LEGAL CASES 82
Bar Chris 82
U.S. Financial 83
Continental Vending 83
Yale Express 83
National Student Marketing 84
1136 Tenants Corporation 84
Equity Funding 84
Fund of Funds 85
Credit Alliance 86
Mann Judd Landau 86
ESM 87
Bily 87
SELF-PROTECTION AGAINST LIABILITY 88
Crazy Eddie 88
TORT REFORM 89
FORENSIC ACCOUNTING 89
CHAPTER 3 ASSIGNMENTS 90
CHAPTER 4 The Elements of Auditing 97
EVIDENCE, ASSERTIONS,AND PROCEDURES 99
Auditing Procedures 99
Evidential Matter and Its Relationship to Procedures 101
Financial Statement Assertions and Audit Objectives 103
OVERVIEW OF THE AUDIT RISK MODEL 106
Types of Tests of Controls 107
TYPES OF AUDIT TESTS 107
Classification by Purpose of Test 107
Types of Substantive Tests 108
OVERVIEW OF AN AUDIT OF FINANCLAL STATEMENTS 109
WORK PAPERS 110
The Function of Work Papers 110
The Contents and Requirements of Work Papers 111
Legal Aspects of Work Papers 113
Mechanics of Work Paper Preparation 114
Illustrative Audit Work Papers 115
CHAPTER 4 ASSIGNMENTS 120
CHAPTER 5 Understanding the Client and General Planning 128
CLIENT ACCEPTANCE AND CONTINUANCE 129
Quality Control Policies and Procedurse 130
Communication with a Predecessor Auditor 130
Engagement Letters 131
Conferences with Client Personnel 131
KNOWLEDGE OF THE BUSINESS 133
Organization Structure 133
Operations of Legal Structure 134
Industry and Economic Conditions 136
GENERAL PLANNING AND THE PRELIMINARY AUDIT PLAN 137
General Planning Decisions to Be Made 137
Knowledge Obtained to Prepare Preliminary Audit Plan 137
Procedures in Preparing Preliminary Audit Plan 138
AUDIT DECISIONS IN PRELIMINARY PLANNING 138
Understanding the Internal Control Structure and the Control Risk Assessment 138
Materiality and Audit Risk 139
Special Areas of Audit Risk 143
Overall Timing of Engagement 149
Involvement of Specialists and Others 152
Assignment and Scheduling of Audit Staff 154
ANALYTICAL PROCEDURES 155
Use of Analytical Procedures 155
Analytical Procedures in Planning the Audit 156
Analytical Procedures as Substantive Tests 157
Analytical Procedures in the Overall Review 158
Data Used in Analytical Proceduress 159
CHAPTER 5 ASSIGNMENTS 159
CHAPTER 6 Understanding the Internal Control Structure and Assessing Control Risk 176
AUDIT STRATEGY AND THE INTERNAL CONTROL STRUCTURE 177
Audit Logic and the Internal Control Structure 178
Internal Control Structure Concepts 179
Internal Control Structure Objectives 180
Detailed Objectives of Internal Control 181
COMPONENTS OF THE INTERNAL CONTROL STRUCTURE 182
Control Environment 182
Monitoring 184
Risk Assessment 186
Information and Communication 186
Control Activities 192
An Overview of the Auditor s Consideration 198
THE AUDITOR S CONSIDERATION OF THE INTERNAL CONTROL STRUCTURE IN A FINANCIAL STATEMENT AUDIT 198
Organizing the Auditor s Consideration 203
Understanding the Internal Control Structure 205
Documenting the Understanding 207
Assessing Control Risk 211
Tests of Controls 214
Documentation of the Assessment of Control Risk 217
Effect on Design of Substantive Tests 217
THE FOREIGN CORRUPT PRACTICES ACT 218
CHAPTER 6 ASSIGNMENTS 219
CHAPTER 7 Planning Tests of Detalls of Transactions and Balances 231
DESIGNING AUDIT PROGRAMS―AN INTRODUCTION 232
Decisions to Be Made 233
Considerations in Deciding on Nature,Timing,and Extent 235
Efficiency and Effectiveness of Audit Tests 235
DIRECT TESTS OF BALANCES 236
Nature of Financial Statement Component and Audit Objectives 237
Materiality at the Account Balance Level 239
Audit Risk an the Account Balance Level 244
Efficiency of Audit Tests 251
Relation of Tests of Transaction Classes to Direct Tests of Balances 258
TESTS OF TRANSACTION CLASSES 258
Types of Tests of Transaction Classes 259
Planning the Scope of Tests of Transaction Classes 260
DESIGNING AUDIT PROGARMS―ADDITIONAL MATTERS 263
Revision of Audit Program as Audit Progresses 263
Client Expectations 263
Generalized Materials 263
Direct Tests of Balances at an Interim Date 264
AUDITING ACCOUNTING ESTIMATES 265
CHAPTER 7 ASSIGNMENTS 265
CHAPTER 8 Audit Sampling 276
AN INTRODUCTION TO AUDIT SAMPLING 277
Definition and Basic Features of Audit Sampling 277
Nonstatistical versus Statistical Audit Sampling 279
Representative Selection Methods 280
AUDIT SAMPLING FOR TESTS OF TRANSACTION CLASSES 283
Planning Samples for Tests of Transaction Classes 283
Selection of Samples for Tests of Transaction Classes 288
Evaluation of Sample Results of Tests of Transaction Classes 288
Statistical Sampling for Tests of Transaction Classes 290
Nonstatistical Sampling for Tests of Transaction Classes 297
Planning Samples for Direct Tests of Balances 300
AUDIT SAMPLING FOR DIRECT TESTS OF BALANCES 300
Selection of Samples for Direct Tests of Balances 302
Evaluation of Sample Results of Direct Tests of Balances 303
Nonstatistical Sampling for Direct Tests of Balances 304
Statistical Sampling for Direct Tests of Balances 308
Establishing Tolerable Misstatement for Sampling Applications 313
Other Statistical Models 316
Accounting Estimation versus Audit Hypothesis Testing 317
Mean-per-Unit Estimation 317
APPENDIX; ESTIMATION SAMPLING―AN AUDIT HYPOTHESIS TESTING APPROACH 317
Stratified Mean-Per-Unit Estimation 322
Difference Estimation 322
Ratio Estimation 323
CHAPTER 8 ASSIGNMENTS 324
CHAPTER 9 The Effect of Computers on the Audit 334
THE RELATION OF COMPUTERS TO AUDITING 335
Relation to Phases of the Audit 335
Recognizing Reliance on the Computer 337
Control Classification in Computerized Systems 338
THE INTERNAL CONTROL STRUCTURE AND COMPUTERIZED SYSTEMS 338
Auditor Use of the Computer 338
Application Controls 340
Ceneral Controls 343
CONSIDERATION OF THE COMPUTER IN PLANNING THE AUDIT 347
Understanding the Client and the Control Environment 348
Understanding the Accounting System 348
Understanding Control Activities 349
Planning Tests of Details of Transactions and Balances 350
COMPUTER-ASSISTED AUDIT TECHNIQUES 352
Testing Client Programs 353
Testing Client Files 354
Use of a Microcomputer as an Audit Tool 356
A Terminology Note 358
OTHER COMPUTER-RELATED CONSIDERATIONS 358
Real-Time Processing Systems 358
Electronic Data Interchange 358
Computer Service Centers 359
Database Management Systems 359
LANs and Other Networks 360
ADVANCED COMPUTER-ASSISTED TECHNIQUES 360
Hardware 361
APPENDIX:BASIC CONCEPTS OF COMPUTER PROCESSING 361
Software 362
Data Processing and Storage 363
CHAPTER 9 ASSIGNMENTS 366
CHAPTER 10 Tests of Transaction Classes and Related Balances 378
REVENUE,RECEIVABLES,AND RECEIPTS 379
Functions,Documents,Inputs,and Accounting Systems 380
Primary Control-Related Features 382
Potential Misstatements 384
Account Balances and Transactions 384
Tests of Transaction Classes for Sales 387
Tests of Transaction Classes for Cash Receipts 392
Tests of Adjustments to Accounts Receivable 393
Special Considerations 394
EXPENDITURES,PAYABLES,AND DISBURSEMENTS 394
Differences from the Sales Cycle 394
Functions,Documents,Inputs,and Accounting Systems 396
Primary Control-Related Features 400
Account Balances and Transactions 400
Potential Misstatements 400
Tests of Transaction Classes for Purchases for Inventory 401
Tests of Transaction Classes for Cash Disbursements 403
Variations for Other Types of Expenditure Transactions 406
RELATED DIRECT TESTS OF BALANCES 407
Accounts Receivable 407
Accounts Payable 415
Cash 419
CHAPTER 10 ASSIGNMENTS 425
CHAPTER 11 Direct Tests of Balances 447
INVENTORIES 448
Differences from the Sales and Expenditures Cycles 449
Assertions,Objectives,and Procedures 451
Observation of the Physical Inventory 453
Tests of Pricing and Summarization 456
Materiality 456
Audit Risk 457
Additional Considerations 458
LONG-TERM ASSETS AND OBLIGATIONS AND OWNERS EQUITY 459
Property and Equipment 459
Investments and Intangible Assets 463
Long-Term Obligations 465
Owners Equity 467
The Income Statement 468
THE INCOME STATEMENT AND INCOME TAXES 468
Income Taxes 471
CHAPTER 11 ASSIGNMENTS 475
CHAPTER 12 Completion of the Audit 498
NATURE OF COMPLETION AND REVIEW PROCEDURES 500
Date of the Audit Report 500
Audit Procedures after Year-End 501
SUBSEQUENT EVENTS AND RELATED REVIEW PROCEDURES 502
Subsequent Events Review 502
Subsequent Events of Audit Interest 502
Subsequent Events and the Report Date 504
Reissuance of the Audit Report 505
REPRESENTATION LETTERS 506
Legal Representation Letters 506
Client Representation Letters 508
REVIEW OF WORK PAPERS AND FINANCIAL STATEMENTS 511
Summarization and Evaluation of Audit Results 511
Evaluation of Going Concern Status 518
Financial Statement Review and Analytical Procedures 519
Administrative Completion of Work Papers 520
AFTER THE AUDIT 521
Subsequent Discovery of Facts 522
Maintaining Quality of Audit Practice 522
Subsequent Discovery of Omitted Procedures 523
CHAPTER 12 ASSIGNMEMTS 524
CHAPTER 13 The Auditor s Report 537
AUDITOR S REPORTING OBLIGATION 539
Departures from a Standard Report 540
Financial Statements and Periods Covered 542
QUALIFICATIONS, DISCLAIMERS, AND ADVERSE OPINIONS 545
Limitations on the Scope of the Audit 546
Departures from Generally Accepted Accounting Principles 548
EXPLANATORY LANGUAGE ADDED TO THE STANDARD REPORT 550
Opinion Based in Part on the Report of Another Auditor 551
Departure from a Promulgated Accounting Principle 553
Uncertainties 554
Going Concern Uncertainties 556
Inconsistent Application of Accounting Principles 556
Comparative Financial Statements―Updated Reports 558
Information outside the Basic Financial Statements 558
Emphasis of a Matter 559
Old Reporting Terms 559
Communicating with Stockholders 560
AUDITOR-CLIENT COMMUNICATIONS 560
Communicating with the Board of Directors 562
Communicating with Audit Committees 562
Communicating with Management 565
CHAPTER 13 ASSIGNMENTS 566
CHAPTER 14 Attestation Services, Unaudited Financial Statements,and Specialized Reporting 588
ATTESTATION AND COMPILATION SERVICES 590
Types of Engagements 591
Attestation Standards 592
Compilation or Review of Financial Statements for Nonpublic Companies 593
UNAUDITED FINANCLAL STATEMENTS 593
Review of Interim Financial Information of a Public Company 600
Other Unaudited Financial Statements of Public Companies 602
SPECIALIZED REPORTING CIRCUMSTANCES 603
Letters for Underwriters 604
Special Reports 604
Reports on Accompanying Information 606
Forecasts and Projections 608
Internal Control Structure 611
Pro Forma Financial Information 613
Compliance Attestation 613
CHAPTER 14 ASSIGNMENTS 615
CHAPTER 15 Operational Auditing 623
FRAMEWORK OF OPERATIONAL AUDITING 624
Operational Auditing Defined 625
Operational Auditor s Qualifications 627
Purpose of the Operational Audit Engagement 629
Arrangements for the Operational Audit Engagement 630
Methods of Conducting the Operational Audit Engagement 631
Form and Content of the Operational Audit Report 632
CONDUCT OF AN OPERATIONAL AUDIT 634
Preliminary Survey 635
Review of Charter and Development of Performance Criteria 636
Revicw of Administrative and Related Controls 637
Development of Specific Findings and Recommendations 637
Preparation and Submission of Operational Audit Report 638
EXAMPLES OF OPERATIONAL AUDITS 638
Independent CPA 638
Governmental Auditor 639
Internal Auditor 640
CHAPTER 15 ASSIGNMENTS 641
Index 645