Tài liệu Auditing a risk based approach to conducting a quality audit 9th by johnstone

Tài liệu Auditing a risk based approach to conducting a quality audit 9th by johnstone Tài liệu Auditing a risk based approach to conducting a quality audit 9th by johnstone Tài liệu Auditing a risk based approach to conducting a quality audit 9th by johnstone Tài liệu Auditing a risk based approach to conducting a quality audit 9th by johnstone Tài liệu Auditing a risk based approach to conducting a quality audit 9th by johnstone Tài liệu Auditing a risk based approach to conducting a quality audit 9th by johnstone Tài liệu Auditing a risk based approach to conducting a quality audit 9th by johnstone Tài liệu Auditing a risk based approach to conducting a quality audit 9th by johnstone

This is an electronic version of the print textbook Due to electronic rights restrictions, some third party content may be suppressed Editorial review has deemed that any suppressed content does not materially affect the overall learning experience The publisher reserves the right to remove content from this title at any time if subsequent rights restrictions require it For valuable information on pricing, previous editions, changes to current editions, and alternate formats, please visit www.cengage.com/highered to search by ISBN#, author, title, or keyword for materials in your areas of interest Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it NINTH EDITION AUDITING A RISK-BASED APPROACH TO CONDUCTING A QUALITY AUDIT Karla M Johnstone University of Wisconsin—Madison Audrey A Gramling Bellarmine University Larry E Rittenberg University of Wisconsin—Madison Australia • Brazil • Japan • Korea • Mexico • Singapore • Spain • United Kingdom • United States Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Auditing: A Risk-Based Approach to Conducting a Quality Audit, Ninth Edition Karla M Johnstone, Audrey A Gramling, and Larry E Rittenberg Senior Vice President, LRS/Acquisitions & Solutions Planning: Jack W Calhoun Editorial Director, Business & Economics: Erin Joyner Editor-in-Chief: Rob Dewey Executive Editor: Sharon Oblinger Senior Developmental Editor: Craig Avery Editorial Assistant: Ann Loch Market Development Manager: Natalie Livingston © 2014, 2012 South-Western, Cengage Learning ALL RIGHTS RESERVED No part of this work covered by the copyright herein may be reproduced, transmitted, stored, or used in any form or by any means graphic, electronic, or mechanical, including but not limited to photocopying, recording, scanning, digitizing, taping, web distribution, information networks, or information storage and retrieval systems, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without the prior written permission of the publisher For product information and technology assistance, contact us at Cengage Learning Customer & Sales Support, 1-800-354-9706 For permission to use material from this text or product, submit all requests online at www.cengage.com/permissions Further permissions questions can be emailed to permissionrequest@cengage.com Brand Manager: Kristen Hurd Library of Congress Control Number: 2013931325 Marketing Communications Manager: Jason LaChapelle Package Edition ISBN-13: 978-1-133-93915-3 Marketing Coordinator: Eileen Corcoran Student Edition ISBN-13: 978-1-133-93916-0 Art and Cover Direction, Production Management, and Composition: PreMediaGlobal Package Edition ISBN-10: 1-133-93915-5 Student Edition ISBN-10: 1-133-93916-3 Media Editor: Bryan England Rights Acquisition Director: Audrey Pettengill Rights Acquisition Specialist, Text and Image: Anne Sheroff South-Western 5191 Natorp Boulevard Mason, OH 45040 USA Manufacturing Planner: Doug Wilke Cover Images: © Tim Mainiero/Shutterstock/ © Samot/Shutterstock/ © upthebanner/Shutterstock/ © Ian D Walker/Shutterstock Cengage Learning is a leading provider of customized learning solutions with office locations around the globe, including Singapore, the United Kingdom, Australia, Mexico, Brazil, and Japan Locate your local office at: www.cengage com/global Cengage Learning products are represented in Canada by Nelson Education, Ltd For your course and learning solutions, visit www.cengage.com Purchase any of our products at your local college store or at our preferred online store www.cengagebrain.com Printed in the United States of America 17 16 15 14 13 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Dedication We dedicate this book to our families who encourage and support us through many hours of development, to our students who inspire us to always improve, to our mentors who guide us, to our professional friends who continue to educate us, and to our colleagues who challenge us KARLA M JOHNSTONE AUDREY A GRAMLING LARRY E RITTENBERG Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it BRIEF CONTENTS Preface, xxiii About the Authors, xxxiii CHAPTER CHAPTER CHAPTER CHAPTER CHAPTER CHAPTER CHAPTER CHAPTER C H A P T E R 10 C H A P T E R 11 CHAPTER CHAPTER 12 CHAPTER 13 14 C H A P T E R 15 CHAPTER Auditing: Integral to the Economy, The Risk of Fraud and Mechanisms to Address Fraud: Regulation, Corporate Governance, and Audit Quality, 32 Internal Control over Financial Reporting: Management’s Responsibilities and Importance to the External Auditors, 72 Professional Liability and the Need for Quality Auditor Judgments and Ethical Decisions, 114 Professional Auditing Standards and the Audit Opinion Formulation Process, 156 A Framework for Audit Evidence, 212 Planning the Audit: Identifying and Responding to the Risks of Material Misstatement, 266 Specialized Audit Tools: Sampling and Generalized Audit Software, 316 Auditing the Revenue Cycle, 366 Auditing Cash and Marketable Securities, 438 Auditing Inventory, Goods and Services, and Accounts Payable: The Acquisition and Payment Cycle, 500 Auditing Long-Lived Assets: Acquisition, Use, Impairment, and Disposal, 560 Auditing Debt Obligations and Stockholders’ Equity Transactions, 594 Activities Required in Completing a Quality Audit, 620 Audit Reports on Financial Statements, 684 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it v vi Brief Contents CHAPTER 16 CHAPTER 17 Advanced Topics Concerning Complex Auditing Judgments, 726 Other Services Provided by Audit Firms, 790 ACL Appendix, 841 Case Index, 857 Index, 859 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it CONTENTS PREFACE, xxiii ABOUT THE AUTHORS, CHAPTER xxxiii Auditing: Integral to the Economy, Overview of the External Auditing Profession, Introduction to the External Auditing Profession, External Auditing: A Special Function, The Need for Unbiased Reporting and Independent Assurance, Overall Objectives in Conducting an Audit, Overview of the Audit Opinion Formulation Process, Parties Involved in Preparing and Auditing Financial Statements, Providers of External Auditing Services, Skills and Knowledge Needed to Enter the External Auditing Profession, 10 Organizations Affecting the External Auditing Profession, 11 Audit Quality, 14 Audit Firm Culture, 15 Skills and Qualities of the Engagement Team, 15 Effectiveness of the Audit Process, 16 Reliability and Usefulness of Audit Reporting, 16 Factors Outside the Control of Auditors That Affect Audit Quality, Achieving Audit Quality and Minimizing Lawsuits, Auditor Independence Requirements, Review Programs, 19 Engagement Letters, 20 16 16 17 vii Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it viii Contents Client Acceptance/Continuance Decisions, Audit Firm Limitations, 21 Audit Documentation, 21 Summary and Next Steps, 21 Significant Terms, 21 True-False Questions, 23 Multiple-Choice Questions, 24 Review and Short Case Questions, 26 Contemporary and Historical Cases, 28 Application Activities, 30 Academic Research Case, 31 CHAPTER 20 The Risk of Fraud and Mechanisms to Address Fraud: Regulation, Corporate Governance, and Audit Quality, 32 Fraud Defined, 34 Misstatements Arising From Misappropriation of Assets, 34 Misstatements Arising from Fraudulent Financial Reporting, 34 The Fraud Triangle, 35 Incentives or Pressures to Commit Fraud, Opportunities to Commit Fraud, 37 Rationalizing the Fraud, 38 37 Recent History of Fraudulent Financial Reporting, 38 Examples of Recent Frauds and Implications for External Auditors, The Third COSO Report, 41 The Enron Fraud: A Key Driver of Regulatory Change, 42 38 An Overview of the Auditor’s Fraud-Related Responsibilities and Users’ Expectations, 44 The Sarbanes–Oxley Act of 2002 as a Regulatory Response to Fraud, 45 The Post Sarbanes-Oxley World: A Time of Improved Corporate Governance, 49 What Is Corporate Governance? 49 Principles of Effective Corporate Governance, Responsibilities of Audit Committees, 53 Summary and Next Steps, 53 Significant Terms, 54 True-False Questions, 54 Multiple-Choice Questions, 55 Review and Short Case Questions, 58 50 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 860 Index Alloy Steel International, alternative procedures, 398, 404 Altman Z-score models, 634 American Institute of Certified Public Accountants (AICPA), 13, 158, 214, 276, 791 code of professional conduct, 134–139 framework on independence, 17–19 principles and standards of, 135, 158–159, 161 safeguards, 18–19 American Institute of Certified Public Accountant’s (AICPA), 686 amortization expense, 562 amortization schedules, 596–597 analytical procedures, 224 acquisition and payment cycle, 513–515 with debt obligations/ stockholders’ equity transactions, 602, 603–604 marketable securities, 467 performing substantive, 228–233 preliminary, 384–385 process for performing, 230 risks at Koss Corporation using, 636–637 risks for, 576 Andersen, Arthur, 43 annual reports, 123 application controls, 84–87 applications development, 87 appropriate descriptions of agreed-upon procedures, 811 Arthur Andersen, 11, 121 assembling, 812 assertions, 18 audit procedure and, 167 cash, 442 cash-related, 563 in debt obligations/stockholders’ equity transactions, 596–598 existence/occurrence, 167 financial statement, 465–466 of financial statement, 164–165 management, 167, 224–225, 390 relevant, 93, 368 substantive audit procedures about, 573 valuation, 164 asset, valuing, 740–741 asset account, 562 asset acquisition, long-lived, 562–563 asset impairment, 167, 563, 577–578 PCAOB audit deficiencies related to, 578 substantive procedures related to, 577–578 asset liquidity, 284 asset misappropriation, 34 misstatements arising from, 34 assets See also long-lived assets fixed, 225, 236 inspection of, 222 overstatement of, 216 assurance need for, 6–7 sustainability reporting and, 819–828 assurance engagement defined, 791 on interim financial information, 800–801 assurance engagement risk, 793 assurance services providers of, 9–10 attestation engagement on agreed-upon procedures engagement, 809–812 components of, 792 defined, 791 levels of assurance in an, 792–793 parties involved in, 792, 793 professional standards for, 793–794, 795 on pro forma financial information, 816–817 standards, 793–794, 795 subject matter of, 791–792 attribute, 324, 351 attribute sampling, 323–335, 351 defined, 324 steps in, 324–335 audit adjustment, 241 audit/auditing See also integrated audit; internal audit audit opinion formulation process, communication of, 16 computer skills, 10 effectiveness of process, 16 as insurance policy, 117 objective, 7, 335–336 peer review of, 19 planning, 240 procedures, 167, 221–233 program, 166 public expectations, 4–6 quality, 14–15 risk approach to, 167 as special function, 4–6 standard setting, 158–161 types of recalculations by, 223 audit committee, 49 communicating with, 645–648 control environment and, 78–81 responsibilities of, 53 audit documentation, 167–168, 239–243 audit engagement letter, 168–169 audit evidence, 165–166, 214–243 accounting records as, 222 appropriateness, 215–221 assertion testing and, 215 assessing the consistency of, 225–226 for auditing management estimates, 236–237 basic questions, 214 corroborating information as, 222 cost and persuasiveness of, 226–227 documenting, 239–243 failure to collect sufficient, 234 framework for, 214–243 gathering, 8, 215–221, 319 obtaining, 175–182 for related-party transactions, 238–239 relevance, 215–218 reliability of, 218–221 sampling, 235 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Index 861 sources of, 223 specialist/expert to assist, 237–238 sufficiency of, 214–215 tools for gathering, 318–351 used in auditing management’s estimates, 236–237 audit evidence of contingencies, 626–627 audit false confirmation process, 652–653 audit findings, 241 audit firm portfolio management issues, 649–656 client acceptance/continuance decision, risks at, 650–653 client acceptance decision, 649–650 client continuance decision, 649–650 partner rotation and audit firm rotation, 653–655 refusing services to client, 652–653 audit firm rotation, 653–655, 656 audit firms, 791–828 attestation services by, 791–794 culture, 15 limitations, 21 nonaudit services by, 791 auditing for fair value estimates, 747–750 financial instruments, 751–756 for financial instruments, 754 for goodwill impairment, 750–751 internal, 759–766 of long-lived assets, 564 management’s fair value estimates, 743–751 merger and acquisition activities, 740–743 multiple locations, 734 for pension obligations and postemployment benefits, 740 for restructuring charges, 743 special-purpose financial statements, 803–809 using ACL software, 845–855 for valuing identifiable assets and liabilities, 741–742 auditing judgments See complex judgments auditing standards, 691 temporary impairment in security’s value and, 749 Auditing Standards Board (ASB), 158 audit management on fair value estimates, 743–751 audit opinion formulation process, 8, 161–186 concepts affecting, 163–168 overview of, 162–163 phase I, 163, 168–169 phase II, 163, 169–175 phase III, 163, 175–182 phase IV, 163, 182–185 phase V, 163, 185 auditor vs client, 735–736 communication to audit committee by, 645–647 fraud-related responsibility of, 44 independence, 6–7, 17–19, 130, 137–138, 702 judgments by, 727–728 references, 705 restrictions on scope of engagement, 705 role of, auditor, statutory liability to, 122–125 auditor-generated memos, 242 auditor independence PCAOB and, 655 auditor’s assessment of materiality, 733 auditors’ responsibilities, 630–632 audit procedures, 165–166 cost–benefit considerations, 226–227 nature of misstatements on, 184–185 purpose of, 216 timing of, 227–228 types of, 166, 217–218, 221–227 audit process, effectiveness of, 16 audit program, 166, 243 example of, 244 audit program for warranty reserves, 738–739 audit quality, 14–15 achieving minimizing lawsuits and, 16–17 factors affecting, 16 audit reports, 16, 684–707 adverse, 700–703 with disclaimer of opinion, 684–707 on going concern issues, 692–693, 694 IFCR and, 705 modifications, 704 modifications for companies, 704 for non-U.S companies, 691 principles underlying, 686 qualified, 697–700 standards on, 685 standard unqualified, 686–687 timeliness of, 687 unqualified, with explanatory language, 691–697 for U.S nonpublic companies, 690 for U.S public companies, 686–690 audit risk, 272 determining, 286 quantitative example of, 288 audit risk model, 288, 292 internal control and, 86 Audit sampling, 317, 351 audit standards comparison of, 159 principles of, 159–161 audit testing, 336–337 See also testing audit work planning audit procedures, 289–291 risk and effect on, 287 authorization procedures, 77 automated controls, 442 automated integrated receiving system, 512 automated purchasing system, 503, 536 automated vs manual transaction controls, 85 B back orders, 370 balance sheet accounts, 729, 730 bank accounts, 440 bank confirmation, 459, 471 bank reconciliations, 445 independent, 458 bank transfer schedule, 463, 471 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 862 Index basic precision, 344, 352 benchmarks materiality judgments and, 730–731 Benford’s law, 350 Berg, Frederick, 120 bias, management, 625 bill of lading, 371, 404 Birkert, Susan, 6, 130 block sampling, 330, 352 board of directors, 49 control environment and, 78–79, 80–81 ineffective, 79 bond covenants, 605–606 bond indenture, 596–597 bond issuance, 596–597 bookkeeping services, 798 brainstorming, 44, 285, 292, 443 brainstorming activities, 375–376 brainstorming techniques, 285–286 breach of contract, 118, 119–120 Bristol-Myers, 375 British petroleum contingent liabilities at, 626 Burger, Warren, business processes, 84 business risks, 273–276, 292 sources of information for assessing, 274–276 business transactions, complexity of, C capitalization of operating expenses, improper, 574 capital turnover ratio, 284 cash accounts, risk assessment procedures, 442–444 accounts overview, 440–441 assessing control risk for, 448–452 authorization with, 445–446 control over, 444–448 documentation with, 446 electronic funds transfer for, 441 financial statement assertions relevant to, 442, 563 fraud schemes, 444 fraud with, 443 identifying inherent risks, 442 internal audit, 446 lockboxes for, 441, 448 reconciliations of, 445 segregation of duties and, 444–445 short-term management of, 440 cash accounts fraud-related substantive procedures for, 464 substantive analytics, 458 substantive tests of details for, 458 cash basis financial statements, 803 cash disbursements, 513 cash flow misstatement in, 737 cash management accounts, 440 cash management techniques, 441, 448 Center for Audit Quality (CAQ), 13, 41, 44 Certified Public Accountants (CPA), 12, 13, 138, 139 channel stuffing, 374 Charter Communications, 33, 375 check endorsements, 445 checking accounts, 440 Citizens State Bank v Timm, Schmidt & Co., 122 Clarity Project, 158 class action suits, 117 classical variables sampling, 337 clearly trivial, 269, 292 client acceptance decision, 649–650 client continuance decision, 649–650 client entity characteristics., 650 client personnel, inquiry of, 221 clients common-law liability to, 119–120 screening, 20–21 client selection, 168 closing entries, 84–85 Coca-Cola, 375 codes of ethics, 134–134 AICPA, 134–139 IESBA, 134 collateral, 459, 471–472 commercial paper, 465, 472 Committee of Sponsoring Organizations (COSO), 13 control environment principles of, 78–81 framework for internal control, 75–96 fraud studies by, 13, 41–42 internal control framework of, 13, 75–96 common law, 117, 119–122, 125 communication between auditor and audit committee, 645–647 with management and auditing committee, 645–648 through management letter, 647–648 compensating balances, 441 compensation committee, 80 compilation engagement, 798–800 compilation report not required, 800 omission of disclosures from, 800 practitioner lacks independence, 800 procedures, 798–799 standard compilation report, 799–800 completeness, 164, 217, 225, 325, 380, 392 weak controls, 447–448 complexity, of business transactions, complex judgments in financial statements, 728–729 component auditor, 696 comprehensive bases of accounting, other, 803 computer controls, 445 computer programs, 91, 95 concurring partner review, 19, 644 confidential information, 132, 138 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Index 863 confidentiality, 134 confirmations, 222–223 comparing positive and negative, 397 follow-up for negative, 400 follow-up on nonresponses for positive, 398–399 follow-up procedures for exceptions on positive, 399–400 negative, 396–397, 400, 404 positive, 394–396, 398–400, 404 process, 397–400 types of, 394–397 undeliverable, 397–398 Congress, U.S., 11 consequences, in financial statement, Consolidata Services v Alexander Grant, 133–134 consulting services, 49 contingencies, 225 loss, 625–626 responsibilities related to, 626 sources of evidence concerning, 626 contingent fees, 117 continuing education, 13 contract law, 117, 119 contractual agreement for ING Partners, Inc., 810 contractual basis financial statements, 803 control activities, 76, 83–87 See also internal control(s) authorization procedures, 77 documentation, 77, 91 physical controls, 77, 86 preventive and detective, 86 reconciliations, 77, 84 segregation of duties, 77 transaction controls, 84 control deficiencies, 90, 93, 95 aggregating, 759 factors affecting, 758 control deficiencies and poor decisions, Reliable Insurcance Co., 74 control environment, 76, 78–83 board of directors and, 78–79, 80–81 elements of, 75–77 integrity and ethical values in, 78, 79–80 management and, 76, 78–81 principles of, 79–81 control failures, 327, 331, 333 controlling totals, 349–350 control processes See internal control(s) control risks, 170, 272, 292, 379–383, 444 acquisition and payment cycle, 506 assessing factors affecting, 279–281 assessment questionnaire, 382–383 completeness, 380 debt obligations, 601 documentation, 382–383, 567 existence/occurrence, 379–380 intangible assets, 567 marketable securities, 466 over natural resources, 567 sales returns, 381 sampling risk and, 320–321 stockholders’ equity, 601–602 tangible assets, 566–567 valuation, 380–382 controls examples and test, 388 results of test of, 389 test of, 386–389 controls reliance audit, 173 cooling off period, 655 cornerstone, corporate governance best practices, 50–52 defined, 49 guidelines, 52 overview of, 49–50 performance and, 50 responsibilities, 51 correcting misstatements, 736–737 corroborating information, 222 corroboration, 233 COSO See Committee of Sponsoring Organizations COSO component control activities, 83–87 control environment, 78–81 information and communication, 87–88 monitoring, 88–90 risk assessment, 81–83 COSO’s updated internal control–integrated framework, 75 components of, 76–77, 78–90 Countrywide, 115 court system, 14 covered members, 137 Credit Alliance Corp v Arthur Andersen & Co., 121 credit approval, 370–371 Cressey, Don, 35 criminal liability, 124 cross-footing, 223 current debt-to-assets ratio, 284 current ratio, 284 cutoff bank statement, 463, 472 cutoff issues, 392 cutoff period, 228 cutoff tests, 228 cycle counts, 507, 536 D data access, 86–87 days’ sales in inventory, 284 recomputation or recalculation of, 221, 223–224 debt covenants, 37, 442, 597 debt obligations, 594–609 activities related to, 596–597 deficiencies in auditing, 595–596 internal control operation for, 603 management assertions for, 605 risk assessment for, 598–603 significant accounts, disclosures, and relevant assertions in, 596–598 substantive evidence in auditing, 603–609 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 864 Index debt-to-equity ratio, 284 decision-making ethical, 130–134 framework for professional, 134–139 decision rules, 127 deep-pocket theory, 116 delivery, 372 Dell, Inc., 33 Deloitte, 234, 642 depletion expense, 562 depreciation, 562–563 accumulated, 574–576 expense, 574–576 depreciation methods, changes in substantive test and, 576 derivative securities risk associated with, 754 detection risk, 272, 288, 292 determining, 286 detective controls, 86 Diebold, Inc., 375 direct evidence, 218 direct financial interest, 137 directional testing, 216–217 disaggregation, 231 disclaimer of opinion auditor lacking independence, 702 ICFR and, 706–707 scope limitation, 701–702 substantial doubt about a client, 702, 703 disclosure, 164 IFRS checklist of, 630 SEC debt presentation and, 606 disclosure, inadequate, 699 disclosure checklists, 629 disclosure of restrictions to dividend payments, 608 disclosure of stockholders’ equity, 597–598, 599 disclosures reviewing adequacy of, 629–630 sustainability reporting, 822–824 disreputable clients, 21 dividend payments, disclosure of restrictions to, 608 dividends, 607 documentation, 91 audit, 21, 239–243 auditor-generated memos, 242 of audit program, 243 audit programs, 243 audit work, 240–241 characteristics of good, 242–243 of controls, 382–383 copies of, 241–242 of engagement quality review, 645 examination of, 216 external, 219–220 inspection of, 222 internal, 219 packing, 371 planning and risk assessment procedures, 240 prenumbered, 446 revisions and retention of, 243 sampling, 334 shipping, 371 significant issues, 241 substantive procedures, 464, 471 turnaround, 446 documentation of controls, 91 documenting controls acquisition and payment cycle, 513 for debt obligations, 602 for long-lived assets, 567 for stockholders’ equity transactions, 602 documenting substantive procedures, 579 for debt obligations, 609 for stockholders’ equity transactions, 609 Dodd-Frank Act, 125 dominant fraud scheme, 34 dual approach, 737 dual dating, 643 dual-purpose test, 185 due care, 118, 134 due professional care, 3, 160 E earnings, retained, 607–608 edit tests, 85 8-K reports, 123 electronic funds transfers (EFT), 441, 448 electronic transaction trail, 92 embezzlement, 34 emphasis of a matter for U S nonpublic companies, 693, 695 engagement letter, 20 engagement quality review, 19–20, 644–645 documentation of, 645 engagement team, 20 skills and qualities of, 15 Enron, 39, 42–43 entity organizational/governance risks, 651 entity-wide controls, 77 Ernst & Ernst v Hochfelder, 124 ethical decision-making framework, 130–134 ethical dilemma, 131 resolving, 130–131 ethical theories, 131 ethical values, 78, 79–80 ethics codes of, 134–139 evidence, 214–221 See also audit evidence evidence example, 167 exceptions, 399, 404 existence, 225, 379–380 existence assertion, 164 existence/occurrence weak controls, 446–447 expectations gap, 117 expected failure rate, 325, 352 expected misstatement, 336, 352 expected population deviation rate, 325, 352 expert, 237 explanatory language emphasis of a matter, 693–695 inconsistent application of GAAP, 691–692 justified departure from GAAP, 691 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Index 865 reference to other auditors, 695–697 substantial doubt about the client’s ability, 692–693 extent of risk response, 291, 292 external audit internal control to, 74–75 external auditing profession auditing services, providers of, 9–10 introduction to, 3–4 organizations affecting, 11–14 skills and knowledge in, 10 special function, 4–6 external communication, 88 external confirmation, 222–223 external documentation, 119–220 external peer review, 19 external risks, 82 F factual misstatement, 344 factual misstatements, 336, 352, 622 fair market value, 727–728 fair value estimates accounting model, 743–747 family relationships, 137 FASB See Financial Accounting Standards Board Fazio, James L., 234 fieldwork standards, 160 file statistics in ACL software, 843 file validity, 349 filters in ACL software, 843 Financial Accounting Standards Board (FASB), 12, 13, 625 for fair value estimate, 743–751 goodwill impairment and, 743–747 financial analysis preliminary, 282 trend analysis in, 282–283, 293 types of procedures, 282–285 financial forecast, 812–815 defined, 812 illustrative report of compilation of, 813 illustrative report on examination of, 814 financial hedges auditing for, 754, 755 financial institutions, cash management, 441, 448 financial instruments auditing for, 751–756 overview, 751–753 risks with, 755 types of, 752–753 financial interests, 131 financial leverage ratios, 284 financial projection, 812–815 defined, 812 illustrative report of compilation of, 814 financial reporting authority and responsibility for, 81 commitment to competence in, 81 evaluation of internal controls over, 92–96 fraud, 34, 36, 37, 41–42, 44 internal control over, 5, 11, 13, 72–96, 704–707 management reports on internal control over, 90–96 quarterly, 123 unbiased, 6–7 Financial Reporting Council (FRC), 14 financial reporting risks, 276–278, 651 financial scandals, 45 financial statement assertions, 465–466, 563 financial statements, 328–329, 686–697, assertion model for audit of analytical review of, 635–637 assertion, inventory, 503–504 assertions, 93 auditing, 3–4 audit reports on, 686–691 cash basis, 803 complex judgments in, 728–729 contractual basis, 803 engagement of audit of special purpose, 803–809 importance of internal control to audit of, 74–75 misleading, 118, 120 parties involved in preparation of, pro forma, 816–817 prospective, 812–815 qualified Reports, adverse reports, and disclaimers on, 697–707 regulatory basis, 803 report on specific elements of, 808 tax basis, 803 for U.S nonpublic companies, 690 for U.S public companies, 686–691 users of, fixed assets, 225, 561 fixed interval sample selection, 343 footing, 223 Ford Motor Company, 5, 729, 827 management report on internal control, 93 Foreign Corrupt Practices Act of 1977 (FCPA), 631 forensic accounting, 818–819 vs accounting, 818 foreseeability, 121 foreseeable users, 119, 122 foreseen users, 119, 121 fraud, 34–49, 75, 79, 118, 223, 233 acquisition and payment cycle, 505–506 asset misappropriation as, 34 auditing standards and, 44 auditor responsibility and, 44 with cash, 443 conduct of audit, 40 defined, 34 Dell, 39 Enron, 39, 42–43 examples of fraud in organizations, 33–34 financial reporting, 34, 36, 37, 41–42, 44 fraud triangle, 35–37 HealthSouth, 39 incentives of pressures to commit, 37 inventory and cost of goods sold, 529 opportunities to commit, 37–38 Parmalat, 223, 460 personal factors leading to, 37 at Phar-Mor, 506 prevalence of, 44 rationalization of, 38 red flags for, 36 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 866 Index fraud (continued) related procedures, 402–403 related substantive procedures for cash accounts, 464 risk factors, 36, 375–378 risks, in marketable securities, 466 schemes, 375–377 skepticism regarding, 40, 41, 44 skimming as, 453 small business, 34 WorldCom, 39 at WorldCom, 506 fraud considerations, 174–175 fraud-related substantive procedures, 579 for debt obligations, 608 for stockholders’ equity transactions, 608–609 fraud risk factors, 375–378, 565 debt obligations, 599 identifying, 377–378 stockholders’ equity transactions, 600–601 fraud risks, 83 fraud schemes, 375–377 fraud triangle, 35–37 fraudulent financial reporting misstatements arising from, 34–35 recent history of, 38–43 fraud vs nonfraud companies, 41–42 G GAAP See generally accepted accounting principles GAAS See generally accepted auditing standards GAO See Government Accountability Office GAS See generalized audit software Gateway, 375 general checking accounts, 440 general computer controls, 86 General Electric (GE), 375, 654–655 generalized audit software (GAS), 318, 347–351, 352 benefits of, 350–351 tasks performed by, 348–350 generally accepted accounting principles (GAAP), 5, 13, 75, 622 explanatory language and, 691–696 goodwill impairment in accordance with, 744 generally accepted auditing standards (GAAS), 14, 159–160 general standards, 160 going-concern assumption, 632–635 mitigating factors, 634–635 potential indicators of, 633–635 process of, 633 going concern issue, 692–693, 694, 702 goods and services accounting for, 510–511 purchase of, 509–510 receipt of, 510–511 requisition for, 507–509 goodwill, valuing, 741 goodwill impairment accounting to, 744–747 factors affecting, 750 FASB guidelines for, 745, 747 at Maxim Pharmaceuticals, 746 testing, 746–747, 751 Government Accountability Office (GAO), 14 Grant, Thornton (Alexander Grant), 133–134 Great Salad Oil Swindle, 34 greed, 37 gross benefit payments, future, 739 gross margin, 274, 283 gross negligence, 118, 120, 124 group, defined, 696 group audit, 696 group audit opinion, 696 group engagement partner, 696 group financial statements, 696 H haphazard sampling, 330, 352 HealthSouth, 39, 79, 375 Herzfeld v Lauenthol, Krekstein, Horwath & Horwath, 124 Hewlett, Flora, 89 Hewlett, William, 89 Hitachi America, Inc., 33 Honda Motor Co., Ltd., 699 Husky Corporation ACL audit software for, 845–855 I IAASB See International Auditing and Assurance Standards Board IASB See International Accounting Standards Board identified user, 119, 121 IFRS See International Financial Reporting Standards illustrative report on agreed-upon procedures, 812, 815 of compilation of forecast, 813 of compilation of projection, 814 on examination of, 814 on pro forma financial information, 817 impairment, 744 impairment judgments audit considerations and, 743–751 imprest bank account, 440, 472 imprest payroll accounts, 440 inappropriate descriptions of agreed-upon procedures, 811 income-tax effects, misstatement and, 624 incremental allowance for sampling risk, 344–346, 352 independence, 50, 137–138 auditor, 6–7, 17–19, 130, 137–138 rules of SEC and PCAOB, 17, 122, 138 independence risk factors., 651 independent bank reconciliations, 458 indirect evidence, 218 indirect financial interest, 137 industry data, 285 information, potential bias in, information and communication, 87–88 information technology general controls, 86 ING Partners, Inc contractual agreement for, 810 inherent risks, 170, 272–278, 292, 442, 563–565 at account and assertion levels, 272–273 acquisition and payment cycle, 504–505 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Index 867 for debt obligations, 599 with intangible assets, 564–565 with natural resources, 564 for stockholders’ equity transactions, 599, 600 input controls, 85 input validation tests, 85 inquiries, 91, 93, 224 inquiry, 387 inspection, 387 Institute of Internal Auditors (IIA), 13 intangible assets, 562 control risk for, 567 examples of controls over, 568 inherent risk associated with, 564–565 potential impairment of, 577 substantive tests of details for, 577 integrated audit, 3, 75, 161 benefits of, 162 example, 187–189 implementing within audit opinion formulation process, 172–173, 174, 180 misstatement and, 624–625 integrated audit report, integrity, 78, 79–80, 134, 135, 138 intentional misstatements, 736 interim date, 227 interim financial information reporting on, 801 reviews of, 800–801 internal, 759–766 internal audit, 446 internal audit charter, 760 internal audit function, client’s, 728, 759–766 assurance activity, 760 consulting activities, 761 effect of, over external audit, 764–766 vs external auditing, 762–763 independence and objectivity, 760 quality of, 763–764 risk management, control, and corporate governance, 761 serving management and the audit committee, 761–762 staffing, 762 standards for, 762 systematic and disciplined approach, 761 internal auditing overview, 759–761 internal audits’ work vs external audit, 764–766 internal communication, 88 internal control on audit report, 701–707 deficiencies, over financial reporting, 728, 756–759 management’s annual report on, 705 over financial reporting, 647, 704–707 Internal Control Integrated Framework, internal control operation for debt obligations, 603 for long-lived asset accounts, 571–572 for stockholders’ equity, 603 internal control over financial reporting, 704–707 audit report on, 705 disclaimer of opinion on, 706–707 elements of management’s annual report on, 705 restrictions on the scope of the engagement, 705 internal control over financial reporting (ICFR) deficiencies in, 756–759 internal control(s) See also control environment adverse opinion on, 186 assessing internal effectiveness and implementation, 171–172 auditor evaluation of, 188–189 automated, 442 for cash, 444–448 for cash management techniques, 448 components of, 77–90 computer, 445 control activities for, 83–87 COSO framework for, 13, 75–96 deficiencies in, 93, 96 defined, 75 documenting auditor’s understanding of, 171 expertise with, 10 impact of Sarbanes-Oxley on, 90 importance of, to financial statement audits, 74–75 information and communication for, 87–88 management evaluation of, 92–96, 187–188 material weaknesses, NutraCea, 80 material weaknesses in, 94 monitoring, 76, 78, 88–90 operating effectiveness of, 453–457 over financial reporting, 5, 72–96 for petty cash, 448 preventive and detective, 86 principles of, 77–90 reporting on, 11 risk assessment and, 208 for safeguarding assets, 73 significant deficiency in, 96 technology controls and, 86–87 internal documentation, 219 internal risks, 82 internal vs external auditing, 762–763 International Accounting Standards Board (IASB), 13 International Auditing and Assurance Standards Board (IAASB), 13, 158, 214, 276, 685, 791 standards of, 159 International Audit Standards Board (IASB), 13 International Financial Reporting Standards (IFRS), 13, 630 International guidance on mandatory partner/audit firm rotation, 656 International Standard on Quality Control (ISQC), 159 International Standards on Auditing (ISA), 13, 158, 691 interoffice review, 20 inventory cost of goods sold, 518–529 defined, 502, 536 financial statement assertions relevant to, 503–504 obsolete, 525–526 physical, 521–524 testing of, 242–243 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 868 Index inventory and cost of goods sold completeness assertion, 524 existence or occurrence assertion, 520–524 fraud related to, 529 presentation and disclosure assertion, 527–529 rights and obligations assertion, 524–525 substantive analytical procedures, 520 valuation or allocation assertion, 525–527 inventory ratios, 284 inventory shrinkage, 505, 536 inventory turnover, 284 invoices, 167, 371 iron curtain method, 737 J Janus Capital Group, Inc v First Derivative Traders, 124 joint and several liability, 116 judgmental estimates, 627 judgmental misstatements, 622 K KBA Group, 232 Kiewet Royalty Trust cash basis financial statements for, 806 kiting, 463, 472 Kmart, 375 known misstatements, 336, 352, 622 Koss Corporation, 33, 40 KPMG, 115, 130 L language, audit report, 701 lapping, 377, 404, 444, 472 large vs small audit firms, 10 leases, substantive procedures related to, 578–579 legal action, causes of, 117–118 legal environment/concepts, 116–117 See also Sarbanes-Oxley Act breach of contract in, 118, 119–120 causes of legal action in, 118 class action suits in, 117 common law in, 117, 119–122, 125 contingent-fee cases in, 117 contract law in, 117, 119 and effects of lawsuits on audit firms, 116–125 foreseeability in, 119, 121 foreseeable users in, 119, 122 foreseen users in, 119, 121 fraud in, 118 gross negligence in, 118, 120, 124 identified user in, 119, 121 liability doctrines, 116–117 negligence in, 118, 121, 124, 125 parties bringing suit in, 118 precedence in, 125 Securities Act of 1933, 123 Securities Exchange Act of 1934, 123–125 statutory law in, 117, 122–125 third-party liability in, 120–122 tort in, 118 Lehman Brothers, 79 letter of audit inquiry, 626–627 liabilities contingent, 626 understatement of, 216 valuing, 740–741 liability doctrines, 116–117 liability to assets ratio, 284 likelihood of misstatements, 757–758 likely misstatements, 336, 352 limited assurance engagements, 793 liquidity, 442 litigation, pending, 224, 242 loans, 137 lockboxes, 441, 448, 472 logical unit, 342, 352 long-lived assets, 561–579 account interrelationships, 562 activities in, 562–563 auditing risks of material misstatement in, 569–570 identifying control risk of material misstatements in, 565–567 internal control operating effectiveness for, 571–572 performing preliminary analytical procedures with, 567–569 risk assessment procedures for, 563–567 significant accounts, disclosures, and relevant assertions, 561–563 substantive procedures for, 571–572, 573 long-term liabilities subjective judgment and, 737–740 Longtop Financial Technologies, 40 loss contingencies, 625–626 lower stratum, 337, 344–346, 352 Lucent Technologies, 12, 375 M Madoff, Bernie, 34, 35 magnitude of potential misstatements, 757–758 Majestic Capital, Ltd., 703 management annual report on internal control, 705 application of audit procedures to, 224–225 assertions, 167, 224–225, 390, 573 certifications of financial statements by, 638 communicating with, 645–648 control environment, 76, 78–81 for debt obligations, 605 representation letter, 639–640 representations, evaluating, 637–640 responsibilities of, 49 management bias, 625 management estimates, of account balances, 224–225 management integrity sources of information regarding, 277–278 management letter, 647–648 management representation letter, 639–640 communication through, 647–648 examples of, 639–640 management representations in certification under SOX, 637 management’s annual report on ICFR, 705 management’s incentives, misstatement and, 624 management’s report, 92 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Index 869 management’s specialist, 220 management testing, 94 marketable securities analytical procedures, 467 auditing, 465–471 control risks, 466 financial statement assertions, 465–466 inherent and fraud risks, 466 substantive tests of details, 468–471 tests of controls, 468 marketable security, 440, 472 materiality, 169 assessing, 268–271 by auditors, 727 audit risk and, 268–271 benchmarks and thresholds, 730–731 defined, 268, 292 difficulties in making, 733–734 auditing multiple locations, 734 considering qualitative factors, 733–734 guidance, 269–270 judgments concerning, 270–271, 729–734 making, 729–734 performance, 269, 293 posting, 270, 293 regulatory guidance for, 737 SEC views on, 270 setting levels of, 731–732 material misstatement, 288 acquisition and payment cycle, 515–516 assessing risks of, 169–171 identified risks of, 386 responding to identified risks of, 173–174, 452–453 respond to assessed risks of, 289–291 material weaknesses indicators of, 759 material weakness in internal control, 95 material weakness vs significant deficiency, 96 Matmown, Inc., 799 Maxim Pharmaceuticals goodwill impairment at, 746 McDonald’s, 90 mergers and acquisitions, 740–743 asset and liabilities valuation with, 740–741 measuring restructuring charges, 742–743 valuation of goodwill with, 741 Meridian Mortgage, 120 misstatements, 352 aggregating and netting, 736 assessing materiality of, by auditors, 727 in cash-flow classification, 737 correction of, 736–737 debt obligations and, 602–603 defined, 268, 293, 335, 352 evaluating, 734–737 examples of asset, 566 expected, 336 factual, 336, 344 identifying and assessing risks of material, 271–286 intentional, 736 known, 336, 622 likelihood of, 757–758 likely, 336 in long-lived assets, 565–567 magnitude of potential, 757–758 management bias and, 625 materiality judgments in, 737 most likely, 344 projected, 336, 344 responding to identified risks of material, 386, 569–570 reviewing, summarizing and resolving detected, 622–625 sampling to test for, 335–347 tolerable, 269, 293, 336 total estimated, 345 mitigating factors, 634–635 modified opinion, 697 monetary unit sampling (MUS), 337, 340–347, 352 designing and selecting a, 340–343 evaluating, 343–344 illustration, 345–347 no misstatements in, 345 strengths and weaknesses, 340 zero and negative balances in, 343 monitoring, 76, 78, 88–90 monitoring controls in fast-food franchises, 90 monthly statements, 371 Moore Stephens, Moss Adams, 120 most likely misstatement, 344, 352 multiple attributes, 328–329 N natural resources control risk over, 567 inherent risk associated with, 564 substantive test of details for, 576–577 nature of risk response, 290, 293 negative balances, 343 negative confirmations, 396–397, 400, 404 negligence, 118, 121, 124, 125 net profit margin, 284 net realizable value tests, 525–526 netting misstatements, 736 net worth to sales ratio, 284 New Century Financial Corporation, 115 New York Stock Exchange (NYSE), 50 nonaudit services, 19, 137–138 noncompliance, clients’, 630–632 nonsampling risk, 320, 353 nonstatistical sampling, 322–323, 334–335, 339, 353 comparison of statistical and, 323 non-U.S companies disclaimer of opinion and, 702 financial statements for, 691 Nortel Networks, 375 numerical analyses, 350 NutraCea, 80 O objectivity, 50, 134, 135, 138 observation, 222, 387 obsolete inventory, 525–526 occurrence, 379–380 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 870 Index Olympus, 40 omitted procedure, 644 ongoing evaluations, 89 operating segment, 745 organizational change, 83 organizational structure, 81 output controls, 85 outside parties, confirmations from, 241–242 P packing documents, 371 paper and electronic documents, guidelines for, 91 Parmalat, 39, 223, 446 partner rotation, 19, 653–655, 656 passwords, 87 payment cycle, 562–563 payments, 371 PCAOB See Public Company Accounting Oversight Board peer reviews, 19–20 pending litigation, 224, 242 pension obligations, 739 PepsiCo, Inc review report on interim financial statements for, 802 performance materiality, 269, 293 periodic inventory system, 507, 536 perpetual inventory system, 507, 536 personal factors, 37 pervasive GAAP departures, 698 petty cash accounts, 440–441 Pfizer pharmaceuticals, 275 Phar-Mor, 506 physical controls over assets, 86 physical inventory, 521–524 planning audit, 169 Ponzi scheme, 35, 120 population, 319, 325, 336, 337, 353 positive assurance, 684 positive confirmations, 394–396, 398–400, 404 postemployment benefits, 737, 739–740 audit considerations for, 740 posting materiality, 270, 293 potential impairment, 577 preliminary analytical procedures, 384–385, 452, 602 trend analysis, 384–385 prenumbered documents, 446 prenumbered paper/computer-generated documents, 91 presentation, 164 presentation/disclosure, 225 preventive controls, 86 previous year data, 285 PricewaterhouseCoopers, 4, 186 pricing error, misstatement and, 622, 624 print confirmations, 349 Private Securities Litigation Reform Act (PSLRA), 116 privileged communication, 138 probability proportional to size (PPS) sampling, 337, 353 See also monetary unit sampling processing controls, 85 product costs, 525 professional behavior, 134 professional competence, 134 professional conduct codes of, 134 principles of, 135 rules of, 135–136 professional decision-making, framework for, 134–139 professional judgment, 127 professional judgments See complex judgments professional liability, 114–125 common-law, 119–122 continuing education requirement and, 13 criminal, 124 joint and several liability, 116 legal concepts with, 117–118 legal environment and, 116–117 liability doctrines, 116–117 minimizing exposure to, 16–17 peer reviews and, 19–20 proportionate liability, 116–117 quality-control programs and, 19–21 review programs and, 19–20 statutory, 122–125 professional skepticism, 3, 41, 128–130, 161, 173 professional standards for attestation engagement, 793–794, 795 pro forma financial information, 816–817 reporting on, 817 program access, 86–87 projected misstatements, 336, 353, 622 proportionate liability, 116 prospective financial statements, 812–815 agreed-upon procedures of, 815 defined, 812 reporting on, 813–815 prospectus, 123 proved reserves, 34 Public Company Accounting Oversight Board (PCAOB), 3, 11–12, 13, 17, 122, 128, 129, 157, 213, 215, 276, 685 accounting estimate issues and, 628 audit deficiencies related to asset impairment and, 578 deficiencies related to stockholders’ equity transactions, 607 on fraud, 35, 44 independence requirements of, 17 independence rules of, 138 inspections by, 19 management bias and, 625 principal auditor and, 697 standards of, 159–161 public trust, 130 purchase of goods and services, 509–510 purchase orders, 369 Q qualified audit report, 697–700 pervasive GAAP departures, 698 qualitative evaluation, 333 qualitative risk factors, 651 quality of internal audit function, 763–764 quantification, 233 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Index 871 quantitative evaluation, 330–331 quantitative risk factors, 651 quarterly financial reports, 123 quick ratio, 284 Qwest, 375 R ratio analysis, 283, 293, 385 ratio and trend analysis, 568–569 reasonable assurance engagements, 793 reasonableness test, 231 reasonable period of time, 632 reasonable possibility, 95 recalculations, 221, 223–224 receivable ratios, 284 reconciliations, 77, 84 red flags, 36 regression analysis, 232, 233 regulatory basis financial statements, 803 related-party transactions, 37, 238–239 relevant assertions, 93, 368, 502–504 reliability, of audit evidence, 218–221 reliable financial reporting, 82 Reliable Insurcance Co., 74 remoteness, 6–7 reperformance, 224, 387 reporting on interim financial information, 801 special considerations for, 801–809 standards, 160–161 reporting unit, 745 report release date, 643 omitted procedures after, 644 subsequently discovered facts after, 643–644 reports See audit reports requisition defined, 503, 536 for goods and services, 507–509 residual risk, 182, 185 Restatement (Second) of Torts, 121 restrictive endorsements, 445 restructuring charges, measuring, 742–743 results of test of controls in long-lived assets, 571–572 retained earnings, 607–608 Return on equity, 284 returns, allowance for, 524 revenue accounts receivable, 392–394 completeness assertion, 392 cutoff issues, 392 existence and valuation assertions, 391–392 internal control, 386–389 ratio analysis with, 385 recognition, 372–374 relevant assertions with, 368 substantive analytical procedures, 390–391 substantive tests of details, 391 transactions, 368–371 trend analysis, 384–385 revenue cycle defined, 368, 405 identifying inherent risk, 372–374 internal control operating effectiveness in, 386–389 management assertions and substantive procedures, 390 revenue transactions, 368–371 risk assessment procedures in, 372–386 revenue recognition criteria for, 372–374 revenue transactions, 368–371 review engagement, 794–798 for interim financial information, 800–801 procedures, 795–797 standard review report, 797–798 reviewing accounting estimates, 627–628 activities, 622–625 adequacy of disclosures, 629–630 analytical review of financial statements, 635–637 contingencies, 625–627 management representations, 637–640 performing engagement quality, 644–645 quality, 621–622 significant estimates, 627–629 subsequent events, 640–643 subsequently discovered facts, 643–644 review programs, 19–20 rights/obligations, 164, 225 rights theory, 131 risk analysis, 82 risk assessment, 76, 78, 81–83 understanding management’s process for, 81 risk assessment, 76, 78, 81–83, 563–570 identifying control risks, 565–567 inherent risk, 563–565 preliminary analytical procedures, 567–569 understanding management, 280–281 risk assessment procedures, 165–166 for debt obligations, 598–603 for stockholders’ equity, 598–603 risk of assessing control risk too high See risk of incorrect rejection of internal control reliability risk of assessing control risk too low See risk of incorrect acceptance of internal control reliability risk of incorrect acceptance of book value, 321, 353 risk of incorrect acceptance of internal control reliability, 320, 353 risk of incorrect rejection of book value, 321, 353 risk of incorrect rejection of internal control reliability, 320, 353 Risk of material misstatement, 272, 282, 283, 286–288, 290–291, 293 risk of overreliance See risk of incorrect acceptance of internal control reliability risk of underreliance See risk of incorrect rejection of internal control reliability risk response extent of, 291 nature of, 290 timing of, 290, 293 risks, 267, 293 assessment procedures, 170, 175 audit, 272 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 872 Index risks (continued) business, 273–276, 292 at client continuance/acceptance decisions, 649–650 control, 170, 272, 292 with derivative securities, 754 detection, 272, 288, 292 with financial instruments, 755 inherent, 170, 272–278, 292 of material misstatement, 272 nonsampling, 320 residual, 182, 185 sampling, 320–322 significant, 272, 293 at substantive procedures/tests, 576 roll-forward period, 228, 400 roll-forward procedures, 400 rollover method, 737 Rosenblum, Inc v Adler, 122 Royal Ahold, 375 Rules of conduct, 134, 135–136 S Sabine Royalty Trust, financial statement for, 808 SABMiller Company, 826–827 Safety-Kleen Corporation (SK), 574 sales to assets ratio, 284 sales transactions complex, 373 sample evaluating, 349 method of selecting, 329–330 no misstatements in, 345 overstatements in, 345 selecting, 349 unacceptable results, 338 understatements in, 347 sample selection, 397 sample size, 325, 337–338 determination of, 326–327 working backwards from, 327–328 sample sizes, 235 sampling, 235 account balance misstatements tested with, 167, 335–347 attribute, 324 audit objectives with, 335–336 block, 330 choosing appropriate method, 337 control procedures and, 320–321 documentation, 333, 339 evaluation of results from, 331–333 expected failure rate with, 325 haphazard, 330 multiple attributes, 328–329 nonsampling risk and, 320 nonstatistical, 322–323, 334–335, 339, 353 objectives of, 319 overview of, 318–319 period covered by, 325 population for, 319, 337 qualitative evaluation in, 333 quantitative evaluation in, 330–331 risk, 325 risk and, 320–322 simple random, 329 statistical, 322–323 stratification with, 337 substantive testing with, 333–334, 334–335 systematic, 329–330 systematic random, 330 test of details of account balance, 321–322 tolerable failure rate with, 325, 354 unacceptable Sample Results, 338–339 unit, 325 working backwards from sample size, 327–328 sampling risk, 325 defined, 320, 353 incremental allowance for, 344 related to tests of control procedures, 320–321 test of details of account balance, 321–322 sampling units, 319, 325, 336–337, 354, 397 Sarbanes-Oxley Act (SOX), 11, 17, 122, 637 auditor independence provisions in, 17 impact of, in internal controls, 90 management’s annual certification pursuant to section 302, 705, 707 PCAOB in, 122 post Sarbanes-Oxley, 49–53 as a regulatory response to fraud, 44–49 sanctions provided in, 122 significant provisions of, 45–48 scanning, 224 scienter, 118 scope limitation disclaimer of opinion on ICFR due to, 706–707 qualified audit report and, 699–700 scope of engagement, restrictions on, 705 Scrushy, Richard, 79 Securities Act of 1933, 123 Securities and Exchange Commission (SEC), 3, 12, 34, 157, 270 debt presentation and disclosure, 606 guidelines for financial reporting of, 91 independence rules of, 122 reporting requirements for timeliness, 687 Securities Exchange Act of 1934, 123–125, 653 security management, 86–87 segregation of duties, 86, 444–445 self-checking digits, 85 separate evaluations, 89–90 Shell Oil Company, 34 shipment of goods, verifying, 371 shipping documents, 371 side letter, 396, 405 significant accounts, 93, 368, 502–504 significant deficiency, 96 in internal control, 96 significant estimates, reviewing, 627–629 accounting estimates, 627–628 judgmental estimates, 627 key factors and assumptions for, 628–629 significant issues, 241 significant risk, 272, 293 simple random sampling, 329, 354 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Index 873 skepticism, 41, 44, 128–130, 161, 173 skimming, 447, 472 small business fraud, 34 specialist, 237 Special Purpose Entities (SPE), 42 special-purpose financial statements AU-section 800, 803–805 AU-section 805, 805–807 AU-section 806, 807–809 defined, 803 overview of, 804 special purpose framework, 803 specified parties, 809 staffing internal audit function, 762 stakeholders, 49–50, 131 standards See also auditing standards auditing, 158–161 fieldwork, 160 general, 160 internal audit function, 762 reporting, 160–161 Starbucks Coffee Company, 826 state boards of accountancy, 14 statistical sampling, 235, 322–323, 354 comparison of nonstatistical and, 323 statutory law, 117, 122–125 stockholders’ equity, 594–609 activities related to, 597–598 balance sheet disclosure of, 598 deficiencies in auditing, 595–596, 607 internal control operation for, 603 presentation/disclosure of, 597–598 risk assessment for, 598–603 substantive evidence in auditing, 603–609 valuation of, 597 stock options, 37, 38 stock status, 369 stratification, 337, 354 subjective judgment long-term liabilities and, 737–740 subsequent events review, 640–643 audit procedures concerning to, 642–643 dual dating, 643 type I, 641 type II, 641–642 subsequently discovered facts, 643–644 substantive analytical procedure application of, 232–233 effectiveness of, 231–232 substantive analytical procedure, effectiveness of, 231–232 substantive audit, 173 substantive procedures, 166, 390 analytical, 572, 603–604 audit decisions prior to determining, 180–182 deficiencies in, from PCAOB, 607 documenting, 403–404, 579, 609 fraud-related, 579, 608–609 low audit quality and, 183 performing, 182–184 related to asset impairment, 577–578 related to depreciation for tangible assets, 574–576 related to leases, 578–579 for tangible assets, 574–576 substantive testing linking of sampling to, 333–334 substantive tests of details debt obligations and, 605–606 for intangible assets, 577 for natural resources, 576–577 for tangible assets testing current period additions, 572–574, 575 testing current period deletions, 574, 575 sufficiency, of audit evidence, 233–234 sufficient appropriate audit evidence, 166 summary of possible adjustments, 623 supply chain management, 503, 536 sustainability reporting activities and outcomes, 821–825 assurance and, 819–828 examples of, 822–824 providing assurance on, 825–828 standards for, 821 Symmetry Medical, Inc., 157 systematic random sampling, 330, 354 systematic sampling, 329–330, 354 T tainting percentage, 345, 354 tangible assets, 561–562 control risk for, 566–567 substantive procedures for, 574–575 substantive tests of details for, 572–574 tax basis financial statements, 803 technology acquisition, 87 technology controls, 86–87 technology development, 87 technology infrastructure, 86 technology maintenance, 87 temporary impairment in security’s value, 749 Tennessee Commerce Bancorp, Inc., 700 testing See also substantive testing assertions, 167 directional, 216–216 of extensions, 223 of inventory, 242–243 operating effectiveness, 179–180 period covered by, 325 substantive, 333–334 tests of controls, 166, 386–389 additional sample size considerations for, 235 concepts affecting, 177 considering the results of, 179–180 example of approaches to, 178 in long-lived assets, 571–572 marketable securities, 468 performing, 176, 454–455 results of, 389, 457 selecting controls for, 176 theft, 33, 34 Third COSO report, 41–42 third-party beneficiary, 121 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 874 Index third party/due diligence risk factors, 651 third-party liability, 120–122 third-party users, 924 Thornton Precision Components, Limited (TPC), 157–158 three-way match, 511, 537 thresholds materiality judgments and, 730–731 timely preparation, 91 time period, covered by sampling, 325 timing differences, 399, 405 timing of procedures, 227–228 timing of risk response, 290, 293 tolerable failure rate, 325, 354 tolerable misstatement, 269, 293, 336, 354 tolerable rate of deviation, 325, 354 top stratum, 337, 339, 354 tort, 118 Toyota Motor Corporation, 738 tracing, 217 traditional receiving system, 512 transaction controls, 77 transaction processing, 84 transactions See also sales transactions authorization of, 445–446 vouching of, 216, 217 transaction trail, 85, 91 transfer agent, 606 transparency corporate governance and, 50 Treadway Commission, 5, 13, 75, 93 trend analysis, 282–283, 293, 384–385, 452 Triton Energy, 631 turnaround documents, 446, 472 type II subsequent events, 641–642 type I subsequent events, 641 U Ultramares Corporation v Touche, 121, 122 unacceptable Sample Results, 338–339 unbiased reporting, 6–7 undeliverable confirmations, 397–398 understatements, 347 Uniform CPA Examination, 13, 14 United States v Arthur Young & Co et al, unmodified opinion See unqualified opinion unqualified audit report, examples of, 688–689 with explanatory language, 691–697 on financial statements, 686–697 with going concern issues, 692–693, 694 inadequate disclosure, 698–699, 701 modifications to, 704 scope limitation, 699–700 for U.S public companies, 686–690 unqualified opinion, 684 unusual entries, 84–85 U.S nonpublic companies unqualified audit report with emphasis of matter for, 693, 695 U.S public companies audit report modifications for, 704 financial statements for, 686–690 user expectations, 44 utilitarian theory, 131 V valuation, 380–382 stockholders’ equity, 597 valuation/allocation, 225 valuing assets and liabilities, 741 valuing goodwill, 741 valuing identifiable assets and liabilities, 741–742 vendor invoice, 220 volume of activity, 442 vouching, 216, 217 W walkthrough, 93 warranty reserves, 738 audit considerations for, 738–739 waste management, 566 well-trained employees, 446 Wendy’s, 90 whistleblower function, 88 William and Flora Hewlett Foundation, 89 working papers/workpapers, 167 WorldCom, 33, 39, 375, 506, 565 restructuring reserves and, 742 waste management and, 566 X Xerox, 375 Y year-end cutoff information, 461–463 Z zero balances, with MUS, 343 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it ... International Auditing and Assurance Standards Board The International Auditing and Assurance Standards Board (IAASB, www.ifac.org/iaasb) is a part of the International Federation of Accountants... A Risk- Based Approach to Conducting a Quality Audit represents the most up -to- date professional guidance available, and reflects the clarified auditing standards and the newest PCAOB standards... with Explanatory Language, 691 Explanatory Language: Justified Departure from GAAP, 691 Explanatory Language: Inconsistent Application of GAAP, 691 Explanatory Language: Substantial Doubt About